Corporate Law 2

Master in Business Laws Part I Corporate Law
Course No. : III Module Nos. : I - IX
CORPORATE LAW
Distance Education Department
National Law School of India University

(Sponsored by the Bar Council of India and Established by Karnataka Act 22 of 1986) Nagarbhavi, Bangalore - 560 072 Phone: 23211010 Fax: 23217858 E-mail: mbl@nls.ac.in 1
(Sys 4) - D:\shinu\lawschool\books\module\corporate law
CONTENTS
TOPICS 1. 2. 3. 4. 5. 6. 7. 8. Formation of a Company (Module No. I) .................................................................... Characteristics of Corporate Personality (Module No. II) ......................................... Corporate Management (Module Nos. III & VI) ........................................................ Company Law and Secretarial Functions (Module No. IV)....................................... Corporate Investment and Investors Protection (Module No. V) ............................ Monopolies and Restrictive Trade Practices (Module No. VII) ................................. Corporate Accounts and Audit (Module No. VIII) ..................................................... Winding up and Alternative Devices (Module No. IX) .............................................. 3 68 121 169 220 280 317 368
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Master in Business Laws Corporate Law

Course No: III Module No: I
FORMATION OF A COMPANY

Materials Prepared By :
1. Prof. M.P.P. Pillai 2. Prof. N.L.Mitra
Materials Checked By :
1. Ms. Archana Kaul 2. Ms. Sudha Peri
Materials Edited By :
1. Prof. T.Devidas 2. Dr.P.C.Bedwa
Published By : Distance Education Department National Law School Of India University Post Bag No: 7201 Nagarbhavi, Bangalore - 560 072 India Printed By : National Printing Press, Koramangala, Bangalore -95
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INSTRUCTIONS
Basic Readings The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics included in the course. Experts in the area have collected the basic information and thoroughly analysed the same in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative provisions are also included. Care has been taken to communicate basic information required for decision making in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading information provided are to be selected by making marginal notes using markers. The first reading, therefore, necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the implications of those informations. In the second reading the reader has to critically analyse the material supplied and jot down in a separate note book points stated in the material as well as the critical comments on the same. A third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at every stage.) Supplementary Reading Several supplementary readings are suggested in the materials. It is suggested that the reader should register with a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National Library, any University Library where externals are registered for the purpose of library reading, any commercial library or any other public library run by Government or any private institution. Readers in Metropolitan and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept in the course file. Supplementary readings are also required to be read more than once and marginal notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the payment. Case Law The course material includes some case materials generally based upon decided cases. These cases are to be studied several times for, (a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/ appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence. Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the experts comment to the students. Through these exercises one can build up an effective dialogue with the experts of the Distance Education Department (DED). Problems and Responses After reading the whole module which is divided into several topics and sub-topics the reader has to solve the problems specified at the end of the module. The module is designed in such a manner that a reader can take about a weeks time for completing one module in each of the four courses. It is expected that after finishing the module over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already prepared. After completing the exercise the student is directed to send the same to Course Coordinator for evaluation. Though there is no time stipulation for sending these responses a student is required to complete these exercises before he/she can be given the certificate of completion to appear for final examination. 5
FORMATION OF A COMPANY AND COMMENCEMENT OF BUSINESS
TOPICS 1. Features of a Company form of Business Organisation : An introductory note ............................................................ History of Company Law................................................................................................ Formation of a Company and its Constitutional documents ............................................................................................. Detail provisions of Constitutional documents : Memorandum ............................................................................................................... Detail provisions of Constitutional documents : Articles ........................................................................................................................... Commencement of business and outline for necessary legal steps ................................................................................... Case Law............................................................................................................................. Problems............................................................................................................................ Supplementary readings ................................................................................................
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25
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53 60 64 67
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1. FEATURES OF A COMPANY FORM OF BUSINESS ORGANISATION: AN INTRODUCTORY NOTE

SUB-TOPICS 1.1 Introduction 1.2 Various types of business organisations 1.3 Essential features of a Company 1.4 Different modes of incorporation 1.5 Various types of Companies 1.6 Why a Company? 1.7 Organs of a Company 1.8 Applicability of Companies Act, 1956 1.9 Applicability of English Law in India 1.10 Problem of 20th Century : A concluding remark 1.1 INTRODUCTION political frontiers as well. Our society is heavily dependant on modern corporations. Of the different types of Corporations operating in the business world the registered company is the most prominent one. More than 90% of business corporations belong to this category. The registered company had its origin in the English Law by the middle of the 19th century (i.e., by 1844). During the early days it had close affinity with the Partnership firm. In fact, the predecessor of the registered company was a large partnership firm popularly known as the deed of settlement company. But in the subsequent years which brouhgt out revolutionary changes in its character and functioning many new issues have sprung up recently which were not contemplated by the traditional law. A typical instance is the change brought out in the concept and use of property. In industrially advanced countries the bulk of productive property is in the form of investments in Corporate securities. The control and use of this property is not in the hands of the investors, but is vested with the Corporate Management. As pointed out by Bearle and Means in their classical work, The modern corporation and Private Property, the modern corporation effected a divorce between ownership of property and its control and management. 1.2 VARIOUS TYPES OF BUSINESS ORGANISATIONS The following Flow Chart shows various types of business organisation: Flow Chart 1 Business Organisation Individual Ownership or Proprietorship Collective Ownership
20th century has aptly been described as the age of corporations. Though our legal system facilitates the formation and operation of business organisations of different hues and colours, the corporation or the company as we call them, is found to be the most suitable vehicle to carry out industrial and commercial activities. It has virtual monopoly of the manufacturing, distribution and service activities of the modern world. It is the most important economic institution of the century having its tremendous impact felt in the social and
Joint Hindu Family business
Partnership
Companies
Cooperative Societies
Trust
Partnership at will
Joint Venture
Unlimited Company
Private Ltd Company
Public Ltd Company
Government Company
Corporations
Each of these business organisations are briefly described on the next page:
1. A Proprietorship form of business is one where an individual subscribes the capital, generates other necessary funds by way of securing loan and manages the business himself. Inspite of the importance of Companies as a form of business organisation in modern times proprietorship outnumbers all other forms of business organisations taken together. Of course, it basically dominates the wholesale and retail trade. 2. Joint Hindu Family business is a sui generis or a class by itself in India. Joint Hindu families in India have a long tradition of being engaged in business and trading activities. Even today this form of business organisations dominate in North, West and Central India. These are neither Partnership firms nor Companies. The joint Hindu family business occassionally termed as HUF in taxation laws cannot be said to be an association of persons because it doesnt arise out of agreement. It cannot also be called a plural proprietorship because excepting the Karta other members of the HUF cannot deal with any business without authorization of the Karta. The Karta is usually the senior-most male member of the family who himself runs the business either personally or through his authorised representatives. The Karta himself has unlimited liability for all transactions. Other members liability is restricted to their share of the HUF resources invested in the business. HUF business has some similar features with limited partnership in England. In such a partnership firm atleast one members liability is unlimited and other members liability is limited. Importance of HUF business organisation in India may be one of the reasons why limited partnership is not allowed in India, though this form of business organisation is very common in England specially in wholesale and retail trade. 3. Partnership at will is a form of business organisation where the partners enter into the business contract without either fixing the duration of, or determining their partnership. This partnership organisation can do any business for any period of time until the partners break their relations. [See Sec. 7 of the Partnership Act, 1932] 4. Loosely speaking, all forms of organisation owned by more than one person can be called as joint venture. But specifically speaking a partnership between two or more natural or legal persons to perform a specific adventure or undertaking is known as joint venture. Recently these types of joint ventures between foreign Companies and Indian Companies have gone up [See Sec. 8 of the Partnership Act, 1932]. Joint ventures are therefore, specific agreements relating to joint carrying on of a venture. 5. An Unlimited Company is one where the liability of its member or members is not limited. 6. A Private Limited Company is one which is registered as private Limited Company, restricting by its Articles the transferability of shares and limiting its number of members to fifty. It has also to prohibit invitation to the public for raising public subscription. [See Sec. 3(i)(iii) of the Companies Act, 1956]
7. A Public Limited Company is one which is not a private limited Company. It means that the shares of such companies are transferable, membership is unlimited and it can raise fund from the public. [See Sec. 3(1)(iv) of the Companies Act, 1956] 8. A Government Company means any company in which not less than fifty one percent of the paid up share capital is held by Central Govt or by the State Govts or by both the Govts or by one or more State Govts. [See Sec. 617 and 619(6) of the Companies Act, 1956]. 9. A Company specially floated by an Act of Parliament is known as a Corporation in strictu sensu. But Companies Act itself provides the status of Corporation aggregate by assigning the status of body corporate to all companies registered under the Companies Act. As such, all types of Companies are also generally formed as Corporations in the sense that they have a Corporation aggregate which is a distinct identity from the identity of its members. 10. In India Cooperative Societies registered under the Cooperative Societies Act is an incorporated body. It also is an important form of business organisation. Of course according to sec.2(7) of the Companies Act a Cooperative Society is not a body Corporate for the purpose of the Companies Act. 11. A Trust is a society registered under the Indian Trust Act. In some parts of India, Trust is a very popular institution amongst the business communities for undertaking business organisation for the benefit of the beneficiaries. This is popular primarily because of certain tax incentives and concessions given to trusts. Incorporated societies can also be created under Socieity Registration Act. Such societies cannot extend any benefit to either its members or to any stipulated group of people. [See Sec. 2 of the Indian Trust Act]. 1.3 ESSENTIAL FEATURES OF A COMPANY 1. Legal Nature The registered Company is an incorporated body and is one among the different species of Corporations. Jurisprudentially, Corporation has a legal existence which is distinct and separate from persons who constitute its corpus or body. The Corporation may be a Corporation sole or Corporation aggregate. At any given time a corporation sole will consist of only one person, whereas a corporation aggregate will consist of two or more persons. As stated by Salmond in his text book on Jurisprudence the former is a series of successive persons (eg : the Bishop of a Dioces) whereas the latter consists of a group of co-existing persons (eg : a registered company). The companies Act uses the expression body corporate to denote a Corporation aggregate. As a business organisation, we are concerned with the Corporation aggregate only which may also be called a body corporate. Another variety of body corporate engaged in business activities is the statutory corporation. Like the Life Insurance Corporation, Unit Trust of India, State Bank of India, Air India International etc.
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2. Perpetual Existence A Company is a legal person and therefore until it is legally extinguished it has a perpetual existence. As for example, suppose a Company with all its assets and its entire body of members were destroyed and killed as the case may be in Hiroshima,when the atom bomb was dropped on it during the second world war. The Company would still have existence and therefore it could sue or be sued on claims. Here,the mere fact that all the members were killed and the registered office was destroyed would not mean that the Company was dead until and unless the Company was wound-up the Company would continue. [See Sec. 34(2) of the Companies Act, 1956] 3. Common Seal Every registered Company shall have a Common seal [Refer to Sec. 34(2) of the Companies Act, 1956]. This Common seal is required to be affixed to all documents, deeds, contracts, communications, etc, in order to bind the Company. 4. Separate Personality A Company is a separate and legal person as mentioned earlier. On account of this separation between the Company and its members a shareholder can be the creditor or debtor to the Company. He cannot be held liable for the acts of the Company even though he holds virtually the entire capital. Similarly shareholders cannot bind the Company by their acts as they are not its agents. These points, were brought out by the House of Lords in the case of Salomon Vs Salomon Ltd [(1897) A.C 22]. In this case Salomon who carried on a prosperous leather business sold his concern for the sum of ,30,000 to a company which he formed consisting of himself, his wife, daughter and his four sons as its shareholders. His daughter, wife and four sons took 1 share each whereas Salomon took 20,000 1 shares and debentures worth 10,000. The debentures were secured by a floating charge on the Companys assets. The Company ran into difficulties and had to wound up. The total assets realised were 6,050. The unsecured creditors having a claim of 8,000 demanded the entire amount from the assets realised. The plea of them was that the Company and Salomon were one and the same person and that the Company was merely an alias or agent for Salomon. The House of Lords rejected the contention and held that as soon as the Company was incorporated it became a separate and distinct person from Salomon and was not his agent or trustee. Salomon was a secured creditor and therefore must be paid out of the assets in priority to the unsecured creditors. Lord Macnaghten observed : The Company is at law a different person altogether from the subscribers ..... and, though it may be after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands received the profits, the Company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers or members, liable in any shape or form, except to the extent and in the manner provided by the Act. A similar decision was given in Tunstann Vs Steigman [(1962) 2 All.E.R. 417] and in Dhulia Transport Co Vs Roy Chand [AIR 1962 Bom 337].
5. Limited Liability Legal personality of the Company and the limited liability of the members are two sides of the same coin having similar importance. Of course the Companys liability towards any claim against it is unlimited but the members liability is limited by the nominal amount of the shares held by the concerned member(s) or the guaranteed amount which he promised to pay in the event of winding up of the Company. In Bacha, F. Gazadar Vs. CIT, Bombay (AIR 1955 S.C 74), the Court held that the persons buying shares, become entitled to participate in the profits when the company decides to divide them, and is at liberty to dispose of them (i.e., the shares)whenever he likes, and if anything goes wrong with the Company, his liability is limited by the nominal amount of the shares held by him. 6. Nature of Corporate Personality and Immunity A Company is a legal person having a residential status and nationality. Since it has a residential status it has a domicile. But a Company is not a citizen because the right to citizenship is given to all natural persons, therefore, a Company cannot have a right to franchise. A body corporate does not really have a Corpus and therefore it cannot be subjected to corporeal punishment like imprisonment in the event of an offence being committed for and on behalf of it. It can be argued that a Corpa Juris i.e., a juristic person cannot commit any unlawful act, because that is antithesis to its legal existence. Besides no one can empower or delegate another to commit an unlawful act, therefore, it is not possible for a Company to authorise, ask or delegate to any of its officials the right to commit an act which is an offence. It is also not jurisprudentially valid to criminalise any act of Corpa Juris. If any offence is committed by any one even for the benefit of the Company, the Company is not bound by such an act. A Corpa Juris cannot as a matter of fact derive any benefit out of any such act because a Corpa Juris is a neutral face, it can neither gain nor lose. If such an act is benefited by anybody it would be the shareholders. But since the shareholders are distinct personality and have nothing to do with the day to day functions of the Company, shareholders could not be put into the position of sufferance due to an unlawful act of any employee or agent of the Company. For civil wrongs, the Company is ofcourse liable to pay compensation for an act of its official(s) if he discharges his functions within its authority and in the process commits such a civil wrong. The vicarious liability of a Company is sometimes extended even to acts of a person ultravires to his authority provided he does it bonafide and does it for the protection of companys interest. [Gobald Motors Services Vs. Veluswami (AIR 1962 S.C.1)] Presently there is a tendency of criminalising some of the activities done in the name of the Company, attaching liability to the Company, This goes against the basic philosophy of corporate system. Every person must be liable personally for any of his act amounting to an offence. As such non-payment of tax by window-dressing is to be considered as personal liability and not a corporate liability. On this issue there is a scope of debate. 9
1.4 DIFFERENT MODES OF INCORPORATION As stated earlier incorporation is the legal process by which an association or entity obtains the status of a legal entity or legal person. It is the exclusive prerogative of the state to determine the policy and procedure with respect to incorporation. English common law has provided for three different modes of incorporation. Based on this there are three kinds of companies (i) Chartered Companies: These are associations incorporated by a Royal Charter eg. The East India Company incorporated in 1600 AD. (ii) Statutory Companies: They are associations incorporated by a statute which
especially confers incorporated status on such associations, such as RBI, SBI, LIC, GIC, etc. (iii) Registered Companies: Here a general enactment empowers a state authority to incorporate certain associations, on being satisfied that the requirements of the statute for incorporation of such association has been satisfied. 1.5 VARIOUS TYPES OF COMPANIES Companies can be divided into various categories on the basis of different yardsticks or criteria as given in the following chart
Flow Chart - 2 Types of Companies
1 on the basis of liability
2 on the basis of nature of incorporation
3 on the basis of size & shareholding
4 5 on the on the basis of basis of inter-Company listing in relation Stock Exchange
6 on the basis of functions
7 on the basis of nationality
8 on the basis of capital
9 on the basis of aims
Unlimited Statutory
Private
Holding Co
Manufacturing Company
National Companies
Company without profit motive
Limited byRegistered shares Chartered
Public Government
Subsidiary Co Group Companies
Listed Companies Mining Co Transnational Companies Company having Share Capital Company with profit motive
Limited by guarantee Deemed Public Joint Venture or Partnership Unlisted Companies
Trading Co Service Co
Multi-National Companies Companies not having Share Capital
The chart thereof shows that there are different ways of categorising the Companies though the very identity on the basis of categories make the distribution of Companies clear but still the Companies Act has defined some of the above categories of Companies. As for example Sec 4 of the Company Act has defined holding and subsidiary relationship. A Company is deemed to be a subsidiary of another if the other controls the composition of its board of directors or holds more than 50% of the voting power of the Company or it is subsidiary to another subsidiary of the other Company, then such other Company is 10
known as holding Company. A holding Company thus, may have chain of subsidiaries, some of which are a direct subsidiary of the holding Company and others are subsidiary to the subsidiaries of the holding Company. All these Companies together are known as Group Companies which essentially show the group interest or group holding. Some of the definitions of other types of Companies are given earlier under flow chart (1). Others will be explained at appropriate places.
1.6 WHY A COMPANY? Relation between Corporate Personality and Industrial Revolution: Corporate personality with its legal character is perhaps the most innovative step in the legal realm,in order to support and sustain large scale production made possible through industrial revolution.Science has resulted in the creation of industrial civilization in 17th & 18th centuries,whereas law has innovated corporate form of organisation to sustain and further the industrial growth.The whole macro-economic situation during this period did change on account of the operation of economy on this scale. A large capital input became necessary for economic operations on this scale. Why is a big firm necessary? A firm in this situation shall strive for reaching equilibrium in order to earn maximum profits. This equilibrium is reached when marginal cost of production cuts marginal revenue curve from below. The level of output where marginal cost and marginal revenue are equal is determined at the cutting point known as point of equilibriumor point of maximum profit. A rational businessman in the industrialized civilization will expand only so long as he thinks that he can increase his profits. Unlike small scale operations the system in the industrial culture became massproduction oriented due to internal and external economies. Internal economies are the economies in production accruing to the firm itself when it expands its output or enlarges its scale of production. This type of economies operate due to technical, managerial, commercial,financial,and risk-bearing reasons. As for example, larger the production, higher is the efficient use of capital equipment. If a machine produces 500 units per hour, production of 100 units per hour will not reach a cost benefit standard. Internal economies operate over and above the technical reasons due to economy of specialised labour, better and better utilisation of specialised management, economies in buying and selling, utilisation of by products, etc. External economics are those which accrue to each member firm as a result of the expansion of the industry as a whole. Generally, industrial civilisation has experienced localisation of industrial activities both horizontal and vertical. This type of development of horizontal and vertical concentration is advantageous to skilled workers, credit facilities, better transport, etc. Besides that, there are external economies arising out of group advertisement, publication of trade and technical journals, R&D, etc. On account of this operational scale, a firm requires to raise its production level atleast to a break-even point. In the following figure the cost revenue equation of a hypothetical firm is shown, where TC represents total cost curve and TR represents a total revenue curve. In the figure, TC starts from point A of the Y axis because it is assumed that even if the firm is not put to work (say when it is shut down or on strike) it has to bear certain cost of production. These costs are fixed. It is clear from the figure that any output smaller than OB would make the total cost exceed the total revenue and the firm shall be at a loss.
But once the production reaches at OB the firm is able to raise sufficient revenue to meet its cost. This is known as the earliest break-even point. The firm is going to experience the breakeven point as well at a later stage, due to increasing total cost and diminishing total revenue after sometime, provided, there is no sudden change either in the demand factor or in the supply factors like technology change, better and higher quality machine being introduced, sudden change of demand on account of test and selection variation in the consumers behaviour, etc. In the figure, the firm reaches this point at OC when the production level goes high to OC. Here again TC and TR shall interact. The important point that one has to bear in mind that in the case of production upto B level the TR will cut the TC from below whereas at C level the TR will cut TC from above. The maximum profit point in this diagram is pp' where the distance between TR and TC (TR-TC) is the maximum. This point is reached at point D. That means a firm will try to maximise its profit by trying to produce at a level not below D.
Therefore one can easily understand that a large scale industry shall strive for maximising its output through increasing its marginal revenue or decreasing its marginal cost or by both. In order to achieve this production level it is necessary to raise huge capital for the purpose of investing in capital goods and reducing per capita production cost. It, therefore becomes impossible for proprietorship or partnership business to support or further the cause of industrial growth, whereas in retail and wholesale trading proprietorship and partnership continued to play a vital role. A new form of business organisation emerged which was known as corporations. A large amount of capital was required to be raised from a large number of people. But such a large body of capital holders could not run the business. This necessitated the separation of ownership and management. A major section of shareholders contributing a large amount of share capital had to repose faith on a few persons with managerial skills, in order to run the organisation for and on their behalf. This resulted in the development of modern concept of delegation and accountability. It has also resulted ultimately in an assurance from the State about the limited liability of the shareholders. Over the years big industrial houses like General Motors dominated over the industrial world with their huge corporate structures. 11
In the last quarter of the 20th century the world is experiencing another technological change with the change in the organisation pattern. Consumerism has overtaken huge infrastructural industries from the point of view of priority and importance. As a result, service industries started dominating the whole globe. Naturally fashion variation has become as popular as the product variation. Investment and technology movement has started becoming globalised. National character of organisation obviously started being underplayed. Through a complicated organisation structure of holding subsidiaries large industrial empires have started coming up, de-emphasizing the role of national jurisdiction and national laws. A new system of economic logic has started building up. A new breed of management professionals have started dominating the scene. 1.7 THE ORGANS OF A COMPANY The registered company, which has a virtual monopoly of the Commercial Corporations of our society, has two primary organs viz. (i) the members in general meeting and (ii) the Board of Directors. The division of power between the two organs, is provided in the Articles of the Company. But there are certain powers which can be exercised by the members in a general meeting only. The management is usually vested in the Board. The control over the managerial organ and the ultimate power is legally vested in the members in general meeting. This topic is discussed in detail in another module. As regards, small sized Companies, the legal distinction between the two organs may only be in theory. In most cases, the members of both the organs are the same personnel. But the position is different with respect to large size Companies. The Board of Directors of these Corporations have emerged as the real power wielding organ. The shareholders are relegated to the background. They have neither the capacity nor the inclination to discharge the supervisory or controlling function assigned to them by law. Two major factors responsible for this position are : a) Emergence of passive and institutionalized investors, who have no inclination for entrepreneurship; and b) Scattered shareholding. This has resulted in the Board of Directors not being subject to effective shareholder control. Another factor to be noted is the emergence of Managing Director, the administrative head of the Corporation as a pivotal organ of the Company. Many of the powers of the Board are now delegated to the Managing Director. Yet another development is the growth of professional managers. Most of the large size companies today have whole time or Executive Directors, who are members of the Board by virtue of their professional expertise, and not on account of their shareholding. 1.8 APPLICABILITY OF COMPANIES ACT, 1956 Sec.3(i) of the Companies Act 1956, provides that the term company, for the purposes of the Act, means a company formed and registered under the Act, or an existing company which is a company registered under any of the earlier 12
Companies Act specified in the section. Thus, statutory companies and other kinds of corporations are not governed by the Act. Even in respect of registered companies the Act is not exhaustive. As observed by L.C.B. Gower (The Principles of Modern Company Law) Behind the Act is a general body of law and equity applying to all companies irrespective of their nature and it is there that most of the fundamental principles (of company law) will be found. Many of the cardinal principles of company law, such as the doctrines of ultra vires indoor management, rules relating to the fiduciary position of Directors, etc are founded on case laws. In addition to the Companies Act, 1956, there are many special statutes governing companies carrying on particular business activities. For example, the Insurance Act, 1938 is applicable to companies doing insurance business. Similarly the Banking Companies Act, 1949, governs banking companies. Except in so far as its provisions are inconsistent with those of the special statutes, the Companies Act, is applicable to all companies incorporated under the Act. The following are the main types of associations governed by the Act. (1) Companies incorporated under the Act (2) Existing companies as defined under S3(i) (ii) (3) Foreign Companies within the meaning of S.591 (4) Unregistered companies for the purpose of winding up under Part X of the Act. (5) Nidhis or Mutual Benefit Societies declared as such by the Central Government through notification in the official gazette. 1.9 APPLICABILITY OF ENGLISH LAW The Statute in force is the Companies Act, 1956. It is modelled on the English Companies Act, 1948 which has since been repealed. The Statute now in force in England is the Companies Act 1985 which attempts to harmonize English law with the continental law. Though the Indian statute is not a verbatim copy of the English Company Act 1948, and has developed its own lines, the English decisions can profitably be referred to and relied upon especially when the language used in both the statutes are identical. In Hind Overseas (P.) Ltd. v. Raghunath Prasad [AIR 1976 S.C. 565] the petitioners and the other members of their family held about 40% of the shares of a company. The remaining shares were held by one VDJ and the members of his family. Though the petitioners were appointed as Directors of the Company, the business was always controlled by VDJ, who was the majority shareholder. Differences of opinion developed between the petitioners and VDJ, on many matters of administration and management. The petitioners filed a petition under Section 433(b) of Companies Act, 1956 for winding up of the company. While examing the scope and ambit of the section, the court adverted to the corresponding provisions in the English Statute and relied upon the interpretation given to those provisons.
Although the Indian Companies Act is modelled on the English Companies Act,the Indian law is developing on its own lines. Our law is also making significant progress of its own as and when necessary. Where the words used in both the Acts are identical, the English decisions may throw good light and reasons may be persuasive. But as the Privy Council observed long ago in Ramanandi Kuer v. Kalawati Kuer,[ AIR 1928 PC 2] It has often been pointed out by this Board that where there is a positive enactment of the Indian legislature, the proper course is to examine the language of that statute and to ascertain its proper meaning uninfluenced by any considerations derived from the previous state of the law or of the English law upon which it may have been founded. If it was true in the twenties it is more appropriate now. In view of the background, conditions and circumstances of the Indian society, the needs and requirements of our country calls for a somewhat different treatment. We will have to adjust, adapt, limit, or extend, the principles derived from English decisions, entitled as they are to great respect, suiting the conditions of our society and the country in general, always, however, with one primary consideration in view that the general interests of the shareholders may not be readily sacrificed at the altar of squabbles of directors of powerful groups for power to manage the company. 1.10 PROBLEMS OF 20TH CENTURY : A CONCLUDING REMARK The modern corporation is the offshoot of industrial revolution. When collective enterprise became a necessity, to work out the
business opportunities provided by science & technology, the corporation emerged as a convenient instrumentality. During the early days, the shareholders were mainly entrepreneurs who took a keen interest in the affairs of their company. Very often the Directors were appointed merely on the strength of their shareholding. All these factors ensured proper shareholder control over the Board. In fact the whole scheme of the Companies Act is based on the assumption that the shareholders can and will check corporate abuses. But the assumption has proved to be wrong. In fact the members of the modern corporation are a hapless lot, weak and vulnerable and in urgent need of legal protection. Apart from the shareholders, the other groups whose interests have to be recognised by Corporate Law are the workers and the consumers. The skill, efficiency and dedication of the workers are as much a contributory factor to the growth and prosperity of the enterprise as the managerial skill or the capital employed. Another area of concern of corporate law should be the social interest. The modern corporation is much more than a mere business organisation. Because of its predominant position in the economic frontier, having a significant impact on the political and social arenas as well, it is widely recognised that the modern corporation has a social responsibility. No society can afford to permit a company to disregard its social responsibility or the legitimate claims of the workers and consumers. But at present company law has not properly addressed itself to these vital issues.
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2. HISTORY OF COMPANY LAW

SUB-TOPICS 2.1 Introduction 2.2 Early History of Company Law in England 2.3 Modern history 2.4 History of Company Law in India 2.5 Administration of Companies 2.6 Jurisdiction of Courts 2.7 Concluding remarks 2.1 INTRODUCTION Rapid scientific inventions and innovations in the 16th, 17th and 18th centuries paved the way for industrial revolution, first in England and then in Europe. Similarly the innovation of Corporate personality concept during this time, resulted in the form of business organisation which became the vehicle of rapid industrial growth in 18th and 19th century. Initially this type of Corporate personality started developing through the Royal Charters. In fact the East India Company which was formed as joint stock Company in order to carry on trade in India, obtained the Charter from the British Sovereign in 1599. 2.2 EARLY HISTORY OF COMPANY LAW IN ENGLAND A registered Company in England is the youngest member in the family of corporations. The statute which gave birth to it was the Joint Stock Companies Act, 1844. Before that there were only two types of corporations namely : (1) the Chartered Company which came into being on the issuance of a Royal Charter; and (2) the statutory corporation which was created by a special enactment. Incorporation through these devices was not easily available. Further the cost was also prohibitive. The Chartered Companies were incorporated mainly for the purpose of overseas trade: The statutory corporations on the other hand operated in the domestic field mainly in the railway and other public utility sectors. Since it was very difficult to obtain incorporation through the above two methods, most of the business activities were carried out through large unincorporated business associations which were often referred to as common law companies or 'deed of settlement companies. Legally these associations were only partnerships, which set out the constitution of the company. The capital was divided into shares of specific denominations and were made transferable. The management of the business was entrusted to a committee of directors or governors. The property of the association was vested in another body of trustees. Many of the trustees were also members of the Board, Thus we find that these associations were having all the salient features of a modern company. But the legal validity of many of the provisions of the deed was doubtful. Whatever that be the deed 14
of settlement company was the main vehicle through which commercial activities were carried out. Being Partnerships they were free from many of the regulations and restrictions to which the Statutory Corporations and Chartered Companies were subjected to. By the beginning of 18th Century speculative activities reached its zenith and paved the way for malpractices. Gower observes that the period was marked by an almost frantic boom in company floatation. Large unincorporated companies with transferable stock appeared on the commercial scene. Many of them had only a short span of life and burst like the bubbles of water. The story of the notorious South Sea bubble is a clear illustration of the gambling mania of the period. The company was incorporated in 1710, with the object of exploring the trade with South Africa. It launched a scheme to acquire all the national debt in exchange for the companys shares. The scheme turned out to be a failure. In 1720, the directors of the South Sea Company were summoned before Parliament and fined for their fraud. To control the prevailing speculative fever, Parliament enacted a statute, known generally as the Bubble Act, 1720. The statute which was the first attempt of English law at framing of a Company Act, was clearly negative in its approach. Section 18 of the Act provided that all those undertakings as were therein described, tending to the common grievance prejudice and inconvenience of His Majestys subjects should be illegal and void. Associations purporting to act as corporate bodies but without legal authority and the raising of transferable stock by such bodies were manifestly to the prejudice of the public trade and commerce of the Kingdom. Broker dealings in illegal companies were also prohibited. But companies and partnerships established before 1718 were exempted from the purview of the Act. They could carry on any local or foreign trade in such manner as has hitherto been done. The full legal implication of the statute was not beyond doubt. Commenting on the effect of the Bubble Act, Holdsworth says; What was needed was an Act which made it easy for joint stock societies to adopt a corporate form and at the same time, safeguard both the shareholders in such societies and the public against frauds and negligence in their promotion and management. What was passed was an Act which deliberately made it difficult for joint stock societies to assume a corporate form and contained no rules at all for the conduct of such societies, if and when they assumed it. The Repeal of Bubble Act The Bubble Act 1720 had a restraining influence on the commercial activities of the period following it. Gower observes that the Statute was for long a sword of Damocles which exercised a restraining influence as patent as the memory of the great slump. Since the Bubble Act made it a criminal offence to form any company presuming to be a corporate body the commercial community was forced to operate within the limits
of the unincorporated partnership. Though towards the end of the century, Parliament showed willingness to incorporate by special Acts, it was limited to activities such as banking, insurance, and canal works. It was a negative policy in respect of other trading associations. The only alternative available was the unincorporated partnership. This resulted in the rebirth of the deed of settlement companies which the Bubble Act attempted to suppress. As the Bubble Act expressly exempted genuine partnerships from its ambit, it was thought that large unincorporated bodies with joint stock were not hit by it, provided that, some restrictions were imposed on the transferability of shares. In the latter half of the 18th century the unincorporated joint stock company with a large number of shareholders, emerged as the dominant type of trading association. In course of time, many of them operated with transferable shares. The Bubble Act was conveniently forgotten. At the turn of the century, speculative activities and company promotion reached a height comparable to that of the first two decades. In many cases unscrupulous, company promoters could easily defraud the investing public. This brought to light, the many disadvantages of the unincorporated joint stock companies of the period. State intervention to regulate the trading activities became inevitable. The first step taken by the government was to initiate prosecution against a few unincorporated associations with transferable stock, for violation of the Bubble Act, though the statute was at that time an almost forgotten one. In two cases the court took the view that unincorporated joint stock companies with transferable stock were illegal. But some other judges refused to hold that all unincorporated bodies with transferable shares were illegal. These conflicting decisions also contributed to the confusion that prevailed in the succeeding decades, as to the status of joint stock companies. It was increasingly felt that active governmental intervention was essential to bring law in tune with the commercial urge of the period. The first step taken in this regard was the repeal of the Bubble Act in 1825. 2.3 MODERN HISTORY The repeal of the Bubble Act was also followed by a slump. But soon, the joint stock company appeared again and began to dominate the industrial and commercial field. This made it clear that it was an inevitable necessity of the period to have trading associations through which capital could be readily raised for commercial projects. Pressed by the urgent necessity of taking some concrete steps to regulate trading associations, the Trading Companies Act of 1834 was enacted. It empowered the Crown to confer by letters patent all or any of the privileges of incorporation without actually granting a charter. The Chartered Companies Act of 1837 re-enacted the provisions of the Trading Companies Act of 1834. It specifically provided that the liability of the members could be limited by the letters patent.
The Companys Act of 1844-1862 In 1841, a Parliamentary Committee was appointed to study and report on the functioning of joint stock companies. In 1843, Gladstone the then President of the Board of Trade, became the Chairman of the Committee. Based on the report of the committee, The Joint Stock Companies Act, 1844 was passed. The enactment is popularly known as Gladstones Act. The statute which is still the foundation of our company law, introduced three cardinal principles. (1) Incorporation by mere registration The Joint Stock Companies Act, 1844 provided a comparatively easy and cheap method for the incorporation of commercial associations. Hitherto, an association could be incorporated only through the grant of a royal charter or by a special Act of Parliament. But now every association satisfying the requirements stipulated in the Act, was entitled to the incorporated status. (2) Compulsory Registration The Act also provided that companies with membership above 25 or with shares transferable without the consent of all the members could function only as incorporated bodies. The above principle is incorporated in Section 11, of our Companies Act, 1956. (3) Publicity The Act is founded on the principle of disclosure. It insisted that various information regarding the company and its affairs should be periodically supplied to the Registrar of Companies. It was thought that the mandatory provisions in the Act providing for full publicity of the affairs of the company is an effective guarantee against fraud and other malpractices. The drawbacks of the Act The Joint Stock Companies Act, 1844, is a landmark in the history of commercial associations in England. Still the statute had certain vital defects. The main drawbacks of the Act were: (i) Provisions for Provisional and final registration The Act provided for provisional and final registration of companies. Final registration could be obtained only on the fulfilment of certain stringent conditions. (ii) Absence of limited liability to the members Though the Act evolved a legal device for easy and cheap incorporation of commercial associations, the most important advantage of incorporation, namely limited liability of the members, evaded them. Even after incorporation the members remained fully liable for all the debts and liabilities of the company, as if they were members of a partnership firm. Limited Liability Act, 1855 The Joint Stock Companies Act, 1844 provided a cheap and easy mode of incorporation. Then onwards incorporation was no more a privilege of a few, who could influence the Crown or the Parliament, but a legal right of all those who complied with the requirements of the Act. But an anomalous position had 15
arisen in so far as the statute fastened personal liability on the members for the debts and liabilities of the Company. In this respect Gladstone's Act put the registered company on par with partnership, rather than with the other two types of corporations. But limitation of personal liability was the most cherished goal of the business community. And they clamoured for it,till ultimately the Limited Liability Act, 1855, was enacted. But it was a very cautious approach,and limited liability could be claimed by the members of the registered company, only if the following conditions were satisfied: (a) The company had at least 25 members each holding a minimum of shares of nominal value $10, paid upto 20 percent. (b) Not less then three fourth of the authorised capital was subscribed. (c) The auditors of the company were approved by the Board of Trade. (d) The word limited was added to the companys name. It was thought, that these provisions would, to some extent, safeguard the interest of the creditors. But Limited Liability Act 1855, had only a short span of life. Within a year of its birth, the Joint Stock Companies Act, 1856 was enacted which repealed both the earlier enactments, namely, Joint Stock Companies Act 1844 and Limited Liability Act, 1855. The Joint Stock Companies Act 1856 This statute revealed a complete reversal of the cautious policy hitherto followed by the legislature. It did away with provisional registration. All the safeguards provided by the limited liability Act for the granting of limited liability to the members, except the one requiring that the word limited' should be added to the companys name were also thrown away. The deed of settlement which was the constitutional document of the company, to be registered with the Registrar for incorporation, was split up into two viz : (a) the Memorandum of Association and (2) the Articles of Association. The statute denotes the triumph of the champions of laissez-faire doctrine, who pleaded: If there was a rule established by reason, authority and experience it is that the interest of a community is best consulted by leaving to its members, as far as possible, the unrestricted and unfettered exercise of their talents and industry( Lord Bramwell). The effect of the statute is commented upon by Prof. Gower thus: Passed, as it was in the, hay day of laissez faire, it allowed incorporation with limited liability to be obtained with a freedom amounting almost to licence; all that was necessary was for seven or more persons to sign and register a memorandum of association." Companies Act 1862 The next important statute was the Companies Act, 1962. This was the first enactment to bear a short title The Companies Act. According to Sir Francis Palmer, this statute was the magna carta of corporate enterprise. This was a consolidating Act. It included a model form of Articles of Association which the company could adopt instead of drafting its own articles. The legislative policy reflected in the statute was one of granting 16
maximum liberty to registered companies. With this enactment, the pendulum of corporate enterprise reached the extreme end of liberty. Then onwards, it had been a movement in the opposite direction as subsequent Company law legislations have been trying to impose more and more restrictions on companies and corporate activities. The Companies Act 1908 The next important English statute was The Companies Act 1908 which also was a consolidating Act. It consolidated in the main, the Companies Act 1862, and the Companies Act 1907. The latter enactment introduced the concept of private company, which was granted many privileges and concessions including balance sheet secrecy. The Companies Act 1928 The main contribution of this Act and the subsequent consolidating Act of 1929 was that they recognised the special authority relationship that existed in a group of companies connected together by the holding- subsidiary relationship. The Act also contained certain provisions aimed at the protection of the minority. The Companies Act 1948 This statute was based on the report of Cohen Committee which recommended far reaching reforms in company law. The suggested reforms were aimed mainly at two directions : (1) to ensure that as much information as was reasonably required shall be made available both to shareholders and creditors of the company concerned and to the general public, (2) to ensure effective shareholder control over the management. The Act also conferred power on the members in a general meeting to remove any director from office, even before the expiration of his term of office. The investigatory power of the board of trade was strengthened. The Companies Act 1967 The statue was mainly a supplementary legislation attempting to curb corporate abuses but by somewhat halfhearted steps (Gower). It gave effect to some of the recommendations of the Jenkins Committee and incorporated new stringent provisions enhancing the fiduciary duties of the directors and further strengthening the investigatory power of the board of trade. The European Communities Act, 1972 In 1972, England became a member of European Economic Community. Thereafter many legislative reforms were carried out to comply with the EEC directives which aimed at harmonisation of the company laws in the member states. The Company Act 1985 The Companies Act 1985, consolidated all these legislations and made suitable amendments to the law. In the next year, the Insolvency Act, 1986 was enacted which removed from the Companys Act, all the provisions relating to winding up. There are a few other supplemental legislations, such as the Company Securities (Insider Dealing) Act, The Company Directors Disqualification Act, 1986, The Financial Services Act, 1986.
The latest legislation is the Companies Act 1989 which was necessary to implement the seventh and eight directives of European Commission on consolidated accounts and audits of group companies. 2.4 HISTORY OF COMPANY LAW IN INDIA
As noted earlier the Indian Company law was closely following its English counter part. Even the language of most of the statutory provisions was identical with the corresponding provisions of the English Statute. Our Company Law is greatly influenced by the English Law. The history of Indian Company Law begins with the Joint Stock Companies Act, 1850. It was modelled on the English Act of 1844. This was followed by the two Acts of 1857 and 1860 respectively. The Companies Act 1866 which repealed all the earlier statutes remained in force till the Companies Act of 1882, came into force. This statute was repealed by the Companies Act of 1913. It was mainly based on the English Act of 1908, though it also incorporated certain additional provisions taking into account the peculiar conditions that prevailed in our country. A drastic amendment to the 1913 Act was introduced by the Amending Act of 1936. The statutes remained in the statute book till the Companies Act 1954, came into force. The Act of 1956 which is the principal Company law statute in force is mainly based on the English Act of 1948, though in certain respects our statute is more progressive than the English Act of 1948 and contains many provisions, which are not found in the English Law. Amendments The Act has been amended several times. Some of the amendments have introduced drastic changes. Till date 16 amendments have been made. Of these, the Amendment Acts of 1960, 1965, 1966, 1967, 1969, 1974, 1985 and 1988 are very significant. A new Company' Bill of 1993 introduced in the Parliament is expected to repeal and replace the 1956 Act soon. Other statutes Though the Compay Act, 1956 is the principal legislation on registered companies, there are a cluster of other laws having a direct bearing on corporations. These statutes are supplementary to the Companies Act, 1956. Some of the important legislations are : (1) The Securities Contract Regulation Act, 1956 (2) The Monopolies & Restrictive Trade Practices Act, 1969 (3) The Foreign Exchange Regulation Act 1973 (4) The Industries Development Regulation Act, 1951 (5) The Sick Industrial Companies Special Provisions Act, 1985 (6) The Securities Exchange Board of India Act, 1991. 2.5 ADMINISTRATION OF COMPANIES We have noticed that the legal framework within which the registered company operates was moulded about one and a half
centuries ago in an atmosphere of laissez faire. Subsequent developments in the structure and character of corporators (members) necessitated more state regulations. The regulatory function of the state over corporations are now carried out mainly by the Department of Company Affairs which is a wing of the Ministry of Law, Justice and Company Affairs. Under the Department there are four Regional Directors with their Head Quarters at Delhi (North zone). Bombay (West Zone) Madras (South Zone) and Calcutta (East zone). There are also Registrars of companies, each Registrar having a specified territorial jurisdiction. Most of the administrative and regulatory powers vested in the Central Government under the Act are delegated to the Regional Directors or the Registrar. Apart from the delegated powers the Registrar is also vested with certain statutory powers. The Registrar and the Regional Directors are essentially administrative authorities under the control of the Central Government. Company Law Board In addition to the above two there is also the Company Law Board vested with vast powers mainly of quasi judicial nature. The Board was first established by the Companies Amendment Act, 1963 for a better and convenient administration of the Companies Act. It was envisaged that most of the powers and functions of the Central Government under the Companies Act and allied statutes would be entrusted with the Board, but the Board would function under the control of the Central Government. Consequently many of the powers of the Central Government were transferred to the Board, which functioned as a delegate or agent of the Central Government. Amendment Act 1974 But with the Amendment Act of 1974, a qualitative change in the legal position of the Board took place. Certain powers which were hitherto vested in the court were now transferred to the Company Law Board. The judicial powers which were so transferred to the Company Law Board were:(1) power to sanction alteration of the registered office and object clauses in the Memorandum of Association (Ss.17 to 19); (2) power to sanction the issue of shares at a discount (S.79); (3) the power to order rectification of the register of charges (S. 141); and (4) the power to convene any general meeting other than the annual general meeting (S. 186). Thus with the Amendment Act, 1974, the Company Law Board was assigned a dual role, namely:(a) as a delegate of the Central Government; and (b) as a quasi judicial organ vested with statutory powers. Nevertheless, in the discharge of its powers and functions the Board was subject to the control of the Central Government. This was expressly provided by sub clause (6) of section 10 E as it stood before the Amendment Act of 1988. At this stage 17
the Board consisted of ex officio members only. Thus the Board was ill equipped to discharge its quasi judicial function in an independent and impartial manner. The Amendment Act, 1988 This defect was rectified by the Amendment Act, 1988 which provided for the Constitution of a truly independent body vested with judicial and quasi judicial functions. It was freed from the administrative control of the Central Government. In addition to the statutory powers conferred on it the Board may also exercise such other powers and functions as may be delegated to it by the Central Government. [(Section 10E(1A)]. The Company Law Board is also vested with powers under allied statutes such as the Securities Contract Regulation Act, 1956. The MRTP Act, 1969 etc. The Board is empowered to regulate its own procedure [(See 10 E(6)]. Its decisions and orders are appealable to the High Court. But the appeal is only on questions of law (and not on questions of fact) arising out of such orders (Section 10 F). 2.6 THE JURISDICTION OF COURTS The Companies Act 1956, contains many provisions which are penal in nature. For violation of those, the officers in default and in certain cases the company also are fastened with criminal liability. There are more than 170 sections in the Companies Act, which are penal provisions. These offences may be tried in the court of Judicial Magistrate First Class or Presidency Magistrate, as the case may be [Section 2(11)(b)]. As regards civil matters under the Act, the jurisdiction is vested with the High Court having territorial jurisdiction over the place at which the registered office of the company concerned is situated. But the Central Government may by notification in the Official Gazette empower any District Court subordinate to such High Court to exercise jurisdiction over all or any of the matters over which the High Court has jurisdiction under the Act. A District Court can be conferred jurisdiction only in respect of companies having their registered office situate within its territorial jurisdiction. (Sections 2(11) and 10 of Company Act). Further restrictions on conferment of jurisdiction on District Courts are: (i) matters under Sections 391, 394 and 395 (Compromises and arrangements reconstruction and amalgamation, and takeovers) (ii) Winding up of companies with a paid up capital of Rs.1 Lakh or more. The jurisdiction of the High Court or the District Court as the case may be, does not cover all cases where a company is a party to a civil litigation. The provisions of the Company Act,
dealing with civil jurisdiction are applicable only to those cases where a right or liability arises out of the provisions in the Company Act. As regards other civil matters, the company, like any other person is within the jurisdiction of ordinary civil court. Reference may also be made to Section 9 of the Civil Procedure Code 1973, which provides that an ordinary civil court shall have jurisdiction to entertain all suits of civil nature except those which are expressly or by necessary implication excluded. Even though the Company Act 1956 contains elaborate provisions dealing with the management and conduct of the affairs of the company and providing remedial measures it does not always exclude the jurisdiction of civil court. On certain matters the jurisdiction of the ordinary civil court and the company court may be concurrent. The leading Indian case on the topic is Nagappa Chettiyar v. Madras Race Club [(1949) 19 Comp.cas.174]. The main object of the respondent company was to carry on the business of a race club. At an extraordinary general meeting of the club held on 7th November 1947 a special resolution was passed to amend some of the provisions of the Articles of the company. Two members of the club instituted a suit, for a declaration, that all the business conducted at the meeting including the special resolution passed was invalid, null and void. One of the issues in this case was whether the civil court has jurisdiction to entertain the suit against a company pertaining to a matter of internal management. It was held that the court has jurisdiction. In Star Tile works v. Govindan [AIR 1959 Ker 254], the dispute related to the proceedings of the Annual General Meeting of the 1st defendant company. The plaintiff were the shareholders of the company. They alleged that their proxies were not allowed to exercise their votes at the meeting. In this case Vaidialingam J held that there is also a considerable body of authority for the proposition that many of the speedy remedies provided by the Act are equally enforceable in the other courts by suits. That being so it is impossible to regard the company court as having exclusive jurisdiction in all matters pertaining to companies. 2.7 CONCLUDING REMARKS The present Industrial policy of the Govt of India will require a thorough revision of the Companies Act. The new Company Bill proposed in 1993 was withdrawn with a view to place a comprehensive new Bill incorporating various new proposals required for supporting the new economic policy. Some of the important areas for new provisions to be incorporated are corporate management, structure, capital formation, accountability, standard of corporate accounts, winding up, etc.
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3. FORMATION OF A COMPANY AND ITS CONSTITUTIONAL DOCUMENTS

Sub-Topics 3.1 Steps of company formation at a glance 3.2 Company promotion & promoters role 3.3 Who can be the subscribers ? 3.4 Pre-incorporation Contract 3.5 Constitutional document : Memorandum 3.6 Constitutional document : Articles 3.7 Certificate of Incorporation 3.1 STEPS OF COMPANY FORMATION AT A GLANCE Formation of a company has several phases. These phases at a glance are given below: Formation of a Company 1 Planning Stage ........ Formulation of an idea ........ Design of the project outline ........ Viability study ........ Study of legal implications 2 Association of persons or Promotional State ........ Assemblage of Promoters [Sec. 12] ........ Applying for necessary licence/permit/discount ........ Making agreements for infra-structure ........ Pre-incorporation Contracts ........ Appointing Lawyers Registration ........ Documentation [Sec. 13-15] ........ Application for registration [Sec. 33(1)] ........ A statutory declaration [Sec. 333(2)] ........ Certificate of incorporation [Sec. 34] 3.2 COMPANY PROMOTION AND PROMOTERS' ROLE According Sec 12 of the Companies Act any seven or more persons, or where the Company to be formed is a private company, any two or more persons associated for any lawful purpose may, by subscribing their names to a memorandum of associations form an incorporated company. Before they subscribe to the memorandum of association they are called promoters. They undertake all promotional activities which inter alia includes planning activities, and pre-incorporation activities. They are also called subscribers because they sign the memorandum. In advanced countries there is a professional class who undertake the job of promoting a company and after taking all necessary steps of formation of a company leave the company to the subscribers who become signatories of the memorandum of the company. In our country such a promotional class has not been professionally built up. As a result, the promoters are those who themselves become subscriber by directly participating in the formation of the company. The stage of promotion is legally speaking a very intricate stage. At this stage the company does not come into existence but many of the important primary decisions and activities are to be undertaken without which the company will never come into existence. Many of these activities involve the undertaking of liabilities. Intricate question arises as to the legal status of these promoters. What is Promotion? The word promotion has not been defined in the Companies Act, nor its area demarcated. The best description of the term is found in the judgement of Bowell, L.J., in Whaley Bridge Co Vs Green [(1879)Q.B.D. 111]. According to Bowell L.J, promotion is not a term of law, but of business operations familiar to the commercial world, by which a company is generally brought into existence. Promotional activities include the wide range of commercial activities which include many technical and non-technical operations. Amongst the technical activities include project planning, feasibility study, looking for technical cooperation and collaboration, and locational studies. Non-technical activities include assembling required number of signatories, obtaining advice on different legal requirements, appointing key people like company lawyer who will make documentations and enter into all types of pre-incorporation contracts . In spite of the fact that at present many of the stringent conditions of the license raj have been dispensed with, nevertheless, in most of the project planning and company matters lot of infrastructural activities are required to be done at the govt. level like arrangement for industrial site, if it is an industrial concern, arranging for facilities like water, electricity etc., talking with financial institutions, to arrange for finances and the like.
4 Commencement of business ........ Private limited company can start as soon as it receives certificate of incorporation [Sec. 34] ........ Public Limited company : ........ (a) Invite public to subscribe by issue of prospectus Sec 149(1) read with [Sec. 55] ........ (b) Raise Minimum subscription mentioned in prospectus Sec 149A read with [Sec. 69] ........ (c) Allotment of share - [Sec 149(1)(a)] ........ (d) Certificate of allotment [Sec. 149(1)] ........ (e) Certificate to act as Directors [Sec. 266(1)(a)] ........ (f) Statutory declaration - [Sec. 149(1)(d) or Sec. 149(2)(c) or Sec. 149(2)A] ........ (g) Certificate to Commence business given <=> then the Public Ltd company can commence business [Sec. 149]
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Position of a Promoter : Therefore, promoters play a very important role. They undertake to form a company with reference to a given object. It is difficult to identify a legal role of a promoter. Promoters are not agents of a company because there cannot be an existence of the agent in absence of the principal itself. Therefore, a company cannot appoint an agent even by application of fiction before the company receives the certificate of incorporation. Promoters cannot also be called as trustees, in absence of the company being their beneficiary. [See Weeners Mills Ltd Vs. Bulkies Ammal AIR 1969 Mad 462] Lord Blackburn, however observed those who accept and use such extensive power are not entitled to disregard the interest of the corporation altogether. They must make reasonable use of the power which they accept from the legislature, and, consequently they do stand with regard to that corporation when formed, in what is commonly called a fiduciary relation to some extent [Erlenger Vs. New Sombrero Porphate Co (1878)3 A.C 1280]. The principle was applied to Gluckstein Vs. Barnes [(1900)A.C 240]. In this case a company owning the property called Olympia thereunder Rough Weather and the debentures charged on that property were worth very little. Gluckstein and three others as trustees for the Syndicate formed to buy Olympia and resell it to a company to be promoted by them purchased the debentures for a sum much below the amount they realised and made a profit of 20,000. The company went into liquidation and the syndicate purchased Olympia for 1,40,000 which they sold to Olympia Ltd, a company formed by them, at 1,80,000. Gluckstein and three of his friends involved in promoting the company also became the directors of the company. They issued a prospectus for raising the capital from the public wherein they disclosed that the property Olympia was purchased by them at 1,40,000 and sold the same to the company after registration at 1,80,000 but they did not disclose the profit made on the dealings of the debenture of the old company. The House of Lords decided that the promoters have a fiduciary obligation to the company which they were to form, from the moment they proposed to buy the property with a view to resell it to the company. Therefore, the non disclosure of the profit of 20,000 was a wrong in law, which was to be compensated. Of course if the company does not come into existence the relation does not arise. According to Ghickstein, the fiduciary relation is created not from the day of incorporation of the company but it arises from a prior date when the promoters decide to gain by their promotional activity. Promoters are not bound to refrain making any personal or individual gains but they are bound to disclose that gain to the prospective shareholders of the new company. What makes a person a promoter? In Tiruvengadachariar Vs. Vellumudaliar (1938 ILR Mad 192) the Madras High Court decided that signing the memorandum or showing that the money paid by him was utilised in paying of the expenses of the formation of a company does not make a person promoter of a company. In order to be a promoter a person has to be involved in the process of conception, planning during the formative stages of the company. Vendor of a property while selling it to 20
a promoter of a company who took it for resale to the company after promotion is not considered as a promoter if he joins other promoters to promote the company after the sale of the company. Liability of a Promoter: Promoter has a duty of disclosure because he has a fiduciary obligation. A disclosure has to be actual and express and it must be made to the body of persons who act on behalf of the company after incorporation of the company. Out of this obligation the liability of a promoter arises to the company as soon as the company is formed. He is duty bound to disclose the full account of all profits he may have earned at the stage of formation of the company. His obligation begins as soon as he sets out to act for or promote the company. In Ladysoell Mining Co Vs. Brooks (35 Ch.D 400), five persons purchased a mine for 500. At that time there was no steps taken for forming a company. Afterwards four of these persons with some other persons promoted a company to which the mine was sold for 18,000. They did not disclose the profit thus made. The Court held that there was no fiduciary obligations to disclose this profit because the duty does not arise before the promotional work begins. Promoters are not responsible to account for the profit and return it to the company. They are entitled to make such profit. The only responsibility that they have a responsibility of disclosure failing which there shall be a liability for account of non disclosure and breach of trust for which they have to compensate. Promoters to take part in the issue of prospectus are liable further to the shareholders on statements made therein. In the event of winding up they will be liable for misfeasance and breach of trust. Renumeration: A promoter is entitled to a reasonable remuneration. He may purchase the property and resell it to the company at a profit subject ofcourse to disclosure. He may also charge commission on properties acquired for the company. Generally speaking such remuneration is stipulated in the Articles of Association. Ofcourse in some cases like In Re Englefield Colliery Co [1878 Ch.D 388], it was held that the Board of Directors are duty bound to examine the reasonability of the remuneration as stipulated in the Articles of Association, payable to the promoters. Once the promoter signs the Memorandum of Association he becomes a subscriber. 3.3 WHO CAN BE THE SUBSCRIBERS Any person competent to contract is qualified to be a subscriber. A subscriber need not be beneficially interested in the shares for which he has subscribed.e.g. a trustee. A company or corporation can be subscriber but not a partnership firm or a 'minor'. An agent can sign on behalf of his principal (refer to Circular dated 27th July 1964, issued by C.L.B) A HUF or a Partnership firm cannot be a subscriber because these are not legal entity. Ofcourse if a Karta or a partner signs a memorandum they are treated as individual subscriber's or subscriber's in their own name. Ofcourse if it can be proved that the Karta purchased the share as a subscriber out of the
HUF fund other members of the HUF can demand to be the beneficiaries. But they are in no way under any obligation or responsibility to share any loss. As regards Foreign Institutional Investors (FII) or Non-Resident Indians (NRI) there is no restriction imposed in the Company's Act. Foreign Exchange Regulation Act of 1973, however, imposes certain restrictions most of which are now in the process of withdrawl. As for example, a FII subscriber does not require any clearance by the RBI if the subscription limit is less than 24%. Similarly many of the restrictions on NRI's are also not there at present. In other cases a general or special permission of the RBI is needed. Certificate of incorporation is considered as conclusive evidence of birth of a company, as Pennigton puts it. This gives rise to many of the issues relating to disability of the signatories. In Mossa Gulam Arif Vs. Ibrahim Gulam Arif [ILR (1913) 40 Cal I(PC)] all but two of the subscribers of a companys memorandum were infants who had no legal capacity to sign it. It was held that matter could not be reopened as the certificate of incorporation was already issued. How to become a subscriber A person becomes a subscriber by signing the memorandum as a subscriber, at the place intended for that purpose. If his name does not appear in the place where the list of subscribers and their addresses are specified in the memorandum, he cannot be treated as a subscriber even if his name appears on all other pages of the memorandum. In Arthanari Transport Pvt. Ltd. v. K.P. Sami Gowaden [35 Comp.cases 930] the plaintiffs, signed the bottom of every page of the memorandum of the company in pursuance of an agreement with the defendants to form a transport company. Disputes arose as to whether by such signature they became subscribers to the companys memorandum. Holding that they did not, the court held subscribers to a memorandum of association means not merely signing at every one of its pages, but signing their names as a token of entering into an agreement both as signatories forming themselves into a company but also as an undertaking to take the number of shares indicated against their names. We do not think that the plaintiffs signature elsewhere in the memorandum other than in token of being parties to a declaration as to the formation of the association and undertaking to accept the number of shares mentioned therein can be regarded as subscribing to the memorandum for they are not by their signature parties to the declaration which is the vital part of the memorandum. 3.4 PRE-INCORPORATION CONTRACT Before a company commences business it has to enter into several contracts and incur several initial expenses. These contracts are known as preliminary contracts and the expenses as preliminary expenses. Preliminary expenses can be either expenses incurred before the company is incorporated or after the company receives the certificate of incorporation but before commencing business. Preliminary expenses are treated as deferred revenue expenses and written off over a period of years. In accounting language this is known as amortisation.
The conflict on the legal status of pre-incorporation contract is very delicate to resolve. The general principle here is that no one can authorise another to do an act on his behalf before he himself comes into existence i.e., before the birth of the principal, a principal cannot appoint an agent because he does not have an existence. As such, promoters are not acting as agents of the company which is not yet born. Therefore, promoters are personally liable for all contracts entered into by the promoters even though they declare in the contract that they are acting for the prospective company. A company which is not yet born cannot be represented. So such contracts binds the promoters personally and not the company. Ofcourse if the promoters specifically stipulate in the contract that they are not personally bound, the contract infact becomes infructuous because nobody is bound by that Contract. Persons entering into a contract with promoters are required to be cautious about the role and status of the promoters. Contracts entered into on behalf of the company are required to be in writing signed by persons having the authority express or implied, for or on behalf of the company (Sec. 46). But such a contract can be made on behalf of the company only after the company is registered. In Seth Sobhagmal Lodha,Vs. Edward Mills Co. Ltd [(1972)42 Comp.Cas 1 (Raj)] the High Court of Rajasthan followed the Common Law decisions of England and decided that contract into on behalf of a company before its incorporation is not binding on the company. A Contract made on behalf of the prospective company cannot be ratified by the company after its incorporation on the ground that is possible. A company which is not in existence and hence cannot delegate is not in a position to ratify that act after it is incorporated. This principle is clearly enunciated In re English & Colonial Produce Co Ltd [(1906)2 Ch. 435] nor can the company claim any benefit under it [See NatalLand, Colonisation & Co Ltd V. Pauling Colliery and Development Syndicate Ltd (1904)A.C 120] According to Pennignton, a pre-incorporation contract cannot bind the company. It takes effect as a personal contract, and the promoters themselves are personally liable. But under Sec.230 of the Indian Contract Act, an agent cannot personally enforce a contract entered into by him on behalf of his principal nor is he personally bound by them. An agent is personally liable when his principal is undisclosed either both as to existence or identity or as to his identity only. Therefore, if a promoter enters into a contract with a landowner for purchasing a land for an industry without mentioning that he is acting only as a promoter the contract is personally binding on him. But if he discloses that he is acting on behalf of a proposed company and he is not personally liable for the contract no personal liability can be attached. Ofcourse, under the provision of Secs.15(h) and 19(e) of the Specific Relief Act of 1963 there is a marked deviation of Common Law principles on the matter of pre-incorporation contract. According to Sec.19(e) of the Specific Relief Act, specific performance can be enforced against a company where its promoters have before its incorporations entered into a 21
Contract for the purpose of the company and such contract is warranted by terms of incorporation, as for example by inclusion in the Articles of Association. Madras High Court has extended the principle by its decision in Weavers Mills Ltd Vs. Balkies Ammal [AIR 1969 Mad 462]. In this case promoters agreed to purchase some properties for and on behalf of the company to be promoted. On incorporation the company assumed possession and built structures upon it. It was held that the company adopted the benefit of the purchase as such the companys title over the property could not be set aside though there was no conveyance by the promoter in favour of the company after its incorporation. According to the Law Commission though a company cannot technically ratify a contract made before its incorporation, there would appear to be no reason why the company should not be entitled to take the benefit or burden of a Contract made on its behalf by its promoters by communicating its acceptance of the benefit or the burden to the other party to the contract. It is therefore clear that in Seth Subhogmal Lodha the provision of the Specific Relief Act was not brought to the notice of the Court. Ofcourse in some other cases the provisions of the Specific Relief Act was taken into consideration in order to arrive at a different conclusion. [Sec. Income Tax Officer Vs. Bhurangiya Coal Co Ltd (AIR 1953 Pat 298)] Pre-incorporation contracts are generally undertaken by the company after its registration either by (a) incorporating the contract in the terms of incorporation, as for example, by inserting the contract into Articles of Association, or (b) by entering into a fresh contract with the other party if the contract is executory or with the promoters if the contract is executed between the promoters and the other party. Ofcourse Weavers Mills Ltd has extended the doctrine of equity and stipulated that if the company accepts the benefit impliedly or expressly, the order of specific performance can be given to the company to perform the contract. 3.5 CONSTITUTIONAL DOCUMENT: MEMORANDUM Section 2(28) defines the memorandum thus : Memorandum means the memorandum of association of a company as originally framed or as altered from time to time. The definition does not throw any light as to the contents of the memorandum. But being the basic document of the company it must contain the fundamental provisions relating to its constitution. Section 13 to 15 contain the details with respect to the form and contents of the memorandum. The most important legal steps necessary in company formation relates to the drafting of constitutional documents. Every company has to prepare a memorandum of association. According to Sec 13 of the Companies Act, memorandum contains the following: (a) Name Clause: The name of the company with the word Ltd in case of Public Ltd company and with Pvt Ltd as the last words in case of Private Ltd company. 22
(b) State of the Registered office: The State in which the registered office is to be situated. It may be noted in this connection that at this stage the exact address of the registered office is not necessary though in most of the cases the practice is to specify the address of the registered office. The company has to have a registered office to which all communications and notices have to be addressed, and this is to be notified to the Registrar within 30 days from the day of incorporation. [See Sec. 146] (c) Object clause: The objects of the company as indicated below: (i) The main objects of the company to be pursued by the company on its incorporation. (ii) Objects incidental or ancillary to the attainment of the main objects. (iii) Other objects of the company not included above. [N.B] : Company registered before 1965 were required to state objects of the company without classification] (d) Liability Clause : (i) Company limited by shares or by guarantee shall also specify the nature of liability of the members to be limited [N.B. Liability of the member may be either limited by share or by guarantee] (ii) A company to be limited by guarantee shall specify that each subscriber undertakes or contributes to the assets of the company in the event of its being wound up while he is a member or within one year after he ceases to be a member for payment of the debts and liabilities of the company as well as other charges and other expenses. (e) Capital Clause : A company having a share capital shall state the amount of the share capital with which the company is registered (which is called as registered capital or nominal capital or authorised capital upto which the company can raise capital) and the division thereof in various classes of shares (equity and preference) of a fixed amount. (f) Subscribers Clause : Each subscriber shall sign the memorandum specifying his address, description and occupation and shall also specify opposite to his name the number of shares that he proposes to subscribe. No subscriber can take less than one share. (g) Witness : The memorandum has to be signed by the subscribers in the presence of atleast one witness who shall attest the signature and shall likewise add his address, description and occupation. The above clauses are obligatory in nature which means that the company must specify these clauses. According to Sec 16(2) these provisions shall be deemed to be conditions contained in the memorandum. It is often observed that memorandum of a company contains various other issues including issues relating to appointment of a Managing Director or a Manager or some
pre-incorporation contracts. These provisions are non-obligatory in nature. According to Sec 16(3) these provisions are given the same status as the provisions included in the Articles of Associations and can be altered in the same manner as the provisions in the Articles can be changed. The memorandum should be divided into paragraphs numbered consecutively and is required to be printed. Detailed discussion about each of these clauses of the memorandum specifying all related laws is discussed in the next topic. The Company Act contains draft forms of memorandum of association of various types of Companies in Table B,C,D & E of Schedule 1. 3.6 CONSTITUTIONAL DOCUMENT : ARTICLES According to Sec 2(2) Articles of a company means its Articles of Association as originally framed or altered from time to time in pursuance of the Company's Act. The regulation contained in Table A of Schedule 1 of the Companies Act, 1956 which is given in Annexure II in this volume is also to be included in the term Articles. Articles provide internal regulation and administration, distribution of the powers among the various agents and organs of the company. It provides for matters such as (1) conduct of the general meeting (2) the appointment of the Directors, their powers and conduct of its business by the Board (3) borrowing (4) issue of shares (5) transfer and transmission of shares (6) dividend (7) alteration of capital etc. All matters other than those required to be included in the memorandum under section 13 are the proper subject matter of the Articles. Articles optional in certain cases In the case of Public company limited by shares, the preparation and presentation of the Articles, along with the memorandum of association with the Registrar for registration is optional. In all other cases, the Articles shall be prepared, signed by the subscribers and presented to the Registrar along with the memorandum [Secs.26&27] If a public company limited by shares has not prepared its own articles, the model Articles in Schedule I, Table A, will be deemd to be the Articles of the company. [S.28(i)] Table A articles shall be read as part of the articles of all companies limited by shares in so far as they are not excluded or modified by the articles if any of the company concerned. [Sec.28] In Prayan Prasad and others v. Gaya Bank and Trades Association Ltd [(1931) 1 Comp.Cas 85] the shares of the appellant were forfeited for non payment of the amount due on those shares. The forfeiture was effected after giving notice to the appellants. But the notice served was not in compliance with Article 24 of table A of Company's Act, 1913. Holding that non compliance of the requirement under Art.24 of Table A rendered the forfeiture invalid . The court held in case of a company limited by shares, if articles are not registered or in so far as the articles do not exclude or modify the regulations in Table A in Schedule I those regulations shall, so far as applicable, be the regulation of the company in the same manner and to the same extent as if, they were contained in the duly registered articles.
Articles must be written into paragraphs consecutively numbered and signed by the subscribers specifying their respective address, description and occupation. Atleast one witness must attest the signature of the subscribers. He shall also specify his address, description and occupation. Articles shall be printed [See Sec. 30] A company limited by shares may adopt all or any of the shares contained in Table A of Schedule 1. Other types of Companies may draft an article in a form specified for various types of Companies in Table C,D & E of Schedule 1 of the Companies Act [See, Sec. 28 & 29] (Annexure I). 3.7 CERTIFICATE OF INCORPORATION 1. Application of Registration After preparation of the Constitutional documents , ie. Articles of Association and Memorandum of Association an application has to be made for registration of the company to the Registrar in the State in which the company is going to have its registered office. The application shall be accompanied with: (a) the Memorandum of the company (b) Its Articles if any (c) An agreement if any, which the company proposes to enter into with any individual for appointment as its Managing or whole time Director or Manager. (d) A Statutory declaration by an Advocate or a practising Chartered Accountant or Director or Manager or Secretary of the company certifying that all the requirements of this Act and the rules thereunder have been complied with in respect of registration, and (e) The registration fee If the Registrar is satisfied that all the requirements have been complied with he shall register the memorandum, the articles if any and other agreements and shall certify under his hand that the company is incorporated [See Sec 33 and 34(1)]. This certificate is known as certificate of incorporation. 2. Effect of Certificate of Incorporation : The certificate of incorporation is conclusive evidence that all the requirements of the companies Act, 1956, in respect of registration and matters precedent and incidental thereto have been duly complied with and that the company is a company authorised to be registered and duly registered under the Act (Section 35). Thus the certificate is not only proof of the companys birth, but also of its legitimate birth. It is also conclusive evidence that the company was rightfully born after the proper ante-natal procedure had been followed. (Pennington). In the result all registered companies are corporation de-jure. Since the certificate is conclusive evidence evidence of the companys rightful birth, any irregularity in connection with the incorporation of the company or matters precedent and incidental to it cannot affect the companys position as an incorporated body. The plea that the formation of the company
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is vitiated by viertal irregularities, or that the requirements of the Act have not been complied with, cannot be sufficient grounds to annal the incorporation. Thus in Mossa Gulam Arif v. Ibrahim Gulam Arif (ILF 40 Cal.1) all but two of the subscribers of a companys memorandum were infants who had no legal capacity to sign it. Held that the matter could not be reopened after the issue of the certificate of incorporation. The certificate of incorporation was conclusive proof of the fact that memorandum was duly signed by the required number of subscribers. In Oeels case [(1867) .2 Ch. App.674], the memorandum was altered so materially by a person after it had been subscribed by seven persons, but before registration, that the document could not be regarded as signed by the required number of subscribers. Though the alteration entirely neutralised and annihilated the original execution and signature of the document, it was held that the irregularity did not affect the birth and existence of the company as a legal person. Lord Cairns observed in this case: The certificate of incorporation is not merely a prima facie answer, but a conclusive answer to such objections. When once the certificate of incorporation is given, nothing is to be enquired into as to the regularity of prior proceedings. The conclusiveness of the certificate of incorporation prevents the reopening of matters prior and contemporaneous to the registration and essential to it. So even when the signatures of all the subscribers were forged, the certificate of incorporation is conclusive proof that the company was rightfully born. As a logical corollary, a subscriber cannot after the issue of the certificate of incorporation repudiate his subscription on any ground, though he may have a remedy against the wrongdoer. In Cotman v. Brougham [(1918-19) All E.R. Rep. 265]it was argued that the object clause of a company containing inflated objects was not in accordance with the requirements of the act. Though the contention was factually correct, Lord Wrenbury held that the matter cannot be reopened, as the certificate of incorporation was conclusive that the requirement of the Act had been duly complied with. Exception to the conclusiveness of certificate of incorporation It is true that the certificate of incorporation is conclusive evidence of the legitimate birth of the company and also of the due compliance of all matters precedent and incidental to the formation of the company. But there are two exceptions to the conclusive nature of the certificate of any result of a formal application, like an application for seire facias to repeal a charter, the company can be got rid of unless by winding up.
But a contrary view is taken by the House of Lords in Bowman v. Secular Society [(1917) AC 406]. It was held therein that proceedings could be instituted by the Attorney General to get the registration of a company formed for an illegal object cancelled. In the above case Lord Parker of Waddington observed- only by misconduct, or great carelessness on the part of the Registrar could a company with objects wholly illegal obtain registration. If such a case did occur it would be open to the court to stay its hand until an opportunity had been given for taking appropriate steps for the cancellation of the certificate of registration. It should be observed that - the Attorney General on behalf of the Crown could institute proceedings by way of certiorari to cancel a registration which the Registrar had improperly or erroneously allowed. In a recent case R.V. Registrar [(1991) BCLC 476], a prostitute managed to get her business registered as a company under the name of Lindi St Claire (Personal Services) Ltd. The main object as stated in the memorandum was to carry on the business of prostitution. On a petition filed by the Attorney General, the court cancelled the registration on the ground that the objects of the company were unlawful. 3. Date of Incorporation The company comes into existence as a legal person on the date mentioned in the certificate of incorporation as the date of incorporation.(Section 34(2)). Because of the conclusiveness of the certificate of incorporation, the matter cannot be reopened. In Jubilee Cotton Mills Ltd v. Lewis (1924 AC 958), the memorandum and other documents of a company was presented to the Registrar on 6th. The Registrar issued the certificate of incorporation on 8th, but put the date as 6th. Held that the company was incorporated on 6th and not on 8th as the certificate is also conclusive that the company came into existence on the date of the certificate. Accordingly the allotment of shares by the company on 6th was valid as the company was in existence on that date. 4. Commencement of Business A private Ltd company can straightway commence business on receiving the certificate of incorporation. It does not require any further trading certificate or certificate of incorporation. The main reason is that a Private Limited company does not require public subscription and it collects share capital from the subscribers and their friends and relations.
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4. DETAIL PROVISIONS OF CONSTITUTIONAL DOCUMENTS: MEMORANDUM

SUB TOPICS 4.1 Introduction 4.2 Name Clause (a) Choosing of name (b) Publicity need (c) Dispensation with Ltd (d) Alteration of the name (e) Procedure of alteration 4.3 Registered office (a) General Provisions (b) Change of Registered office 4.4 Object Clause (a) General Principles (b) Doctrine of ultra vires (c) Indian Law (d) Alteration 4.5 Liability Clause (a) General provisions (b) Alteration 4.6 Capital Clause (a) General provisions (b) Alteration 4.7 Association Clause 4.8 Annexures 4.1 INTRODUCTION Memorandum of Association is the fundamental document of registration of the Company. It overrides all other regulations including provisions of Articles of Associations. Any person entering into contract with the Company is supposed to have knowledge about this instrument. The Court has to interpret about the provisions of Articles of Association in consistency with the memorandum of Association. In case any provision of Articles is irreconciliable with the Memorandum, the memorandum prevails. Once corporate lawyers used to argue about the status of memorandum vis-a-vis the Company as if it was the same as a Constitution to the State. Naturally the Legislative policies with respect to the amendment of the two constitutional documents viz.(1) the memorandum and (2) articles of association are entirely different. The provisions in the memorandum being the essential and fundamental conditions of incorporation are treated as normally unalterable. The Articles being a document dealing with matters of internal regulation and administration are made freely alterable. These conflicting policies are evident from the following provisions. Section 16(i) which embodies the legislative policy as regards the amendment of the provisions in the memorandum reads :A company shall not alter the conditions contained in its memorandum, except in the cases in the mode and to the extent for which express provision is made in the Act. On the other hand, section 31(1) dealing with amendment of the provisions in the articles reads :Subject to the provisions of this Act and to the conditions contained in the memorandum a company may by special resolution alter its articles. When the Joint Stock Companies Act, 1856 (U.K.) split the 'deed of settlement into the memorandum of association and articles of association the obvious purpose was to separate the basic provisions of the constitution from those dealing with matters of internal regulation and to place the former beyond the amending process (Palmer). Though the statute of 1856, did not expressly prohibit amendment of the provisions in the memorandum, the Companies Act, 1862 made explicit that except in two cases no alteration shall be made by any company in the conditions contained in its memorandum of association. The legislative intention was to provide a rigid constitution for the registered company. But later, it was realised that business organisations cannot function effectively with an absolutely rigid constitution. Business exigencies and commercial needs may require a company to change the provisions in its memorandum from time to time. Hence rigidity was gradually relaxed. Now the Companys Act has incorporated many provisions which empower the company to amend all the provisions in the memorandum except the liability clause and association clause. The grounds on which such alterations are permitted cover almost all exigencies for alteration. Thus a strictly rigid constitution under the 1962 Act (England) has been transformed today into a constitution of utmost flexibility. It is true that the alteration must be carried out in the mode stipulated by the Act and only for the purposes specified therein. [Secton 16(i)]. But even in respect of the obligatory clauses in the memorandum the company enjoys wide powers of alteration. On account of all these there is today no meaningful distinction between the memorandum and the articles (Gower). Still from the procedural angle the distinction between the two documents is substantial. The procedure for alteration of the provisions in the articles is comparatively simple. But the statute has stipulated different and sometimes cumbersome procedures for the amendment of the different obligatory clauses in the memorandum. A strict compliance of those procedural steps are insisted upon. 4.1 NAME CLAUSE The first paragraph in the memorandum is the name clause. It states the name of the company. The identity of the company 25
as a separate legal person can be established only through its name. In the case of a limited company, whether limited by shares or by guarantee the last component of the companys name shall be limited or private limited (private company) or any abbreviation of such word (eg., Ltd., Pvt. Ltd., (P)Ltd.) Sec.13(1) the purpose of insisting on the use of the word limited as a component of the companys name is to give a constant notice to third parties that unlike in the case of a partnership firm the liability of the members is limited. (a) Choosing the name There is no legal requirement as to what shall be the name of a company. It may be indicative of the name of the controlling shareholder or of the business activities of the company or neither. Usually the name is choosen by the companys promoters, whose freedom in doing so is curtailed in two ways:(1) The power of the Central Government under Section 20. (2) The common law restrictions. (1) The Central Governments Power: Though the companys name is choosen by the promoters, it is subject to the previous approval of the Central Government. Section 20(1) provides that no company shall be registered with a name which in the opinion of the Central Government is undesirable. Any name which is identical with or too nearly resembling the name of mother company will be deemed to be an undesirable name. [Section 20(2)] The Central Governments power under the section is discretionary and not confined to the cases specified in section 20(2). But difficulties and hardships may be caused to company promoters if the Registrar refuses registration on the ground that the name of the proposed company is undesirable. To avoid this facilities are available for consultation before hand about the acceptability of a proposed name. Now an application can be made by the company promoters to the Registrar in the prescribed form (Form 1A) seeking the availability of the proposed name. If permission is granted, the name will be reserved for the use of the proposed company, for a period of 90 days. The company may be formed within this period. In 1962, the department of Company Affairs have issued a circular containing the guidelines to be followed in deciding whether a name is desirable or not. If the proposed name is not in consonance with the principal objects of the company as stated in the memorandum or if it has a close phonetic resemblance to the name of an existing company or it is likely to produce a misleading impression regarding the scope or scale of is activities, it will be an undesirable name in the opinion of the Central Government. (2) Common law restrictions: In addition the law restrains a proposed company from using an undesirable name under The Emblems and Names (Prevention of Improper use) Act,1950. Further in choosing the name of the company the Promotors should ensure that they 26
are not guilty of the tort of passing off. If they choose a business name which cause the public to confuse the company with some other existing business, the company may be prevented from using such name. This right is independent of and unconnected with the power of the Central Government under the Act. The legal basis of a passing off action is on the proprietary right of the plaintiff which is the goodwill of the business rather than the business name. (b) Publicity in respect of the name On incorporation a company must give due publicity of its name. It must be exhibited at the outside of every office or place where its business is carried on. Its name shall also be engraved on its seal. The name and address of its registered office shall be mentioned in all its business letters, bill heads, letter papers notices and other official publications, failing which the company and the officers in default may be penally liable (Section 147). (c) Dispensation with the requirement of limited. as a component of the name Section 25 contains an exception to the rule that the word limited shall be the last component of the name of a limited company. It is with respect to non commercial association incorporated as companies. The Central Government may by licence exempt such companies from the requirement of limited added as a component of the companys name on being satisfied that : (1) The association to be formed as a limited company is for the promotion of commerce, art, science, religion, charity or any other useful object. (2) Such company intends to apply its profits and other name in promoting its objects. (3) Payment of dividend to the members is prohibited. The licence may be granted on such conditions and subject to such regulations as the Central Government may think fit. (d) Alteration of the Name Section 21 and 22 deal with the alteration of the name clause. The alteration may be optional or obligatory. (i) Obligatory Change: Section 22(1)(b) empowers the Central Government to issue directives to a company to change its name. The company shall comply with such direction within 3 months of the receipt of such direction or such extended time as the Central Government may allow. The Central Governments power under this section is subject to the following conditions. (1) It is available only when the registered name of the company is, in the opinion of the Central Government, identical with or too nearly resembles the name of an existing company registered under the present Act or any of the previous Acts. (The Central Governments power is now delegated to the Regional Director). This type of alteration is known as alteration by rectification. (2) The direction is issued within 12 months of the registration of the present name of the company.
Failure to comply with the direction issued under the section will fasten penal liability on the company as well as the officers in default. [S..22(2)]. An alteration under this section can be carried out by passing an ordinary resolution. (ii) Optional change: A company may suo moto, change the name by amending the name clause in two situation. (1) When the name is identical with or too closely resembling the name of another company in existence [Sec.22(i)(a)]. (2) In any case where the company decides to change the name (Sec.21). (e) Procedure of Alteration The following are the procedures of alteration : (1) In all cases of change of name, the previous approval of the Central Government is necessary. The power of the Central Government has now been delegated to the Registrar of companies. (2) Obligatory alteration may be carried out by passing an 'ordinary resolution, but optional alteration warrants a special resolution. (An ordinary resolution requires only a simple majority, whereas a special resolution requires a 3/4th majority). (3) A certificate copy of the resolution effecting the change of name along with certified copies of the memorandum and articles along with some other documents are filed with the Registrar for the issue of a fresh certificate of incorporation incorporating the change of name. On the issue of the fresh certificate the change takes effect. The fresh certificate issued in consequence of the change of name does not affect the rights and liabilities of the company which continues as the same legal entity [Sec.23(3)]. In this connection the Supreme Court held that the Legal proceedings commenced prior to the change of name may be continued after the change. Even the proceedings commenced in the old name after the alteration are treated as instances of misdescription only, rectification of name will be allowed. 4.3 REGISTERED OFFICE (a) General Provisions The second paragraph in the memorandum is the registered office clause which merely states the State in which the registered office of the company is situated. The registered office clause merely states the State within which the registered office is situated and not the address of the company or the place where it is situated. The situation of the registered office of the company is a matter of vital legal significance, as it determines which Registrar and High Court are having jurisdiction over it. It also determines the domicile and nationality of the company, though not its residence. Within thirty days of its incorporation or on the day on which it
commences business whichever is earlier, the company shall have a registered office [Section 146(i)]. Notice of the situation of the registered office shall be given to the Registrar within 30 days of incorporation. If the situation of the registered office is changed at any time, notice of such change shall also be given to the Registrar within 30 days of the change. [Section 140(2)]. Since the memorandum only indicates the State wherein the registered office of the company is situated, the location of the registered office may be changed from time to time within the State without amending the registered office clause. But notice of such change shall be given to the Registrar. All notices and other communications to the company are sent to its registered office. Many important records and registers have to be kept at the registered office. The following are some of them:(1) Registered of members [Section 163(1)] (2) Register of Debenture holders [Section 163(1)] (3) Register of Directors [Section 303] (4) Register of changes [Section 143] (5) Books of account. [Section 209] (b) Change of Registered Office Clause [Ss.17 to 19] A company may change its Registered Office:(1) from one place to another in the same city, town or village, or (2) from one city, town, or village to another city, town or village in the same State, or (3) from one city town or village in one State to another city, town or village in another State. As the registered office clause merely states the State wherein the Registered Office is situated, alteration of the Registered office clause is required only in the last case. In the first case change may be effected by a Board resolution. The second case requires permission of the general meeting by a special resolution [Section 146(2)]. The procedure for amendment of the Registered office clause is the same as that for the object clause. Procedure of Alteration (a) The Company has to pass a special resolution so as to change its registered office from one place to another. (b) Apply to the Company Law Board (i.e., CLB) for confirmation of the alteration. (c) Notice to be given to every debenture holder and every other person whose interest may be affected by the alteration. (d) The consent of every creditor who is entitled to object the change of the registered office must be obtained or his claim be secured to the satisfaction of CLB. (e) The CLB shall cause notice of the petition for confirmation of alteration to be seen on the registrar who may also state his objections or suggestions. The CLB generally consider the following matters before approving the Change. 27
1) 2) 3) 4)
the interest of the company and its members; public interest; interest of the creditors; and bonafides of the company in seeking the amendment.
persuasive force in regard to change of office from one State to another is to rob section 17 of the Companies Act of the statutory power conferred on a company to change its registered office and also to impose upon the statute a limitation with regard to change of registered office." In Minerva Mills Ltd. v.Govt.of Maharashtra [(1975) 45 comp. cases 1]the petitioner company,the registered office of which was situate in the State of Maharashtra, passed a special resolution amending clause 2 of the memorandum to change its registered office to to the State of Karnataka and filed a petition under section 17 for confirmation of the resolution . The State of Maharashtra opposed the petition on the following among other grounds.(i) the amendment was not in the interest of the company (ii) the sanctioning of special resolution would affect adversely the general economy of the State. On the various issues which come up for consideration the court held:(i) though there is no express provision in the Companies Act which requires that notice of a petition to shift the registered office of a company from one State to another State must be given to the former State, the court has the power to direct notice of the petition be given to any person other than those mentioned in clauses (3) and (4) of Section 17. (ii) A State from which the registered office is to be transferred and which is served with a notice under section 17(3)(a) can oppose the petition only on the ground on which it is entitled to be served with that notice viz., on the ground of its adverse effect on some specific pecuniary or proprietary interest of that particular State and not on regional considerations or on the vague ground of the effect of the shifting of the registered office on the general economy of the State which must necessarily be involved in every case... The State is not entitled to assume the role of the protector of the interests of the share holders of the company or its workmen or the public at large. In the instant case the court held that the State could object to the alteration in its capacity as a creditor of the company in respect of arrears of Sales Tax. 4.4 OBJECT CLAUSE (a) General Principles: The basic philosophy of Corporate identity in so far as reflected in object clause has undergone a sea change. The traditional idea and purpose of the object clause is given in Cotman V. Brougham [(1918)A.C. 514], Lord Parker of Waddington has stated the purpose of the object clause to be this. It is intended to serve a double purpose. In the first place it gives protection to subscribers who learn from it the purposes to which their money can be applied. In the second place it gives protection to persons who deal with the company and who can infer from it the extent of the companys powers. In other words the object clause enables the shareholders creditors and those dealing with the company to know what is its permitted range of enterprise. The object clause operates in a two fold way: (i) it affirmatively determines the powers of the company. The company has power to indulge in all activities which are
Can the State object to the Change of the Registered Office? The question whether the State in which the Registered Office of the company is presently situated has any locus standi to object to the change of the registered office to another State was considered by many High Courts. The decisions are conflicting. In Re Orissa Chemicals and Distillers Ltd., [AIR 1961 Ori 162 or (1962)32 Comp, cas.497].the Company which was engaged in the business of manufacturing the dealing in Sugar and allied products had its registered office in Tharsuguda (Orissa). A special resolution was passed to change its Registered office to the Masulipatnam (Andhra Pradesh). The Company presented an application to the company court for confirmation of the resolution. (Before the Amendment Act, 1958 the jurisdiction was vested with the court and not Company Law Board). The issue for the consideration of the court in this case was whether the State of Orissa had any locus standi to oppose the application. The objection was mainly based on the plea that the proposed alteration would seriously affect the State of Orissa and deprive it of a considerable source of revenue. The company argued that these matters are irrelevant for deciding an application under Section 17 and the confirmation of the court should be based on consideration of grounds specified in grounds (a) to (g) of section 17(i) only. Other considerations should not be allowed to prevail. Rejecting the contention of the company [S. Burman J. held: It is clear from section 17(3)(a) that the State of Orissa is a person whose interest, in the opinion of the court be affected by the alteration]. But in Mackinnon Mackenzia & Co Pvt,Ltd. In re [(1967)37 Comp.cas.516] a contrary view was taken by the Calcutta High Court. The Registered office of the petitioner company was situate in Calcutta (West Bengal). The company passed a special resolution substituting the existing clause 2 of the memorandum by the following clause: The Registered office of the company will be situated in the State of Maharashtra. The application filed by the company under Section 17 for confirmation of the alteration was contested by the State of West Bengal, on the ground that it would result in a loss of revenue to the State. To the question whether the State has any locus standi to object the application filed under S.17, A.N. Ray. J. (as he then was) held that the State has no right of its own to be heard. Section 17 does not treat the State as an entity entitled to notice or to be heard. To the argument that since the change of registered office would affect the revenue of the affected State, it must be treated as an interested person, his Lordship observed: The question of revenue if it falls for consideration is to be considered on the basis of the integrity of the Republic of India and not in a sectional and parochial manner. To hold that the possibility of loss of revenue is not only relevant but of 28
reasonably necessary or ancillary to the attainment of the objects pursued by the company. (2) it restricts the powers of the company to those which are reasonably necessary or incidental to the objects pursued by the company. Any activity which transgresses the limits so set out has no legal validity. Such an act is an ultra vires transaction. Palmer points out that the subscribers not only initiate the creation of the company but also determine the purposes for which it is formed. Subject to the following limitations, the object clause of a company may contain any business purpose as its objects. The limitations are :(1) The object clause must not contain anything in contravention of the Companies Act or allied statutes. (2) The objects stated must not be in contravention of the general law. For example, a company cannot have its objects, the promotion of untouchability. (3) The objects shall not have the effect of rendering the company to trade union. The conservative and traditional British Courts followed a positive theory of prescription. According to the Common Law judiciary the object laid down in the memorandum stipulates the character of personality and strictly delimits the Corporate existence. British Courts strictly interpreted the object clause and used to consistently follow the decision in Eastern Countries Railway Vs. Hawkes [(1855)5 HLC 331], in which it was laid down that it must therefore be now considered as a well settled doctrine that a Company incorporated by an act of Parliament for a special purpose cannot devote any part of its funds to object unauthorised by the terms of its incorporation, however desirable such an application may appear to be. Similarly in Ashbury Rly Carriage & Iron Co Ltd Vs. Riche [(1875)L.R 7 HL 653] explaining the same principle that an act done not strictly included in the object clause of the memorandum was ultra vires the Company and therefore altogether void, Lord Cairnes held : objects for which the proposed Company is to be established, and the existence, the coming into existence, of the Company is to be an existence and to be a coming into existence for those existence alone. Therefore, in laying down the objects in memorandum it is always necessary to be extremely careful while drafting the memorandum. The British Cours did not allow an act permissible because the memorandum "contained all other acts what the Board deems it necessary. According to the Court other clauses only include those acts which were necessary and essentially for the purpose of conducting the main object. This type of strict interpretation give rise to the doctrine of ultra vires. (b) Doctrine of Ultra Vires : Palmer has given the following reasons for the development of rule of ultra vires: (i) as a matter of Constitutional Law, Parliament as a sovereign power in the country does not grant more power to delegated bodies than it has authorised; and
(ii) as a practical consideration it was thought that the rule would protect investors in the company and creditors of it against the unauthorised use of funds. According to Bullantine on Corporation, the theoretical justifications for the principle of Ultra Vires are : (i) that the intending shareholders who contemplate an investment in business enterprise should know within what lines of business in monies to be put at risk. Prof. Gower puts this as ensuring an investor in a gold mining Company not suddenly finding himself holding shares in a fried fish shop ; (ii) that the Directors and Management may know within what lines of business they are authorised to act; and (iii) that anyone who shall deal with the Company may ascertain if he is able to read and construe the charter whether a Contract or transaction into which he contemplates entering is one within the general authority of the management. Ultra vires may either be substantive or procedural. Where the object clause does not provide an act, the Company is not bound by the act because there is a lack of legal capacity to incur responsibility for the action. This is a substantive ultra vires. A procedural ultra vires is one where there is no lack of power or capacity of the Company but the organ of the Company which has done the act does not have the power or has exceeded the power. A procedural ultra vires act nevertheless binds the Company because an outsider is not always expected to know the power arrangement unless such power arrangement is provided in the memorandum or articles. [See Royal British Bank Vs. Tarkunde (1856)6 E.B. 627] Substantive ultra vires however is decisive and a Company is not bound by such an act. Every person entering into a Contract by the Company is presumed to have the knowledge about the Constitutional documents of the Company. An act may be ultra vires per se as well. As for example, a Company purchasing its own share was held to be doing an act which is ultra vires per se even though the articles empowered the Company to do so. [Trevor Vs. Whitworth (1887)12 A.C 409] Similarly a Company paying dividend out of its Capital is per se ultra vires even though empowered by the articles. [Guiness Vs. Land Corporation of Ireland (1882)22Ch.D 349]. During the middle of the 20th century many authors as well as judges of England and America started questioning the validity of the principle of ultra vires. The movement started slowly with Belhouse Ltd Vs. City Wall Properties Ltd [(1966)36 Comp. Cases 779] In this case the object clause included the power to carry on any other trade or business whatsoever, which can, in the opinion of Board of Directors, be advantageously carried on by the Company. The Court held that the object is quite in order. Many disadvantages of the principle of ultra vires and its impracticability were noticed. A presumption of notice often becomes very difficult to sustain if a contract is afterwards avoided on interpretation. That is not covered by the object if the Company puts an innocent party into difficulty. No except every person who deals with a Company or uses a 29
Companys products to have knowledge of the Memorandum is not a practical proposition as the judge observed in Re John Banforte (London) Ltd [(1953)Ch. 131] . It also creates difficulties for the management for interpreting objects at every stage. Many of the authors in USA empirically tried to prove that the shareholders invest in the Company not liking or disliking the business of the Company. In most of the times most of the shareholders are ignorant about the range of activities that their company is against to. Empricially it is established that investing public primarily invest trusting the management. And therefore, they like the management to earn profit efficiently if necessary, with product variation. They do not mind their management to run fried fish shop if gold mining becomes uneconomic. Cohen Committee in its report very rightly suggested doctrine of ultra vires as illusory protection to the shareholders which the shareholders themselves discarded long back. In fact the rigid approach of the Common Law Court induced the Corporate Lawyers to include a very large number of unnecessary powers to the object clause which Lord Werenbury condemned though not unlawful. In recent times the principle of ultra vires has become teethless, due to circumventing commercial practice. Further comments on the issue shall be made later. (c) Indian Law : The pernicious practice of writing the object clause of a Company including all possible activities is very much in practice in India. This is an outcome of right application of ultra vires. In order to curb the above practice of inflating the object clause Section 13 was amended by the Amendment Act 1965. Now it is required to divide the object clause into two parts viz., (i) the main objects along with objects (powers) incidental or ancillary to the main objects (each to be stated separately); and (ii) the other objects of the company. Thus, after 1965, the powers of the company if included in the object clause has to be stated separately. But Indian Courts are still greatly influenced by the British Courts in this matter. Supreme Court in Dr. Lakshmanaswami Mudaliar Vs. LIC [(1963)33 Comp.Cases 420(S.C)] held that acts incidental must have reasonable proximity with the main object specified. An object is required to be differentiated from power. Powers are necessary ingredient to attain objects. For example, the objects of a textile manufacturing company is to manufacture and sell textile goods. For this it may have to enter into various transactions such as service contracts with technical personnel, colloboration agreements, purchase of landed property and materials, operation of bank accounts, etc. These transactions are not the objects, but only powers which may be necessary or incidental to the objects. Similarly borrowing money cannot be an object of the company, it is only a power which a company may exercise in the pursuit of its object.
In the strict sense powers shall not be included in the memorandum of a company as its objects. But in practice it has become customary to include in the object clause a catalogue of powers also. In the result it has become difficult to find out by a perusal of the object clause the real objects of the Company. In the words of Lord Wrenbury in Cotman Vs. Brougham [(1918) AC 514] the function of the memorandum is taken to be, not to specify, not to disclose, but to bury beneath a mass of words the real object or objects of the company with the extent that every conceivable form of activity shall be found included somewhere within its terms. (d) Alteration : The object clause being the most fundamental provision in the companys constitution was originally thought to be unalterable. The Companies Acts, 1862 (U.K) and Company Act 1866 (India) explicitly prohibited alteration of all the provisions in the memorandum except the capital clause. But realising that the regidity of the object clause is an obstacle in the way of legitimate expansion of a companys business, subsequent statutes permitted alteration for certain specified purpose. The purposes for which alteration was permitted were extended from time to time. Now amendment of the object clause is permissible under the Companies Act, 1956 for the seven purposes specified in section 17(1). The grounds specified therein are so wide that almost all alterations would be covered by one or more of them. Palmer says, It is extremely unusual to find an alteration of objects which cannot be brought under one head or another (24th edn. par.9-40). Gower observes that, the rigidity of the memorandum has long since been relaxed (Gowers principles of Modern Company Law. 4th Edn.) Thus within a period of less than hundred years the legislative policy has completely reversed regards amendment of the object clause. Grounds for alteration of the object clause: Section 17(1) has laid down seven grounds which may be invoked by a company to amend its object clause. The grounds are : (a) to carry on its business more economically or more efficiently; (b) to attain its main purposes by new or improved means; (c) to enlarge or change the area of its operations; (d) to carry on some business which under existing circumstances many conveniently or advantageously be combined with the business of the company; (e) to restrict or abandon any of the objects specified in the memorandum; (f) to sell or dispose of the whole, or any part of the undertaking or any of the undertakings of the company; (g) to amalgamate with any other company or body of persons. Since the companys powers are positively and negatively determined by the object clause, its amendment may be necessary if the company has to enter into transactions which at present are not warranted by the object clause. Now let us examine these provisions:
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(i) carrying on the business more economically or more efficiently The amending power under this clause is a very limited one. An alteration on this ground does not contemplate change of business. The original busines must remain the same as before. The amendment must only affect the mode of conducting the business. A company which had suspended its business of interior decorators and house furnishers altered the object clause to embark upon the business of financiers. Held, the alteration could not be permitted under this head [In Re Drages (1942)1 All ER 194]. This clause permits an alteration which would enable the company to carry on its existing business with greater economy and efficiency. In re scientific poultry breeders Association [(1933) CR.413] the company was formed to encourage poultry breeding without any profit motive, altered its object clause to empower the company to pay equitable remuneration to its governing body members, was held to be permissible under clause (a). (ii) to attain its main purpose by new or improved means If an industry is to survive, it has to keep pace with scientific and technological advancement. Adoption of new and improved means of production and distribution may necessitate the alteration of its object clause. But alteration under this head is permissible only for attaining the main purpose of the company. The word purpose has a more restricted meaning than the term object. The alteration to be valid under this head must be to carry out the mainpurpose of the company more effectively and efficiently. In re Government Stock Investment Co. [(1891) 1 Ch. 649] the object clause as originally drafted provided that the object was to make investment in government securities. The alteration of the object clause to enable the company make investment in other kinds of securities also was held to be not within the ambit of this head. (iii) To enlarge or change the local area of operation. A company may want to change or enlarge the area of its business operation. For example suppose the object of a company is to trade in a particular commodity in the State of Tamilnadu. Due to adverse market conditions in Tamilnadu, the company may desire to change the area of operation to Karnataka. For this, amendment of the object clause is necessary. Similarly, for expansion of the area of operation amendment of the object clause may be required. All these alterations can be done under S.17(1)(c). (iv) Additional business: Sec.17(1)(d) gives powers to the company to amend the object clause for the purpose of carrying on any new or additional business. The power of the company under this clause is very wide. Though the language of sec. 17 (1)(d) is somewhat restricted as it envisages only those additional or new business which can be "conveniently or advantageously combined with the existing business, but the courts have interpreted, this
provision liberally. In many cases it has been held that the new business need not be connected with or similar to the existing business. A business which is wholly different from the existing business can be undertaken provided the new business is capable of being conveniently or advantageously combined with the existing business. In Re Ambala Electric Supply Co. ltd. [(1963)33 Comp. Cas. 583] a company which was engaged in the business of generating power was allowed to alter the object clause for the purpose of carrying on cold storage and other allied business. Similarly in Re Parent Tyre Co.ltd. [(1923)2 Ch.222] the existing business consisted of holding large investments in two other companies. The object clause of the company was altered with a view to carry on the business of bankers, financiers, underwriters and dealers in secdsurities. Though the new business was not similar to the existing business, it was held that the alteration was within the purview of S.17(1)(4). A company formed to manufacture textile goods was allowed to amend the object clause under s.17(1)(d) to enable it to carry on the business of alcohol production. [See Straw Products v. Registrar, AIR 1969 Orissa 91] Whose discretionary power: As seen above, amendment of the object clause under section 17(i)(d) is conveniently or advantageously combined with the existing business. But who is to decide this ? Theoritically it is within the power of the court (now CLB) to take the ultimate decision; for the alteration becomes operative only if the sanction of the court is given to it. But the matter being a business proposition the courts are generally reluctant to substitute their wisdon to the foresight of the business community. In Re Parent Tyre Co. [(1923)2 Ch 222] Lawrence.J. observes:It is essentially a business proposition, whether an additional business can or cannot be conveniently or advantageously carried on under the existing circumstances with the business of the company. The additional business may be one which is different from the original business and yet may well be capable of being conveniently and advantageously combined with the business which is being carried on. In Straw Products Ltd. v. Registrar of Companies [AIR 2969 Orissa 91] the petitioner company amended its object clause in the memorandum by inserting new provisions to enable the company to embark upon many new business activities which were not akin to the existing business of the company. The amendment also sought to empower the company to make donations. Holding the amendments to be valid ,B.K.Mohanty J.observed: The proposed step can be justified on the basis of section 17(1)(a)which is of very wide import and it can be said that the company by contributing to the funds to political parties would be carrying on business more efficiently.True it is that the court,has a discretion to confirm or not to confirm an alteration even if the conditions laid down in section 17 are satisfied.But it has to be borne in mind that it is primarily for the company to decide whether it is for its good that it should make such contributions and it is not for the court to tell the company as to how it is to carry on its business.
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NOTE: Now certain companies are prohibited from making political contributions. As regards others, ceiling is imposed (Refer sec.293-A). Similarly in Re Dalmia Cements (Bharath)Ltd.[(1964) 34 Comp. Cases 729], the petitioner company was engaged in the manufacturing cement and allied products. The petition was filed for confirmation of a special resolution passed by the company to amend the object clause with a view to embark upon the business of exporters. Holiding that the alteration falls within the purview of section 17, Rangasamy Iyengar J. of the Madras High Court held:Section 17(1)(a) and (d) has employed language of wide amplitude and it is difficult to confine its scope by a statement that it will be applicable to this or that situation. Whether a company can carry on its business more economically or more efficiently is a matter for the judgment of the Directors. They alone are best fitted by reason of their experience in the particular business to decide whether the business can be carried on more economically or more efficiently by adding fresh objects. The Court of course, on given facts may apply its mind and see whether the Directors may reasonably and fairly form that opinion. I consider that the court can do no more about it. Limitation on the power of alteration: The Companys power to embark upon new business under s.17(i)(d) though very wide, is subject to certain limitation. The most important one is that new business shall not be prejudicial to or destructive of the existing business of the company. Similarly no new busines can be embarked upon the suspending or terminating the existing business. (iv) Amalgamation: Amalgamation is the process of fusion of two or more companies into one. If such a power is not given by the object clause Section 394 gives jurisdiction to the court to sanction an amalgamation or arrangement. [Marybong and Kyel Tea Estate Ltd. Re (1977) 47 Comp. cas. 802]. Procedural requirements: The first step to be taken for the alteration of the object clause or registered office clause is the passing of a special resolution at a general meeting. Within 30 days of the passing of the special resolution a copy of the same has to be filed with the Registrar (s.192). The next step is to file a petition before the Company Law Board for confirmation of the alteration. Atleast one month before the filing of the petition a general notice about the amendment shall be given by publication in two newspapers, one in English and the other in the principal language of the District where the registered office of the company is situate. Individual notice of the petition shall be given to all the debenture holders and other creditors of the company. The petition before the Company Law Board shall be accompanied with copies of the memorandum, articles, notice calling the meeting, special resolution, etc. Wide power is given to the Company Law Board either to confirm the alteration or to reject it. Alteration may be confirmed either wholly or in part and on such terms and conditions as it may think fit. 32
Though the concerned Registrar shall be given a reasonable opportunity to be heard, the state where the registered office of the company is situate has not statutory right to be heard on a petition under section 17. But the CLB regulation provides that where the registered office is changed from one state to another notice of the petition shall be served on the concerned states. If the Company Law Board has confirmed the alteration, a certified copy of the order together with a printed copy of the memorandum as altered shall be filed with the Registrar. This shall be done by the company within a period of 3 months from the date of the order of the Company Law Board. The Registrar will issue a fresh certificate within one month from the filing of the documents [S.18(1)]. The certificate is conclusive evidence that all the requirements with respect to the alteration and confirmation thereto have been duly complied with. Consequences of failure to file the order of CLB within the stipulated period If the company fails to file the order of the Company Law Board within the period as specified in sec.18(1) the order becomes voide and inoperative [sec.19(2)]. But before the expiry of 3 months from the date of the order of CLB, the Company Law Board may extend the period for filing of the order with Registrar. In such a case the order can be filed within the expected period [s.18(4]. An order which has become null and void may be revived by the Company Law Board on sufficient grounds, if application for the same is made within a period of 1 month from the date on which the order became void [proviso to s.19(2)]. Sections 18(4) and Proviso to section 19(2) compared The power of the CLB under S.18(4) to extend the period for filing its order with Registrar, only when it is alive. The power under section 19 arises when the order has become null and void on grounds of failure to file with the Registrar within the stipulated period. Amendment Act, 1974: Before the Companies Amendment Act, 1974, the application for confirmation of the alteration had to be made to the court. The jurisdiction was transferred to CLB by the Amendment Act, 1974, to give effect to the recommendation of the Administrative Reform Commission. Differences between the English Law and Indian Law: The English Law on the topic is entirely different. Though the grounds for the alteration of the object clause were the same as in our Law, the Companies Act, 1948, dispensed with requirement of confirmation by the court to give effect to the alteration. On the other hand the English statute conferred a right to the dissenting minority to apply to the court for cancellation of the alteration. The Companies Act, 1985 retained the same provision. But the Companies Act, 1989 effected radical changes as regards the amendment of the object clause. Under the new provision (sec.4) a company may by special resolution alter its memorandum with respect to the statement
of the companys objects. The power is not fettered by any restriction or condition, though the dissenting minority of members (holding not less than 15% voting rights) or debenture holders holding not less than 15% of the companies debentures may apply to the court for cancellation of the alteration. 4.5 LIABILITY CLAUSE (a) General Provision : The memorandum of a company limited by shares or guarantee must state that the liability of its members is limited. The limited liability clause, whether of a company limited by guarantee, or by shares, merely states that liability of the members is limited. It does not indicate either the nature or extent of their liability. In the case of a company limited by guarantee, the next paragraph will be guarantee clause. It contains the undertaking by the subscribers that in the event of the company being wound up while he is a member or within one year after he ceases to be a manner, for payment of the debts and liabilities of the company incurred before he ceased to be a member. The undertaking is to pay such sum as may be required to discharge such debts and liabilities but not exceeding the amount specified therein. It is this clause which determines the nature and extent of the liability of the members in a guarantee company. A company registered under sec 25 obtaining a licence from the Central Govt exempting the use of the word Ltd or Pvt Ltd as the case may be, in its name must also specify in the memorandum that the liability of its members is limited. (b) Alteration : The Companies Act does not include any amending or alteration provision in so far as liability clause is concerned. Though it is theoritically possible to alter the liability limited by shares to the liability limited by guarantee or vice-versa. Sec 32(1)(a) provides for a fresh registration of an unlimited Company into a limited Company or re-registration of a limited Company into an unlimited Company. Such a re-registration will necessarily involve amendment of a Constitution and re-submission of the Constitutional documents and undertaking other registration formalities. Ofcourse, such registration of an unlimited Company into a limited Company shall not affect any existing debts and liabilities before the Company is thus registered. 4.6 CAPITAL CLAUSE (a) General Provisions The memorandum of a company limited by shares or of a company limited by guarantee and having a share capital will also contain a capital clause. This clause states the authorised capital of the company. Authorised capital is the nominal value of the maximum number of shares which which the company is authorised to issue to the members at any time. It does not include the premium if any collected on the shares. The premium does not constitute part of the capital though for
many purposes it is treated on a par with capital. Under Indian law shares should have a specified nominal value. But many other legal systems permit the issue of shares with no nominal value. If the company intends to issue more than one class of shares the capital clause must divide the authorised capital into shares of different classes and fix the nominal value of each class. As regards companies, whose shares are not dealt with on recognised stock exchanges the nominal value should be in accordance with the listing agreements. The modern practice is to fix the nominal value of the shares at a small amount so as to attract maximum number of people to apply for and subscribe in the shares. While fixing this authorised Capital a Company has to carefully analyse its future needs because if it prescribes a lower amount it will not be able to raise further capital from the people in the event of need for future expansion or growth. There are professionally competent persons who give appropriate advice. One has to keep in mind therefore, the possibility of future growth, expansion, diversification and product variation in order to prescribe the authorised capital. But at the same time it is also necessary not to prescribe an unrealistic quantum of authorised capital mainly for two reasons - (i) it may enable the management to over-capitalise the Company for covering up managerial inefficiency, (ii) it may attract registration charges. (b) Alteration Change of nominal capital may mean either increase of share capital or decrease of share capital. The relevant sections of such alteration are Ss.94A, 97 and 100. These provisions were discussed in the Module on share capital. 4.7 ASSOCIATION CLAUSE (a) General Provision The last clause in the memorandum is the association clause. This is unnumbered and the memorandum concludes with the association clause. It states that the persons subscribing their signatures to the memorandum (We the several persons whose names are subscribed) are desirious of being formed into a company in pursuance of the memorandum. The association clause is followed by the Names, Addresses, and occupation of the subscribers and the number of shares each subscriber has agreed to take in a tabular form. The memorandum is signed by each subscriber in the presence of at least one witness who will atteast the signature of the subscriber. The minimum number of subscribers required for a public company is seven and that for a private company is two [Section 12(1)]. The term subscribing as used in section 12 means the signing in the memorandum and articles by those persons on their attorneys, who have agreed to be associated with the company. The subscribers are the first members of the company. On incorporation they, ipso facto become members of the company [sec.41(1)]. A Subscriber need not be beneficially interested in the shares for which he has subscribed. A subscriber need not 33
be a natural person. A body corporate being a legal person can be subscriber. But a partnership firm or a Joint Hindu Family, as such, cannot be a subscriber, as they are not persons. So also a minor cannot be a subscriber to the memorandum. If a guardian has subscribed to the memorandum on behalf of the minor, he will be deemed to have subscribed in his personal capacity [Palniappa V. Official liquidator AIR 1942 Mad.470]. But a Partner of the firm or the Kartha of of the family can be subscribers. As regards foreign nationals and NRIs, the Foreign Exchange Regulation Act, 1973, has imposed certain restrictions. Irregularity in connection with Subscription If an irregularity has crept in connection with subscription to a memorandum can the aggrieved party have any remedy ? For example, suppose a person was fradulently induced to subscribe to the memorandum. Can he claim any relief ? The answer depends upon whether the relief was claimed before or after the issue of the certificate of incorporation. In the former case he is entitled to the usual remedies. But after the issue of the certificate of incorporation the irregularity cannot affect the existence of the company. This is because the certificate of incorporation is conclusive proof of the fact matters. It is assumed that all matters incidental to incorporation have been duly complied with. [Sec. 350]. But Conclusiveness of the certificate of incorporation is not a bar for the aggrieved person to claim relief against others. 4.8 ANNEXURES Following are the Forms of Memorandum for various kinds of company's as specified in Table B,C,D & E in Schedule I of the Company Act, 1956. Memorandum of Association of a Company Limited by Shares Ist The name of the company is The Eastern Steam Packet Company Limited. 2nd. - The registered office of the company will be situated in the State of Bombay, 3rd - (a) The main objects to be pursued by the company on its incorporation are the conveyance of passengers and goods in ships or boats between such places as the company may from time to time determine. (b) The objects incidental or ancillary to the attainment of the above main objects are the acquisition, construction, building, setting-up and provision of establishments for repairing ships or boats, for the training of personnel required for the running of ships or boats and the doing of all such other things as are conducive to the attainment of the foregoing main objects. (c) The other objects for which the company is established are carrying on the business of carriers by land and air and the running of hotels for tourists.
4th. - The liability of the members is limited. 5th. - The share capital of the company is two hundred thousand rupees, divided into one thousand shares of two hundred rupees each. We, the several persons whose names and addresses are subscribed, are desirous of being formed into a company in pursuance of this memorandum of association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names. Names, addresses, descriptions and occupations of subscribers 1. A.B. of 2. C.D. of 3. E.F. of 4. G.H. of 5. I.J.of 6. K.L of 7. M.N. of Merchant Total shares taken .. .. .. .. .. .. .. .. Number of shares taken by each subscriber 200 25 30 15 5 5 10 325
Dated the.......................day..............................of 19 Witness to the above signatures. X.Y. of....................................... Memorandum of a Company Limited by Guarantee and not having a share Capital Memorandum of Association Ist.- The name of the company is The Mutual Calcutta Marine Association Limited. 2nd.- The Registered office of the company will be situate in the State of West Bengal. 3rd.- (a) The main objects to be pursued by the company on its incorporation are the mutual insurance to ships belonging to members of the company. (b) The objects incidental or ancillary to the attainment of the above main objects are providing for the welfare of employees or ex-employees of the company and the making, drawing, accepting, endorsing, executing and issuing of any negotiable or transferable documents and the doing of such other things as are conducive to the attainment of the foregoing main objects. (c) The other objects for which the company is established are building, equipping and maintaining charitable hospitals, running of schools and undertaking any other social service. 4th.- The liability of the members is limited. 5th.- Every member of the company undertakes to contribute to the assets of the company in the event of its being wound-up
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while he is a member, or within one year after he ceases to be a member, for payment of the debts and liabilities of the company contracted before he ceases to be a member, and the costs, charges and expenses of winding-up and for the adjustment of the rights of the contributors among themselves, such amount as may be required, not exceeding one hundred rupees. We, the several persons whose names and addresses are subscribed, are desirous of being formed into a company, in pursuance of this memorandum of association. Names, address, descriptions and occupations of subscribers. 1. 2. 3. 4. 5. 6. 7. A.B. of ------------------------------ Merchant. C.D. of ------------------------------ " E.F. of ------------------------------- " G.H. of ------------------------------ " I.J. of -------------------------------- " K.L. of ------------------------------ " M.N. of ----------------------------- "
5th.- Every member of the company 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 he ceases to be a member, for payment of the debts and liabilities of the company contracted before he ceases to be a member, and the costs, charges and expenses of winding-up and for the adjustment of the rights of the contributors among themselves, such amount as may be required, not exceeding fifty rupees. We, the several persons whose names and addresses are subscribed, are desirous of being formed into a company, in pursuance of this memorandum of association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names. Names, addresses, descriptions and occupations of subscribers 1 2 3 4 5 6 7 A.B. of .................. Merchant C.D. of .................. Merchant E.F. of .................. I.J. of .................. Merchant Merchant G.H. of .................. Merchant K.L. of .................. Merchant M.N. of .................. Merchant Total shares taken Number of shares taken by each subscriber ... ... ... ... ... ... ... ... 200 25 30 40 15 5 10 325
Dated the.............................day of ....................19 . Witness to the above signatures X,Y, of.....................
Memorandum of a Company Limited by Guarantee and having a share Capital Memorandum of Association Ist. - The name of the company is The Snowy Range Hotel Company Limited. 2nd. - The Registered office of the company will be situate in the State of West Bengal. 3rd. - (a) The main objects to be pursued by the company on its incorporation are the facilitating of travelling in the Showy Range, by providing hotels and conveyances by sea and by land for the accommodation of travellers". (b) The objects incidental or ancillary to the attainment of the above main objects are conducting coaching classes in catering, hotel management etc., and the doing of such other things as are conducive to the attainment of the foregoing main objects". (c) The other objects for which the company is established are running a publsihing house and the publishing of peridocials/magazines/newspapers catering to various interest pertaining to the objects aforesaid". 4th.- The liability of the members is limited.
Dated the ............................. day......................... of 19 Witness to the above signatures. X.Y. of ....................................................................
Memorandum of Association of an Unlimited Company Memorandum of Association Ist. The name of the company is The Patent Stereotype Company.
2nd. - The registered office of the company will be situated in the State of West Bengal. 3rd. -(a) The main objects to be pursued by the company on its incorporation are the working of a patent method of founding and casting stereotype plates of which method P.Q. of Bombay, is the sole patentee, (b) The objects incidental or ancillary to the attainment of the above main objects are purchasing, taking on lease or licence or concession or otherwise, lands, buildings, works and any rights and privileges or interest therein for establishing the necessary workshops/factories and the doing of such other 35
things as are conducive to the attainment of the foregoing main objects. (c) The other objects for which the company is established are conducting research in any fields pertaining to the science of metallurgy and turning to account the results of the same. We, the several persons whose names are subscribed, are desirous of being formed into a company in pursuance of this memorandum of association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names.
Names, address, description and occupation of subscribers 1. 2. 3. 4. 5. 6. 7. A.B. of ----------------------- Merchant C.D. of ----------------------- " E.F. of ------------------------ ,, G.H. of ----------------------- ,, I.J. of ------------------------- ,, K.L. of ------------------------ ,, M.N. of ----------------------- ,, Total shares taken
Number of shares taken by each subscriber 3 2 1 2 2 1 1 12
Date of the .........................day of ....................19 Witness to the above signatures X.Y. of ...........................
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5. CONSTITUTIONAL DOCUMENT: ARTICLES

SUB TOPICS 5.1 Contents of the Articles 5.2 Status of Constitutional documents 5.3 Memorandum Versus Articles 5.4 Alteration 5.5 Annexure 5.1 CONTENTS OF THE ARTICLES It has been already pointed out that Articles of Association which contains detail regulations as to the functioning of the Company, is one of the two constitutional documents that a Company must have. It has also been stated that a private limited Company must prepare its own articles of association specifying therein: (a) restriction on transferability of shares: (b) limiting the number of members to fifty not including persons who are employed in the Company and persons who have been in the employment when they became members and continued to be so; and (c) prohibiting invitations to the public to subscribe for any shares or debentures of the company. A public Company limited by shares may adopt all or any of the regulations contained in Table A of Schedule I of the Companies Act. Similarly a Public Company limited by guarantee and not having a share capital may adopt one laid down in Table C. A Public Company limited by guarantee and having a share capital may prepare its regulations in the form specified in Table D. Unlimited Companys articles of association is given in Table E of Schedule I. If a public company limited by shares does not have articles at the time of registration, the regulation specified in Table A of Schedule I shall be considered as the duly registered Articles. According to Sec 30 the Articles shall be (a) printed (b) divided into paragraphs consecutively numbered and (c) signed by each subscribers of the memorandum of association in the presence of atleast one witness who shall attest the signature and shall also specify his name, address and occupation. If one examines the content of Table A of Schedule I one can understand the contents of articles of association. A list of these contents can be specified as under (i) interpretation of various terminologies; (ii) Regulation regarding share capital, various types of share capital, rights of the share holders, procedure of issuing share certificate, variation of the rights, etc ; (iii) Right of lien of the Company and its extent and character; (iv) Calls on all shares; (v) Procedure of transfer of shares; (vi) Transmission of shares; (vii) Right of forfeiture of shares; (viii) Conversion of share into stock; (ix) Share warrants and the procedure of issuing share warrant; (x) Alteration of capital; (xi) Various types of meeting and proceedings in those meetings; (xii) Voting and Proxies; (xiii) Board of Directors, their powers and proceedings of the meetings of the Board of Directors; (xiv) Manager and Secretary and their powers; (xv) Provisions regarding the Corporate Seal; (xvi) Dividends and reserves; (xvii) Procedure of accounts; (xviii) Capitalisation of profits; (xix) Regulation relating to winding up; and (xx) Idemnity A Public Company having a share capital may adopt these regulations or may amend or omit some of the regulations. 5.2 STATUS OF CONSTITUTIONAL DOCUMENTS The registered company being an association of persons as it is, is founded on the agreement or contract between its members. But it also has a legal existence distinct and separate from that of its members. Its relationship with the members is also based on an agreement or contract which is supposed to exist between them. This principle is embodied in section 36 which read as follows: (1) Subject to the provisions of this Act the memorandum and articles shall when registered bind the company and the members thereof, to the same extent as if they respectively had been signed by the company and each memeber and contained covenants on its and his part to observe all the provisions of the memorandum and of the articles. (2) All the money payable by any member to the company under the memorandum or articles shall be a debt due from him to the company. The history of the section can be traced back to the Joint Stock Companies Act, 1844 which for the first time provided the legal framework for the formation of registered companies. The statute made it obligatory on existing partnerships with membership above 25 to be incorporated. This was done by registering the partnership deed (the deed of settlement) with the Registrar of companies. Thus the deed which originally was only a contract between the members of an unincorporated body, became the constitution of the registered company. Though the deed was subsequently split into and substituted by the memorandum and articles, they were continued to be 37
treated as contractual documents by the subsequent statutes also. Section 36 embodies this. 2. How far a contract? Read literally sec.36 implies that the provisions in the memorandum and articles are contractual terms between the company and its members in respect of all matters stated therein. But judicial interpretation to the provision has curtailed its ambit considerably. Now it is settled law that they are contractual terms between the company and its members in respect of maters relating to membership rights only. Thus provisions dealing with voting rights, rights to dividend, calls on shares,lien, transfer of shares proceedings of General meeting,etc. are contractual terms. But provisions dealing with matters, such as appointment and removal of Directors, Auditors, Solicitors, etc. are outside the ambit of section 36 as they do not affect the rights or liabilties of members as members. In Eley v. Positive Life Assurance Co. Ltd. [(1876)1 EX.D 88] the articles of a company provided that one E should be the solicitor of the company. The company refused to appoint him. Held, he could not claim damages for breach of contract for the following reasons: (1) There was no specific contract between the parties, express or implied. (2) E could not rely upon the relevant provisions in the articles because those provisions did not affect him in his capacity as a member. 3. Special features of the Contract: The contract embodies in the memorandum and articles has many special features. In the words of Ross. J. it is a contract of the most sacred character [Clark v Workman (1920)1 1r.R.107]. The shareholders advance money and become members relying mainly on the provisions contained in these documents. Some of the special features of this most important statutory contracts are:(1) Its terms can be unilaterally altered by one of the contracting parties namely the company. We have seen that the provisions in the memorandum and articles are liable to amendment. (Sec. 36 expressly provides that it is subject to the provisions of this Act.) (2) Normal contractual remedies are available only to the company. Courts have consistently shown reluctance to a member against the company for breach of the contractual provision contained in the memorandum or articles. In Houldsworth v City of Glasgow Bank [(1880)5 App. Cas. 317], the plaintiff was fraudulently induced by the company to take shares. The House of Lords refused to award damages to him, while he remained a member. The jurisprudential basis of this rule was never satisfactorily explained. (Sealey: Cases and materials in company law, 5th edn. p.335). Remedies like rectification of instrument are also not available.
4. Binding force of the contract in the articles: (a) Company and members: As regards the provisions in the memorandum and articles which deal with membership rights, it is well settled that both the company and members are bound to each other as if they had entered into an express contract incorporating all those terms. In Hickman v Kent or Romney Marsh Sheep Breeders Association [(1915)1 Ch.881] the defendant was a non profit making association registered as a company, the object being to maintain the purity of a particular breed of sheep. Art. 49 of the articles of association provided that disputes between the associations and any of its members should be referred to arbitrator. Hickman, a member instituted a suit against the association, pertaining to his membership rights. The court upheld the objection of the company that the civil court has no jurisdiction, as Art.49 is to be treated as an agreement between the company and the members that disputes shall be referred to arbitration. Can a member restrain the company from breach of articles? It is settled law that provisions in the memorandum and articles do not constitute a contract between a company and its members in respect of matters relating to outsiders right. But Prof. Wedderburn (1957 CL.J.193) argues that a member in his capacity as a member has the right to restrain the company from committing any breach of the articles even though this may amount to enforcing outsiders' right indirectly. For example, if the articles provide that certain transactions may be entered into by the Company with the consent of the General meeting a member may sue the company to prevent it from entering into the transactions without such consent. [See Quinn and Axtens Ltd. v. Salmon, (1909 A.C.442]. But the learned authors view involves disregarding innumerable weighty dicta and overruling a number of leading cases [Gower, p.319). Goldberge (35 M.L.R. 362) suggests that Wedderburns proposition can be narrowed and reformulated thus : A member of a company has under section 20(1) of the Act (This corresponds to section 36 of the Companies Act, 1956) a contractual right to have any of the affairs of the company conducted by the particular organ of the company specified in the act or the companys memorandum or articles. (b) Between members inter-se Are the provisions of the memorandum and articles contractual terms between an individual member and another ? Section 36 says that these provisions shall bind the company and the members thereof to the same extent as if they respectively had been signed by the company and by each member and contained covenants on its and his part to observe all the provisions. The section is ambiguous as to whether a member is to be treated as impliedly covenanting with another. The preponderant view now is that the provisions of the memorandum and articles are contractual terms between the members inter se. Each member impliedly covenants with every other to obey those provisions so far as they relate to their rights and duties as members. In
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Shiv Omkar Maheswari v Bansidhar Jaganath (AIR 1956 Bom. 459), the Bombay High Court reivewed the case law on the point and held that the memorandum and articles have contractual force between the members inter se. Between the company and outsiders: As noticed earlier, the memorandum and articles have contractual effect only in respect of matters pertaining to membership rights and not in respect of outsider rights. So section 36 will not imply a contract between the company and an outsider, on the ground of the provisions of these constitutional documents. But in many cases, both the company and other party might have transacted business on the basis of the articles. In those cases, the relevant provisions of the articles shall be treated as contractual terms between the company and the other party. For example the article of a company may fix the salary of the managing director at Rs.5,00,000/- per annum. If A is appointed as the managing director without any express term as to his salary, the particular provision of the articles providing for the salary of the managing director will be treated as a term of the contract between A and the company. But as the company has a statutory right to alter all the provisions of the articles, if it has unilaterally altered a provision which was an implied contractual term between it and an outsider, the alteration cannot be pleaded by the other party as a breach of contract. He must be presumed to have consented to the power of the company to alter the terms of the articles which are read into the contract between them. In the above illustration, if the company has altered the salary clause and reduced the salary of the managing director to Rs.2,50,000/- per annum, A cannot plead that the company has committed breach of contract. If he wanted sanctity to the provisions of the articles which are read into the contract between him and the company, those provisions should have been expressly incorporated into the contract. Otherwise he will have no remedy if the company varies those provisions. But this does not mean that the accrued rights of the other party can be prejudicially affected by varying the terms impliedly read into the contract. Thus, if A was appointed as the managing director in 1978 and the salary clause in the articles was altered in 1980 reducing the salary of Managing Director with retrospective effect, the alteration cannot affect the right of A to claim remunaeration at the previous rate, from the date of his appointment till the date of alteration. 5.3 MEMORANDUM VERSUS ARTICLES Articles of Association is a subordinate document to the memorandum which is treated as the general constitution of the Company. The memorandum is fundamental and therefore can be altered as prescribed in the Act. Articles of Associationns on the other hand regulates internal relations within the company as also distributes the power. It can be altered according to what the members think fit. The distinction between these two documents is highlighted by Lord Aciras in Ashbury Rly Carriage & Iron Company Ltd v. Riche [(1875) L.R. 7H.L.653] thus :-
I will ask your Lordships to observe the marked and entire difference between the two documents - I mean the memorandum of association on the one hand and articles of association, those articles play a part subsidiary to the memorandum of association. They accept the memorandum of association, as the charter of incorporation of the company, and so accepting it, the articles proceed to define the duties, the rights and the powers of the governing body as between themselves and the company at large, and the mode and form in which the business of the company is to be carried on. Thus the basic or fundamental provisions relating to the constitution of a company are set out in its memorandum of association. Being the fundamental document of the company which specifies its business activities and powers the early Companies Acts did not contain any provision for amendment of provisions in the memorandum. The articles on the other hand deal with matters of internal regulation, such as, the distribution of powers among the various agents of the company, conduct of meetings, appointment of Directors, etc.. Any provisions in the articles of association is to be interpreted in consonance with all the provisions of the memorandum or in other words no part of the articles can be construed in such a way that it intervenes or contradicts any provision of the memorandum. Ofcourse, the principle of construction does not apply where the words are clear and unambiguous, and are in consonence with the provisions of the memorandum. Memorandum delimits the boundary of the comapny. Every one entering into the contract with the company is bound to have constructive notice of the provisions of the memorandum. Articles on the other hand provides regulation for internal management. Any internal regulation of power application can be presumed to have been accomplished according to internal regulations. This principle of indoor management is discussed elsewhere along with the principle of constructive notice. 5.4 ALTERATION 1. Unfettered Power to alter: Unlike the provisions in the memorandum the legislative policy with regard to amendment of the articles had always been to grant maximum liberty to the company. As the articles deal with the composition and powers of its organs and other matters for the smooth and efficient operation of its administrative machinery it was recognised from the early days of company law that companies should have the unfettered freedom to alter its articles. How and in what manner shall the business be carried on is essentially a business proposition to be determined primarily by the company itself. This policy is reflected in section 31(i), which reads :Subject to the provisions of this Act and the conditions contained in its memorandum a company may, by special resolution alter its articles. The companys power to alter the articles is a statutory one and cannot be curtailed by a restrictive provision in the articles. It 39
cannot also stipulate in section 31(1)namely the passing of a special resolution. For example,suppose it is provided in the articles of a company that the alteration of any provision in the articles shall be effective only if such alteration is assented to by X, the promoter of the company. Such a provision is invalid, as it is inconsistent with section 31(1) which provides that the alteration can be carried out by passing a special resolution. A contrary view is expressed in Palmers Company Law. (24th Edn.page 180). It is stated therein : A provision in the articles that any specific article may not only be altered with the consent of a named person is valid and without such consent any attempted alteration would be ineffective. But this is on the assumption that the shares held by that person is of a separate class. In India, public companies and private companies which are subsidiaries of public companies can issue only two classes of shares viz. equity shares and preference shares. The terms of issue of such preference shares contain the rights attached to them. But in England any number of classes of shares, even with disproportionate voting rights can be issued. In England it is also possible to incorporate a protective provision in the memorandum and provide therein that it is unalterable. Though section 31(1) provides that the companys power to alter the articles are subject to the conditions contained in the memorandum it is not possible to curtail the amending power of the company by a restrictive provision in the memorandum for the following reason. By virtue of sec.16(2) the non obligatory clauses in the memorandum shall be treated as if they are provisions in the articles only. The phrase subject to the provisions in the memorandum only means that the altered provision shall not be inconsistent with the obligatory clauses in the memorandum. In Andrews v Gas Metre Co. [(1897)1 Ch.361] the original articles did not contain any provision for the issue of preference shares. The articles were altered to enable the company to issue such shares. The court held that the alteration was valid. 2. Can alteration lead to breach of Contract? Another question to be considered is whether the company can amend any provision in the articles or incorporate a new provision, if such amendment would empower the company to commit a breach of contract. This interesting question was finally settled by the House of Lords in Southern Foundries Ltd. v. Shirlaw [(1940)2 All ER 445]. In 1933 the defendant company (Southern) by a written agreement appointed the plaintiff as its Managing Director for a period of 10 years. In 1936, Federated founderies Ltd. (Federated) became its controlling shareholder. Consequently Southern altered its articles so as to include a new provision which empowered Federated to remove any Director of Southern. Exercising the power conferred by the new article, Federated removed the plaintiff from his directorship in 1937. The plaintiff contented that the alteration was invalid as the effect of the amendment was to empower the company to break its contract with him.
Rejecting the contention of the plaintiff Lord Porter observed A company cannot be precluded from altering its articles thereby giving itself power to act upon the provisions of the altered articles. But this does not mean that the company can construe a breach of contract with impunity by altering its articles. As pointed out by Lord Porter in the above case to act upon the provisions of the altered articles may nevertheless be a breach of contract, if it is contrary to a contractual term validly made before the alteration. Gower says: If, the company has entered into contracts it will be liable if at the behest of those in control it breaks the contract and it cannot justify a breach by alleging that its constitution justified or required it so to act. (Principles of modern Company Law). Articles will not relieve the company from its liability to pay damages for breach of the express terms of contract. On the other hand in the absence of an express contract if the parties proceeded on the assumption that, the existing provisions in the article would be the basis of the service terms, it must be presumed that both the parties have tacitly agreed that the company shall have the power to alter those provisions. But this cannot prejudicially affect the accrued rights of the parties. Let us take an illustration. Suppose A is appointed as Managing Director of the company. The articles at the time of appointment of À specified the tenure of the Managing Director. If no express service contract was entered into between the company and À the provisions in the the Article would govern the contract between them. But the company can alter those terms without being liable for breach of contract, though by such alteration the accrued rights of the other party cannot be affected. In strict legal theory the plea that the company shall not be permitted to alter its articles, if such alteration would empower it to commit breach of contract, is not valid. Barring the exceptional cases where specific relief or injunction will be granted there is no rule of law, that a contracting party shall not breach the contract. It only provides for damages to be paid to the aggrieved party. 3. Retrospective alteration: The statutory power of the company to alter the provisions in its articles is wide enough to include a alteration with retrospective effect. In Allen v. Gold Reefs of West Africa [(1909)1 Ch. 656] regulation 29 of the Companys articles provided that the company shall have a first and paramount lien for debts owing by a member to the company upon all shares (not being fully paid up) held by such member. The company altered the articles by deleting the words not being fully up and giving it retrospective effect. The alteration prejudicially affected the plaintiff who was the owner of certain fully paid shares and also a debtor of the company. Rejecting his contention that the retorspective operation was invalid it was held that the power thus conferred on companies to alter the regulations contained in their articles is limited only by the provisions contained in the statute and the conditions contained in the companys memorandum of assocaition. In Sidebotton v Kershaw Lees & Co. Ltd [(1920)1 Ch. 154] the defendant company incorporated a new provision in its articles to empower the Directors to buy out at a fair price the shares of
40
any member who carried on any business in competition with the company. The plaintiff who challenged the alteration, was at the time of alteration carrying on a competing business. Held, the alteration was valid. In State of Karnataka v. Mysore Coffee Curing Works Ltd. [(1984)55 Comp. cas.70]. The petitioner was a company incorporated in 1938. Arts. 70(a) and 97 of Articles of Association of the Company that the State Government, which was a member of the company has the pwoer to nominate three Directors, and another as Chairman of the Board. Subsequent to the further issue of shares the shareholding of the petitioner State was reduced to 20%. The company proposed to amend Articles 70(a) and 97, with a view to take away the special rights conferred on the petitioner. The move was attempted to be thwarted by the petitioner by moving petition to restrain the company from amending the provisions. Rejecting the contentions of the petitioner, the Karnataka High Court held that the only restriction on the unfettered power under subsection (1) of section S.31 of the act is the restriction imposed by the proviso to that section." 4. Retrospective Operation of amendment and accrued rights: Though the company enjoys wide pwoers to alter the provisions in the articles will such alteration affected accrued rights ? The issue has much practical significance with respect to transfer of shares. As regards the company transferee becomes a member only on his name being entered in the register of members. Suppose A, the holder of a block of shares transfers the same to B, the transfer is strictly in consonance with the articles of association as they are on the date of transfer. Can the company susbsequently alter the articles, so as to prejudice the rights of the transferee to get his name entered in the Register of Members as a member. The issue came up for the consideration of the Kerala High Court in Vardhaman Publishing Ltd. v. Mathrubhoomi Ltd [(1991)71 Comp. cas.1]. The petitioner purchased a block of shares of the respondent company from a registered bolder and applied for registration of the same. Subsequent to the presentation of the relevant documents for registration the company altered the articles by incorporating a new provision therein. The purpose of the amendment was to confer on the Board of Directors a discretionary power to refuse any transfer of shares on the ground that the transferee is not a desirable person in the opinion of the Board. A single judge of the Kerala High Court held that the amendment of the articles could not deprive the petitioner of his right to have the transfer registered, as it was accrued prior to the alteration. He held that alteration of articles cannot affect concluded transactions. As per original articles there was a subsisting contract that the shares were freely transferable and there was no power in the Board to reject the transfer, so as to take away a right already accrued. Referring to section 31(2) which provides that any alteration of the articles shall be as valid as if originally contained in the articles, the
learned judge observed that the provision can only relate to the procedural validity of the altered articles.... On appeal the Division Bench [(1992))73 Comp.cas]) agreed that accured rights cannot be upset by retrospective alteration of the articles. But the transferees rights become accrued only on lodgment of the proper instruments of transfer and no other obstacle remain in enforcement of the right of transfer. 5. Procedure for alteration: The company may alter any of the provisions in the articles by a special resolution. But an alteration which has the effect of converting a public company into a private company, the consent of the Central Government is necessary [proviso to section 31(1)]. This is to ensure that the attempted conversion is not for the purpose of avoiding the regulations and restrictions applicable to public companies only. The power of the Central Government has been delegated to the Regional Director. (Notification dated:31-5-1991). The alteration to be effective must be filed with the Registrar within 30 days of the passing of the special resolution. 6. The Power of the CLB to alter the articles Apart from the company at its General Meeting the Company Law Board is empowered to order alteration of the articles. (S.404). This is to provide relief against oppression and mismanagement. 7. Limitation on the power of Alteration: The general rule that the company in General Meeting can alter any of the provisions in its articles is subject to certain exceptions. They are :(i) The alteration must be bonafide: The statutory power under section 31 must be exercised not only in the manner required by law but also bonafide for the benefit of the company as a whole. (per Lindley M.R. in Allen v Gold Reef of West Afica (1900)1 Ch. 656) The obvious purpose of this limitation is to safeguard the interest of the minority. But on challenging the validity of the alteration on this ground the plaintiff must adduce clear proof of mala fides or discrimination on the part of the company or the majority who amended the articles. If he fails to establish this the courts would be inclined to hold that the alteration was valid.' (ii) Class rights: If the company has issued different classes of shares, and the special rights of particular class of shareholders are embodied in the articles, those rights cannot be varied by mere alteration of the articles. The class rights embodied in the articles are entrenched provisions which are subject to the limitations contained in section 106. If the variation of the rights of any particular class of shares are prohibited by the terms of issue of those shares, the alteration is ineffective. The same is the position when the memorandum of articles contain provisions prohibiting variation. The variation of class rights can be effected only by strictly complying with the requirements of 41
section 106. The variation contemplated here is one which detrimentally affect the interests of the holders of the special class of shares. (iii) Increase in members liability: A fundamental term of the contract between a company limited by shares or guarantee and its members is that the liability of each member is limited to the amount agreed by him to pay or contribute at the time of his becoming a member. By altering the memorandum or articles, the company cannot impose on him an increased liability. But if a member agrees to be bound by the alteration effecting the increased liability, he will be bound by the terms of the alteration. (Section 38). (iv) Restriction for the protection of minority: In a petition filed under section 397 or 398, the court has power to alter the memorandum or articles of a company, in any manner it thinks fit (S.404). When the court has thus amended the memorandum or articles, they cannot be further amended by the company so as to effect the amendments already made by the court. 5.5 ANNEXURE Schedule I of the Company Act, 1956 provides a model for Articles of Association of a Company limited by shares. For other types of companies the model is provided in Schedule I tables' C, D, and E. [See Section 2(2), 14, 28(1), 29 and 223] Table A Regulations for Management of a Company Limited by Shares Interpretation 1. (1) In the regulations(a) the Act means the Companies Act, 1956. Memorandum of Association of a Company Limited by Shares, (b) the Seal means the common seal of the company. (2) Unless the context otherwise requires, words or expressions contained in these regulations shall bear the same meaning as in the Act or any statutory modifications thereof in force at the date at which these regulations became binding on the company. Share Capital and Variation of Rights 2. Subject to the provisions of section 80, any preference shares may, with the sanction of an ordinary resolution, be issued on the terms that they are, or at the option of the company are liable, to be redeemed on such terms and such manner as the company before the issue of the shares may, by special resolution, determine. 3. (1) If at any time the share capital is divided into different classes of shares, the rights attached to any class (unless otherwise provided by the terms of issue of the shares of that class) may, subject to the provisions of sections 106 42
4.
5.
6.
7.
and 107, and whether or not the company is being wouldup, be varies with the consent in writing of the holders of three-fourths of the issued shares of that class or with the sanction of a special resolution passed at a separate meeting of the holders of the shares of that class. (2) To every such separate meeting, the provisions of these regulations relating to general meetings shall mutatis muntandis apply, but so that necessary quorum shall be two persons at least holding or representing by proxy one-third of the issued shares of the class in question. The rights conferred upon the holders of the shares of any class issued with preferred or other rights shall not, unless otherwise expressly provided by the terms of issue of the shares of that class, be deemed to be varied by the creation of issue of further shares ranking pari passu therewith. (1) The company may exercise the powers of paying commissions conferred by section 76, provided that the rate per cent, or the amount of the commission paid or agreed to be paid shall be disclosed in the manner required by that section. (2) The rate of commission shall not exceed the rate of five per cent of the price at which the shares in respect whereof the same is paid are issued or an amount equal to five per cent of such price, as the case may be. (3) The commission may be satisfied by the payment of cash or the allotment of fully or partly paid shares or partly in one way and partly in the other. (4) The company may also, on any issue of shares, pay such brokerage as may be lawful. Except as required by law, no person shall be recognized by the company as holding any shares upon any trust, and the company shall not be bound by, or be compelled in any way to recognize (even when having notice thereof), any equitable, contingent, future or partial interest in any share, or any interest in any fractional part of a share of (except only as by these regulations or by law otherwise provided) any other rights in respect of any share except an absolute right to the entirety thereof in the registered holder. (1) Every person whose names is entered as a member in the register of members shall be entitles to receive within three months after allotment or [within two months after the application for the] registration of transfer (or within such other period as the conditions of issue shall provide)(a) one certificate for all his shares without payment; or (b) several certificates, each for one or more of his shares, upon payment of one rupee for every certificate after the first; (2) Every certificate shall be under the seal and shall specify the shares to which it relates, and the amount paid up thereon. (3) In respect of any share or shares held jointly by several persons, the company shall not be bound to issue more than one certificate, and delivery of a certificate for a share to one of several joint holders shall be sufficient delivery to all such holders.
8. If a share certificate is defaced, lost or destroyed, it may be renewed on payment of such fee, if any, not exceeding [two rupees] and on such terms, if any, as to evidence and indemnity and the payment of out-of-pocket expenses incurred by the company in investigating evidence, as the directors think fit. Lien 9. (1) The Company shall have a first and paramount lien(a) on every share (not being a fully-paid share), for all moneys (whether presently payable or not) called, or payable at a fixed time, in respect of that share; and (b) on all shares (not being fully-paid shares) standing registered in the name of a single person, for all moneys presently payable by him or his estate to the company: Provided that the Board of Directors may at any time declare any share to be wholly or in part exempt from the provisions of this case. (2) The companys lien, if any, on a share shall extend to all dividends payable thereon. 10. The company may sell, in such manner as the Board thinks fit, any shares on which the company has a lien: Provided that no sale shall be made(a) unless a sum in respect of which the lien exists is presently payable, or (b) until the expiration of fourteen days after a notice in writing stating and demanding payment of such part of the amount in respect of which the lien exists as in presently payable, has been given to the registered holder for the time being of the share or the person entitled thereto by reason of his death or insolvency. 11. (1) To give effect to any such sale, the Board may authorise some person to transfer the shares sold to the purchaser thereof. (2) The purchaser shall be registered as the holder of the shares comprised in any such transfer. (3) The purchaser shall not be bound to see to the application of the purchase money, nor shall his title to the shares be affected by any irregularity or invalidity in the proceedings in reference to the \sale. 12. (1) The proceeds of the sale shall be received by the company and applied in payment of such part of the amount in respect of which the lien exists as is presently payable. (2) The residue, if any, shall subject to a like lien for sums not presently payable as existed upon the shares before the sale, be paid to the person entitled to the shares at the date of the sale. Calls of Shares 13. (1) The Board may, from time to time, make calls upon the members in respect of any moneys unpaid on their shares (whether on account of the nominal value of the
share or by way of premium) and not by the conditions of allotment thereof made payable at fixed times: Provided that no call shall exceed one-fourth of the nominal value of the share or be payable at less than one month from the date fixed for the payment of the last proceeding call. (2) Each member shall, subject to receiving at least fourteen days notice specifying the time or times and place of payment, pay to the company, at the time or times and place so specified, the amount called on his shares. (3) A call may be revoked or postponed a the discretion of the Board. 14. A call shall be deemed to have been made at the time when the resolution of the Board authorising the call was passed and may be required to be paid by installments. 15. The joint holders of a share shall be jointly and severally liable to pay all calls in respect thereof. 16. (1) If a sum called in respect of a share is not paid before or on the day appointed for the payment thereof, the person from whom the sum is due shall pay interest thereon from the day appointed for payment thereof to the time of actual payment at five per cent per annum or at such rate, if any, as the Board may determine. (2) The Board shall be at liberty to waive payment of any such interest wholly or in part. 17. (1) Any sum which by the terms of issue of a share becomes payable on allotment or any fixed date, whether on account of the nominal value of the share or by way of premium, shall, for the purpose of these regulations, be deemed to be a call duly made and payable on the date on which by the terms of issue such sum becomes payable. (2) In case of non-payment of such sum, all the relevant provisions of these regulations as to payment of interest and expenses, forfeiture or otherwise shall apply as if such sum had become payable by virtue of a call duly made and notified. 18. The Board (a) may, if it thinks fit, receive from any member willing to advance \the same, all or any part of the moneys uncalled and unpaid upon any shares held by him, and upon all or any of the moneies so advanced, may (until the same would, but for such advance, become presently payable) pay interest at such rate not exceeding, unless the company in general meeting shall otherwise direct, six per cent per annum, as may be agreed upon between the Board and the member paying the sum in advance.
(b)
Transfer Shares 19. (1) The instrument of transfer of any share in the company shall be executed by or on behalf of both the transferor and transferee. 43
(2) The transferor shall be deemed to remain a holder of the share until the name of the transferee is entered in the register of members in respect thereof.
Date of presentation to the prescribed authority ..................................
[20. subject to the provisions of section 108, the shares in the company shall be transferred in the following form, namely:-]
Form No &B
Share Transfer Form [Pursuant to section 108 (1-A) of the Companies Act, 1956] For the consideration state below the Transferor(s) named do hereby transfer to the Transferee(s) named the same the shares specified below subject to the conditions on which the said shares are now held by the Transferors(s) and the Transferee(s) do hereby agree to accept and hold the said shares subject to the conditions aforesaid. ___________________________________________________________________________________ Full name of company Name of the recognised stock exchange where dealt in, if any ___________________________________________________________________________________ Description of Equity/Preference Shares ___________________________________________________________________________________ No. in figures Number in Words Consideration (in figures) Consideration in (words) ___________________________________________________________________________________ Distinctive from ___________________________________________________________ numbers To Corresponding Certificate Nos. ___________________________________________________________________________________ Transferors(s) Seller(s) Particulars Names (s) in full Regd. Folio No. Signature(s)
1. _____________________________ 2. _____________________________ 3. _____________________________ 4. _____________________________
1. _____________________________ 2. _____________________________ 3. _____________________________ 4. _____________________________ Signature of Witness
Attestation I, hereby attest the Signature of the Transferors(s) herein mentioned Signature Name Address/Seal * Please see overleaf for instructions
______________________________ Name and Address of Witness ______________________________ ______________________________ ______________________________ ______________________________ ______________________________ PIN
subs. vide Notfn. No. GSR 480 (E) dated 22-4-88, (See Chartered Secretary issue May 1988, p 427).
*Instructions For Attestion: Attestation, where required (thumb impressions, marks, signature difference, etc,) should be done by a Magistrate, Notary Public or Special Executive Magistrate or a similar authority holding a Public Office and authorised to use the Seal of his office or a member of a recognised Stock Exchange through whom the shares are introduced or a manager of the transferors bank. Note: Names must be rubber stamped preferably in a straight line. Chronological order should be maintained. Brokers Clearing Number should be stated when delivery is given by a Clearing Member Bank.
44
Transferee(s) (Buyer(s) Particulars Names(s) in full 1. _______________________________ 2. _______________________________
Signature(s) 1. ____________________________ 2. ____________________________
3. _______________________________ 3. ____________________________ ___________________________________________________________________________________ Occupation Address Fathers/Husbands Name ___________________________________________________________________________________ 1 ___________________________________________________________________________________ 2 ___________________________________________________________________________________ 3 ___________________________________________________________________________________ Transferee(s) existing Folio, if any, in same Order of Names Value of Stamps affixed Rs.
Dated this .................... day of ................. One Thousand Nine Hundred .......... Place ............................... Folio For office use only Checked by ______________________________ signature tallied by ________________________ Entered in Register of Transfer No. ___________ Approval Date ___________________________ Continuation of front page (herein enter the Distinctive numbers when the space on the front page is found to be insufficient) ___________________________________________________________________________________ Distinctive Number From ____________________________________________________________________ To 1. 2. 3. ________________________ ________________________ ________________________
Specimen Signature(s) of Transferee(s)
Company Code
___________________________________________________________________________________ Corresponding Certificate Nos. ___________________________________________________________________________________
45
___________________________ Name of delivery Broker or Date Clearing Number ___________________________
_________
______________________________________ Power of Attorney Probate Death Certificate ______________________________________
________
Letters of Administration Registered with the Company No. ______________ Date ________________ ______________________________________ Signature (not initials) of Broker, Bank, Company or Stock Exchange Clearing House) ______________________________________ ______________________________________ Lodged by _____________________________ full Address ____________________________ ___________________________________ ___________________________________ ___________________________________ ______________________________________ ______________________________________ Share Certificates to be returned to (Full in the name and address to which the Certificates are required to be returned) NAME & ADDRESS ____________________ ___________________________________ ___________________________________ ___________________________________
SHARE TRANSFER STAMPS ___________________________________________________________________________________ * To be filled only if the documents are lodged by a person other than the transferee.
46
21. The Board may, subject to the right of appeal conferred by section 111, decline to register (a) the transfer of a share, not being a fully-paid share, to a person of whom they do not approve; or (b) any transfer of shares on which the company has a lien. 22. The Board may also decline to recognise any instrument of transfer unless(a) a fee of two rupees is paid to the company in respect thereof; (b) the instrument of transfer is accompanied by the certificate of the shares to which it relates, and such other evidence as the Board may reasonably require to show the right of the transferor to make the transfer; and (c) the instrument of transfer is in respect of only one class of shares. 23. Subject to the provisions of section 154, the registration of transfers may be suspended at such times and for such periods as the Board may from time to determine: Provided that such registration shall not be suspended for more than thirty days at any one time or for more than fortyfive days in the aggregate in any year.) 24. The Company shall be entitled to charge a fee not exceeding two rupees on the registration of every probate, letters of administration, certificate of death or marriage, power-ofattorney or other instrument. Transmission of Shares 25. (1) On the death of a member, the survivor or survivors where the member was a joint holder, and his legal representatives where he was a sole holder, shall be the only persons recognised by the company as having any title to his interest in the shares. (2) Nothing in clause (1) shall release the estate of a deceased joint holder from any liability in respect of any share which had been jointly held by him with other persons. 26. (1) Any person becoming entitled to a share in consequence of the death or insolvency of a member may, upon such evidence being produced as may from time to time properly be required by the Board and subject as hereinafter provided, elect, either: (a) to be registered himself as holder of the share; or (b) to make such transfer of the share as the deceased or insolvent member could have made. (2) The Board shall, in either case, have the same right to decline or suspend registration as it would have had, if the deceased or insolvent member had transferred the share before his death or insolvency. 27. (1) If the person so becoming entitled shall elect to be registered as holder of the share himself, he shall deliver or send to the company a notice in writing signed by him stating that he so elects.
(2) If the person aforesaid shall elect to transfer the share, he shall testify his election by executing a transfer of the share. (3) All the limitations, restrictions and provisions of these regulations relating to the right to transfer and the registration of transfers of shares shall be applicable to any such notice or transfer as aforesaid as if the death or insolvency of the member had not occurred and the notice or transfer were a transfer signed by that member. 28. A person becoming entitled to a share by reason of the death or insolvency of the holder shall be entitled to the same dividends and other advantages to which he would be entitled if he were the registered holder of the share, except that he shall not, before being registered as a member in respect of the share, be entitled in respect of it to exercise any right conferred by membership in relation to meetings of the company: Provided that the Board may, at any time, give notice requiring any such person to elect either to be registered himself or to transfer the share, and if the notice is not complied with within ninety days, the Board may thereafter withhold payment of all dividends, bonuses or other moneys payable in respect of the share, until the requirements of the notice have been complied with. Forfeiture of Shares 29. If a member fails to pay any call, or instalment of a call, on the day appointed for payment thereof, the Board may, at any time thereafter during such time as any part of the call or instalment remains unpaid, serve a notice on him requiring payment of so much of the call or instalment as is unpaid, together with any interest which may have accrued. 30. The notice aforesaid shall (a) name a further day (not being earlier than the expiry of fourteen days from the date of service of the notice) on or before which the payment required by the notice is to be made; and (b) State that, in the event of non-payment on or before the day so named, the shares in respect of which the call was made will be liable to be forfeited. 31. If the requirements of any such notice as aforesaid are not complied with, any share in respect of which the notice has been given may, at any time thereafter, before the payment required by the notice has been made, be forfeited by a resolution of the Board to that effect. 32. (1) A forfeited share may be sold or otherwise disposed of on such terms and in such manner as the Board thinks fit. (2) At any time before a sale or disposal as aforesaid, the Board may cancel the forfeiture on such terms as it thinks fit. 33. (1) A person whose shares have been forfeited shall cease to be a member in respect of the forfeited shares, but shall, notwithstanding the forfeiture, remain liable to pay to the 47
company all moneys which, at the date of forfeiture, were presently payable by him to the company in respect of the shares. (2) The liability of such person shall cease if and when the company shall have received payment in full of all such moneys in respect of the shares. 34 (1) A duly verified declaration in writing that the declarant is a director the manager or the secretary, of the company, and that a share in the company has been duly forfeited on a date stated in the declaration, shall be conclusive evidence of the facts therein sated as against all persons claiming to be entitled to the share. (2) The company may receive the consideration, if any, given for the share on any sale or disposal thereof and may execute a transfer of the share in favour of the person to whom t he share is sold or disposed of. (3) The transfer shall thereupon be registered as the holder of the share. (4) The transferee shall not be bound to see to the application of the purchase money, if any, nor shall his title to the share be affected by any irregularity or invalidity in the proceedings in reference to the forfeiture, sale or disposal of the share. 35. The provisions of these regulations as to forfeiture shall apply in the case of non-payment of any sum which, by the terms of issue of a share, becomes payable at a fixed time, whether on account of the nominal value of the share or by way of premium, as if the same had been payable by virtue of a call duly made and notified. Conversion of Shares into Stock 36. The company may, by ordinary resolution,(a) convert any paid-up shares into stock; and (b) reconvert any stock into paid-up shares of any denomination. 37. The holders of stock may transfer the same or any part thereof in he same manner as, and subject to the same regulations under which, the shares from which the stock arose might before the conversion have been transferred, or as near thereto as circumstances admit: Provided that the Board may, from time to time, fix the minimum amount of stock transferable, so , however, that such minimum shall not exceed the nominal amount of the shares from which the stock arose. 38. The holders of stock shall, according to the amount of stock held by the, have the same rights, privileges and advantages as regards dividends, voting at meetings of the company, and other matters, as if they held the shares from which the stock arose; but no such privilege or advantage (except participation in the dividends and profits of the company and in the assets on winding-up) shall be conferred by an amount of stock which would not, if existing in shares, have conferred that privilege or advantage. 39. Such of the regulations of the company (other than those 48
relating to share warrants), as are applicable to paid-up shares shall apply to stock and the words, share and shareholder in those regulations shall include stock and stockholder respectively. Share Warrants 40. The company may issue share warrants subject to, and in accordance with, the provisions of sections 114 and 115; and accordingly the Board may in its discretion, with respect to any share which is fully paid-up, on application in writing signed by the person registered as holder of the share, and authenticated by such evidence (if any) as the Board may, from time to time, require as to the identity of the person signing the application, and on receiving the certificate (if any) of the share, and the amount of the stamp duty on the warrant and such fee as the Board may from time to time require, issue a share warrant. 41. (1) The bearer of a share warrant may at any time deposit the warrant at the office of the company, and so long as the warrant remains so deposited, the depositor shall have the same right of signing a requisition for calling a meeting of the company, and of attending, and voting and exercising the other privileges of a member at any meeting held after the expiry of two clear days from the time of deposit, as if his name were inserted in the register of members as the holder of the shares included in the deposited warrant. (2) Not more that one person shall be recognised as depositor of the share warrant. (3) The company shall, on two days written notice, return the deposited share warrant to the depositor. 42. (1) Subject as herein otherwise expressly provided, no person shall, as bearer of a share warrant, sign a requisition for calling a meeting of the company, or attend, or vote or exercise any other privilege of a member at a meeting of the company, or be entitled to receive any notices from the company. (2) The bearer of a share warrant shall be entitled in all other respects to the same privileges and advantages as if he were named in the register of members as the holder of the shares included in warrant, and he shall be a member of the company. 43. The Board may, from time to time, make rules as to the terms on which (if it shall think fit) a new share warrant or coupon may be issued of by way of renewal in case of defacement, loss or destruction. Alteration of capital 44. The company may, from time to time, by ordinary resolution increase the share capital by such sum, to be divided into shares of such amount, as may be specified in the resolution. 45. The company may, by ordinary resolution,(a) consolidate and divide all or any of its share capital into shares of larger amount that its existing shares; (b) sub-divide its existing shares or any of them into shares of smaller amount that is fixed by the
memorandum, subject, nevertheless, to the provisions of clause (d) of sub-section (1) of section 94; (c) cancel any shares which, at the date of the passing of the resolution, have not been taken or agreed to be taken by any person. 46. The company may, by special resolution, reduce in any manner and with, and subject to, any incident authorized and consent required by law, (a) its share capital; (b) any capital redemption reserve account; or) (c) any share premium account General Meetings 47. All general meetings other than annual general meetings shall be called extraordinary general meetings. 48. (1) The Board may, whenever it thinks fit, call an extraordinary general meeting. (2) If at any time there are not within India directors capable of acting who are sufficient in number to form a quorum, any director or any two members of the company may call an extraordinary general meeting in the same manner, as nearly as possible, as that in which such a meeting may be called by the Board. 49. (1) No business shall be transacted at any general meeting unless a quorum of members is present at the time when the meeting proceeds to business. (2) Save as herein otherwise provided, five members present in person, (in the case of a public company) - two members present in person, (in the case of a private company) shall be a quorum. 50. The chairman, if any, of the Board shall preside as chairman at every general meeting of the company. 51. If there is no such chairman, or if he is not present within fifteen minutes after the time appointed for holding the meeting, or is unwilling to act as chairman of the meeting, the directors present shall elect one of their number to be chairman of the meeting. 52. If at any meeting no director is willing to act as chairman or if no director is present within fifteen minutes after the time appointed for holding the meeting, the members present shall choose one of their number to be chairman of the meeting. 53. (1) The chairman may, with the consent of any meeting at which a quorum is present, and shall, if so directed by the meeting, adjourn the meeting from time to time and from place to place. (2) No business shall be transacted at any adjourned for thirty days or more, notice of the adjourned meeting shall be given as in the case of an original meeting. (3) When a meeting is adjourned for thirty days or more, notice of an adjournment or of the business to be transacted at an adjourned meeting. (4) Save as aforesaid, it shall not be necessary to give any notice of an adjournment or of the business to be transacted at an adjourned meeting.
54. In the case of an equality of votes, whether on a show of hands or on a poll, the chairman of the meeting at which the show of hands takes place, or at which the poll is demanded, shall be entitled to a second or casting vote. 55. Any business other than that upon which a poll has been demanded may be proceeded with, pending the taking of the poll. Votes of Members 56. Subject to any rights or restrictions for the time being attached to any class or classes of shares,(a) On a show of hands, every member present in person shall have one vote; and (b) on a poll, the voting rights of members shall be as laid down in section 87. 57. In the case of joint holders, the vote of the senior who tenders a vote, whether in person or by proxy, shall be accepted to the exclusion of the votes of the other joint holders. For this purpose, seniority shall be determined by the order in which the names stand in the register of members. 58. A member of unsound mind, or in respect of whom an order has been made by any Court having jurisdiction in lunacy, may vote, whether on a show of hands or on a poll, by his committee or other legal guardian, and any such committee or guardian may, on a poll, vote by proxy. 59. No member shall be entitled to vote at any general meeting unless all calls or other sums presently payable by him in respect of shares in the company have been paid. 60. (1) objection shall be raised to the qualification of any voter except at the meeting or adjourned meeting at which the vote objected to is given or tendered, and every vote not disallowed at such meeting shall be valid for all purposes. (2) Any such objection made in due time shall be referred to the chairman of the meeting; whose decision shall be final and conclusive. 61. The instrument appointing a proxy and the power of attorney or other authority under which the proxy was executed, or the transfer of the shares in respect of which the proxy is given: Provided that no intimation in writing of such death, insanity, revocation or transfer shall have been received by the company is its office before the commencement of the meeting or adjourned meeting at which the proxy is used. Board of Directors 64. The number of the directors and the names of the first directors shall be determined in writing by the subscribers of the memorandum or a majority of them. 65. (1) In addition to the remuneration payable to them in pursuance of the Act, the directors may be paid all travelling, hotel and other expenses properly incurred by them (a) in attending and returning from meetings of the Board of Directors or any committee thereof or general meetings of the company; or 49
66. 67. 68.
69.
70.
71.
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(b) in connection with the business of the company. This qualification of a director shall be the holding of at least one share in the company. The Board may pay all expenses incurred in getting up and registering the company. The company may exercise the powers conferred by section 50 with regard to having an official seal for use abroad, and such powers shall be vested in the Board. The company may exercise the powers conferred on it by sections 157 and 158 with regard to the keeping of a foreign register; and the Board may (subject to the provisions of those sections) make and vary such regulations as it may think fit respecting the keeping of any such register. All cheques, promissory notes, drafts, hundies, bills of exchanged and other negotiable instruments, and all receipts for moneys paid to the company, shall be signed, drawn, accepted, endorsed, or otherwise executed, as the case may be, by such person and in such manner as the Board shall from time to time by resolution determine. Every director present at any meeting of the Board or of a committee thereof shall sign his name in a book to be kept for that purpose. (1) The Board shall have power at any time, and from time to time, to appoint a person as an additional director, provided the number of the directors and additional directors together shall not at any time exceed the maximum strength fixed for the Board by the articles. (2) Such person shall hold office only up to the date of the next annual general meeting of the company but shall be eligible for appointment by the company as a director at that meeting subject to the provisions of the Act.)
Proceedings of Board 73. (1) The Board of directors may meet for the despatch of business, adjourn and otherwise regulate its meetings, as it thinks fit. (2) A director may, and the manager or secretary on the requisition of a director shall, at any time summon a meeting of the Board. 74. (1) Save as otherwise expressly provided in the Act, questions arising at any meeting of the Board shall be decided by a majority of votes. (2) In case of an equality of votes, the chairman of the Board, if any, shall have a second or casting vote. 75. The continuing directors may act not withstanding any vacancy in the Board; but, if and so long as their number is reduced below the quorum fixed by the Act for a meeting of the Board, the continuing directors to that fixed for the quorum, or of summoning a general meeting of the company, but for no other purpose. 76 (1) The Board may elect a chairman of its meetings and determine the period for which he is to hold office.
(2) If no such chairman is elected, or if at any meeting the chairman is not present within five minutes after the time appointed for holding the meeting, the directors present may choose one of their number to be chairman of the meeting. 77. (1) The Board may, subject to the provisions of the Act, delegate any of its powers to committees consisting of such member or members of its body as it think fit. (2) Any committee so formed shall, in the exercise of the powers so delegated, conform to any regulations that may be imposed on it by the Board. 78 (1) A committee may elect a chairman of its meetings. (2) If no such chairman is elected, or if at any meeting the chairman is not present within five minutes after the time appointed for holding the meeting, the members present may choose one of their number to be chairman of the meeting. 79. (1) A committee may meet and adjourn as it thinks proper. (2) Questions arising at any meeting of a committee shall be determined by a majority of votes of the members present, and in case of an equality of votes, the chairman shall have a second or casting vote. 80. All acts done by any meeting of the Board or of a committee thereof or by any person acting as a director, shall, notwithstanding that it may be afterwards discovered that there was some defect in the appointment of any one or more of such directors or of any person acting as aforesaid, or that they or any of them were disqualified, be as valid as if every such director or such person had been duly appointed and was qualified to be a director. 81. Save as otherwise expressly provided in the Act, a resolution in writing, signed by all the members of the Board or of a committee thereof, for the time being entitled to receive notice of a meeting of the Board or committee, shall be as valid and effectual as if it had been passed at a meeting of the Board or committee, duly convened and held. Manager or Secretary 82. Subject to the provisions of the Act,(1) a manger or secretary may be appointed by the Board for such term, at such remuneration and upon such conditions as it may think fit; and any manager or secretary so appoint may be removed by the Board, (2) a director may be appointed as manager or secretary.) 83. A provision of the Act, or these regulations requiring or authorising a thing to be done by or to a director and the manager or secretary shall not be satisfied by its being done by or to the same person acting both as director and as or in place of, the manager or secretary. The Seal 84. (1) The Board shall provide for the safe custody of the seal.
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(2) The seal of the company shall not be affixed to any instrument except by the authority of a resolution of the Board or of a committee of the Board authorised by it in that behalf, and except in the presence of at least two directors and of the secretary or such other person as the Board may appoint for the purpose; and those two directors and the secretary or other person as aforesaid shall sign every instrument to which the seal of the company is so affixed in their presence. 85. The company is general meeting may declare dividends, but no dividend shall exceed the amount recommended by the Board. 86. The Board may from time to time pay to the members such interim dividends as appear to it to be justified by the profits of the company. 87. (1) The Board may, before recommending any dividend, set aside out of the profits of the company such sums as it thinks proper as a reserve or reserves which shall, at the discretion of the Board, be applicable, for any purpose to which the profits of the company may be properly applied, including provision for meeting contingencies or for equalising dividends; and pending such application, may, at the like discretion, either be employed in the business of the company or be invested in such investment (other than shares of the company) as the Board may, from time to time think fit. (2) The Board may also carry forward any profits which it may think prudent not to divide, without setting them aside as a reserve. 88. (1) Subject to the rights of persons, if any, entitled to shares with special rights as to dividends, all dividends shall be declared and paid according to the amounts paid or credited as paid on t he shares in respect whereof, the dividend is paid, but if and so long as nothing is paid upon any of the shares in the company, dividends may be declared and paid according to the amounts of the shares. (2) No amount paid or credited as paid on a share in advance of calls shall be treated for the purposes of this regulations as paid on the share. (3)All dividends shall be apportioned and paid proportionately to the amounts paid or credited as paid on the shares during any portion or portions of the period in respect of which the dividend is paid; but if any share is issued on terms providing that it shall rank for dividend as from a particular date such shares shall rank for dividend accordingly. 89. The Board may deduct from any dividend payable to any member all sums of money, if any, presently payable by him to the company on account of calls or otherwise in relation to the shares of the company. 90 [Omitted] 91 (1) Any dividend, interest or other moneys payable in cash in respect of shares may be paid by cheque or warrant sent through the post directed to the registered address of the
holder or, in the case of joint holders, to the register of members, or to such person and to such address as the holder or joint holders may in writing direct. (2) Every such cheque or warrant shall be made payable to the order of the person to whom it is sent. 92. Any one of two or more joint holders of a share may give effectual receipts for any dividends, bonuses or other moneys payable in respect of such share. 93. Notice of any dividend that may have been declared shall be given to the persons entitled to share therein the manner mentioned in the Act. 94. No dividend shall bear nearest against the company. Accounts 95. (1) The Board shall from time to time determine whether and to what extent and at what times and places and under what conditions or regulations, the accounts and books of the company, or any of them, shall be open to the inspection of members not being directors. (2) No member (not being a director) shall have any right of inspecting any accounts or books or document of the company except as conferred by law or authorised by the Board or by the company in general meeting. Capitalisation of Profits 96. (1) The company in general meeting may, upon the recommendation of the Board, resolve(a) that it is desirable to capitalise any part of the amount for the time being standing to the credit of any of the companys reserve accounts, or to the credit of the profit and loss account, or otherwise available for distribution; and (b) that such sum be accordingly set free for distribution in the manner specified in clause (2) amongst the members who would have been entitled thereto if distributed by way of dividend and in the same proportions. (2) The sum aforesaid shall not be paid in cash but shall be applied, subject to the provision contained in clause (3), either in or towards (i) paying up any amounts for the time being unpaid on any shares held by such members respectively; (ii) paying up in full, unissued shares of the company to be allotted and distributed, credited as fully paid up, to and amongst such members in the proportions aforesaid; or (iii) partly in the way specified in sub-clause (i) and partly in that specified in sub-clause (ii). (3) A share premium account and a capital redemption reserve account may, for the purposes of this regulation, only be applied in the paying up of unissued shares to be issued to members of the company as fully paid bonus shares. (4) The Board shall give effect to the resolution passed by the company in pursuance of this regulation. 51
97. (1) Whenever such a resolution as aforesaid shall have been passed, the Board shall (a) make all appropriations and applications of the undivided profits resolved to be capitalised thereby, and all allotments and issues of fully paid shares if any; and (b) generally do all acts and things required to give effect thereto. (2) The Board shall have full power (a) to make such provision, by the issue of fractional certificates or by payment in cash or otherwise, as t thinks fit, for the case of shares or debentures becoming distributable in fractions; and also; (b) to authorise any person to enter, on behalf of all the members entitled thereto into an agreement with the company providing for the allotment to them respectively, credited as fully paid-up, of any further shares to which they may be entitled upon such capitalisation or (as the case may require) for the payment up by the company on their behalf, by the application thereto their respective proportions of the profits resolved to be capitalised, of the amounts or any part of the amounts remaining unpaid in their existing shares. (3) Any agreement made under such authority shall be effective and binding in all such members.
Winding-Up 98. (1) If the company shall be wound-up, the liquidator may, with the sanction of a special resolution of the company and any other sanction required by the Act, divide among the members, in special or kind, the whole or any part of the assets of the company, whether they shall consist of property of the same kind or not. (2) For the purpose aforesaid, the liquidator may set such value as he deems fair upon any property to be divided as aforesaid and may determine how such division shall be carried out as between the members or different classes of members. (3) The liquidator may, with the like sanction, vest the whole or any part of such assets in trustees upon such trusts for the benefit of the contributories as the liquidators, with the like sanction shall think fit, but so that no member shall be compelled to accept any shares or other securities whereon there is any liability. Indemnity 99. Every officer or agent for the time being of the company shall be indemnified out of the assets of the company against any liability incurred by him in defending any proceedings, whether civil or criminal, in which judgement is given in his favour or in which he is acquitted or in connection with any application under section 633 in which relief is granted to him by the Court.
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6. COMMENCEMENT OF BUSINESS
SUB - TOPICS 6.1. Formal procedures for commencing business at a glance. 6.2. Restriction on commencement of business. 6.3. Issue of prospectus or statement in lieu of prospectus. 6.4. A few other issues. 6.5. Certificate to commence business and its effect. 6.6 Annexure 6.1. FORMAL PROCEDURES FOR COMMENCING BUSINESS AT A GLANCE At a glance: 1. A public company having a share capital has to issue a prospectus inviting public to subscribe for shares; and 2. The prospectus thus issued must be delivered to the Registrar for registration on or before the date of publication. OR A company not requiring to call for public subscription is required to issue a statement in llieu of prospectus, and the statement in lieu of prospectus is required to be registered with the Registrar in the same manner as the prospectus is required to be registered. 3. Shares are to be allotted to the applicants. 4. A return of allotment is to be filed with the Registrar within 30 days. 5. Certificate from every Director is to be procurred, stating that he has paid to the company the money for shares taken by him or promises to pay the money for shares contracted to be taken by him. 6. A duly verified declaration by one of the Directors or the Secretary in the prescribed form stating that : (a) a minimum subscription has been raised; (b) Directors have paid for the shares or agree to pay for them; and that (c) no money is repaid to applicants by reason of failure to apply for or to obtain permission for listing in a recognised stock exchange (when the company issued the prospectus), has to be filed with the Registrar. 7. Every Director has to give a certificate that he is agreeable to act as such. 8. A Registrar shall on filing of a duly verified declaration as stated above certify that the company is entitled to commence business. (Refer to Sections 44(1), 56, 61,70 and 149) 6.2. RESTRICTION ON COMMENCEMENT OF BUSINESS A public limited company after receiving the certificate of incorporation cannot commence business unless it receives the trading certificate. This public company after receiving the certificate of incorporation may be required to raise capital from the public. In that case it has to issue a prospectus as laid down in Sec.56 read with part-I and II of Schedule II of the Company Act. If the company does not raise capital from the public it is not to issue a prospectus inviting a public to susbcribe but it has to file with the Registrar a statement in lieu of prospectus as stipulated under Sec. 70(1) read with Schedule III of the Company Act. The law relating to obtaining trading certificate is specified in Sec.69 and Sec.149. Both these sections stipulate negative conditions that may stand in the way of issuing a certificate to commence business. According to Sec. 69(1) company cannot allot shares unless the amount stated in the prospectus as minimum subscription has been raised and the application money thereon has been received by the company. According to Sec. 149 a company cannot commence business unless: (a) shares held subject to the payment of the whole amount thereof in cash has been allotted to an amount not less than the minimum subscription; (b) every Director of the company has paid to the company for the shares taken or contracted to be taken by him for which he is liable to pay in cash; (c) no money is or may become liable to be paid to the applicants by reason of any failure to apply for or to obtain permission for listing in any recognised stock exchange; and (d) there has been filed with the Registrar a duly verified declaration by one of the Directors or the Secretary, in the prescribed form, that the previous conditions in (a),(b) and (c) have been complied with. According to Sec.149(3) the Registrar shall, on filing of a duly verified declaration as stated above certify that the company is entitled to commence business and that certificate shall be conclusive evidence that the company is so entitled. If any company commences business in contravention of Sec.149 every person who is responsible for the contravention shall be punishable with fine upto Rs.500/- for every day during which the contravention continues. A company which has issued statement in lieu of prospectus shall also submit a duly verified declaration by one of its Directors or the Secretary that the Directors have paid to the company for each of the shares taken or contracted for. On receiving the verified declaration the Registrar shall issue the certificate for commencing business. An existing company which has to start a business falling in the subsidiary or ancilliary issues or other issues in the object clause cannot start a business under that clause unless a special resolution is passed on that behalf in the Annual General Meeting, and a verified declaration by one of the Directors or Secretary to that effect is filed with the Registrar. 53
6.3. ISSUE OF PROSPECTUS OR STATEMENT IN LIEU OF PROSPECTUS A prospectus has been defined as any document, notice or circular inviting deposits from the public or offers from the public for the subscription or purchase of any shares in or debentures of a body corporate. [Sec. 2(36)] A prospectus issued by or on behalf of the company shall be dated which shall be its date of publication. The prospectus shall contain the matters as provided in Schedule II of the Company Act. Some of these are as follows: 1) Main objects of the company; 2) Name, address, description and occupation of the signatories; 3) Number and class of shares; 4) Number of redeemable shares with the date of redemption; 5) Number of qualification shares of Directors, if any; 6) Remuneration of Directors; 7) Main address, description and occupation of Director, Managing Director, Secretary and Manager; 8) Shares offered to the public for subscription; 9) Minimum subscription required for purchase of property, preliminary expenses, repayment of money borrowed, working capital and other expenses; 10) Time of the opening of the subscription list; 11) Substance of important contracts; 12) Share premium payable if any; 13) Names and addresses of underwriters and their obligations; 14) Name, address, description and occupation of the vendors; 15) Particulars of the nature and interest of the promoters of the company or property acquired of every Director or Promoter; 16) A report of the auditor in respect of profit and loss and excess of liabilities, rates of dividends, if any, etc; 17) If proceeds of the issue is to be applied directly or indirectly towards purchase of the business a financial report about the business as certified by the auditor. The prospectus is to be signed by the Directors, Secretary and the Manager. A statement in lieu of prospectus as specified in Sec.70 includes: i) nominal share capital of the company; ii) names, addresses, description and occupation of Director, Managing Director, Secretary and Manager; iii) Number and amount of shares, debentures agreed to be issued as fully or partly paid up; iv) amount payable to each vendor; v) amount to be paid to the promoter; vi) amount payable as commission; vii) the statement is to be signed by the Directors or their agents authorised in writing.
Legal status of Prospectus: A prospectus is not a mere statement but it contains absolute disclosure of the company. The matter shall be discussed in detail in the module on protection of investors interest. No application form is valid for the share capital unless it is accompanied by a prospectus. The prospectus is required to be registered with the Registrar on or before the day of publication. Since this is the document on which the prospective sharesholders apply for entering into the contract with the company the statements made in the prospectus are treated as conditions and terms of contract. Any misstatement in the prospectus therefore may either become a fraud or a misrepresentation thereby making the contract voidable. Of course one may argue that since the Act has criminalized the untrue statement in a prospectus the act is an unlawful one and therefore the agreement is void. In between these two probabilities the nature of the untrue statement shall determine the position. An untrue statement which is immaterial or is reasonably believed as true at the time of issue of the statement shall create only civil liability of damages. An untrue statement whether it is a fraud or misrepresentation makes the contract voidable only at the option of the shareholder. Contracts made before receiving the trading certificate . Section 149 (4) provides that a contract made by a public company before obtaining the trading certificate is provisional only. Palmer states that the words of the section are very wide and would appear to extend to all contracts including contracts of membership constituted by application for shares and allotment. (22nd ed., p.273). But Pennington takes a different view. He says:- Since the purpose of the section is to prevent the company from commencing to carry on its business until it obtains the trading certificate, contracts which are not directly concerned with carrying on its business are outside the ambit of the section and are binding immediately they are entered into (15th Edn. p.92). According to this view, contracts for the allotment of shares, underwriting contracts etc. being contracts not directly concerned with the carrying on of the companys business are outside the ambit of Section 149(4). This view seems to be preferable. 6.4. A FEW OTHER ISSUES 1. Can a Trading Certificate be avoided ? Though a public company having a share capital can commence its business only on obtaining the trading certificate, in practice this is avoided by incorporating the company initially as a private company and later converting it into a public company. 2. Legal effect of transactions entered into before obtaining the trading certificate Before 1985 the English Law was the same as that under the Indian Company Act, 1985, i.e., transactions entered into by companies before obtaining the trading certificate are valid and binding on the company as well as the other party.[Section
54
117(8)]. But if a public company commences business before obtaining the trading certificate the company and the officers in default will incur penal liability [Section 117(7)]. 3. What happens if Trading Certificate is not or cannot be obtained ? A public company which fails to obtain the trading certificate within one year of its incorporation is liable to be wound up.(Sec.433(c)) 6.5 CERTIFICATE TO COMMENCE BUSINESS AND ITS EFFECT Once the Registrar issues the certificate of commencing the business all contracts made against the company become operative.According to Sec. 149(4) contracts made after the date of incorporation, but before it is entitled to commence business shall be provisional only. These shall become binding on the day of receiving the trading certificate.Contract made during this time by the Directors or the promoters will ordinarily bind the company,if the position of the company is disclosed (if the company is stipulated as the principal). 6.6 ANNEXURE A draft prospectus is given in Schedule II as follows: Matters to be specified in Prospectus and Reports to be set out therein [See sections 44(2) (a) and 56] Part I Matters to be Specified 1. (1) Save as hereinafter provided in clause 27, the main objects of the company, with the names, addresses, descriptions and occupations of the signatories of the memorandum and the number of shares subscribed for by them. (2) The number and classes of shares, if any, and the nature and extent of the interest of the holders in the property and profits of the company. (3) The number of redeemable preference shares intended to be issued, with the date of redemption or, where no date is fixed the period of notice required for redeeming the shares and the proposed method of redemption. 2. (1) The number of shares, if any, fixed by the articles as the qualification of a director. (2) Any provision in the articles as to the remuneration of the directors whether for their services to the company as directors, managing directors or otherwise. 3. (1) The names, addresses, description and occupations of(a) the directors or proposed directors; (b) the managing director or proposed managing director, if any; (c) [ * * * * ] (d) [ * * * * ]
(d) the manger or proposed manger, if any: Provided that (i) where any such person is already a director, managing director or manager of any other company or (ii) where any such person (including a firm or a body corporate) is already a managing agent or secretaries and treasurers of any other company, the matters to be specified under this clause shall include the names of all the companies in which such person is a director, managing director or manger and, where, any such person is a firm or a body corporate the said particulars shall be given in respect of every partner of the firm or, as the case may be, in respect of every director of the body corporate.] (2) Any provision in the articles or in any contract which has been entered into as to the appointment of a managing director, or manager, the remuneration payable to him or them, and the compensation, if any, payable to him or them for loss of office. 4. [ * * * * ] 5. Where shares are offered to the public for subscription, particulars to (a) the minimum amount which, in the opinion of the directors or of the signatories of the memorandum arrived at after due inquiry, must be raised by the issue of those shares in order to provide the sums, or, if any part thereof is to be defrayed in any other manner, the balance of the sums required to be provided in respect of each of the following heads and distinguishing the amount required under each head:(i) the purchase price of any property purchased or to be purchased which is to be defrayed in whole or in part out of the proceeds of the issue; (ii) any preliminary expenses payable by the company, and any commission so payable to any person in consideration of his agreeing to subscribe for, or of his procuring or agreeing to procure subscriptions for, any shares in the company; (iii) the repayment of any moneys borrowed by the company in respect of any of the foregoing matters; (iv) working capital; (v) any other expenditure, stating the nature and purpose thereof and the estimated amount in each case; and (b) the amounts to be provided in respect of the matters aforesaid otherwise than out of the proceeds of the issue and the sources out of which those amounts are to be provided. 6. The time of the opening of the subscription lists. 7. The amount payable on application and allotment on each share, and in the case of a second or subsequent offer of shares, the amount offered for subscription on each previous allotment made within the two proceeding years, the amount actually allotted, and the amount, if any, paid on the share so allotted. 55
8. The substance of any contract or arrangement or proposed contract or arrangement, whereby any option or preferential right of any kind has been or is proposed to be given to any person to subscribe for any shares in or debentures of, a company, giving the number, description and amount of any such shares or debentures and including the following particulars of the option or right: a) the period during which the option or right is exercisable; b) the price to be paid for shares or debentures subscribed for under the option or right; c) the consideration, if any, given or to be given for the option or right or for the right thereto; d) the names, addresses, descriptions and occupations, of the persons to whom the option or right or the rights thereto has been given or is proposed to be given or, if given to existing share-holders or debenture-holders as such, the description and numbers of the relevant shares or debentures; e) any other material fact or circumstances relevant to the grant of the option or right. Explanation Subscribing for shares or debentures shall, for the purposes of this clause, include acquiring them from a person to whom they have been allotted or agreed to be allotted with a view to his offering them for sale. 9. The number, description and amount of shares and debentures which within the two preceding years have been issued or agreed to be issued, as fully or partly paid-up otherwise than in cash and in the latter case the extent to which they are so paid-up, and in either case the consideration for which those shares or debentures have been issued or agreed to be issued. 10. The amount paid or payable by way of premium, if any, on each share which had been issued within the two years preceding the date of the prospectus or is to be issued, stating the dates or proposed dates of issue and, where some shares have been or are to be issued at a premium and other shares of the same class at a lower premium, or at par or at a discount, the reasons for the differentiation and how any premiums received have been or are to be disposed of. 11. Where any issue of shares or debentures is underwritten, the names of the underwriters and the opinion of the directors that the resources of the underwriters are sufficient to discharge their obligations. 12. (1) As respects any property to which this clause applies a) the names, addresses, descriptions and occupations of the vendors; b) the amount paid or payable in cash, shares or debentures to the vendor and, where there is more than one separate vendor, or the company is a subpurchase, the amount so paid or payable to each vendor, specifying separately the amount, if any, paid or payable for goodwill; 56
the nature of the title or interest in such property acquired or to be acquired by the company; d) short particulars of every transaction relating to the property completed within the two preceding years, in which any vendor of the property to the company or any person who is, or was at the time of the transaction, a promoters, or a director, or proposed director of the company or any person who is, or was at the time of the transaction, a promoters, or a director or proposed director of the company had any interest, director or indirect, specifying the date of the transaction and the name of such promoter, director or proposed director and stating the amount payable by or to such vendor, promoter, director or proposed director in respect of the transaction. (2) The property to which sub-clause (1) applies is property purchased or acquired by the company or proposed so to be purchased or acquired, which is to be paid for wholly or partly out of the proceeds of the issue offered for subscription by the prospectus or the purchase or acquisition of which has not been completed at the date of the issue of the prospectus, other than property(a) the contract for the purchase or acquisition whereof was entered into in the ordinary course of the company's business, the contract not being made in contemplation of the issue nor the issue in consequence of the contract; or (b) as respects which the amount of the purchase money is not material. (3) For the purposes of this clause, where any of the vendors is a firm, the members of the firm shall not be treated as separate vendors. 13. The amount, if any, or the nature and extent of any consideration, paid within the two preceding years, or payable, as commission to any person (including commission so paid or payable to any sub-underwriter, who is a promoter or officer of the company) for subscribing or agreeing to subscribe, or procuring or agreeing to procure subscriptions for any shares in, or debentures of the company; and giving also the following particulars, namely:(a) the name, address, description and occupation of each such person; (b) particulars of the amounts which each has underwritten or sub-underwritten as aforesaid; (c) the rate of the commission payable to each for such underwriting or sub-underwriting; (d) any other material term or condition of the underwriting or sub-under-writing contract with each such person; and (e) when any such person is a company or a firm, the nature of any interest direct or indirect, in such company or firm of any promoter or officer of the company in respect of which the prospectors is issued.
c)
14. (1) Save as hereinafter provided in clause 27, the amount or estimated amount of preliminary expenses and the persons by whom any of those expenses have been paid or are payable. (2) Save as aforesaid, the amount or estimated amount of the expenses of the issue and the persons by whom any of those expenses have been paid or are payable. 15. Any amount or benefit paid or given within the two preceding years or intended to be paid or given to any promoter or officer and the consideration for the payment or the giving of the benefit. 16. (1) The dates of, parties to, and general nature of (a) every contract appointing or fixing the remuneration of a managing director [ * * * * * * ] or manager whenever entered into, that is to say, whether within or more than, two years before the date of the prospectors; (b) every other material contract, not being a contract entered into in the ordinary course of the business carried on or intended to be carried on by the company or a contract entered into more than two years before the date of the prospectus. (2) A reasonable time and place at which any such contract or a copy thereof may be inspected. 17. The names and addresses of the auditors, if any, of the company. 18. (1) Full particulars of the nature and extent of the interest if any, of every director or promoter (a) in the promotion of the company; or (b) in any property acquired by the company within two years of the date of the prospectus or proposed to be acquired by it. (2) Where the interest of such a director or promoter consists in being a member of a firm or company, the nature and extent of the interest of the firm or company, with a statement of all sums paid or agreed to be paid to him or to the firm or company in cash or shares or otherwise by any person either to induce him to become, or to qualify him as, a director, or otherwise for services rendered by him or by the firm or company, in connection with the promotion or formation of the company. 19. If the share capital of the company is divided into different classes of shares, the right of voting at meetings of the company conferred by, and the rights in respect of capital and dividends attached to, the several classes of shares respectively. 20. Where the articles of the company impose any restriction upon the members of the company in respect of the right to attend, speak or vote at meeting of the company or of the right to transfer shares, or upon the directors of the company in respect of their powers of management, the nature and extent of those restrictions. 21. (1) In the case of the company which has been carrying on business, the length of time during which the business of the company has been carried on.
(2) If the company proposes to acquire a business which has been carried on for less than three years, the length of time during which the business has been carried on. 22. (1) If any reserves or profits of the company or any of its subsidiaries have been capitalized, particulars of the capitalization. (2) Particulars of the surplus arising from any revaluation of the assets of the company or any of its subsidiaries during the two years preceding the date of the prospectus and the manner in which such surplus has been deal with. 23. A reasonable time and place at which copies of all balancesheets and profit and loss accounts, if any, on which the report of the auditors under Part II of this Schedule is based may be inspected. PART II Reports to be set out 24. (1) A report by the auditors of the company with respect to (a) profits and losses and assets and liabilities, in accordance with sub-clause (2) or (3) of this clause, as the case may require; and (b) the rates of the dividends, if any, paid by the company in respect of each class of shares in the company for each of the five financial years immediately preceding the issue of the prospectus, giving particulars of each class of shares on which sub dividends have been paid and particulars of the case in which no dividends have been paid in respect of any class of shares for any of those years; and, if no accounts have been made up in respect of any part of the period of five years ending on a date three months before the issue of the prospectus, containing a statement of that fact [and accompanied by a statement of the accounts of the company in respect of that part of the said period up to a date not earlier than six months of the date of issue of the prospectus indicating the profit or loss for that period and the assets and liabilities position as at the end of that period together with a certificate from the auditors that such accounts have been examined and found correct by them. The said statement may indicate the nature of provision or adjustments made or are yet to be made.] (2) If the company has no subsidiaries, the report shall (a) so far as regards profits and losses, deal with the profits or losses of the company (distinguishing items of a non-recurring nature) for each of the five financial years immediately preceding the issue of the prospectus; and (b) so far as regards assets and liabilities, deal with the assets and liabilities of the company at the last date to which the accounts of the company were made up. (3) If the company has subsidiaries the report shall (a) so far as regards profits and losses, deal separately with the company's profits or losses as provided by sub-clause (2) and in addition deal either 57
(i)
(ii)
(b)
(i)
(ii)
as a whole with the combined profits or losses of its subsidiaries, so far as they concern members of the company; or individually with the profits or losses of each subsidiary, so far as they concern members of the company; or, instead of dealing separately with the company's profits or losses, deal as a whole with the profits or losses of the company, and, so far as they concern members of the company, with the combined profits or losses of its subsidiaries; and so far as regards assets and liabilities, deal separately with the company's assets and liabilities provided by sub-clause (2) and in addition, deal either: as a whole with the combined assets and liabilities of its subsidiaries, with or without the company's assets and liabilities, or individually with the assets and liabilities of each subsidiary; and shall indicate as respects the assets and liabilities of the subsidiaries, the allowance to be made for persons other than members of the company.
(i)
the profits or losses of the other body corporate for each of the five financial years immediately preceding the issue of the prospectus; and (ii) the assets and liabilities of the other body corporate at the last date to which its accounts were made up. (2) The said report shall (a) indicate how the profits or losses of the other body corporate dealt with by the report would, in respect of the shares to be acquired, have concerned members of the company and what allowance would have fallen to be made, in relation to assets and liabilities so dealt with, for holders of other shares, if the company had at all material times held the shares to be acquired; and (b) where the other body corporate has subsidiaries, deal with the profits or losses and the assets and liabilities of the body corporate and its subsidiaries in the manner provided by sub-clause (3) of clause 24 of this Schedule in relation to the company and its subsidiaries. PART III Provisions Applying to Parts I and II of Schedule 27. Clause 1 (sofar as it relates to particulars of the signatories of the memorandum and the shares subscribed for by them) and clause 14 (so far as it relates to preliminary expenses) of this Schedule shall not apply in the case of a prospectus issue more than two years after the date at which the company is entitled to commences business. 28. Every person shall for the purposes of this Schedule, be deemed to be a vendor who had entered into any contract, absolute or conditional, for the sale or purchase, or for any option of purchase, of any property to be acquired by the company, in any case where (a) the purchase money is not fully paid at the date of the issue of the prospectus; (b) the purchase money is to be paid or satisfied, wholly or in part, out of the proceeds of the issue offered for subscription by the prospectus; (c) the contract depends for its validity or fulfilment on the result of that issue. 29. Where any property to be acquired by the company is to be taken on lease, this Schedule shall have effect as if the expression "vendor" included the lessor, the expression "purchase money" included the consideration for the lease, and the expression "subpurchaser" included a sub-lessee. 30. If in the case of a company which has been carrying on business, or of a business which has been carried on for less than five financial years, the accounts of the company or business have only been made up in respect of four such years, three such years, two such years or one such year, Part II of this Schedule shall have effect as if references to four financial years, three financial years, two financial years or one financial year,
25. If the proceeds, or any part of the proceeds, of the issue of the shares or debentures are or is to be applied directly or indirectly (i) in the purchase of any business; or (ii) in the purchase of an interest in any business and by reason of that purchase or, anything to be done in consequence thereof, or in connection therewith, the company will become entitled to an interest as respect either the capital or profits and losses or both, in such business exceeding fifty per cent, thereof; a report made by accountants (who shall be named in the prospectus) upon (a) the profits or losses of the business for each of the five financial years immediately preceding the issue of the prospectus; and (b) the assets and liabilities of the business at the last date to which the accounts of the business were made up, being a date not more than one hundred and twenty days before the date of the issue of the prospectus. 26. (1) If (a) the proceeds, or any part of the proceeds, of the issue of the share or debentures are or is to be applied directly or indirectly in any manner resulting in the acquisition by the company of shares in any other body corporate; and (b) by reason of that acquisition or anything to be done in consequence thereof or in connection therewith, that body corporate will become a subsidiary of the company; a report made by accountants (who shall be named in the prospectus) upon 58
as the case may be, were substituted for references to five financial years. 31. Where the five financial years immediately preceding the issue of the prospectus which are referred to in Part II of this Schedule or in this Part cover a period of less than five years, references to the said five financial years in either Part shall have effect as if references to a number of financial years the aggregate period covered by which is not less than five years immediately preceding the issue of the prospectus were substituted for references to the five financial years aforesaid. 32. Any report required by Part II of this Schedule shall either (a) Indicate by way of note any adjustments as respects the figures of any profits or losses or assets and liabilities dealt with by the report which appear to the persons making the report necessary; or
(b)
make those adjustments and indicate that adjustments have been made.
33. Any report by accounts required by Part II of this Schedule (a) shall be made by accountants qualified under this Act for appointment as auditors of the company; and (b) shall not be made by any accountant who is an officer or servant, or a partner or in the employment of an officer or servant, of the company or of the company's subsidiary or holding company or of a subsidiary of the company's holding company. For the purposes of this clause, the expression "officer" shall include a proposed director but not an auditor.
59
7. CASE LAW
T.V. Krishnan v. Andhra Prabha (p) Ltd. (AIR 1960 A.P. 123.) By virtue of the powers conferred by Act IXXX of 1958 the Union Government appointed a wage committee for fixing and determining the rates of wages of the working Journalists. The committee classified newspapers into five categories (A to E) on the basis of their gross income. Separate pay scales were recommended for journalists working in the different classes of newspapers. In the classification the Express Newspapers Ltd. was assigned to Group A. As a result of the recommendations, The express Newspapers Ltd. had to pay an additional sum of Rs.2.00 lakhs per month as wages. At an extraordinary meeting of the Company held in February 1959, it was resolved that the company should cease to do business as proprietors and Publishers of newspapers dailies. Consequently the Board of Directors of Express Newspapers Ltd., sold to the Andhra Prabha (P) Ltd. a company incorporated in April, 1959, the proprietary rights of printing and publishing of Andhra Prabha and Andhra Prabha Illustrated Weekly as a going concern. The petitioners alleged that the Andhra Prabha (P) Ltd. was not promoted for any bonafide purpose. The motive was to circumvent the recommendation of the wage committee and to defeat the lawful claims of the employees. Petitioner pleaded for cancelling or revoking the incorporation of a company. The court held that Under Sec. 12 of the Companys Act the essence of a validly incorporated company is that it should consist of a particular number of persons and that it should be asociated for a lawful purpose. It is not the petitioners case. The only point that is stressed is that the company was not started for any lawful purpose but to circumvent the rights of the employees. The fact that this company is calculated to affect the future interests of its workers would not nullify the selling of property rights to another Prabhu (P) Ltd.. It is not suggested that any attempts are being made to carry on the business by illegal methods. So the objectives and the means are good. Even if this tends to jeopardize the interests of the petitioners, it cannot enter the determination of the character of the object of the association since it is a collateral consequence. Moosa Goolam Ariff v. Ebrahim Baolam Ariff [ILR (1913) 40 Cal.1 (P.C.)] All but two of the subscribers of the companys memorandum were infants who had no legal capacity to sign it. Holding that the matter could not be reopened after the issue of the certificate of incorporation, LORD MACNAGHTEN observed: Their Lordship will assume that the conditions of registration prescribed by the Indian Companies Act were not duly complied with, that there were not seven subscribers to the memorandum and that the Registrar ought not to have granted the certificate. But the certificate is conclusive for all purposes. 60
Seth Mohanlal and another v. Grain Chambers Ltd. [(1968) 38Comp. Cas.543 S.C.] The respondent company was engaged in the business of an exchange in grains, cotton, sugar, gur and other commodities. Under its articles no person could remain a member of the company for a continuous period of six months. In March 1949 the Board of Directors of the company sanctioning transactions of business in futures in gur for March 1950, settlement. One of the issues in this case was about the validity of the resolution. The Supreme Court held that the resolution could not be challenged in view of Regulation 94 of Table A of Companies Act, 1913. Speaking for the court, Shah.J. observed, the respondent company is limited by shares and was registered after the commencement of the Indian Companies Act, 1913. The company has adopted special articles of association, but there is no article which excludes or modifies Regulation 94 of Table A and by operation of section 18 of the Act (section 2 of 1956 Act) that regulation must be deemed to apply in the same manner and to the same extent as if it was contained in the registered articles of the company. We are unable to hold that because the company has not incorporated regulation 94 of Table A in its articles of association, an intention to exclude the applicability of the regulation to the company may be inferred. His Lordship pointed out that in order to exclude any regulation Table A by implication, it must be inconsistent with any express provision in the memorandum or the articles of association of the company. Kishangarh Electric Supply Company Ltd. v. United State of Rajasthan. [AIR 1960 Raj.49.] In 1942, the State of Kishangarh, which subsequently was merged with the State of Rajasthan, granted a licence to one Lohawala for the supply of Electricity to the State, on certain condition. It was agreed that a company would be formed to take over the business of supplying electricity with equity participation by the State. The plaintiff company alleged that it was incorporated for the purpose of taking over the business of Lohawalla and the Co., (the business name of the licensee), which transferred all its rights in favour of the company in 1946. Thereafter the business was being carried out by the plaintiff company. In September 1946, the then Kishangarh state forcibly and unlawfully took possession of the building of the PowerHouse plants and machinery and records of the company. The contention of the Respondent State was that the plaintiff company was not formed in accordance with the terms of the agreement between the State and the licensee (Mr. Lohawalla). The shares allotted to the State were not accepted by the State, and the certificate of commencement of business was not issued to the palintiff company by the Registrar. As such, the company had no locus standi to carry on business or even to institute the suit. On the above issues, the Court observed that the argument advanced on behalf of the plaintiff is that the Company was entitled to commence business, but the certificate had been
wrongly refused to the company by the Registrar, who was an employee of the Kishangarh State. One of the conditions when a company can commence business is that the shares held subject to the payment of the whole amount thereof in cash have been allotted to an amount not less in the whole than the minimum subscription, vide Section 103(1)(a) of the Indian Companies Act then in force in Kishangarh. The minimum subscription, according to the statement in lieu of prospectus was Rs.50,000-, vide document Ex.P.7. Now the total of issued capital was Rs. 1,00,000/- of which Rs.50,000/- was to be counted in lieu of fully paid shares to H.H. the Darbar of Kishangarh State, and the remaining amount of 50,000/-, which was to be subscribed in cash was the minimum subscription fixed by the Directors, according to the Statement in lieu of prospectus. Of this minimum subscription at least 1000 shares were such on which no amount had been paid to the company. Under clause 8 of the Articles of Association, the amount payable on application on each of the shares so offered was not to be less than 25% of the nominal amount of the shares. In respect of the allotment of these 1000 shares, therefore there must have been paid to the company Rs.2500/- before allotment could be made. Under Section 101 of the Indian Companies Act, no allotment can be made unless the amount mentioned, as minimum subscription has been applied for, and at least 5% thereof has been paid to or received in cash by the company. Admittedly in respect of 100 shares no amount had been received by the company. The provision as to minimum subscription having been applied for had not been fulfilled. The company, therefore, was rightly held by the Registrar not to be entitled to commence business unless the allotment has been made of shares for not less than the minimum subscription. In the present case the allotment of requisite shares could not have been made as shown above and the company consequently was not entitled to commence any business. Now, the section does not say that it shall not commence its business. It says that it shall not commence, which means that it cannot enter into any agreement for sale or purchase of any property also. As stated earlier, there was no sale of the property by the Kishangarh State to the company, and, therefore, if the State took back into its possession all that handed over to Lohawalla and Co., the Company had no cause of action against the former Kishangarh State. In the absence of the right to commence business the company had no right even to file a suit. Section 103 sub-section (3) of Company Act 1913 corresponding to Section 149 of Company Act 1956, is provisional only and shall not bind on the company until that date and on that date it shall become binding. Query: (1) Do you agree with the observation of the learned judge that the company has no right even to file a suit before obtaining the certificate of commencement of business? What is the true scope of section 149 ? Query: (2) Will the carrying on of preliminary steps such as issue of prospectus or the allotment of shares, be activities within the purview of Section 149 ?
Beattie v. Beattie (E&F) Ltd. [(1938)3 All ER 214] A provision in the articles provided that the disputes between the members and the company should be settled by arbitration. The defendant was a Director of the plaintiff company, he was sued by the company for return of certain sums which was alleged to be improperly paid to him. He tried to invoke the arbitration clause. Held, the arbitration clause was not applicable to the present dispute as it did not relate to the rights or liabilities of a member in his capacity as member. As stated by Astbury J, in Hickmans case [1915-1 Ch.881] No right merely purporting to be given by an article to a person whether a member or not in a capacity other than that of a member, as for instance, as solicitor, promoter, director, etc. can be enforced against the company. Nor can the company base its claim upon the Articles or memorandum to enforce a provision therein, which does not deal with membership rights. Johnson v Lyttles Iron Agency (1877)5 Ch.D.687 The steps taken by a company to forfeit the shares of a member in violation of the provisions in the articles were held invalid on the ground that the company did not comply strictly with the provisions of the contract between the company and the shareholders which is contained in the regulations. A shareholder may enforce the contract contained in the articles and compel the company to allow him to vote at general meeting or to enter his name on the register of members, or to obtain the fiancncial benefits. Similarly the company may also enforce its rights conferred by the articles, against the members. [Also see: Borland Trustees v. Steel Bors (1901)1 Ch.279] Re Cyclists Touring Club [(1907)1 ch.269] The object of the company was to promote cycling and to protect pedal cyclists. The company sought to expand its objects so as to permit motorists also become members. Held that alteration is not permissible under S.17(1)(d) as the interests of cyclists (present objects), and those of motorists (new objects) were to some extent, antithetical. In re Drages Ltd. The company which was incorporated to do the business of house furnishers and interior decorators temporarily suspended its business. Later on the object clause was altered to enable the company to carry on the business of financiers. Held, the alteration was invalid. The new business cannot be carried on by closing down the original business. It can only be combined with the existing business which must remain intact even after the commencement of the additional business. In re Motilal Hirabhai Spinning & Weaving Co. Ltd. [(1970) 40 Comp.cas. 1215] A company was formed to carry on the business of manufacturing and trading textile goods. After about 52 years, it closed down the business in 1949 due to financial difficulty and let out the premises. In 1969 it amended the object clause by passing a special resolution, the purpose being to indulge in the business of manufacturing photographic materials and pharamaceuticals. In an application for confirmation of the petition, D.A. Desai.J of the Gujarat High Court held:61
When the court is called upon to confirm the proposed alteration in the object clause, notwithstanding fact that the same has been approved by a special resolution, and notwithstanding the fact, that no member or creditor has appeared to contest the petition, the court should examine the petition to find out whether it is open to the company to alter the object clause and if so whether the proposed alteration falls within one or the other clauses of sub-section(1) of section 17.... The language of claims (a) and (d) unmistakably indicate that before any alteration in the object clause is sanctioned which enable the company to start or undertake a new business activity, the company must invariably be doing some business at the relevant date. If on that date the company is virtually a defunct company the court will have no jurisdiction to sanction the proposed alteration in the object clause. This is implicit in the language used in clauses (a) and (d). [See also Eastern Wollen Mills Ltd. In re (1958)60 Bom.LR 1121] Strathspay Public Assembly Hall Co. Ltd. v. Anderson trustees, [1934 S.C. 385.] The original objects of a company were to build and let a public hall with shops and cellars. When the building was destroyed by fire the company altered its object clause by susbstituting a new one which provided for the erection and letting of shops and houses and warehouses. Held, the alteration could nto be permitted [under S.17(1)(e)] as it sought to effect a fundamental change in the character of the main objects. But it is doubtful whether at present such a restrictive attitude would be taken by the courts. Geo Rubber Exports Ltd. In re [(1991)72 Comp.Cas. 713] The petitioner company was incorporated with the object of carrying on the business of dealing in latex rubber gloves and other rubber products. As the market conditions turned unfavourable it was forced to abandon its project. Subsequently a special resolution was unanimously passed for alteration of the object clause. This was to enable the company to do the business of aqua farming and dealing in marine products. The companys assets exceeded its liabilities. Further, there was no objection from any shareholder or creditor to the proposed alteration. On a petition filed before the Company Law Board it was observed (Per K.K. Dhar, Member):As the company is not carrying on any business at present the point arising for determination is whether the alteration of the object clause of the memorandum of association as prayed for in the petition is in accordance with the provisions of section 17(1) of the Act...... The scope of alteration covered by clauses (a) and (d) came up for consideration before the Court/C.L.B. from time to time. It has been held that if a company wants to add some new objects so as to carry on its existing business more economically or more efficiently, such an amendment should be allowed under clause (a). In so far as clause (d) is concerned, the Court/ C.L.B. has allowed alteration of the object clause for inclusion of new 62
objects after being satisfied that, under existing circumstances, the company can conveniently combine the new business with the existing business, and new business is not inconsistent with or destructive of the business being carried on by the company. In this case however, the company has not been carrying on any business either on the date when the special resolution was passed or when the petition is heard by CLB, it is for consideration whether the company can be allowed to alter the object clause as there is no existing business with which the new business can be combined as provided in clause (d) of section 17(1). It has been held in Motilal Hirabai Spinning and Weaving Co. Ltd. [40 comp.cas. 1216] that, the language of clauses (a) and (d) of sec. 17(1) unmistakably indicates that before any alteration in the object clause is sanctioned, which enables the company to start or undertake a new business activity, the company must invariably be doing some business. In many other cases the court/CLB held that the object clause of the memorandum of association can be allowed for carrying on some new business even if the company is not carrying on any business... The CLB then referred to a few cases which held so, but admitted that in all those cases, the companies were compelled by process of law to part with their existing business, but not voluntarily. But these cases were strong enough according to the Board to hold that the combination of new business with the existing business is not to be considered essential for alteration under section 17(1)(d). Querry: Do you think this case can be reconciled with other cases? [See also: Mahalakshmi Bank Ltd. v. Registrar AIR 1961 Cal.666] All India Railway Mens Benefit Fund Ltd. v. Jamedar Beheswarnath Bali [(1945) 15 Comp.cas. 142] The appellant was an association of railway employees registered under the Companies Act, 1913 with the object of affording relief to the members on their retirement from service. The respondent was enrolled as a member of the appellant asociation in 1932. Dispute arose between the parties as to the quantum of amount payable to him on his retirement from service in 1940. The main issue was whether the respondent was bound by the amendment made to the original articles by a special resolution passed in 1939. His contention was that he was only bound by the articles as they existed on the date of his becoming a member of the association. Holding that the respondent was bound by the amendment articles and quoting with approval the statement of Lindley M.R. in Allen v. Gold Reef of West Africa,Nijogi.J. of the Nagpur H.C. held section 31 of Companies Act, 1956 authorises a company to alter or add to its articles by a special resolution and declares that any alteration or addition so made shall be as valid as originally contained in the articles and be subjected in like manner to alteration by special resolution. It has been held that a company cannot deprive itself of the statutory power to alter its articles of association either by a statement in the articles or by a contract that they shall not be altered..
Shuttleworth v Cox Bros & Co. (Maiden head) Ltd. [(1927)2 KB.9] Article 18 of the company provided that the plaintiff shall be a permanent Director of the company. A new provisions was incorporated in the articles to the effect that any Director shall vacate his office, if he shall be requested in writing by all the other Directors to resign his office. Invoking the power under the new provision, the plaintiff was asked by his fellow Directors to resign. The plaintiff contented that the new article was invalid. The court held that it was valid as the plaintiff failed to prove that the majority acted malafide. In Greenhalh v. Arderne Cinema Ltd. [(1950)2 All ER 1120]. Evershed M.R. said I think the matter can, in practice, be stated... by saying that a special resolution of this kind is liable to be impeached if the effect of it were to discriminate between the majority share holders and the minority shareholders so as to give the former an advantage of which the latter were deprived. In the above case, an alteration of the articles sought to empower the company to relieve any member from the liability under the pre-emption clause by passing an ordinary resolution to that effect. Held, the alteration was valid. Jayantilal Ranchoddas v. Tata Iron & Steel Ltd [(1957) 27 Comp. cas. 604; AIR 1958 Bom.155] Before confirming the alteration the C.L. Board should ensure that sufficient notice has been given to every debenture holder and to every other person or class of persons whose interest would be affected by the alteration. The interests of ordinary creditors and members also shall be taken into consideration. Every creditor who in the opinion of the Company Law Board is entitled to object to the alteration must either consent to the alteration or must be paid off or secured.
Oriental Paper Mills Ltd. In re [(1958)28 Comp.cas.523; AIR 1957 Orissa 232] The Petitioner company, by a special resolution amended the Registered office clause to change the Registered office from Orissa to West Bengal. The State of Orissa objected to the change. The company argued that the State had no locus standi to oppose the petition. Rejecting the contention the Orissa High Court held that the expression any person or class of persons in section 12(3)(a) of Companies Act, 1913 (coorsponding to section 17(3)(a), of Companies act, 1956) were very general and were applicable not only to creditors or debenture holders of a company but also to every person whose interest might be affected. It was also held that as the proposed alteration would affect the revenue of the State of Orissa, the court while deciding whether the special resolution should be confirmed must also take into account the interest of the affected State. [See Company Law Boards Regulations regarding alteration of Registration Office Clause.] 17. Fertiliser Corporation of India v Workman : AIR 1970 SC 867 The appellant was a government company registered under the Companies Act, 1956. The articles of association of the company gave power to the President of India to appoint the members of the Board of Directors and also to issue directive to the Board from time to time in regard to the conduct of the business of the company. Held: The exercise of the powers of the Board of directors of the company is apart from other restrictions, subject to the directives if any, issued by the President from time to time with regard to the conduct of the business of the company or Directors".
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8. PROBLEMS
1.(a) If you are asked to frame an Articles of Association of a Private Limited Company, what ten items you will require to include in it as the most important ones ? (b) X Co. Ltd. is a public limited Company having its object clauses like the following : Main object : a) Manufacturing, branding, selling, etc., cigarettes and other tobacco products. b) Purchasing all materials needed to manufacture, brand, patent of the above products and all assets including plants and machineries needed. Ancillary objects: a) Enter into any contracts, lease agreement etc., for the purpose of the main objects. b) Manufacture, sale and otherwise disposal of any byproducts. Other objects : a) Manufacturing consumable food stuffs and selling the same. b) Doing any other business that the Company deems it profitable and beneficial to the Company. (i) Directors of the Board of the said Company ask for your advice on the proposal of starting a Hotel business at Bangalore. Give a detailed advice to the Company. (ii) Suppose any change in the object clause is necessary, Can the Company change and how? (iii) How can the Company change its name? 2. Mr. Anil Desai is engaged in trading activities as a grocer. The business at present is a sole proprietory concern. He wants to expand the business by entering into the food processing industry, for which a minimum investment of Rs.200 lakhs as capital is required. His existing business is worth Rs.25 lakhs. He may be able to invest another 50 lakhs. Two of his friends are prepared to invest a total amount of Rs.120 lakhs provided the business is run as a Corporation. There are a few others who are prepared to be associated in the new venture of Anil Desai. But he is apprehensive. He wants to be quite sure that inspite of the association of his two friends and few others in the capital, the control over the business concern shall always remain with him. 1. Which type of company is suitable to achieve the purpose? Explain how this would ensure Anil Desais perpetual control. 2. Assume that the company may require another 300 lakhs in the near future for its expansion. The present members of the company are not in a position to make further investments. But, the members of the public and a few other friends of Anil Desai, will be inclined to take shares of the company. What would be the device to be resorted to ? 64
b)
Assuming that Mr. Anil Desai is agreeable to form a company, advise him as to the steps to be taken for the purpose. c) Assume that the company was formed with an initial membership of six persons. Of these, two persons were minors at the time when they subscribed to the constitutional documents of the company, but they attained majority within three months of incorporation of the company. One of the members pleads that the company is not legally incorporated. Advise. 3. Mr. Karan Singh is the kartha of a Mitakshara Hindu Family, engaged in the traditional business of dealing in Silk and other textile items. He has four adult sons and three daughters. The four adult sons have altogether 15 issues, (10 males and 5 females, all minors). With the implied consent of all his sons, Mr. Karan Singh entered into an agreement with the kartha of another joint family, with a membership of 15 (4 males and 11 females, all adults), to carry on the business jointly as a partnership firm. a) The two karthas are prosecuted on the ground that the business organisation which they have formed is legally prohibited. Decide, stating the reasons. b) Assume that A Co. Pvt. Ltd., with a membership of 30, is carrying on the business of travel agency. B Co. Pvt. Ltd., with a membership of 25 is also engaged in the same business. The managements of both the companies with the unanimous consent of all their members have decided to merge the business activities of both the companies. The legal device contemplated is the formation of a third company as a private company. Is it possible ? If so how ? Examine the legal issues involved. c) As association with a membership of 25 is carrying on the business of grocers as an unincorporated body. Due to differences among the members, some of them decided to withdraw from the joint venture. They have instituted a suit for dissolution of the association. Others object. Decide. d) Assume that in situation (c) above, the association has business dealings with M/s. P & Co. Ltd. It has instituted a suit against the company (P & Co. Ltd) for realisation of the amount due from them. P & Co. Ltd. pleads that the suit is not maintainable. Decide. 4. Prepare the memorandum of association of a company limited by guarantee and having a share capital. The object of the company is to promote cultural activities. 5.a) Rajaram & company is engaged in the business of money lending. Mr.Rajaram, the Proprietor of the business concern wanted to convert it into a private limited company. Advise him as to the procedural steps to be taken to achieve this.
b) What are the essential documents to be filed for registration of the company? c) The Memorandum of Association of the Company presented to the Registrar for registration, contain, inter alia, the following clauses : i) All the directors of the Company shall be appointed by Mr. Rajaram, the promoter; ii) The Articles embodied in Table A, of Schedule I of Companies Act, 1956 shall be deemed to be the Articles of the Company. The Registrar objects to the incorporation of these Provisions in the Memorandum. Decide. d) Assume that the Company now wants to embark upon the business of manufacturing consumer durables. Advise the secretary as to the steps necessary to achieve this. 6. Forty years ago Mr. Rajaram started his career as a good grains dealer in Palani. Though there was no one else associated with him in the venture, the business was started under the name and style Raja & Company. In course of time, Raja & Company embarked upon many other areas of trading and manufacturing activities. More than 5000 employees took shelter under its umbrella. When Rajaram died recently, his two sons Pramod and Pradeep inherited the business. a) The two brothers decided to convert the business into an incorporated body. They also want to enter the new pastures of oil drilling. For this they have negotiated with M/s. Name Inc., USA for technical collaboration. The latter are willing to provide the technical assistance and other facilities, if, but only if they are permitted equity participation in the oil drilling business. The brothers are prepared, provided that they are quite sure that the management and control of the business will always remain with them. Assume that the brothers are prepared to make a cash investment of Rs.5 crores in the oil drilling business, which they have in their personal accounts with M/s. Deena Bank, Palani Branch. A few friends of the brothers are also willing to make investments upto Rs.5 crores in the oil drilling venture. The foreign collaborators want a minimum of 15% of equity participation. The project cost of the oil drilling venture is assessed at Rs.60 crores. This amount is to be raised by equity and term loan. The IDBI is prepared to provide the loan on condition that the Debt-Equity ratio does not exceed 2:1. The brothers seek your opinion. Give a detailed legal opinion, explaining the legal provisions and modus operandi for the same. It must be specifically explained how your advice when implemented would ensure that the brothers together can always retain control over the management of the new company. b) Specify the contents of the essential matters to be included in the Articles of the Company or Companies formed under Clause (a).
c) Assume that after the death of Rajaram, the proprietory business run by him was converted by his legal heirs into a company under the name and style Mayil Vahana Enterprises Pvt. Ltd. in May 1991 with its registered office at Palani. On receipt of a petition from one Mr. Murugan that he had been carrying on the business of grocers and dealers in foodgrains for the last 25 years under the trade name Mayil Vahana Enterprises at Dindigal at about 100 Km. from Palani, the Regional Director, Department of Company Law Affairs, has issued notice to the company on 2nd July 1992 to change its name immediately. On the company failing to comply with the directive issued by the Regional Director, Criminal Proceedings were launched against the following : a) the company b) Mr. Pramod, the Managing Director c) Mr. Janaki Ram, an advocate practicing in Madras, and who is a Director of the Company. Advise each one of the accused as to defences (if any) available to them. d) What would be your advice to the three accused in situation (c) above, if the Regional Director did not receive any petition complaining about the name of the company. But he acted suo moto, on coming to know that there is an existing company in the same field of business and operating for the last ten years under the name Mayil Vahana Enterprises Ltd. What would be your advice to the three accused. e) Assume that the Registrar did not issue any notice for change of name of the company. But it was brought to the notice of the Board in August 1992, that there is an existing company functioning under the same name in Dindigal. Immediately they got an ordinary resolution passed at a general meeting in early September and changed the name to Palani Andavan Enterprises Pvt. Ltd. The Companys application to the Registrar for registration of the new name, is pending. The Registrar seeks your advice as to whether he can refuse to register the change of name. Decide f) Assume that in situation (c) above, the Company, i.e. Mayil Vahana (P) Ltd., was formed with a membership of ten. All the members of the Company are the members of the family of Pramod and Pradeep. Immediately after the formation of the Company, Pramod, his wife and two children died in a road traffic accident. The legal heir of the deceaseds is Pradeep. The accident was in July 1991. 7. Fortune seems to play a hide and seek game with him. a) After having seen her protean face at glances in many and varied business activities, Pramod thought that she had come to stay with him permanently in his beverage business, which consisted of running a coffee house and sale of coffee powder under the brand name Ruchi coffee. He started the business as a Private limited company under the name and style Ruchi Coffee Works (P.) Ltd. The Company was incorporated in April 1990. On the first anniversary of the coffee business, when he 65
examined the accounts, Pramod thought that he had at last conquerred her. His modest investment has grown three-fold. But the joy was soon shadowed by the clouds of threatened legal proceedings. In June 1991 along with the dark, gloomy monsoon days came an unusual visitor to him in the form of a notice from the Regional Director (MADRAS), of the Department of Company Affairs, asking to change the name of the company within three months. The reason adduced was that the name of the company closely resembles the name of another business firm Ruchi & Company, engaged in the business of manufacturing coffee powder and having business activities in the locality, for the last four or five years. The notice was served on the company as well as on Pramod, its Chairman-cum-Managing Director. It warned them, that if the directive is not complied with within the stipulated time, they will be prosecuted. Advise Pramod and the Company, pointing out the possible contentions of the other party and your defences to them. b) Assume that the Regional Director did not serve any notice. But Pramod wants to change the name of the company as he felt that the customers are a bit confused about the two brands
of coffee powder in the market. Advise him in detail, the steps to be taken to change the name of his business to Kudak Coffee (P) Ltd. c) Assume that Pramod wants to enter into the field of film distribution also. The object clause of the company as it exists today, does not permit this. Advise the company as to the steps to be taken to achieve this. d) The company has four members, Mr. Pramod, holds 9000 out of the 10000 issued shares of nominal value of Rs.10 each, the remaining shares are held by his wife, father-in-law, and brother-in-law. Pramods idea of entering the film business was not cherished by other members. But they did not oppose him. The object clause got altered. Now he wants the issued capital to be raised to 30 lakhs. His father-in-law objected to this. A general meeting was convened, to alter the Articles of association by inserting a new provision, wherein it is provided that in any fresh issue of shares duly decided by the Board of Directors, the shares shall be offered to the existing shareholders proportionately and the shareholders are bound to purchase the shares so offered. Mr. Janardhan, the father-in-law of Pramod questions the validity of the new article. Give your legal opinion.
[NOTE: Specify your name, ID No, and address while sending answer papers]
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9. SUPPLEMENTARY READINGS
1. 2. 3. 4. Companies Act, 1956, Sections 52 to 56, 90, 149 Ramaiya, A Guide to the Companies Act, 10th Edn, Wadhwa & Co Pvt Ltd, Nagpur, pp. 1-170 S.C. Sen, New Frontiers of Company Law, 1971, Eastern Law House,Lucknowk, pp. 1-59 S.M Shah, Lectures on Company Law, N.M. Tripathi, Bombay, pp. 1-74
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Master in Business Laws Coporate Law

Course No: III Module No: II
Characteristics of Corporate Personality

Materials Prepared by : 1. Ms. Sudha Peri 2. Dr. N. L. Mitra Materials Checked by : Ms. Archana Kaul, B.Sc., LL.M. Materials Edited by : Dr. P. C. Bedwa
National Law School of India University Published by : Distance Education Department National Law School of India University Post Bag No. 7201 Nagarbhavi, Bangalore - 560 072
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INSTRUCTIONS
Corporate Personality is the most ingenious invention in the Anglo-American Jurisprudence in the sixteenth century. The large scale production system and the individualism required a legal vehicle. Corporate personality met that demand. It is not that the corporate personality was not known in earlier legal systems but no body earlier thought that such a device would be necessary to be the vehicle of progress in industrial civilization. The corporate personality is unique in several senses. As for example, it has a distinct personality separate from its shareholders, on which law confers rights and impose duties; it has a perpetual life unlike a person in fact and in the absence of its members it does not automatically die. In the Second World War all the shareholders of several companies were killed. It was held in one such a case that the company was still alive and could lawfully function. In this module we have discussed various special characters of a corporate body and its functions. In the I module you have understood as to how different type of companies can be floated, registered and commence business. You have also understood the various documents that could be required to incorporate such companies. Once these companies are incorporated the company gets a distinct, separate, perpetual life. It can sue and can be sued in its own name. One very important character of almost entire corporate sector (barring unlimited companies) is that the liability of the members is limited. That does not mean that the liability of the company is limited. Of course if the company has more liability than assets the company cannot continue any longer and has to go in for winding up. The limited liability concept was invented in the middle of the nineteenth century in Joint Stock Companies to give a phillip to rapid industrialisation and capitalism at the centres of imperialism. Therefore companies formed with capitalists in England but having business in India would ensure the shareholders profits but assured them that they would not suffer any loss exceeding the capital that they have contributed. As a result common people started buying shares and stocks of these companies. In this new form of legal personality the capitalism carried out with glorious success until it found stiff resistance from trade cycles specially in the nineteenth and twentieth centuries. It is interesting to note here adaptability of the judicial system to the need of the corporate structure and economic growth. Judiciary served as a faithful servant to the growth of capitalism, but it is also true that judiciary formed the basis of public interest from which the theoretical format of welfare economics ultimately came into being. It is therefore necessary for every student of Corporate Law to carefully examine the extent and limitation of characters of corporate being. N. L. MITRA Course Coordinator
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CHARACTERISTICS OF CORPORATE PERSONALITY
TOPICS 1. Kinds of Companies ...................................................................................................... 72 82 86 100 108 114 117 119 120
2. Legal Personality ................................................................................................................ 3. Lifting of the veil ................................................................................................................. 4. Principle of ultra vires ....................................................................................................... 5. Constructive Notice & Indoor management ................................................................... 6. Legal Institutions under Company Law .......................................................................... 7. Case Law ............................................................................................................................. 8. Problems .............................................................................................................................. 9. Supplementary Readings ...................................................................................................
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1. KINDS OF COMPANIES
SUB TOPICS 1.1 Introduction 1.2 Flow Chart 1.3 Private Companies 1.4 Deemed Public Company 1.5 Public Company 1.6 Government Company & Public Corporations 1.7 Foreign Companies 1.8 Holding and Subsidiary Companies 1.9 Multinational and Transnational Companies 1.10 Illegal Associations 1.11 Conclusion 1.1 INTRODUCTION In the first module of the corporate law, we have briefly studied the nature of a corporation, its evolution from a sole-corporation to the present day giant holdings and have also dealt with various modes of classification of companies. To recapitulate, a company is an organization registered under the Companies Act. Though a company is normally incorporated for business purpose we do have companies which have been incorporated for various non-profit purposes, for example, Stock Exchange, Federation of Chamber of Commerce etc. In India, we have two modes of incorporation viz., (1) by a statute [for ex. Life Insurance Corporation] and (2) under a Statute [for ex. TATA, TELCO. Kirloskar etc]. Though we have already dealt with various modes of classification in the first module, we would now classify the companies in a manner more relevant to our present module. 1.2 KINDS OF COMPANIES Given below is a flow chart, depicting the various kinds of companies presently operating in India. Kinds of Companies Limited By Shares Private National Holding 72
Note: Despite the fact that the basic reason as to why people go in for incorporation rather than partnership is that, of limited liability of members [i.e., their personal assets cannot be utilized for paying off company debts]. There are some companies which provide for unlimited liability of the members [i.e., their personal assets can be utilized for satisfaction of company debts]. These are known as unlimited companies. But normally the liability of members is limited either by shares or by guarantee. In such companies, the liability of the members is limited to the face value of the shares in their hands or the amount guaranteed by them. In a limited company, the members cannot be asked to pay even a single rupee more than what they have agreed to be liable for regardless of the liability of the company. A company is required to add the words Ltd. or Unlimited after its name to indicate to the public in general the nature of its liability. 1.3 PRIVATE COMPANY Initially the most popular form of business enterprise was the 'partnership firm', where two or more persons joined together to carry out a business with an intention of earning and sharing profits [Sec. 4, Indian Partnership Act]. Though a partnership had certain distinct advantages over other forms of business, it was saddled with one very big disadvantage - the unlimited liability of the partners. Slowly people found it more convenient to turn a business into a limited company by forming a private company and selling the existing business to the company [as in Salomon v. Salomon & Co. Ltd., (1897) AC 22]. The sale consideration usually being the allotment of shares to the sellers of the business, the shares credited as being fully paid. The result of such transactions is to limit the liability of the business owners in case of loss, and to make a division of profits and interests in the business easier to accomplish. In general, the shares of a private company are held by a very few persons all belonging to either the same family or being close friends. The basis on which these companies are formed is the close interrelation and mutual trust shared by the parties concerned. For all practical purposes a 'private company' is merely a partnership firm in the guise of a company. S. 28(1) of the Companies Act defines a private company as one which by its articles of association -(a) restricts the right to transfer its shares; (b) limits the number of members (exclusive of persons who are or have been in the employment of the company) to fifty; and (c) prohibits any invitation to the public to subscribe for any shares or debentures of the company. Several joint holders of a share are for the purpose of this definition treated as one member. There are two basic conditions to be satisfied for it to be said that the company has issued an invitation to the public, namely that the invitation must have been issued -
Unlimited
By Guarantee Public Multinational Transnational Subsidiary
by the company itself -- In Booth v. New Afrikander Gold Mining Co Ltd [(1903) 1 Ch 295], it was held that an offer by the liquidator of an old company, of shares in a new company, was not an offer to the public; and 2) to any person who chose to apply for the shares, or to a considerable class of persons selected as being the most likely subscribers -- In Nash v. Lynde [(1929) AC 158], the directors of a private company prepared a document, which was in the form of an offer for shares to persons generally. The document was not, however, advertised, but a copy was shown to one person only with a view to his joining the company and becoming a director. It was held that, though the document was an offer of shares made to the' public' it had not been issued as a prospectus. In the matter of further issue of capital, a private limited company is not bound by the provision of sec 81 of the Companies Act. It is bound by the provisions of its Articles, or in the absence of it, by the general power conferred on the Board by sec.291. In case of further issue offered to the existing shareholders prorata the members of the private company cannot renounce the right in favour of any outsiders [Needle Industries Ltd. v. Needle Industries (Newly) Holdings Ltd. (1981)51 Comp.Cas 743]. "Public" includes any section of the public whether selected as members or debenture holders of the company or as clients of the person issuing the prospectus or in any other manner, but the offer is not a public offer if it can in all the circumstances be properly regarded only as a domestic concern of the persons making and receiving it. Legally, the position of a private company is in most respects the same as that of a public company, and even if one member holds practically all the shares [ex: Solomon's case], the company is still a distinct 'being' or 'person', and the company is not bound by notice of matters which are in the knowledge of this person. If a private company fails to comply with any of the provisions of sec. 28(1), it ceases to be entitled to some of the privileges of a private company (ex: carrying on business with less than two members). In such cases, the court may grant relief, if the default was due to accident, inadvertence or other sufficient cause. Special provisions relating to Private Companies 1) A Private company consist of upto 50 members excluding employee members [sec. 3(iii)]. 2) It must along with its 'Annual Return' send a certificate signed by a director and the secretary that the company has not issued any invitation to the public to subscribe for shares or debentures, and, if the number of members exceeds fifty, a certificate that the excess consists of employees or past employees of the company [sec. 161(2)(b)]. 3) The company need not hold a statutory meeting [sec. 165(10)]. 4) Directors need not deliver to the Registrar a consent to act nor need they sign the memorandum or a contract for their qualification shares [sec. 264(3)].
1)
5) A statement in lieu of prospectus need not be registered even though no prospectus is issued [sec. 70(3)]. 6) The provisions relating to minimum subscription do not apply, and shares can therefore be allotted irrespective of the number of shares subscribed [sec. 69]. 7) A private company may start business immediately on its incorporation -- it need not wait for a special certificate from the Registrar as in the case of public companies. 8) There is no fixed retirement age of directors under the Act, unless the company is a subsidiary of a public company; nor is there any restrictions on their remuneration. 9) Sec. 81 of the Act, providing for issue of new shares of a public company to already existing members in certain cases is not applicable to private companies, which are therefore free to allot new issues to outsiders. 10) According to sec. 416 if any agent of a company makes a contract on behalf of the company but keeping the company as an undischarged principal, he has to make a memorandum in writing of the terms of the contract & specifying the other party to the contract. He has also to deliver the memorandum to the company and send copies to each of the directors so that it may be laid before the board at its next meeting. Private companies are exempted from these requirements. 11) Under sec. 300, an interested director cannot participate in voting at board's proceedings. This section is not applicable to a private company, and an interested director of such a company is under no obligation to retire from a meeting of the board at which the subject-matter of his interest is discussed. He may not only participate in the meeting but may also exercise his vote. 1.4 DEEMED PUBLIC COMPANY & COMPULSORY CONVERSION OF PRIVATE COMPANY INTO PUBLIC COMPANY Popularly speaking sections 43,43A and 44 are treated as provisions for a deemed public company. But correctly speaking only section 43 deals with a private limited company deemed in law as a public limited company though structurally and apparently it looks as if it is a private limited company. When a private limited company fails to include in its article any or all restrictions to be stipulated under section 3(1)(iii), the company is in the eye of law treated as a public limited company. As has been stated earlier a private limited company has to stipulate in its articles (1) higher limits of its members so long as they are in employment, and (2) prohibiting invitation to be made to the public to subscribe for any shares in or debentures of the company. It is not enough that a company to be a private limited company has not issued shares to the public. It is incumbent on the company to declare by its articles that it cannot invite public to subscribe to the shares or debentures of the company. If default is made in this respect the company shall not be entitled to the privileges or exemptions conferred on private companies. For all purposes in the eye of law the 73
company shall be deemed to be a public limited company as per the provisions of section 43. Of course if the Company Law Board is satisfied that the failure is due to an inadvertence or due to some sufficiently valid cause the CLB may by an order relieve the company from such consequences of law on the ground of just and equitable relief. So the CLB can restore the status quo ante if it is convinced that it is just and equitable for not treating the company as public limited in the eye of law. Section 43A and 44 deals with a private limited company becoming public limited in certain cases and the consequences arising out of that. According to section 43A a private company becomes public company if (a) 25% or more of its capital is held by one or more public companies, however excluding shares held by a bank forming part of the subject matter of a trust or for the benefit of the body corporate or as a trustee either in its own name or on behalf of the trustee. This company shall become a public limited company from the date on which the aforesaid percentage was held before the commencement of Companies Amendment Act 1960, on the expirty of three months from the date of such commencement unless the percentage holding drops down during the meantime below this statutory prescription. (b) According to section 43A(1A) where the annual average turnover of the company during the relevant period is not less than such amount as may be prescribed, the private company shall become the public company from the expirty of the period of three months from the last day of relevant period during which the private company had the said average turnover. The ceiling is prescribed by way of rules. According to rule 4(c) of the general rules and forms if the average annual turnover of a private company for three consecutive years exceeds ten crores per annum the company shall become a public limited company. The conversion takes effect after the expirty of three months from the period at the close of which the accounts show the amount of the turnover. (c) Where a private company holds 25% of the paid up share capital of the public company, the private company becomes a public company on and from the date on which the aforesaid percentage is first held. However since this provision is included by Companies(Amendment) Act, 1974, a private company holding such percentage of shares of public company from a date prior to 1974, the private company shall become public company on and from the expiry of three months from the commencement date of the Amendment Act, unless during the time the percentage drops down. (d) A private company becomes a public company after the commencement of Amendment Act, 1988, if it accepts public deposits from the public after an invitation made by advertisement. The private company becomes a public company on and from the date on which such acceptance or renewal is first made after the commencement of Amendment Act 1988. 74
In case the private company becomes a public company in any one of the above ways the company shall inform the Registrar within three months from the date on which the private company becomes public by operation of law, that it has become a public company according to any one of the aforesaid grounds. On receiving the information the Registrar shall delete the word 'private' before the word 'limited' in the name of the company and shall also make necessary alterations in the certificate of incorporation issued to the company and in its memorandum of association. Company shall continue to be public company until with the approval of the Central Government and in accordance with the provisions of this Act becomes a private company again. The company which has thus become public company by operation of law and under compulsive situation of transformation of its organizational pattern may continue to include provisions for the 'cap' on number of membership and limitation on shares and debentures to be issued to the public by advertisements as well as on transfer of shares, in its articles of association, so that its membership may fall below seven, without its incurring any penal liabilities. If the company makes a default in informing the Registrar about the change of status the company and every officer of the company who is in default shall be punishable with fine up to Rs.500/- for every day for which the default continues. A private limited company has to file along with its annual return under section 161 two additional certificates as per section 43A (8) & (9). In the first certificate it has to certify that no body or bodies corporate holds or hold 25% of the share capital or more (if the private company has a share capital) and the annual turnover is not more than ten crores and the company has not accepted or renewed public deposits. In the second certificate to be filed with the Registrar it is to be specified that the concerned private company does not hold 25% or more of the paid up share capital of one or more companies. The basic objective of such automatic conversion of private limited company into public limited company is the protection against the abuse of exemptions and privileges available to private companies. Section 43 A has been inserted by Amendment Act 1960 on the recommendation of Shastri Committee and thereafter several amendments remodified the legal regime. It has been the intention that once the private company indirectly uses public money it forfeits the characteristic of a private company and should be made liable like a public company. According to law private company is required to be limited to an optimal size. The general presumption is that a very big company becomes publicly accountable due to the sheer volume of its turnover. So when a private company crosses that optimal limit it is statutorily responsible as a public company. Section 43A therefore, is interpreted on the public policy design and it compulsorily alters the character of the company, both in structural form as well as from the context of liabilities.
1.5 PUBLIC COMPANY Any company which does not fall within the definition of 'private company' is a 'public company'. These are generally large trading or manufacturing concerns. The shareholders are members of the public and the shares are in general freely transferable. A public company cannot start business till a certificate of 'commencement of business' is issued by the Registrar. As these companies function after raising public money, they have been saddled with more liability and responsibility under the Act. For example, specific provisions have been laid down for the mode of appointment of the directors, auditors etc, their term of office, removal etc., so also provisions for first issue of shares, further issue of shares, raising & reducing of capital etc., have also been made. In general, public companies are levied with a high level of accountability and their mode of operation is seemingly more restricted as compared to the private companies. It is also to be noted that public companies demarcate the division between ownership [which is with the shareholders] and control or management [which is with the board of directors]. A public company can also be converted into a private company, by (i) passing of a special resolution, and (ii) incorporating the limiting provisions in the Articles as prescribed under sec. 3(1)(iii). But sec. 31(1) provides that no alteration made in the articles which has the effect of converting a public into a private company shall have effect unless such alteration has been approved by the Central Government. 1.6 GOVERNMENT COMPANY AND PUBLIC CORPORATIONS Section 617 of the Act defines a Government Company as follows: "Government company means any company in which not less than fifty-one percent of the paid-up share capital is held by the Central Government, or by any State Government or Governments or partly by one or more State Governments and includes a company which is the subsidiary of a company thus defined". The obvious advantage of forming a Govt. Company is that it gives the State activities some of the freedom enjoyed by private corporations and the Government escaped the rules and principles which hampered action when it was done by a government department instead of a government corporation. In other words, it gave the Govt. some of the robes of the individual [Thurman W. Arnold, 193]. And in order to ensure this freedom the Supreme Court has reiterated in a number of cases that a Government Company is not a department or an extension of the State. It is not an agent of the State. Accordingly its employees are not Civil servants and prerogative writs [under Arts 32 & 226 of Constitution] cannot be issued against it. In Tamlin v. Mannaford [(1950) 1 KB 18] it was held that a Government Company will be regarded as an agent of the State only when it is basically performing governmental or sovereign and not merely commercial functions.
A public company which is wholly owned & controlled by the State is known as a public corporation. In contra-distinction to a government company a public corporation is totally under the control and management of the State and for all practical purposes is an instrumentality of the State. The question then arises, as to whether such corporations can be deemed to be 'State' for the purposes of Art. 12 of the Constitution. This question was answered affirmatively by Krishna Iyer, J., in Som Prakash Rekhi v. Union of India [(1981) 1 SCC 449]. Here, the company in question arose out of the acquisition and vesting in the Central Government of the assets and business of Burmah shell. The employee, who had certain rights as to provident fund etc., against the former company, claimed them against the Government by means of a writ. His claim was resisted on the ground that the undertaking had been vested in a company registered under the Companies Act and the question of a writ against a private company could not arise. Krishna Iyer J., brushed aside this contention. He laid emphasis upon the fact that the whole undertaking had been vested in the Central Government and, therefore it became a State undertaking. The learned judge also stressed the fact that the law should not go by the fact whether the company is registered under the Companies Act or otherwise, but by the nature of the functions that the unit was performing. Here the statement of reasons stated that the company was being acquired in public interest and thus the new company was created to perform a function of public nature. The court noted the fact that the reason why the State chose to function through companies was not to frustrate employees, but to assure commercial flexibility and freedom from departmental rigidity, slow motion procedures and hierarchy of officers. The learned judge cited the following remark of President Roosevelt: "Concentration of economic power in all embracing corporations... represents private enterprise become a kind of private Government which is a power unto itself-a regimentation of other peoples' money and other peoples' lives". Hitting at the reality of the situation, Iyer, J., remarked: "The true owner is the State, the real operator is the State and the effective collectorate is the State and the accountability for action to the community and the parliament is of the State. Nevertheless a distinct juristic person with a corporate structure conducts the business. Be it remembered though that while the formal ownership is cast in the corporate mould, the reality reaches down to State control.... What we wish to emphasize is that merely because a company or other legal person has functional and jural individuality for certain purposes, it does not necessarily follow that for the effective enforcement of fundamental rights, we should not scan the real character of that entity; and if it is found to be a mere agent or surrogate of the State, in fact owned by the State, in truth controlled by the State and in effect an incarnation of the State, Constitutional lawyers must not blink at these facts and frustrate enforcement of fundamental rights despite the 75
inclusive definition of Article 12 that any authority controlled by the Government of India is itself State" [Avtar Singh, pp.16-17]. Sec. 620 gives the Central Government power to declare by notification in the Official Gazette that any of the provisions of the Act shall not apply to any Government Company or what provisionsshall apply to such a company. The notification shall be effective only to the extent to which it is approved by the Parliament, and the absence of any such notification the whole Act applies to such Government Companies. The only special provision relating to these companies is given in Sec. 619, relating to the appointment, powers and functions of the auditor of a Government Company. In all other matters a Government company is treated as any other company. 1.7 FOREIGN COMPANIES A foreign company means a company incorporated outside India. But for the purposes of sec. 591, it means a company, which, though incorporated outside India, has a 'place of business' in India. The meaning of the expression 'place of business' has been judicially construed in A/s Dampskib 'Hercules' v. Grand Trunk Pacific Rly. Co [(1912) 1 KB 222]. Here, four directors of a Canadian railway company, were in England to form a London Committee for the purpose of raising loans for the construction of the railway in Canada. They were using the office of another company without rent and transacted no other business than that of raising loans. The Court of Appeal held that defendants were carrying on their business in the office used by the London Committee and would therefore be properly served with a writ. As per Buckley L. J., "We have only to see whether the corporation is "here", if it is, if it can be severed. The best test is to ascertain whether the business is carried on here and at a defined place. In the present case, the Company has a paramount, and also a subsidiary object; its paramount object is to make and run a railway in Canada, to do which a great many things must first happen: it has a subsidiary object, namely, the raising of money to carry out its paramount object. The raising of this loan capital is part of the company's business, and it is done here by a London Committee constituted of directors resident in England". Such a company has to furnish to the Registrar the following documents within thirty days. (i) A certified copy of the Charter, Statutes, or Memorandum and Articles or any instrument containing the constitution of the company. (ii) The full address of the registered or principal office of the company abroad. (iii) A list of the directors of the company, along with their nationality, residential address etc. (iv) A similar information about the secretary of the company. (v) The name(s) and address(es) of one or more persons resident in India, authorized to accept on behalf of the company service of processes, notices, etc. 76
(vi) The full address of the office of the company in India which is to be deemed its principal place of business in India. A foreign company is further bound by the following obligations: a) The company should conspicuously exhibit on the outside of every office or place of business its name and the country of incorporation in English and in the regional language. The statement should also show the nature of liability of members. b) The name and the country of incorporation should also appear in English on all business letters, bill-heads and letter papers and on all notices and other official publications of the company. This statement should also include the nature of liability of members. A failure to comply with these provisions does not affect the validity of any contract made by the foreign company, but the "company shall not be entitled to bring any suit, claim any setoff, make any counter-claim, or institute any legal proceedings in respect of any such contract until it has complied with all the provisions of the Act relating to foreign companies" [sec. 599]. 1.8 HOLDING AND SUBSIDIARY COMPANIES When a company has control over another, it is known as the 'holding or parent company' and the company over which it exercises the control is known as the 'subsidiary company'. This control may be exercised in any one of the following three ways, viz., (i) When one company controls the composition of the board of directors of another, the later becomes the subsidiary of the former. This type of control is deemed to have been exercised when, one company has the power, to appoint or remove the holders of all or a majority of the directors of another company without the consent or concurrence of any other person. A company is further deemed to have the power to appoint to a directorship in the following three cases-a) If a person cannot be appointed to a directorship without the exercise in his favour of the power of appointment held by the company 'A' in company 'B' b) If a person's appointment to directorship in company 'B' follows necessarily from his appointment as director, managing agent, secretaries and treasurers or manager or to any other office or employment in the company 'A'. c) If the directorship of company 'B' is held by an individual nominated by the company 'A' or by any of its subsidiaries. [In all these cases company 'A' is the holding company and Company 'B' is the subsidiary]. (ii) Where one company 'A' holds the majority of shares in another company 'B', the latter becomes the subsidiary of the former. (iii) Where one company 'A' is subsidiary to another company 'B' which is itself a subsidiary of company
'C', then company 'A' also becomes a subsidiary of company 'C'. The above conditions will be deemed to have been satisfied, even if the majority of the shares are held or the power of appointment to directorship is exercisable by any person as a nominee either of the holding company or of any of its subsidiaries. Merely because a company is a subsidiary of another does not make it an 'agent' of the holding company, nor does it destroy the separate legal identity of the subsidiary company. In the words of Cohen, L. J., "Under the ordinary rules of a law, a parent company and a subsidiary company, even a 100 percent subsidiary company, are distinct legal entities, and in the absence of an agency contract between the two companies one cannot be said to be the agent of the other [Avtar Singh, p. 18]. One of the leading cases in this regard is the Smith Stone & Knight Ltd v. Birmingham Corpn. [(1938) 4 KB 116]. Here, a company acquired a partnership concern, registered it as a company, and then continued its existence as its own subsidiary company. The parent company held most of the shares of the subsidiary, treated its profits as its own, appointed managers for it and exercised effectual and constant control. When the business of the subsidiary was acquired by the defendant corporation the court allowed the parent company to claim compensation in respect of removal and disturbance because the subsidiary company was not operating on its own behalf but on behalf of the parent company. Atkinson J., after referring to the basic rule that "....... the mere fact that a man holds all the shares in a company does not make the business carried on by the company his business. It is also well settled that there may be such an arrangement between the shareholders and the company as will constitute the company the shareholders' agent for the purpose of carrying on the business and make it the business of the shareholders", laid down a six point test for ascertaining the person actually carrying on the business of the subsidiary company, viz., (i) were the profits (of the subsidiary) treated as profits of the parent company? (ii) were the persons conducting the business appointed by the parent company? (iii) Was the (parent) company the head and the brain of the trading company? (iv) Did the company govern the adventure, decide what should be done and what capital should be embarked on the venture? (v) Did the (subsidiary) company make the profit by its own skill and direction? (vi) Was the (parent) company in constant and effectual control? The answers to these questions would decide whether the subsidiary was an agent of the parent company or whether it had a distinct legal personality of its own. Total and exclusive control in all respects is the surest indication of agency or trust.
In Wallersteiner v. Moir [(1974) 1 All E R 217(CA)], Lord Denning, M. R., gave a picturesque description of a situation where the company was nothing but the controller himself under another hat. He observed that, "It is plain that W used many companies, trusts or other legal entities as if they belonged to him. He was in control of them as much as any "one-man company" is under the control of one who owns all the shares and is the chairman and managing director. He made contracts of enormous magnitude on their behalf on a sheet of note paper without reference to anyone else. I am prepared to accept that the companies ...... were distinct legal entities .... even so they were just the puppets of W. He controlled their every movement. Each danced to his bidding. He pulled the strings. No one else got within the reach of them. Transformed into legal language, they were his agents to do as he commanded. He was the principal behind them. I am of the opinion that the court should put aside the corporate veil and treat these concerns as being his creatures for whose doings he should be, and is responsible". Shares in the Parent Company The concept of a subsidiary company being the agent of the parent company has another major implication. When such an agent subsidiary company becomes insolvent, the parent company is held liable for its debts. In USA, this principle was evolved in, Taylor v. Std. Gas & Electric Co [306 US 307 (1939)]. Here, the parent company undercapitalized its subsidiary, heavily indebting the subsidiary to the parent company. Mismanagement of the subsidiary led to insolvency. During reorganization proceedings, the parent company declared its claim to be superior to claims of other creditors. The court rejected this argument and subordinated the claims of the parent company, not only to claims of other creditors of the subsidiary but also to those of its 'preferred shareholders'. This resulted in the 'Deep Rock doctrine' which states that: 'The claims of creditors who are also shareholders may be subordinated to the claims of other creditors in insolvency or reorganization proceedings, when the court finds that the shareholder/creditor has violated certain properties necessary to the maintenance of separate corporate identity. When the subsidiary is not an agent of the parent company, the creditors of the subsidiary cannot hold the parent company liable for their debts'. Subsidiary of a multinationl company Unlike subsidiaries of national companies, the subsidiaries of multinational companies have more autonomy in the host country. The extent of power which such parent ocmpanies have on their subsidiaries was debated in Lonrho Ltd v. Shell Petroleum Co Ltd [(1980) 2 WLR 367, CA]. Here, a group of oil companies in UK owned & controlled certain oil companies in Rhodesia. The English parent company was called upon to produce certain documents relating to a pipe line contract which were in the possession of its subsidiaries. The court rules empowered it to order the disclosure of all documents in the possession, custody or power of a party. The question was, 77
whether the documents in the possession of a foreign subsidiary could be deemed to be in possession of the parent? The Court of Appeal answered the question in the negative. Lord Denning, while emphasizing on the position of the company in the jurisdiction of local laws applicable to it and the available degree of freedom from interference by the parent, observed: These South Asian and Rhodesian companies were very much selfcontrolled. Their directors were local directors - running their own show, operating it, with comparatively little interference from London. They were subject, of course, to all local laws & ordinances. That seems to the a different position from the concept of a one-man-company or a 100 percent subsidiary company which is operating in this country with self-same directors, or a 100 percent parent with various subsidiaries. It is important to realize that subsidiaries of multinational companies have great deal of autonomy in the countries concerned". Schimitthoff [Lifting the corporate veil, 1980 JBL p. 158] explains the importance of this decision to the international community, as follows: 'The importance of this case lies in the fact that for the first time an English court has held that, if a multinational finds itself in a conflict between the interest of the home and host country, the interests of the host country will prevail. This rule which was also adopted in France in Frenhauf case should now be regarded as an established principle of international law'. Though a holding company may and in general, and also does acquire the shares of a subsidiary company, the subsidiary is not allowed to acquire membership of its holding company [sec. 42]. Consequently, 'any allotment or transfer of shares by a company to its subsidiary shall be void'. This prohibition does not apply to the case of a subsidiary company which already held shares of its holding company at the commencement of the Act or before becoming a subsidiary of the said holding company. The section also does not apply in the following cases: (i) Where the subsidiary is considered as a legal representative of a deceased member of the holding company; and (ii) Where the subsidiary is considered as a trustee. This exception wont apply where the holding company itself or any of its other subsidiaries is beneficially interested under the trust, except when its interest is only for the purpose of a security for a transaction, (including lending of money) entered into in the ordinary course of its business. 1.9 MULTINATIONAL AND TRANSNATIONAL CORPORATIONS Multinational corporations (MNCs) or Transnational Corporations (TNCs) have been attracting a lot of attention and publicity, both nationally as well as internationally. Public awareness of MNCs & TNCs has grown in the past twenty five years. The reasons for the stupendous growth in the number of MNCs & TNCs is not difficult to trace. Firstly, the rapid advance of industrialization made smaller units non-viable and thus 78
causing an increase in the size of industrial units. Secondly, industrial enterprises earned huge profits in the inflationary period of the late sixties and seventies and they wanted to invest these profits in further business expansion. These enterprises found starting new units in different overseas countries as a useful proposition because of the availability of cheap labour and new markets, their home countries in most cases encouraging them to go abroad. Placing in general historical perspective the phenomenon of USA's initial "lead"and the corresponding lag of the other industrial countries in the race of multinational enterprises, Mr. B.N. Ganguli said "there was, therefore, no need, according to the Eisenhower Administration's assessment, for adventitious governmental aid, because the crisis situation had been resolved. What was needed was an expansion of economic development and trade through the flow of U.S. private capital, management and technique to areas that need them most and could use them to the best advantage. Major attention was focused on direct investment by which private enterprises would start subsidiaries in branch plants, thus retaining a degree of control as well as ownership over the assets in the host countries .....".[B. N. Ganguli, Multinational Corporations, pp.12-14]. This explains the growth of MNCs, now more commonly known as TNCs. Transnational Corporations are those enterprises which own or control production or services outside the country in which they are based. Thus, MNCs or TNCs are national companies for the country of their origin/incorporation, but with extensions overseas. A 1978 United Nations study revealed, that in their search for continued growth, TNCs have been increasing their use of crossborder agreements which are not tied to equity investments. Many host countries, especially developing ones, favour such arrangements as they provide a means of acquiring the skills & products developed by TNCs without the establishment of a long-staying foreign owned entity within their borders. These so-called alternatives to the TNCs have, in fact, been used for many years among OECD countries. These alternatives come in a wide spectra of forms and extend from relatively simple and straight forward licensing, franchising or management agreements to highly complicated combinations of a wide variety of provisions that are collectively referred to as 'industrial cooperation'. Thus TNCs are not only the giant conglomerates with subsidiaries in dozens of countries; they also include small foreign companies and enterprises engaged in various non-equity forms of collaboration with local firms and companies, such as agreements for providing technical services, marketing assistance and managerial expertise. It is not essential for a TNC to own assets in the host country; what is essential is for it to control them. Despite the malpractices of some of the MNCs & TNCs, we cannot deny the fact, that, they have been agents of international division of labour and internationalization of capital. In the words of Mr. L. K. Jha, "essentially a multinational or transnational enterprise is one which carries on its productive operations in more than one country. Prima facie it reflects a
healthier trend in regard to the location of industries globally than the earlier pattern of enterprises concerning manufacturing activities in their own country and only exporting their goods and services to others" [L. K. Jha, Economic Strategy for the 80s, p.144]. Furthermore, MNCs are responsible for augmenting international trade and may help the developing countries in pushing up their exports. In India, MNCs mainly operate in two ways.
i) Through the establishment of a mere place of business, i.e., a branch in India, and (ii) through an Indian subsidiary i.e., a company incorporated in India under the Companies Act, 1956 but controlled by the MNC. In general, the MNCs here dominate the manufacture of consumer goods, because even if they charge nominal profits for them, the profits are bound to be large because of the large consumer market in this country. Some salient features of different types of global players have been tabulated by Bartlett and Ghoshal as follows :
Salient Features of Organisations

Organisational Characteristics Multinational Companies Global Companies International Companies Transnational Companies
Configuration of assets and capabilities
Decentralized and nationally sufficient
Centralized and globally operated
Source of core competences centralized and others decentralised Adopting and leveraging parent company competenace
Dispersed, interdependant and specialised Differentiated contribution by national units to world wide integrated operations. Knowledge developed jointly and shared worldwide Confederal subsidiaries.
Role of overseas operation
Sensing and exploiting local opportunities
Implementing parent company strategies
Developments and diffusion of knowledge
Knowledge developed and retained within each unit. Federal subsidiaries
Knowledge developed and retained at centre Country wide Branching
Knowledge development at the centre and transferred to overseas units Country wide representatives and agencies
Organisational structure
with the rapid development of market economy organisation structures are given an extra emphasis for the purpose of increasing operational efficiency. In order to facilitate transfer of technology and technical know how different forms of organisational structure of global operations, have been devised. Multinational and transnationals generally operate through holding subsidiary relationships either in federal form or in a confederal form. In MNC's self sufficient national units operate and constitute the central unit. In TNC's national units are not only self sufficient but operate independently on product lines, but they have interdependence on global policy formulation. In the case of global and international companies the operation is principally done through either a country agent or a country susbidiary which is entirely dependent on the policy dictates. These mostly operate as clearing houses.
1.10 ILLEGAL ASSOCIATIONS
One of the basic objectives of the Companies Act is to eliminate the evils caused by large partnerships trading in unincorporated form. A business association consisting of a large number of
persons, unless incorporated, leads to inevitable confusion and uncertainty concerning both the rights and liabilities of members inter se, as also their relations with others. sec. 11(2) of the Act, thus provides that no company, association or partnership consisting of more than twenty persons (10 in case of banking business) shall be formed for the purpose of carrying on any business that has for its objects the acquisition of gain for itself or for its members unless it is registered as a company under the Companies Act, or is formed in pursuance of some other Indian law. If it is not so registered it becomes an 'illegal association'. This section does not apply to a Hindu unindividual family [HUF] doing some business, and if a business is carried on by two or more HUFs, in computing the number of members for the purposes of this section, minor members are excluded. Some of the consequences of forming an illegal association are: (i) According to sec. 11(4), every member of such an association shall be personally liable for all liabilities incurred in the business, apart from imposition of fine which may extend to Rs.1000/-. 79
(ii) The members of such an association cannot sue in respect of any contract entered into by the association. For example, price of goods sold by association cannot be recovered by filing of a suit. (iii) It cannot be wound up under the Act even under provisions relating to winding up of unregistered companies. (iv) Lastly, there can be no suit between the members inter se for partition, dissolution or taking of accounts. In Badri Prasad v. Nagarmal [AIR 1959 SC 559], the case arose out of a suit for recovering the contribution made to an illegal association, and also for accounts. It was contended that the objects of the association not being illegal, recovery on dissolution should be allowed in the manner of realization of assets of a dissolved firm. The Supreme Court held that such a claim is clearly untenable. The only course for the courts to pursue is to say that he is not entitled to any relief as the courts cannot adjudicate in respect of contracts which the law declares to be illegal". 1.11 CONCLUSION The later part of 20th century beginning from the end of First world war can be called the era of the corporation. The industrial revolution as it spread over the 20th century, life required collective organization of man and things. To bring its human structure and physical plan into existence, to carry out its operations, to distribute its products, to meet the growing demands made on it in peace and war, proved wholly beyond the capacity of individual entrepreneurs. The modern corporation is an organic growth and a natural development of the industrial revolution in modern society [S. C. Sen, pp.1-2]. In the words of W. T. Gossett, Vice-president in the General Council of the Ford Motor Company, "The modern corporation is a social and economic institution that touches every aspect of our lives, in many ways it is an institutionalized expression of our way of life. During the past 50 years industry in corporate form has moved from the periphery to the very centre of our social and economic existence. Indeed it is not inaccurate to say that we live in a corporate society". There have been fundamental changes in the nature of corporations over a period of time, in the nature of stock-holders, directors, management, and of various other concepts which at one time were considered to be the fundamental concepts in company law jurisprudence. Though judicial recognition of these changes is slow, it has been there and in certain cases such recognition is imminent. Corporations in their most primitive form can be traced to a period as early as the 14th century, where people formed guilds to hold property and perpetuate the guild beyond the lives of the members. The main function of these guilds was regulation of the conduct of its members in their trading and for that purpose they had certain amount of rule making powers for regulation of economic activities. The journey from these guilds to the giant multinational corporations of the 20th century has been a long road with every bend resulting in some new development and every step fought with difficulties. It has been 80
an unbelievable process of evolution through out and it can be honestly said that no other business association has undergone such metamorphosis or changed so drastically. According to Berle and Means in their study - Modern corporation and private property, as property was gathered under the corporate system, and as control became increasingly concentrated, the power of this control steadily widened. Briefly, the past century has seen the corporate mechanism evolve from an arrangement under which an association of owners controlled their property on terms closely supervised by the state to an arrangement by which many men delivered contributions of capital into the hands of a centralized control, accompanied by grants of power permitting such control almost unexplored permission to deprive the grantors at will of the beneficial interest in the capital thus contributed. The stock holder in the modern corporation surrendered a set of definite rights in exchange for a set of definite expectations. The growth of power of control steadily diminished the number of things which shareholders could control, and a shareholder today is in no actual position to demand anything or enforce anything on the control. The shareholder today occupies a subservient position to that of the control of the controlling group of managers. In addition to shareholders and directors, "control" was recognized by Berle and Means as one of the important constituent parts of the modern corporate structure. The same recognition was also given to the management which has now become a very important part in modern corporations. Workers also were given a due recognition by them, but Berle being a legalist preferred not to recognize them as part of the corporate structure, as such recognition would interfere with both legality of the source of power and the legal controlling power in a corporation. Further study of the American corporation was made by Prof. Galraith in the New Industrial State (1967). By then it was clear that the trend relating to dispersion of shareholdings had become an accepted part of corporations and that this trend was continuing and intensifying. He divided corporations into two groups for the purpose of the study of structures. The orthodox type of smaller companies were termed as entrepreneurial corporation" and the second as "mature corporation". The former he felt had maintained the same structure as the classic company and there was not been much change. The mature corporation he said is the giant corporations of modern days dominating the modern economy, and he felt that it was the study of its structure which was more important. In his graphic description of this structure, he said "It is more useful to think of the mature corporation as a series of concentric circles. The band within each pair of circles represents a group of participants with a different motivational system. In the more spacious with bands at the outer reaches are the most numerous groups. Such in general is their motivational system that they are the most loosely attached. At the centre is what is now called the top management. Theirs is the firmest attachment. Between are the others.....". According to him, in the outermost circle are the ordinary shareholders' whose only relation to the
corporation is a pure case of pecuniary motivation'. He does not identify himself with the goals of the enterprise nor does he expect to influence these goals. The next circle is occupied by the production workers' - their motivation is more complex. Pecuniary compensation to them is definitely important, but there is also a sense of identification with the corporation arising due to his daily association with the corporation as opposed to an ordinary shareholder. The combination will vary greatly with the circumstances of the industry and firm. Increased
identification with the corporation, narrows the opportunities for trade union. As one moves inwards, next come the foreman, supervisory personnel and other white collar personnel, who at the inner perimeter merge with technicians, engineers, and other specialists who comprise the techno structure. Beyond these, at the centre are the executives or management. As one moves progressively inwards, identification and adaptation become increasingly important. Given below is a pictorial representation of "Galbraith Circle".
Share & Stock Holders Production Workers Supervisors Technicians Executives
'Galbraith Circle' portrays the realities of a modern corporate structure. The technocrats & the workers in various stages of corporation are now permanent features of a company, much more so than the shareholders who have become mere suppliers of capital. In ascertaining whether in the matters of corporation the workers and management should have a say in addition to the say of the shareholders, the new structure of the modern corporation should always be borne in mind. An assessment of the rights of the different ingredients constituting the corporation would be defective unless this modern corporate structure is given due weightage. The realities of modern corporation were reassessed by Adolf Berle in his book "The 20th Century Capitalist Revolution". He said that, the actualities of modern corporation demonstrate the gradual erosion of even directors' powers and the rise of the power of what he termed as the techno-structure. In modern business, the board of directors are unable to take any decision
unless there is a thorough study of the market and a proper planning by this techno-structure. Shareholder as a prominent figure is now receding to the background. As he puts it graphically, capitalism remains and is galloping but the vanishing figure is the capitalist himself. Peter Drucker made a brilliant study of the modern corporation in "The concept of the corporation". He says that, the structure of the modern corporation has become "an essay in federalism" and on the whole an exceedingly successful one. It attempts to combine the greatest corporate unity with the greatest divisional autonomy and responsibilities; and like every true federation it aims at realizing unity through local self-government and viceversa. This is the result of the policy of decentralization which is the accepted pattern of modern large corporations. The concept of decentralization of modern corporations has developed into a philosophy of industrial management and into a system of local self government. It is not a mere technique of management but an outline of social order'. 81
2. LEGAL PERSONALITY
SUB TOPICS 2.1 Nature and Scope 2.2 Advantages of incorporation 2.1 NATURE AND SCOPE "Although company law is a well recognized subject in the legal curriculum and voluminous literature, its exact scope is vague since the word company has no strictly legal meaning". In legal theory, it implies an association of a number of people for some common object or objects. The purposes for which men and women may wish to associate are multifarious, ranging from those as basic as marriage and mutual protection against elements to those as sophisticated as the objects of the confederation of British Industry or the Atomic Energy Authority. But in common parlance the word 'company' is normally reserved for those associations for economic purposes i.e., to carry on a business for gain"[Gower, p.3]. In the terms of the Indian Companies Act, 1956, a company means a company formed and registered under the Companies Act. A company is not merely a legal institution, but is a legal device for the attainment of any social or economic end and to a large extent publicly and socially responsible. It is, therefore, a combined political, social, economic and legal institution. Thus the term has been variously described. [It] is a means of cooperation in the conduct of an enterprise...." "Corporate device is one form of associated enterprise". It is an intricate, centralized, economic, administrative structure run by professional managers who hire capital from the investor". [Avtar Singh, p.1]. Depending on the availability of resources and size & nature of the (planned) enterprise, persons wanting to do business may go in for either a 'partnership firm' or a 'company'. For a small business it is convenient to go in for a firm or even if they want to go in for incorporation they can go in for a 'private company'. Since the liability of the partners of a firm is unlimited people prefer to go in for incorporation of company with limited liability. Accordingly the Joint Stock Company has become the most dominant form of business organization. In the words of Mahlo, Companies abound in the national economy ranging from the small family or partnership concern to the faceless multinational corporations, they provide the structural framework of the modern industrial society [Avtar Singh, p.2]. It would now be proper to recapitulate in brief, the history of company law. In England, during the 17th and 18th century, a body corporate could be brought into existence either by a Royal Charter or a special Act of Parliament. Both the methods were highly expensive and very time consuming. As a result of which a very large number of huge unincorporated associations came into existence, trading in the corporate form. Though the membership of these associations was large the actual trading and management was left to a few select persons [here is the seed of division between ownership and control which is very 82
evident in the present day public companies]. This led to corruption and mismanagement at a very large scale, resulting in the passing of the 'Bubbles Act of 1720' which instead of making trading by unincorporated associations illegal, made the very business of promoting companies illegal. Though it acted as a major set-back to the growing trade and commerce, the Act remained in force for over a century till it was replaced in 1825. In 1844, the Joint Stock Companies Act, (788 Vict c110) made registration and incorporation of large partnerships compulsory, though the principle of unlimited liability was still left intact. The right to trade with limited liability was granted in 1855 and the Joint Stock Companies Act of 1856, consolidated the whole law relating to such companies. Since then, the Act has been amended a number of times. In India, the first law in this field is the Joint Stock Companies Act, 1850. Since then, after a series of amendments we have the final comprehensive piece of legislation in the form of Companies Act of 1956. Though comprehensive, it is not exhaustive of either the modes of incorporation (we can still have business organizations incorporated by Acts of Parliament, for ex: LIC, RBI etc.) or the whole of company law. It only consolidates certain portions of the Act and common law still has a large role to play in this field, especially in the area of duties of corporate directors and their social responsibilities. 2.2 ADVANTAGES OF INCORPORATION An incorporated company has several characters and advantages. Most of the advantages emanate from the separate legal entity and corporate liability. In this chapter we will discuss the basic outcome of the corporate personality and the resultant insulation of functionaries acting for and on behalf of the company with exceptions. The following chapter is the module will contain other characters and advantages. (i) Separate Legal Identity As stated earlier, the fundamental attribute of corporate personality from which all other consequences and advantages flow is a 'separate legal identity' distinct from its members. It is thus able to enjoy rights and be subjected to duties and liabilities, differing from those being enjoyed or borne by its members. In short, it has a legal personality and is often described as an 'artificial person' as opposed to a 'natural person'. Though joint stock companies legally came into existence from 1844, it was not till the end of 19th century that the implications of 'Corporate personality' were fully grasped by the courts. It was in Salomon v. Salomon & Co [(1897) AC 22, HL] that for the first time the exact meaning of the term 'company' was clearly elucidated in England. Salomon had for many years carried on a prosperous business as a leather merchant, earning healthy profits and having a substantial surplus of assets over liabilities. In 1892, he decided to convert his business into a limited company called Salomon & Co. Ltd., with Salomon, his wife and five of his children as members and Salomon as
the MD. The business was purchased by the company for about 40,000. This price was satisfied by 10,000 debentures conferring a charge over the assets of the company in favour of Salomon, 20,000 in fully paid 1 shares to Salomon and the rest given partly in cash and partly in shares to the other members who held them as nominees of Salomon. Within a year of incorporation, the company went into liquidation, with assets worth 6,000 and liabilities of about 17,000 of which 10,000 was to Salomon who was a secured creditor and remaining 7,000 to unsecured creditors. Thus after paying off Salomon, nothing would have been left for the satisfaction of debt of the secured creditors. They therefore contended, that, though incorporated... the company never had an independent existence; it was simply Salomon under a different name ...... The business was solely his, conducted solely for and by him and the company was mere sham and fraud, in effect entirely contrary to the intent and meaning of the Act. Rejecting this contention, the House of Lords observed: When the memorandum is duly signed and registered, though there be only seven shares taken, the subscribers are a body corporate capable forthwith of exercising all the functions of an incorporated company. It is difficult to understand how a body corporate thus created by statue can lose its individuality by issuing the bulk of its capital to one person. The company is at law a different person altogether from the subscribers of the memorandum; and though it may be that after incorporation the business is precisely the same as before, the same persons are managers, and the same hands receive the profits, the company is not in law their agent or trustee. The statute enacts nothing as to the extent or degree of interest which may be held by each of the seven or as to the proportion of interest, or influence possessed by one or majority of the shareholders over others. There is nothing in the independent or unconnected, or that they should have a mind or will or their own, or that there should be anything like a balance of power in the constitution of the company. Long before the Salomon's case was decided, this principle had already been established in India in re Kondali Tea Co Ltd [(1886) ILR 13 Cal 43]. Here, 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 under another name. Rejecting this, the Court observed: "The company was separate person, a separate body altogether from the shareholders and the transfer was as much a conveyance, a transfer of the property, as if the shareholders were totally different persons". This does not mean, that persons like Salomon can with impunity and openly defraud the company they form or swindle their existing creditors. In Salomon's case it was argued that the company was entitled to rescind in view of the willful overvaluation of the business sold to it. But the House held that, there was actually no fraud at all since the shareholders were fully conversant with what was being done. Had Salomon
made a profit which he concealed from his fellow shareholders the position would have been different [this point will be dealt in greater detail in our module on board of directors]. Nor was there any fraud on Salomon's pre-incorporation creditors, all of whom were fully paid. The case was decided in Salomon's favour because in law the company is a different person from the persons forming it, and the courts do not willingly negate this separate identity unless there are extenuating circumstances warranting their interference. The consequences of this separate identity phenomena are not always beneficial to the members. For example, in Macaura v. Northern Assurance Co [(1925) AC 619, HL), a trader incorporated his timber business, and transferred all his assets to the company. Unfortunately he forgot to assign the insurance policies in favour of the company. There was an incident of fire, and the company assets perished in the fire. When he went to claim the insurance money for those assets, the insurance company refused to pay. He was denied relief by the House of Lords, who reiterating the Salomon case principle held that, on incorporation the company acquired a legal personality distinct from its members and an insurance policy in the name of the founder-member could not be said to have been in the name of the company. In Kahn-Freund's striking phrase "sometimes corporate entity works like a boomerang and hits the man who was trying to use it" [Gower, p. 88]. This theory of corporate entity is still the basic principle on which the whole law of corporations is based. But the theory cannot be pushed to unnatural limits. There are certain situations, where the courts are compelled to identify a company with its members. A company cannot, for example, be convicted of conspiring with its sole director, as held in R V McDonnel [(1966) 1 All ER 193]. The court herein observed, "where the sole responsible person in the company is the defendant himself, it would not be right to say that there were two persons or two minds". The corporate veil is said to be lifted or pierced, when the court ignores the company and concerns itself directly with the members or managers. The principle behind this doctrine is abuse of the concept of separate legal identity of corporation. Where the corporate entity is being abused for an unjust or inequitable purpose, the courts lift the veil to look at the realities and hold the guilty persons liable. Inroads in the 'legal entity' of a corporation have been done both by the courts and the legislature. Where the courts have done it, the doctrine has often been described as 'lifting or piercing of corporate veil', and where the legislature has done it, the doctrine is more properly known as 'cracking the corporate shell'. We have discussed this exception in chapter III of this module. (ii) Limited Liability As the corporation is a separate person, its members are not as such liable for its debts. A company under the Act can be registered either as an unlimited company or a limited company [limited either by shares or by guarantee]. Thus, when obligations are incurred on behalf of a company, the company is liable and not its members, though the company may 83
ultimately be able to recover a contribution from them to cover its obligations. If the company is an unlimited one their liability to contribute will be unlimited, if limited by shares - their liability will be limited to the nominal value of the shares held by them and if the company is limited by guarantee, the liability of members will not arise till the company is wound-up, and then, in practice, only for a derisory sum. In case of small private limited companies, the members' freedom from personal liability may, in practice, proves to be largely illusory. Banks and others who grant the company formal credit facilities, in general require the members/directors to personally guarantee the debt. If then the company goes into liquidation, these members/directors may face personal liability which may bankrupt them. In these cases, the limited liability clause protects them only from small traders who have been unable to get a personal guarantee from them. Speaking of the advantages of trading with limited liability, Buckley, J., in re London & Globe finance Corpn [(1903) 1 Ch 728] observed: "The statutes relating to limited liability have probably done more than any legislation in the last fifty years to further the commercial prosperity of the country. They have, to the advantage as well of the investor as of the public, allowed an 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". (iii) Right to Deal in Property Being a distinct legal person, a company has the right of acquiring, holding, enjoying and disposing off property in its own name. It is the sole owner of all assets in its name, and the shareholders are not the private or joint owners of this property. As Lord Buckmaster observed in the Macuara's case, no shareholder has any right to any item of property owned by the company, for he has no legal or equitable interest therein". In Waton, J.'s simple truism: the property of the company is not the property of the shareholders. It is the property of the company. [Avtar Singh, p. 8]. This kind of a clear distinction between company assets and assets of the members is impossible to make in case of a partnership firm. (iv) Rights to take Legal Actions Closely allied to questions of property are those relating to legal actions. Before the Joint Stock Companies Act came into force unincorporated associations faced great difficulties in either suing or being sued. These difficulties were in part overcome by the use of the trust device but more satisfactorily by means of statutory intervention. A company being a person in its own right can sue or be sued in its own name. (v) Perpetual Succession One of the obvious advantages of an artificial person is that it is not susceptible to the thousand natural shocks that flesh is heir to. It cannot become incapacitated by illness, mental or physical, and it has not (or need not have) an allotted span of
life [Gower, p.92]. This does not mean that the death or incapacity of the human beings running the company would not embarrass/effect it, obviously it will especially if all/majority of the members die or are incapacitated. But generally speaking, the vicissitudes of the flesh have no direct effect on the disembodied company, members may come and members may go but the company goes on for ever'. For example, during the second world 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 destroy it. The insanity of the managing director will be calamitous to the company provided that he is removed promptly; he may be the company's brains but lobectomy is a simpler operation on a company and has less drastic effects on it than on a natural person. The continuing existence of the company irrespective of changes in membership, is helpful in other directions also. When an individual sells his business to another, difficult questions may arise, regarding, the performance of existing contracts by new owners, the assignment of rights of a personal nature, and the validity of agreements made with customers ignorant of the change of proprietorship. Similar problems may arise on a change in the constitution of a partnership. Where the business is incorporated and the sale is merely of the shares, none of these difficulties arise. The company remains the proprietor of the business, performs the existing contracts and retains the benefit of them, and enters into future agreements. The difficulties attending vicarious performance, assignments and mistaken identity do not arise [Gower, p.94]. Some of these problems will arise when the company as a whole either merges with or is taken-over by another company, the consequences of which we will deal later at an appropriate time. Disadvantage of perpetual succession As mentioned earlier, the fact that all/most of the directors and or members of the company die or become incapacitated does not result in an automatic end of the company i.e., 'the company does not reach its death along with its members'. This concept of 'perpetual succession' has a great advantage in the commercial world. It leads to stability and certainty in the uncertain and fluid scenario of an industrial society. Shareholders can invest in a company and the creditors can give loan to it, not on the basis of the management but on the basis of past performance and future opportunities of the company. There is no needless panic or crisis at the stock exchange simply because the chairman or managing director has expired [though the sensex may show a drop of few points, it is usually temporary and the price is stabilized in a comparatively short time]. In short, a company continues to function smoothly, regardless of any upheaval in its management. But, this very advantage of continuity and perpetuity may turn to a major disadvantage, when the members and management want the company to 'cease functioning'. Being a 'legal person' the company cannot die a natural death, its end has to come through legal means alone. To provide for this eventuality, the Companies Act has elaborate provisions given under Ss. 433
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to (about) 481. Thus, not only the promoters etc have to undergo a lot of expense in terms of time money and convenience for 'incorporation of a company', but they have also to invest equally heavily (and sometimes much more heavily) for bringing the existence of the company to an end by following the complicated procedure for winding-up [we will be dealing with winding up in a later module]. Even if the company has been running in a loss for a long time or has accumulated enormous debts, this procedure can not be escaped from. So also, it may happen that the main purpose for which the company was incorporated has failed, i.e., there is no reason for the company to exist, even then the members cannot simply 'down the shutter' of the company, but will have to proceed with winding up. Thus for example in re German Date Coffee Co [(1882) 20 Ch D 169]. Here, the memorandum of a company stated that it was formed for working a German patent which would be granted for manufacturing coffee from dates; for obtaining other patents for improvements and extension of the said invention; and to acquire and purchase any other invention for similar purposes. The intended German patent was never granted, but the company purchased a Swedish patent, and also established works in Hamburg where they made and sold coffee from dates without any patent. A petition having been presented by two shareholders, it was held that the main object for which the company was formed had become impossible, and therefore, it was just and equitable that the company should be wound up. We may thus safely conclude, that not only does a company enjoy an expensive birth - but thanks to the concept of perpetual succession it also gest an expensive funeral - regardless of the hardships caused to the members. (vi) Transferability of Shares Incorporation resulting in giving the business a separate identity apart from its members, has facilitated the easy transferability of a member's interest in it. Previously this result was achieved through the use of 'trust' coupled with an agreement for transferability in the deed of settlement. But this arrangement was only partially successful, since the member even after the transfer, remained liable for the firm's debts incurred during the time he was a member. Moreover, in the absence of limited liability clause, his opportunity to transfer was in practice much restricted. Similarly, in case of partnership, though a partner may transfer his share, his right to do so is subject to the terms and conditions of the partnership deed as well as the Partnership Act. Section 82 of the Companies Act provides that, "the shares or other interest of any member in a company shall be movable
property, transferable in the manner provided by the articles of the company". Thus incorporation enables the member to sell his shares in the open market and get back his investment without having to withdraw the money from the company. This provides for liquidity to the investor and stability to the company'. Does this mean that there is absolutely no restriction on the members right to transfer shares? No - the scope for restriction is given in sec. 82 itself -- '.... in the manner provided in the articles'. Thus, the articles of a company, may impose any condition/restriction on this right to transfer shares. These restrictions are in general more stringent in case of private companies than in case of public companies, in order to allow the former to retain its strictly private character. As observed by Lord Greene M.R. in re Smith & Fawcett Ltd [(1942) Ch 304], "private companies are (no doubt) in law separate entities just as much as are public companies, but from the business and personal point of view they are much more analogous to partnerships than to public corporations". Accordingly, it is to be expected that in the articles of such a company the control of the directors over the members may be very strict indeed. (vii) Borrowing It would be natural to presume that sole traders or proprietors being personally liable would be more capable of borrowing capital from the market but in reality that is not so. Creditors find it easier and safer to lend money to companies rather than to individuals. The reasons are varied: larger number of assets, greater chances of return, better investment with great stability etc. In order to facilitate the borrowing by companies, equity practitioners have come up with an ingenious device known as 'floating charge' over the assets of the company, i.e., a charge which floats like a cloud over the whole assets from time to time falling within a generic description, but without preventing the mortgagor from disposing of those assets in the usual course of business until something occurs (for ex: winding-up) to cause the charge to become crystallized or fixed. By virtue of it the lender can obtain an effective security on all the undertaking and assets of the company both present and future" either alone or in conjunction with a fixed charge on its land. If, in addition, the lender requires some personal security he can insist on the members, or some of them, joining as guarantors. By this he places himself in a stronger position, than if he merely had the personal security of the individual traders. Frequently therefore, a proprietor-business is converted into a company solely for the purpose of raising further capital.
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3. LIFTING OF THE VEIL

SUB-TOPICS 3.1 Doctrine of lifting the veil - general meaning 3.2 Circumstances of lifting the veil 3.3 Personal liability in Companies Act (a) Criminal Liability (b) Civil Liability 3.1 DOCTRINE OF LIFTING THE VEIL It is true as Avtar Singh observes that in question of property and capacity of acts done and rights acquired or, liability assumed thereby .... personalities of the natural persons who are the company's corporations is to be ignored" (Singh , p.9). But this theory cannot be extended to an unlimited extent. During the nineteenth and early twelveth century several corporate lawyer's and economists argued that a blanket legal personality may be used as a shield for defrauding consumers in particular and public in general. A corporate personality being an attribute by law can show in the way of criminialization and fixation of corporate criminal liabilty. The whole range of taxation laws may in that case become non piercing. Some corporate lawyers could argue that corporate personality being a legal personality, even fine cannot be imposed against the corporations. This is an extension of the logic of corporate personality to a very unreasonable extent because in that case legal personality would conflict with the sovereign function of the State. The resolution of this legal puzzle has been attempted in the twentieth century in two ways : (a) Through the means of legislative process, the corporate shell has been broken a number of times to affix individual liability specially in the matter of tax laws. Since the legislature confers the personality and this constitutes the personality shell it can only break it or puncture it. Based on this principle, both the common law legislatures and civil law legislatures have broken the corporate shell. (b) In innumerable instances of fraud and abuse of corporate structure, common law courts and civil law courts lifted the corporate veil in order to identify the responsible person and affix proportionate liability. The basic philosophy behind this is that the legislature attributes the corporate veil with which individual functioning within the corporate structure are insulated against personal liability. The anology can be brought from the sovereign function of state as a corporate body, in which state functionaries do not incur any personal liability for making the state function. In many countries having constitutional form of governance, the secondary rule of the constitution empowers the state to make primary rules for cracking the corporate identify of the state and exposing the functionaries to individual liabilities. In corporate law itself instances of such personal liabilities are immovable in every country. This is therefore, a very strong exception to the rule of corporate liability in which individuals are absolutely insulated from liability arising out of their function in the representative capacity in the corporation. These exceptions on cracking the shell or lifting the veil require further elucidation. It should be emphasized here that the use of the term 'veil' does not mean that the affairs of the company are completely concealed from the view. On the contrary, it is an essential condition of law of corporate personality with limited liability that it should be accompanied by wide publicity. Normally however, third parties are neither bound nor entitled to look behind such information as the law provides shall be made public, in addition to the veil of incorporation, there is something in the nature of a curtain formed by the compay's public file, and what goes on behind it is concealed from the public gaze but under certain situations, even this curtain may be raised. So the phrase 'veil' basically denotes the cut-off line beyond which the general public is not allowed to go for further information. Though in general even the courts prefer to maintain this sanctity and privacy of a corporate personality, under exceptional circumstances they ignore this veil and go behind to ascertain the true circumstances of the given case. The following flow chart shows the various circumstances under which corporate veil may be pierced or the shell cracked open. 3.2 CIRCUMSTANCES OF LIFTING THE VEIL
Lifting the veil By the Legislature (Cracking the corporate Shell) Reduction of No. of members Fraudulent or wrongful trading Premature Trading By the Judiciary (Lifting of the veil) Company groups
Misdescription of company name Determination of character For the benefit of revenue or taxation purpose Fraud or improper conduct Agency or trust and Government companies
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Now we will try to look at each of these situations briefly.
(iii) Misdescription of company name If in any act or contract of a company, its name is not fully or properly indicated as required under S. 147 of the Act, every person who is involved in the doing of the act or making of the contract shall be personally liable for it. Thus, in re William C Leitch Bros. Ltd [(1932) All ER 892], the directors were held personally liable on a cheque signed by them in the name of the company stating the company's name as L.R. Agencies Ltd.-the real name being L. & R. Agencies Ltd. (iv) Premature trading Under S. 149 of the Act, a public company cannot commence business immediately after incorporation, but has to obtain a further certificate of 'commencement of business' from the Registrar. Any contract entered into before the obtaining of this certificate is merely provisional and not binding on the company. If after the certificate is obtained, the company refuses to be bound by the contract, the persons involved in the making of the contract will be held personally liable. Technically speaking, this is not really a case of lifting of the veil, the effect of court intervention is to hold the director's etc., personally liable. This provision is once again of academic interest, since no public company would really enter into a contract before obtaining the requisite certificate. (v) Company groups As seen earlier, even a 100% subsidiary company, is a separate legal entity and its creator and controller is not to be held liable for its acts merely because he is the creator and controller. Nor is the subsidiary to be held as an asset of the holding company. A subsidiary may however lose its separate identity to a certain extent in two cases, firstly due to legislative intervention and secondly by judicial intervention (this we will discuss later). Thus secs. 212-214 contain provisions Designed primarily to give better information of the accounts and financial position of the group as a whole to the creditors, shareholders and public" Similarly, the prohibition on financial assistance for the purchase of company's own shares extends to financial assistance by any of its subsidiaries. These provisions relating to group disclosures have in some respects made matters worse rather than better for they are calculated to lead those who had group annual reports to assume that there is a group liability which is not really true. So people unaware of intricacies in company law, are more likely to be misled by these disclosures. Though, we have given certain specific instances, there are many other miscellaneous provisions spread through out the Act, which make it possible for the courts to disregard the corporate identity and to fix the liability on the person(s) responsible for the breach of such statutory provisions. B] By the Judiciary => Lifting of the veil As stated earlier this entire doctrine of 'lifting of corporate veil' though of paramount importance does not owe its existence to legislative draftsmanship, but is a prime example of judicial ingenuity. Time and again, the courts have gone behind the 87
A] By the Legislature => Cracking of Shell Though, this doctrine owes much to the judiciary for both its evolution and development, the statute itself provides for certain situations where the courts may go behind the corporate veil. Though not as important as the judicial lifting of veil, even these situations merit a brief description. So now we will study each situation in detail where the corporate veil can be lifted. (i) Reduction of number of members Under S. 45 of the Act, if a company carries a business for more than 6 months with less than two members, any person who is a member after the lapse of the 6 month period may become liable, jointly and severally with the company, for the payment of its debts. This section does not operate to destroy the separate personality of the company - it still remains an existing entity even though there may be only one member or more. A creditor's rights under the section are severely limited. It is only a member who remains after the end of 6 months who can be sued, and then also only if he knows that the company is carrying on business with only member, and he is further liable for only those debts contracted after the 6 month period and while he was still a member. A director does not become automatically liable unless he is a member also. Due to these limitations the rule is more of theoretical interest rather than of practical importance. (ii) Fraudulent or wrongful trading Of a far greater importance is S.542 of the Act, creating a specific but widely defined criminal offence of carrying on business with intent to defraud creditors of the company or any other persons or for any fraudulent purpose. Once this fact is established during a winding-up the court may, on the application of the liquidator, creditor or contributory of the company, declare that the persons who were parties to such business shall be personally responsible for such debts of the company as the court may direct. Besides, every person who is knowingly a party to such conduct of business, is punishable with imprisonment, or fine, or both [sec. 543(3)]. This liability arises only when the company is in winding up and for offences committed before or during winding up. Fraudulent trading connotes real dishonesty according to current notions of fair trading among commercial men, i.e., real moral blame. The basis for decisions under this section have been explained in re White & Osmond (Parkstone) Ltd [unreported, cited in Avtar Singh, p.516] as: "There is nothing wrong in the fact that the directors incur credit at a time when, to their knowledge, the company is not liable to meet all its liabilities as they fall due. What is manifestly wrong is if directors allow a company to incur credit at a time when the business is being carried on in such circumstances that it is clear that the company will never be able to satisfy its creditors. However, there is nothing wrong to say that directors who genuinely believe that the clouds may roll away and the sunshine of prosperity will shine upon them again and disperse the fog of their depression are not entitled to incur credit to help them to get over the bad time".
facade of corporate identity in their search for truth, though again, many are the instances when the courts have refused to look behind this veil of legal personality. Thus, whether the court would be willing to pierce the corporate veil or not, would rather depend on the gravity and need of the particular situation, but for the following purposes the courts have been very willing to lift the veil. (i) Determination of character It may in certain situations become necessary for the courts to determine the character of a company to check if it is an enemy. In such cases, it goes behind the legal identity, to examine the character of the persons actually in control of it. One of the leading cases on this point is Daimler Co. Ltd v. Continental Tyre & Rubber Co. [(1916) 2 AC 307: (1916-17) All ER 191]. Here, 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. The holders of the remaining shares (save one) and all the directors were Germans, residing in Germany. Thus the real control of the English company was in German hands. 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. House of Lords held that, "a company incorporated in the UK is a legal entity, a creation of law with the status and capacity which the law confers. It is not a natural person with mind or conscience. It can be neither loyal nor disloyal. It can be neither a friend nor enemy. But it may assume an enemy character when persons in defacto control of its affairs, are residents in an enemy country or, wherever resident, are acting under the control of enemies". Accordingly the company was not allowed to proceed with the action. But where no such monumental questions of public policy or national importance are involved, the courts refuse to look behind the corporate entity to ascertain the nature of persons controlling it [Refer to, People's Pleasure Park Co. v. Rohleder, [61 SE 794]. (ii) For the benefit of the revenue The courts have given to themselves the power to disregard the corporate entity, to reach the person controlling it, if it feels that the company is being used for purposes of tax evasion or to circumvent tax obligation. One of the early cases on this issue is in re Sir Dinshaw Maneckjee Petit, [AIR 1927 Bom 371]. Here, the assessee was a wealthy man enjoying huge dividends and interest income. He formed four private companies and agreed with each to hold a block of investments 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 into four parts in a bid to reduce his tax liability. But it was held that, "the company was formed by the assessee purely and simply as a means of avoiding super-tax and the company was nothing more than the assessee himself. It did no business, but 88
was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assessee as pretended loans". This does not mean, that in all cases, courts will tend to equate the income of the company with the income of the assessee. This is done only in cases, where there is an express intention to deceive. Where such an intention is lacking, the courts refuse to pierce the corporate veil, as is evident from the case of Bacha F. Guzdar v. Commissioner of Income Tax, Bombay [AIR 1955, SC 74]. Here, the income of a Tea company was exempt up to 60% as agricultural income and 40% income was taxed as income from manufacture & sale of tea. The plaintiff was a member of a tea company. She received a certain amount as dividend in respect of shares held by her in the company and claimed that this income should also be regarded as agricultural income upto 60% and be non taxable. It was held that, although the income in the hands of the company was partly agricultural, yet the same income when received by the shareholders as a dividend could not be regarded as agricultural income". (iii) Fraud or improper conduct The corporate entity as such is wholly incapable of being strained to an illegal or fraudulent purposes. Where a company is formed with an express intention to defraud creditors or for improper purposes, the courts will refuse to uphold the corporate identity and hold the controlling person personally liable. One clear illustration is, Gilford Motor Co. v. Horne [(1933) 1 Ch 935]. Horne was appointed as MD of the plaintiff company on condition that "he shall not at any time while he shall hold the office of MD or afterwards, solicit or entice away the customers of the company". His employment came to an end under an agreement. Shortly afterwards he started a company which solicited the plaintiff's customers. It was held that , "the company was mere cloak or sham for the purpose of enabling the defendant to commit a breach of his covenant against solicitation. Evidence as to the formation of the company and as to the position of its shareholders and directors lead to that inference. The defendant company was a mere channel used by the defendant Horne for the purpose of enabling his own benefit, for the advantage of the customers of the plaintiff company and that the defendant company ought to be restrained along with the defendant Horne". (iv) Agency or trust and Government Companies A company may be sometimes deemed to be the agent or trustee of another company or of its principal. In India, earlier, this question used to arise frequently in connection with Government companies. As already discussed earlier, forming of a company, allowed the government to be clothed in the robes of an individual and allowed it to escape the rules and regulations which hampered its actions if it were to act through a government department. Initially, the Supreme Court did everything in its powers to ensure the continuity of this freedom, and it was not till 1981 that Krishna Iyer, J., in Somprakash Rekhi's case imposed the liability of a 'state' even on government companies.
As a general rule it is very difficult to ascertain whether a corporate body is really independent or is being used as the agent or instrumentality of the state or of some other corporation, and unless it becomes really essential, courts are generally reluctant to look into this question. In 1939, in Smith Stone & Knight Ltd v. Birmingham Corpn [(1939) 4 KB 116], Atkinson, J., laid down a six point test to ascertain whether a given company was the agent or instrumentality of another. This test has made the job of the courts easier, in determining this issue. The same test has also been used in taxation cases to see whether a company is an agent or trustee of another. As Lord Denning, M.R. said in Littlewoods Mail Order Stores Ltd v. I R C [(1969) 3 All ER 855 (CA)]: The doctrine laid down in Salomon v. Salomon & Co Ltd has to be watched very carefully. It has often been supposed to cast a veil over the personality of a limited company through which the courts cannot see. But that is not true. The courts can and often do draw aside the veil. They can, and often do, pull off the mask. They look to see what really lies behind. The legislature has shown the way with group accounts and the rest. And the courts should also follow suit. We should also look at the Fork company and see it as it really is - the wholly owned subsidiary of the tax payers in point of fact, and it should be so regarded in point of law". Despite all these advantages which make the idea of doing business in the company form' really lucrative, there a some major disadvantage of incorporation which cannot be overlooked. Apart from the fact that it is very expensive to go in for incorporation, it is time consuming and often inconvenient, one cannot get away from the fact that this shield
of legal personality has been given by the law is the form of judicial pronouncement, and this shield can be removed or disregarded whenever the need arises. Lifting of corporate veil doctrine' evolved by the courts has thus turned into a major disadvantage of incorporation, whereby the privacy of this legal person, called a company can be invaded by the courts to ferret out its innermost secrets. But still, weighing the advantages and disadvantages of incorporation in a balance, the advantages far outweigh the disadvantages. 3.3 INSTANCES OF PERSONAL LIABILITY IN THE COMPANIES ACT Over and above the company being liable, the Companies Act itself provides the following circumstances in which each officer of the company committing default shall be personally liable unless he/she can prove that 1) the decision for the action has been taken or not taken on the bonafide belief that such an action or inaction is for the interest of the institution; 2) the default is not a default in law and 3) as soon as the mistake is perceived the officer concerned has taken a proper action. For the purposes of the Act an officer (in default) shall mean all the following officers of the company (a) Managing Director, (b) Whole time director, (c) the manager, (d) the secretary (e) Any person in accordance with whole company is accustomed to act, (f) Any person charged by the responsibility attributed by the board (sec. 5). An officer shall not be covered by the corporate responsibility and shall be exposed to his personal liability in the following cases:
PERSONAL CRIMINAL LIABILITY OF OFFICERS IN DEFAULT (Instances of cracking the shell) Sl. No. 1. Section No. 22(2) Ground of Offence Imprisonment Failure to change the name when directed by the Central Government. Copies of constitutional documents not given to members. Alteration in constitutional document not noted in copies. Grounds of private company becoming public not notified to Registrar within 3 months. Untrue statement in a prospectus or statement in lieu of Prospectus. Investments not kept in the name of company. Punishment Fine 100/- per day
2. 3. 4.
39 40 43/A/(5)
50/- per day 10/- per copy
upto 2 years
500/- per day and/or upto 500/- per day upto 5000/-
5.
44(3)
6.
49
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7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25.
56(3) 58(A) (5)(6) 58(10) 60(5) 63(1) 68 69 70 72 73 75(4) 76 77 79 80 & 80A 95 97 105 108-I
Statutory matters not disclosed in prospectus. Public deposits accepted without public advertisement Safeguards directed to depositors not taken care of Failure to Register Prospectus Misstatement in the Prospectus Fraudulent or reckless statement in the prospectus Minimum subscription not raised but shares issued Allotment of shares or debentures violating statutory conditions Allotment of shares or debentures violating provision of S. 72 Allotment violating conditions in S. 73 Failure to submit returns as to allotment Prohibition of paying commission and discount Violation of prohibition on purchasing own shares. Issuing shares at a discount in violation of the provision Violating provisions for issuing redeemable preference shares Notice to Registrar for consolidation of share capital not given Notice of increase of share capital or of members not given Concealing the names of creditors and others requiring discloser. Penalty for acquisition & transfer of shares in contravention of section 108 A-D a. Violation of condition 108A b. Violation of condition 108B c. Violation of condition 108C d. Violation of condition 108D Violation of power to refuse registration and appeal against refusal
upto 5 years upto 3 years upto 2 years upto 5 years upto 2 years upto 1 year
upto 5000/and/or fine and/or 50/- per day. upto 5000/and/or upto and/or upto 10000/upto 5000 and/or upto 5000 upto 5000/upto 5000/upto 500/per day upto 500/upto 1000/upto 50/upto 1000/upto 50/per day upto 50/- per day and/or fine
3 years 3 years 3 years 5 years -
and/or 5000/and/or 3000/and/or 5000/and/or also fine upto 50/- per day
26.
111
90
27.
113(1)
Violation in the application for the registration of transfer of shares and debentures or debenture stock in accordance with the provisions of Sec.53 Violation of provision of not entering the names in the register of members on the issue of share warrants. Deceitful personation of an owner of any share or interest in the company. Refusal of copies and inspection of trust deed
upto 500/- per day
28.
115
upto 50/- per day
29.
116
upto 3 years
and fine
30.
118
upto 50/- and further fine which may extend to 20/- for every day of default upto 50/- per day uto 500/- per day
31.
137
Violating the provision for maintaining Register of Charges etc. Default made in filing with the Registrar particulars regarding charges etc. Non keeping of Register of charges Refusal to inspect Register of charges Default in notifying Registered office Name of the Company not properly published in commercial documents Name of the company not properly affixed or painted Authorised,subscription or paidup capital not properly published. Improperly commenced business violating sec.149 Register of members not properly kept Index of members not kept Not keeping Register of debentures False statement made by the trustees Register closed without giving notice
32.
142
33. 34. 35. 36.
143 144 146 147(3)
upto 500/upto 20/- per day upto 50/- per day
upto 500/upto 500/-
37. 38.
147(4) 148
upto 2000/upto 500/- per day upto 50/- per day upto 50/upto 50/upto 100/- per day 2 years and fine upto 500/- per day
39. 149(2A)&6 40. 41. 42. 43. 44. 45. 150 151 152 153-B 154
153-B(3a) Shares & Debentures held in trust
91
46.
157
Register of foreign members and debentures holders not properly kept. Foreign register does not disclose the required information. Register not kept in proper place for inspection Statutory meeting not properly held Annual General meeting not properly held. Notice given for invitation to appoint proxy at the company expenses. Not declaring persons holding beneficial interest Not circulating members resolution as required Non registration of certain resolutions & agreements to be registered Minutes of proceedings of General Meetings of board not properly kept. Not allowing inspection of minutes books of general body meeting as required. Improper publication of reports of the proceedings of General Meeting. Unpaid dividend not treated as per Sec.205-A. Penalty for failure to distribute dividends within 42 days Failure to keep books of account. Default in keeping open books of account for inspection. Default Failure to lay annual accounts and balance sheet before the company. Failure to comply with the provisions of Sec.211 Disclosure in the balance sheet not made properly
upto 50/- per day
47.
158
upto 50/- per day
48. 49. 50. 51.
163 165 168 176(4)
upto 50/- per day upto 500/upto 250/upto 1000/-
52. 53. 54.
187-C 188(8) 192
upto 100 per day upto 5000/upto 10/- per copy distributed upto 50/-
55.
193
56.
196(3)
upto 500/- for each offence
57.
197
upto 7 days upto 1 year
upto 500/upto 500/-per day and fine and/or upto 1000/and/or upto 1000/upto 1000/- or both and/ or upto 1000/upto 1000/-
58. 59. 60.
205A 207 209(5)
61.
209A
upto 1 year upto 6 months
61(a) 210(5)
61(b) 211(7) 62. 212
6 months upto 6 months
92
63. 64. 65.
217 218 219
Improper report by the board Improper issue of final account Members not supplied with financial and audited report Not filing copy of Balance Sheet with Registrar Disclosures not properly made in the annual account Banking or insurance company not publishing statements in the appropriate table specified in Schedule-I Violation in the appointment of auditors Appointment of Auditor without the approval of company by special resolution. Non compliance of provision on annual audit accounts. Auditor's non-compliance with Ss.227 & 229 Non-compliance of government for special audit Non-compliance on cost audit requirement. Non furnishing information or explanation sought by th Registrar Failure or refusal to sign the notes of examination in investigation
upto 6 months upto 6 months 6 months -
and/or upto 2000/upto 500/upto 500/upto 500/and/or upto 5000/upto 50/- per day
65(a) 220 66. 67. 221 223
68. 69.
224 224A
upto 500/-
upto 3 years -
upto 500/upto 500/upto 1000/upto 500/and/or upto 5000/upto 500/and if continuing 50/every day. and/or upto 2000/- and also 200/per day when the failure continues. and/or upto 5000/and/or upto 5000/upto 5000/upto 500/for every day till he vacates office 93
70. 71. 72. 73. 74.
232 233 233A 233B 234
75.
240
6 months
76. 77.
248 250(8)
Furnishing false statement in a material particular Change in the composition of Board of Directors resulting from transfer of shares which is prejudicial to public interest. Issuance of shares involution of restrictions. Want of approval of central government in the matter of appointment of whole time Director or Manager
upto 6 months
upto 6 months
78. 79.
250(10) 269(6)
80.
269(10) (a)(b)(c)
Violation of CLB restrictions in the matter appointing whole time Director, Manager or Officer (a) Company (b) Every Officer (c) Concerned appointee
upto 5000/upto 10000/upto 10000/- and refund of entire amount of salaries, commissions, perquisites enjoyed till date of order and upto 50/-every day of default upto 50/- every day between expiry date and the last day of acting as such. upto 5000 inrespect of each of those companies after the first twenty upto 500/- for each day he function as director upto 5000/with a further fine of 50/- for every day of default. or fine upto 5000/upto 5000/upto 5000/upto 500/for each default upto 1000/upto 50/- per day during default continues
81. 82.
269(11) 272
Contravention of the Company Law Board Order Person acting as director for want of share qualification after the expiry of 2 months
upto 3 years -
83.
279
Person acting as director of more than 20 companies
84.
283
Disqualified person acting as Director
85.
294
Violation of furnishing or refusing to furnish information regarding the terms and conditions of appointment of the selling agent to the Central Government. Grant of Loan security or guarantee to directors without prior approval of Central Government. Non disclosure of personal interest by director. Interested Director knowing participation in Board's proceedings Default in not maintaining properly register of Contracts Non disclosure of Director's interest in contract appointing Manager etc. Default in non-keeping register of directors, manager and secretary at its registered office.
86.
298
simple imprisonment upto 6 months -
87. 88. 89. 90. 91.
299 300 301 302 303
94
92. 93.
304 305
Refusal of inspection of Register of Directors to any member Violation of duty to disclose appointment or relinquishment of office of director, managing director, manager or secretary within 20 days of such happening. Non production of register of director's share holding etc. at the commencement of every general meeting of company. Non maintenance of register of director's shareholdings, debentures etc.
upto 50/upto 500/-
94.
307(7)
upto 500/-
95.
307(8)
upto 5000/with further fine upto 20/- everyday during default and/or 5000/upto 250/-
96. 97.
308 320(3)
Default of directors to make disclosures of shareholdings Director securing payment by way of compensation for loss of office etc. with the transfer of undertaking from the transferee Failure to add statement to the proposal of appointment of a person to the office of director, that his liability will be unlimited.
upto 2 years -
98.
322
upto 1000/and damages which the person so appointed may sustain from default upto 1000/in respect of each company in excess of ten and/or upto 5000/-
99.
332(5)
Acting as managing agent of more than 10 companies
100.
343
Transfer of office by managing agent without approval of the company in general meeting and central government Managing agents default in respect to matters where schedule VIII applies
upto 6 months
101.
347
upto 50/- for everyday during which default continues upto 500/and further upto 50/- per day during fault continues upto 5000/-
102.
370(1-E)
Non keeping of register showing the names of all body corporates unde the same management and particulars of all loans, guarantee or security Violation of section 369,370 or 370-A (regarding loss to managing agent, to companies under same management)
103.
371
simple imprisonment upto 6 months
95
104. 372(8)
Non maintenance of register of investments with all particulars
upto 500 and also 50/- for every day during fault continues upto 5000/-
105. 374
Non compliance of provision u/s 373 regarding purchase of shares by company. Failure to annex court order concerning compromise or arrangement with creditors to every copy of memorandum Non filing of certified copy with Registrar within 30 days of making an order regarding facilitating reconstruction and amalgamation of companies. Default in not filing with the Registrar certified copy of alteration of memorandum or alteration of company within 30 days Termination or modification of agreement by the officials without the leave of CLB Violation of requirements of filing memorandum in the office of company for placing in the next meeting of Board of Directors concerning the contract by agents in which company is undisclosed principal Contravention of provisions concerning provident funds of employees Non filing accounts of receivers as as per requirements u/Ss. 421 and 422 Default in the statement of affairs made to the liquidator Non filing a copy of order of dissolution of a company within 30 days by the liquidator to the Registrar Default in the publication of the resolution of voluntary winding up in the official gazette
106.391(4)
upto 10/- for each copy of which default is made. upto 50/-
107. 394(3)
108.404(3)
upto 5000/-
109. 407
upto one year -
and/or upto 5000/upto 200/-
110. 416
111. 420 112. 423 113. 454
upto 6 months upto 2 years -
or fine upto 1000/upto 200/and/or upto 100/per day during the period of default continues upto 50/per day during which default continues upto 50/every day during which default continues
114. 481
115. 485
96
116. 488
Default in the declaration of solvency in the proposal of voluntary winding up. Failure to give notice of appointment of liquidator to Registrar within 10 days of the event to which it makes Failure to call creditor's meeting in case of insolvency by the liquidator Failure on the part of liquidator to call general meeting at the end of each year. Failure to furnish the return within one week to the Registrar after the meeting on fully winding up of the company Failure to call general meeting by the liquidator Default in holding the creditor's meeting Default in giving notice of resolution passed by creditor's meeting to the Registrar Failure to call meeting of company and creditors at the end of each year Failure to send a copy of accounts to Registrar about final meeting and dissolution Failure of liquidators to call a general meeting of the company or creditors Failure to give notice of his appointment as liquidator within 30 days to Registrar Officer guilty of any false representation or fraud for obtaining the consent of the creditors to agreement relating to affairs of company Where an officer pawns, pledges or disposes profit of the company Falsification of books Frauds of Officers Failure to keep proper accounts
upto 6 months -
and/or upto 5000/upto 100/per day during which defaults continue upto 500/-
117. 493
118. 495
119. 496
upto 100/-
120. 497
upto 50/per day during which the default continues upto 500/upto 1000/upto 50/- per day during which default continues upto 100/for each failure upto 50/- for everyday fault continues upto 500/for each failure upto 50/every day of default and/or fine
121. 497 122. 500 123. 501
124. 508
125. 509(3)
126. 509(7)
127. 516
128. 538(1)
upto 5 years
129. 538(2) 130. 539 131. 540 132. 541
upto 3 years upto 7 years upto 2 years upto 1 year
and/or fine and fine and fine 97
133. 542 134. 547 135. 550
Persons fraudulent conduct of business Failure to notify that company is in liquidation Disposal of books and papers of a wound up company in violiation of requirement Failure to furnish information as to pending liquidation If liquidator makes wilful default Failure to file certified copy within 30 days on whose application of winding up is ordered by the court. Penalties in default of companies incorporated outside India
upto 2 years upto 6 months
and/or upto 5000/upto 500/and/or upto 5000/upto 500/everyday of and or/ upto 1000/upto 50/everyday of default upto 1000/- in case of continuing offence and upto 100/- for every day of default and/or 5000/and/or 5000 and/or upto 1000/and/or upto 5000/-
136. 551(5)
136(a) 137. 559
upto 6 months -
138. 598
139. 606 140. 614-A 141. 615 142. 621-A 143. 625(4)
Violation concerning issue of prospectus Failure to comply with orders of court Furnishing a wrong information to central government Failure to comply with the order of Company Law Board Default in the payment of compensation in cases of frivolous prosecution Penalty for false statement Penalty for false evidence Contravention of any of the provisions for which no punishment is provided for default Penalty for wrongful withholding property.
upto 6 months upto 6 months upto 3 months upto 6 months simple imprisonment upto 2 months upto 2 years upto 7 years -
144. 628 145. 629 146. 629-A
and fine and fine upto 500/and for continuing default upto 50/- per day upto 1000/-
147. 630
upto 2 years
98
(b) PERSONAL CIVIL LIABILITY OF OFFICERS IN DEFAULT (Instances of cracking the shell) Sl.No. 1. 2. Section 62(1) 69 Grounds of Liability Misstatement in prospectus Return of application money when allotment cannot be made Irregular allotment Default in listing of shares and debentures u/s 73 Wrongful refusal of registration and unnecessary delay for registration Statutory civil liability Extent of liability Compensation to suffering member Money with interest at the rate of 6% p.a. from the expiry of 30th day Compensating the shareholder of the company Repayment of money of investor plus 15% interest Damages
3. 4.
71 73
5.
111
6.
607
Compensation to suffering member.
99
4 PRINCIPLE OF ULTRA VIRES

SUB TOPICS 4.1 Introduction 4.2 Ultra Vires transaction 4.3 History of ultra vires rule 4.4 Effects of Ultra Vires transaction (A) Rights of the company and shareholders (B) Rights of other party 4.5 The Organ theory 4.6 Present status of the principle 4.7 Conclusion 4.1 INTRODUCTION In our first module of corporate law, we have seen that for the purposes of incorporation, the promoters of a company have to file with the Registrar certain essential documents along with their application for registration. Two of the main documents required to be so filed are the memorandum and articles of association. The memorandum consists of five major clauses, namely, the name clause, the registered office clause, the object clause, the capital clause, and the liability clause. The memorandum in fact is required to give all the information which a third party may reasonably want to have regarding the company. The articles on the other hand, consist of rules and regulations meant for internal governance of the company. We had further seen though briefly, what was meant by the object clause and what was ultra vires transaction. In this chapter, we will be dealing with this principle in slightly more detail. 4.2 ULTRA VIRES TRANSACTIONS Before going in depth to what ultra vires transactions really are, it would be proper to study the reasons for inclusion of the 'object clause' in the memorandum. There are basically three reasons for this inclusion, viz.: (i) The capital of the company is contributed by the shareholders and held by the company as though in trust for them. Such a fund must be dedicated to some defined objects so that the contributors may know the purposes to which it can be lawfully applied. The statement of objects, therefore, gives a very important protection to the shareholders by ensuring that the funds raised for one undertaking are not going to be risked in another. (ii) It affords a certain degree of protection to the creditors also. The creditors trust the corporation & not the shareholders, and they have to seek their repayment only out of the company's assets. The fact that the corporate capital cannot be spent on any project not directly within the terms of the company's objects gives the creditors a feeling of security. (iii) By confining the corporate activities within a defined field, the statement of object serves the public interest also. It presents diversification of a company's activities in 100
directions not closely connected with the business for which the company may have been initially established. It also prevents concentration of economic power [Avtar Singh, p. 43]. These very reasons, require the company to adhere strictly to the objectives stated in the object clause. The function of the memorandum is, to delimit and identify the objects in such plain and unambiguous manner as that the reader can identify the field of industry within which the corporate activities are to be confined [Per Lord Wrenbury in Cotman v. Brougham, (1918) AC 514]. The function of the courts is to see that the company does not move in a direction away from that field - and it was for this purpose that the principle or doctrine of ultra vires' was evolved. Ultra- means beyond and vires- means power, so the phrase ultra vires' literally means beyond power'. Any action of the company which falls outside the scope of the object clause is ultra vires the company. According to Palmer, there are two reasons why the ultra vires doctrine has been developed by the courts: first, as a matter of constitutional law, parliament, as the sovereign power in the country, does not grant more power to delegated bodies than it has authorized, and, secondly, as a practical consideration, it was thought that the rule would protect investors in the company and creditors of it against the unauthorized use of the company's funds. In the words of Prof. Gower, the purpose of the ultra vires rule was to ensure that an investor in a gold mining company did not find himself holding shares in a fried-fish shop, and [to give] those who allowed credit to a limited company some assurance that its assets would not be dissipated in unauthorized enterprises [Palmer, p.73]. The application of this doctrine was first demonstrated in Ashbury Railway Carriage and Iron Co Ltd v. Richean [(1874-80) All ER Rep Ext 2219]. Here, the memorandum of a company stated its objects as the objects for which the company is established are to make and sell, or lend on hire, railway carriages and wagons and all kinds of railway plants, etc., to carry on the business of mechanical engineers, and general contractors ....". The company entered into a contract with Riche, a firm of railway contractors to finance the construction of a railway line in Belgium. The company however repudiated the contract as being ultra vires, and Riche brought an action for breach of contract - because according to him the contract came well within the meaning of the words general contractors and was, therefore, within the powers of the company, and, secondly, that the contract was ratified by a majority of the shareholders, but the House of Lords held the contract ultra vires and hence null & void. Lord Cairn observed, The subscribers are to state the objects for which the proposed company is to be established and then the company comes into existence for those objects and those only. Such a statement of objects has two-fold operation. It states affirmatively the ambit and extent of powers of the company and it states negatively that nothing shall be done beyond that ambit, and that no attempt
shall be made to use the corporate life for any other purpose than that which is so specified. The terms general contractors must be taken to indicate the making generally of such contracts as are connected with the business of mechanical engineers. If the term general contractors is not so interpreted, it would authorize the making of contracts of any and every description, such as, for instance, of fire and marine insurance and the memorandum in place of specifying the particular kind of business, would virtually point to the carrying on of the business of any kind whatsoever and would, therefore, be altogether unmeaning. Hence the contract was entirely beyond the objects in the memorandum of association. If so, it was thereby placed beyond the powers of the company to make the contract. If the company could not make it, much less could it be ratified. If every shareholder of the company had been in the room and had said: That is a contract which we desire to make, which we authorize the directors to make the case would not have stood in any different position from that in which it stands now. The shareholders would thereby, by unanimous consent, have been attempting to do the very thing which by Act of Parliament they where prohibited from doing [Avtar Singh, pp.43-44]. In India, the first case on this principle seems to be Jahangir Rastamji Modi v. Shamji Ladha [4 Bom. H.C.R. 185 (186667)]. Here, the plaintiff was the registered shareholder of 601 shares in a company of which the defendants were the directors. The plaintiff alleged that the object clause under the memorandum, did not include dealing in shares, nor did it include the purchase by the company's of its own shares; yet the directors not only dealt in shares thereby incurring losses on behalf of the company, but also also purchased 1,422 shares of the company. Two of the issues framed were (1) Whether the purchase of its own shares by the company was ultra vires and (2) Whether purchase of shares in a joint stock company was ultra vires. Delivering the judgment, Sargent, J., observed, "A long series of decisions of the courts of law and equity in England has decided that an incorporated joint stock company can do no act which is not expressly or impliedly authorized by...the deed of settlement of the company... It is therefore to the memorandum and articles of association that we must turn to determine whether those transactions are expressly or impliedly authorized; or as it has been sometimes expressed, whether they fall within the scope of the objects for which the company was established. While holding that the purchase by the company of its own shares was ultra vires, the learned Judge remarked: I have not arrived at this decision without some regret, as I cannot but be aware of a fact perfectly notorious, that it has been the practice not only of companies similar to this, but for other companies, to purchase their own shares, and that this decision may press somewhat harshly upon individuals; but at the same time if the joint stock companies are to flourish, more specially in a country like this, it can only be by the public feeling assured that the courts of law while refusing to interfere with directors in carrying out the objects of these associations into full and complete activity, will prevent the application of the funds of the company to
other than legitimate purposes and objects of the association" [Sangal, pp 8. 9 & 10]. Slowly, a strict interpretation of the objects stated in the memorandum gave way to a slightly more liberal interpretation. In Attorney General v. The Great Eastern Railway Co [(1874-80) All ER Rep Ext 1459], the House of Lords observed that 'the doctrine of ultra vires, as it was explained in the Ashbury case, should be maintained. But it ought to be reasonably and not unreasonably understood and applied and that whatever may be fairly regarded as incidental to the objects authorized ought not to be held as ultra vires, unless it is expressly prohibited'. Thus, a company may do an act which is: (a) necessary for, or (b) incidental to, the attainment of its objects, or (c) which is otherwise authorized by the Act. Applying this rule of construction, a chemical manufacturer was allowed to distribute 1,00,000 Pounds to universities and scientific institutions for the furtherance of scientific education and research as it was conductive to the continued progress of the company as chemical manufacturers [Evans v. Brunner, Mond & Co Ltd, (1921) 1 Ch 359]. But where the money is paid by the company for a good purpose but not one useful to it, the courts refused to hold the payment as valid. For example in A. L. Mudaliar v. LIC [AIR 1963 SC 1185], the directors of a company were authorized to make payments towards any charitable or benevolent object, or for any general public, general or useful object. Accordingly, the directors being permitted by the shareholders, paid two lakh rupees to a trust formed for the purpose of promoting technical and business knowledge. Holding the payment ultra vires, the Supreme Court observed, the directors could not spend the company's money on any charitable or general object which they might choose. They could spend for the promotion of only such charitable objects as would be useful for the attainment of the company's own object. The company business having been taken over by the LIC, it had no business left to promote". This decision is an authority on two points, namely: (i) A company's funds cannot be diverted to every kind of charity even if there is an unrestricted power to that effect in the company's memorandum; and (ii) The objects of the company must be distinguished from powers. Objects have to be stated in the memorandum not the powers. Even if the powers are stated, they have to be used only to effectuate the objects of the company. They do not become independent objects themselves [Avtar Singh, p. 46]. Thus, a power to make charitable contributions cannot be acted upon to make grants of any or every kind. In the famous words of Bowmen, L. J., in Hutton v. West Cork Rly Co [(1883) 23 Ch D 654], charity has no business to sit at boards of directors qua charity. There is, however, a kind of charitable dealing which is for the interest of those who practice it, and to that extent and in that garb charity may sit at the board, but for no other purpose". The ultimate test to decide whether a transaction is ultra vires or not, is to see whether it is beneficial to the company or not. 101
If it does not benefit the company, then the transaction becomes ultra vires however praiseworthy the object may be. Disadvantages of the rule The ultra vires rule suffers from two short comings. In practice, it creates difficulties for both the management and the persons dealing with the company. For the management, their powers of doing business are restricted because at every step, they have to check whether their acts come within the purview or scope of the articles and memorandum. If they dont then the memorandum has to be altered, which is not very convenient. Outsiders dealing with the company are placed at an unnecessary disadvantage, because under law, they are deemed to have knowledge of the provisions of the memorandum and articles. So, if a transaction is not covered by the 'object clause' even a bonafide transaction with a company can be invalidated and as a result an outsider very often finds himself in difficulty. Gower has called the ultra vires rule a great trap for the unwary third party. According to Cohen Committee Report, the doctrine of ultra vires is an illusory protection for the shareholders and yet may be pitfall for third parties dealing with the company". 4.3 HISTORY OF THE ULTRA VIRES RULE In the words of Gower "The ultra vires rule has a long and somewhat tangled history". Chartered corporations were considered as possessing all the powers of a natural person to the extent an artificial entity was physically capable of exercising them. If these powers were misused by exceeding the objects stated in the charter, a writ in the nature of 'Quo Warranto', could be taken, to restrain such action or proceeding, or in the nature of 'Ciare Facias' could be taken to forfeit the charger, but the actions were not null and void. By the English Companies Act of 1844, incorporation became possible by registration under the Act and charters of incorporation became infructuous. The constitution of such companies still followed the existing practice of having a document in the nature of a deed of settlement with no clear exposition of the different objects of the company.
With the passage of time, however, a feeling grew that the unlimited and unrestricted powers of directors ought to be curtailed or should be so construed that investors and creditors were protected. Investors were considered in need of protection against wrongful application of the assets of the company to ventures not in their contemplation and creditors were expected to be protected against wrongful utilization of assets which might result in insolvency of the company, and reaching a position where the creditors could not be paid. A direct result of growth of this feeling was development of a theory that if the directors sought to enter into forbidden or unauthorized transactions they could be restrained by the action of a shareholder, and that a, unauthorized contract could be regarded as ultra vires and unenforceable as against the company. In 1855 in Eastern Counties Railway Co v. Hawkes, [(1855) 5 H L C 331], Lord Cranworth declared, "it must therefore be now considered as a well-settled doctrine that a company incorporated by act of Parliament for special purpose cannot devote any part of its funds to objects unauthorized by the terms of its incorporation, however desirable such an application may appear to be". The companies position was finally settled in 1875 in Ashbury Railway Carriage & Iron Co. v. Riche [(1875) LR 7 HL 653] and further reiterated and clarified in Attorney General v. Great Eastern Railway [(1874-80) All ER Rep Ext 1459]. In London County Council v. Attorney General [(1902) AC 165] Lord Hallsbury L. C. referring to the two above cases said: I think now it cannot be doubted that these two cases do constitute the law upon the subject". 4.4 EFFECT OF ULTRA VIRES TRANSACTIONS As can be easily foreseen, effects of ultra vires transactions are usually grave, influencing the rights of both the company and also the third party to the contract. The flow chart given below shows the various consequences of an ultra vires transaction at a glance.
Effect of ultra vires transaction On Rights of the company & shareholders Injunction Personal Liability of the Directors Repudiation of contract Right to a tracing order Right to retain security once obtained Right to sue directors for breach of warranty of an authority On Rights of the other party
We will now discuss each of these categories in detail. 102

4.4 (A)ON RIGHTS OF THE COMPANY AND SHAREHOLDERS It is the fundamental right of both the company and the shareholders to expect that the funds of the company will be spent only on the objects specified in the memorandum, and that the directors should limit the activities of the company to the objects given in the memorandum. But in cases, where the directors enter into ultra vires transactions, the company and the shareholders can exercise the following rights: 1] Injunction Even a single member of the company can seek an injunction order to restrain the company if he fears that the company has or is about to enter into an ultra vires transaction. Thus for example, in London County Council v. Attorney General [(1902) AC 165], the council had statutory power to work tramways and wanted to run omnibuses in connection with the tramways. The court found that the omnibus business was in no way incidental to the business of working tramways, and, therefore, restrained the company from undertaking it, although it might have materially contributed to the success of the council's tramway business. 2] Personal liability of Directors One of the basic duties of the directors is to see that the corporate capital is used only for the legitimate business of the company. If the funds of the company are diverted for a purpose other than that specified in the memorandum, the directors will be personally liable to replace the funds. This liability of a director does not come to an end on his death, but attaches to his estate in the hands of his legal representatives. Thus in Peoples' Bank of Northern India Ltd v. Hargopal [(1935) 5 Comp. Cas 305], a suit for damages by the Peoples' Bank against the directors of a local branch on the ground of loss caused to the company owning to the wilful breach by the directors of their obligation as directors in granting loans was decreed against the legal representatives of a deceased director. 3] Repudiation of contract So far this discussion has centred around the rights which the company & shareholders have against the responsible directors. But the most fundamental right of the company in such cases, from which the remaining rights flow is the right to 'repudiate the contract'. The general rule is, that, an ultra vires contract is completely null and void and devoid of any legal effect. A very interesting point to note in this regard is that, if the company has executed its part of the ultra vires contract, courts by hook or by crook manage to ensure that the third party is bound by the ultra vires contract. But, where the third party has executed his part of the contract, then alone does the rule of ultra vires transactions being completely void holds good in rem are made available to the third party. For example, in Ahmad Sait v. Bank of Mysore [(1930) 59 M.L.J.R 28], though it was ultra vires for the Bank of Mysore to advance money on mortgage, it did do so. But still the Madras High Court held, that, the Bank had the right to sue on the basis of the mortgage & thus to
enforce the mortgage. The court justified its decision by holding that, 'according to Brice on the Doctrine of ultra vires, property legally and by formal transfer or conveyance transferred to a company in law duly vested in such a company, even though the company was not empowered to acquire such property, and in India, a mortgage was a transfer of interest in immovable property'. This outlook is similar to the device invented by the courts to circumvent the rule of invalidity of a minor's contract only when it suited the minor to evade the rule but not otherwise. Pollock & Mulla in their book on contract have given a good explanation of this rule, by stating: "Section 7 of the Transfer of Property Act, 1882, provided that every person competent to contract an entitled to transferable property was competent to transfer such property. But it was not provided anywhere in the Act that a person not competent to contract was incapable of becoming a transferee of property. This circumstance was pressed into service and it was held that though a sale or mortgage of his property by a minor was void, duly executed transfer by way of sale or mortgage in favour of a minor who had paid the consideration money was not void, and it was enforceable by him or any other person on his behalf. A minor, therefore, in whose favour a deed of sale was executed was competent to sue for possession of the property conveyed thereby [Sangal, p.57]. Thus we find that the Indian courts are inclined to treat the companies on par with minors so far as protection of their interest goes. To give a minor certain one-sided privileges because of his infancy is both reasonable and understandable but to give a company also similar one-sided protection does not stand to reason today when companies because of their resources can utilize and do utilize the services of the best legal brains in the country, and hence are not as defenceless as the minors are. 4.4 (B) RIGHTS OF THE OTHER PARTY We have already discussed in detail the rights which a company or shareholders have in case of ultra vires transactions, we have now to study the rights which the other party to the transaction has against those officers of the company responsible for entering into the contract. These rights briefly are as follows: 1] Right to a tracing order If the other party has advanced an ultra vires loan to a company, then the party does not have a right to recover the money so advanced because an ultra vires loan cannot create any liability on the company. It would be unfair, on the other hand to deprive the lender of the money so advanced. Therefore, the third party has been given the right to follow his money and to recover it in specie from the possession of the company, provided the money can be identified. This right is known as the 'right to a tracing order'. This right was recognized & enforced under the common law, if the money could be identified as such or any asset of the company could be identified as having been 103
purchased out of this money. But, if the money got so mixed up with the company's money that it became incapable of identification then it could not be traced. To rectify this major flaw, equity looked upon such money as being held by the directors in trust for the benefit of the lender. Thus, equity found no difficulty in regarding a 'mixed or composite fund' separate for certain purposes. This approach coupled with and encouraged by the far-reaching remedy of a declaration of charge enabled equity to identify money in a mixed fund. In India, this principle has been applied as early as in 1931, in the case of re Madras Native Permanent Fund Ltd [60 M L J R, 270 (1931)]. The company was started in 1878 under the name of the Madras Native Permanent Fund Ltd., with a capital of rupees two lakhs. The objects of the company as stated in the memorandum of association were to make advances to shareholders upon security of movable or immovable property for enabling them to purchase, build and repair houses and to grant to them simple loans to a limited extent and to do such things as were incidental to the attainment of the above objects. In 1887, a new branch was started and was called the Deposit Branch, to distinguish it from the Loan Branch, the name adopted to designate the company's original activities. The capital of the company was raised and the newly raised shares were allotted to the Deposit Branch. While the Loan Branch was confined to the original objects, the Deposit Branch developed into an ordinary bank and carried on banking business. In the Deposit branch there were deposits and advances, customers depositing money and loans being advanced on pledges of jewels. The customers of the bank included both members and strangers. This went on for about forty years and it was then found that the Company's affairs were not being conducted satisfactorily. The Company having sustained a loss, the depositors were unable to get back their moneys. A liquidation petition was filed and a compulsory order was made in May, 1927. Some of the depositors in the bank were the applicants in this misfeasance summons. Dismissing the application, Venkasubba Rao, J., made the following observations: "The short question I have to decide is, are the amounts due to them debts? In otherwords, are the lenders in the eye of the law, creditors and is the borrowing company, debtor? This point is now well settled by authority. Where the carrying on of a business by the company was ultra vires, it was held that the ultra vires transaction created no debt, either legal or equitable. This was held in re Birkbeck Permanent Benefit Building Society [(1912) 2 Ch 183]. The facts of that case resemble those of the present. A building society carried on banking business altogether beyond what was authorized. Cozens-Hardy M.R. observes that the so-called contracts of loan, though not illegal, are void and in truth have no existence. This is treated as the doctrine as to ultra vires borrowing. The case went up to the House of Lords and this view was affirmed, although on another point the decision of the Court of Appeal was varied [Sinclair v. Brougham (1914) A.C. 399]. The 104
relation between the depositor and the company is not that of debtor and creditor and the only possible remedy for the person who has paid the money is one in rem and not in personam. This is a most unequivocal declaration, that ultra vires transactions do not create the relationship of debtor and creditor. The preliminary objection, therefore, must be upheld and on this short ground the application is dismissed". The learned judge went on to say: from this it does not follow that the lenders can, in no circumstances, recover their deposits. The very case I have cited, Sinclaire v. Brougham, decides what their rights are and how and to what extent they can be enforced". The depositors to whom moneys were due from the Deposit Branch, had already under orders of the Court been paid sums amounting to over a lakh. The learned Judge further indicated certain sums of money which he directed the liquidators to distribute among the depositors of the Deposit Branch. In this manner, the depositors were repaid only about 75 per cent of their deposits. They suffered losses of about 25 per cent of their deposits for, practically speaking, no fault of theirs but due to the technical rule of ultra vires [Sangal, pp.19-20]. 2] Right to retain security once obtained This right of an ultra vires lender was recognized in Deonarayan Parasad Bhadani v. Bank of Baroda, Ltd [(1957) 27 Comp Cas 223]. The plaintiffs sought a declaration that a prior first English mortgage on its properties & assets created by Deft. no. 2 (the mill), in favour of the deft. no. 1 bank, to secure repayment of a sum of Rs.25,00,000 advanced to the mills by the bank was ultra vires and of no effect. They also sought the consequential relief that the bank might be ordered to deliver up the mortgage to be canceled and for a permanent injunction restraining the bank from taking any action under the mortgage or any steps to enforce and realize the mortgage. After going through a series of arguments, Desai, J., held .... I have reached the comforting conclusion that even if I were to take the view that the whole transaction of mortgage in favour of deft. no. 1 bank was ultra vires and a nullity, I would yet hold that there is an equity arising in favour of the bank which entitles it to retain possession of the property given to it in the purported performance of the contract between the parties and to claim restitution before it can be compelled to part with the possession of that property. Therefore, in that view of the matter also the plaintiffs are not entitled to the relief they seek in this suit". 3] Right to sue the directors The directors of the company are its agents, and as such they are duty bound to keep within the limits of the company's powers. If they, induce, however innocently, an outsider to contract with the company in a matter in which the company does not have the power to act, they will be personally liable to such a person, for the loss caused to him. For example, in Weeks v. Propert [(1873) LR 8 CP 427], a railway company invited proposals for a loan on debentures. At the time the
advertisement was published, the company had already issued debentures to the extent of 60,000 being the full amount which it was authorized by its constitution to issue. It had, thus exhausted its borrowing powers. The plaintiff offered a loan of 500 based on the advertisement. The directors accepted it and issued to him a debenture of the company. The loan being ultra vires was held to be void. In an action by the plaintiff against the directors, it was held that the directors by inserting the advertisement had warranted that they had the power to borrow which they did not in fact possess. Their warranty consequently was breached, and hence they were personally liable. It must be remembered, that, the representation held out by the directors must be of fact & not of law. Thus, whether a company is authorized by its memorandum to borrow at all is a question of law which every person dealing with the company is presumed to know, but, whether the company had already borrowed the entire amount authorized by the memorandum, is a question of fact, which an outsider cannot under normal circumstances be presumed to know. A representation of the former kind will not render the director personally liable, but a representation of the latter will render him so. 4] Ultra vires torts The rule of constructive notice of memorandum and articles explains why a company is not liable for an ultra vires contract, but that does not solve the problem of injustice involved. Moreover, the rule altogether fails to hold ground when a company is sought to be made liable for a tort committed by a servant of the company while acting beyond the company's powers. Any one dealing with a company may, at the pain of losing the bargain, be required to acquaint himself with the company's memorandum. But that can hardly be expected of a person who has been the victim of an ultra vires tort. For example, a company is operating omnibuses - a venture entirely alien to its objects as described in the memorandum. The driver of one such bus negligently injures the plaintiff who sues the company for the tort. It can, no doubt, be contended against him that the driver was not a servant of the company. The company, having no existence outside its corporate sphere, could not have appointed him. But can it be said that the plaintiff ought to have know this fact. Doubtless the plaintiff deserves to be compensated. But the law has not yet clearly declared the justice of his demand. As the law seems to stand at present, to make a company liable for any tort it must be shown that(1) that the activity in the course of which it has been committed falls within the scope of the memorandum, and (2) that the servant committed the tort within the course of his employment [Avtar Singh, p. 55]. 4.5 THE ORGAN THEORY It is a central feature of incorporation, that the company acquires a new and separate legal identity capable of enjoying rights, exercising powers, and incurring duties and obligations. It is traditional to describe any subject possessing rights and duties
as a 'person' But it is one thing to attribute legal capacities and characteristics to a company, and quite another to treat it as having human characteristics and qualities. It is unnecessary and unreasonable to suppose that the latter step follows directly from the former - yet the courts have now taken this analogy with a physical person to its utmost limits; ascribing to a company human attributes such as 'reputation' 'character'; or an 'intention to defraud' etc. This kind of attribution has been made in order to make it difficult for the companies to escape liability for acts undertaken on their behalf - because there are some types of liability which demand actual fault of the principal/master i.e., the company itself. For the purpose of attributing such liability the English judiciary started distinguishing between "organs" and "agents" of the company and attributed the acts of the former to the company. For example, in Bolto (Engineering) Co Ltd v. Graham & Sons [(1957) 1 QB 159, CA], the question which arose was, whether the landlord company had effectively terminated a business tenancy, because it had the intention to occupy the premises for its own business. There was no formal general or board meeting to decide on such intention but the executive directors of the company had clearly manifested such an intention and such manifestation was held to be sufficient intention of the company's mind. Lord Denning, L.J., observed: "A company may in many ways be likened to a human body. It has a brain and nerve centre which controls what it does. It also has hands which holds tools and act an accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands and cannot be said to represent the mind and will. Others are directors and managers who represent the directing mind and will of the company and control what it does. The state of mind of these managers is the state of mind of the company and is treated by the law as such". However, it is in the sphere of criminal law that the organic theory made a major impact. Except where the crime is one in which the 'actus reus' (or the act) is such that an artificial person is either physically incapable to commit it, or, the punishment for the act is such that it cannot be imposed on an artificial person (say imprisonment), or where it is a statutory offence is and corporate liability is clearly excluded by the statute itself, the corporation is made liable for the acts of its 'organs'. Though extremely useful, this theory has thankfully not been carried over to absurd extremes. For example, if persons who constitute the head and brains are imbibed in defrauding the company, they cannot successfully defend either a civil action or a criminal prosecution by the company by saying, "we were the controlling organs of the company and accordingly the company knew all about it and consented" [Belmont Finance Corp v. Williams Furniture Ltd (1979) Ch 250 CA; R V Phillipon (1989) 89 Cr App R 290, CA]. To allow such a defence, would mean that the duties which the organs owe to the company, would be wholly negated. 4.6 PRESENT STATUS OF THE PRINCIPLE The ultra vires doctrine confines corporate action within fixed limits. While it handicaps the ambitious manager, it lays a trap 105
for the unwary creditor. That is why there has been a revolt against it almost ever since its inception. The businessman has always endeavoured to evade the limitations imposed by the doctrine. One of the methods of by-passing ultra vires is the practice of registering memoranda containing a profusion of objects and powers. For example, in Cotman v. Brougham [(1918) AC 514], the House of Lords had to consider a memorandum which contained an objects clause with thirty sub-clauses enabling the company to carry on almost every conceivable kind of business which a company could adopt. Such an object clause naturally defeats the very purpose for which it is there. In a bid to control this tendency the courts adopted the "main objects rule" of construction. The rule owes its origin to the decision in the Ashbury case where it was held that the words "general contractors" must be read in connection with the company's main business. German Date Coffee Co. In re Failure of Substratum, [(1973) 47 Aust LJ 718] is another illustration of its application. The memorandum of a company stated that it was formed for working a German patent which would be granted for manufacturing coffee from dates ; for obtaining other patents for improvements and extension of the said invention; and to acquire and purchase any other invention for similar purposes. The intended German patent was never granted, but the company purchased a Swedish patent, and also established works in Hamburg where they made and sold coffee from dates without any patent. A petition having been presented by two shareholders, it was held that the main object for which the company was formed had become impossible and, therefore, it was just and equitable that the company should be wound up. Lindley, L. J. said: In construing a memorandum in which there are general words...they must be taken in connection with what are shown by the context to be the dominant or main objects. It will not do under general words to turn a company for manufacturing one thing into a company for importing something else. Taking that as the governing principle, it seems to be plain that the real objects of this company which is called German Date Coffee Co., was to manufacture a substitute for coffee in Germany under a patent. It is what the company was formed for and all the rest is subordinate to that". This principle will, however, be of no help where a company is formed for general purposes as opposed to a defined subjectmatter. Pointing this out in re Kitson & Co. Ltd [(1946) 1 All ER 435 CCA)], Lord Greene MR said: The impossibility of applying such a construction seems to be manifest when one remembers that business is a thing which changes. It grows or it contracts. It changes; it disposes of the whole of its plant; it moves its factory; it entirely changes its range of products, and so forth. It is more like an organic thing. It must be remembered that in these substratum cases there is every difference between company which on the true construction of its memorandum is formed for the paramount purpose of dealing with some specific subject-matter and a company which is formed with wider and more comprehensive objects. With regard to a company which 106
is formed to acquire and exploit a mine, when, you come to construe its memorandum of association you must construe the language used in reference to the subject-matter, namely, a mine and, accordingly, if the mine cannot be acquired or if the mine turns out to be no mine at all the object of the company is frustrated, because the subject-matter which the company was formed to exploit has ceased to exist...... But when you come to the subject-matter of a totally different kind like the carrying on of a type of business, then, so long as the company can carry on that type of business, it seems that prima facie at any rate it is impossible to say that its substratum has gone. The facts of the case were: The company was incorporated with the object of (a) acquiring an existing engineering concern and (b) carrying on the business of general engineering. Subsequently the company proposed to sell the original business and to embark upon other general engineering activities. Some of the shareholders petitioned for winding up on the ground that the company's substratum had disappeared. The court rejected the petition. In Cotman v. Brougham the main object rule was excluded by a declaration in the objects clause that every clause should be construed as a substantive clause and not limited or restricted by reference to any other sub-clause or by the name of the company and none of them should be deemed as merely subsidiary or auxiliary. The House of Lords expressed strong disapproval of the inclusion of such a clause, but their Lordship held that it excluded the "main objects rule" of interpretation. Thus the rule has failed to prevent the evasion of ultra vires. And now the decision of the court of Appeal in Bell Houses Ltd v. City Wall Properties [(1966) 2 All ER 674] has stamped its approval upon another technique of evasion. In this case a company's objects clause authorized it to carry on any other trade or business which in the opinion of the board of directors could be carried on advantageously in connection with the company's general business. The court held the clause to be valid and an act done in bonafide exercise of it to be intra vires. But a clause of this kind does not state any objects at all. Rather, it leaves the objects to be determined by the directors' bona fides [Avtar Singh, pp.49 - 51]. 4.7 CONCLUSION It may be safely observed that, the doctrine of ultra vires, once very useful to shareholders and creditors of the company, has now practically become devoid of any value, though it may still to some extent retains its potentiality for vice, name, that it can allow persons to avoid with impunity an obligation which ought to be fulfilled in good conscience and can thus be a trap for the other innocent party. Though the entrapped party is not left without a remedy, the remedies themselves are of limited efficacy. All these factors underline the need for a major legislative action in this area, aiming at both - simplification of law and ensuring justice to the third party. A company's liability to third parties no longer depends solely on principles of agency or 'respondeat superior'. Though the word 'organ' is not used, the Act recognizes that the board of
directors is not a mere agent of the company but an organic part of it so that third parties can treat the acts of the board as acts of the company itself. In case of tortious or criminal liability, the courts have held that when 'managerial powers' have been delegated by the board to other officers, those officers also may be treated as organs, rather than agents or servants of the company so that their acts can be regarded as those of the company itself and not merely as acts of the officers for which it is liable only vicariously. This state of affaris has resulted in further eroding of the doctrine of ultra vires. The 'English Company Law Revision Committee' (known as the Cohen committee, 1945) recommended the abolition of this doctrine, but this recommendation has not been implemented in theory atleast, though in practice the doctorine at present is of little utility value. In India, the 'Bhabha Committee' in 1952, looked at the matter from the view point of the management of the companies continuing to indulge in activities only very remotely connected with their principal business, and remarked: For present, we do not think that the evil is either so serious or widespread as to call for immediate action. Strangely enough, it did not look at the matter from the view point of innocent third persons who are put to hardship and inconvenience for no fault of theirs, but solely due to the doctrine of ultra vires, which itself owes its origin to judicial creativity. To overcome this injustice, it would be better if this doctrine was abolished, and, registered companies, in their dealings with outsiders, should have the same legal capacity to act as a natural person, and so, as between the outsiders and the company, the company should take full responsibility for its acts. Further, the
memorandum should lay down its objects clearly (instead of phrasing it in broad terms capable of more than one interpretation) form which the company's powers can be easily inferred, and as between the company and its managerial personnel, if the latter take the company beyond those powers, they should be obliged to refund to the company, as they presently do in cases of ultra vires expenditure [P S Sanghal, p.98]. This course of action is possible because the principle of ultra vires is not based on some dogmatic concept of limited liability company. The 'object clause' indicates the permissible range of corporate activities, every thing else beyond that is implicitly prohibited so that the corporate capital may be preserved for the protection of both shareholders and creditors. But that protection does not in any way suffer if the memorandum like the articles, is deemed to be a contract between the shareholders and the company. Every contract made on behalf of the company whether within or beyond its powers should be valid. But if it involves a misapplication of corporate capital the directors should be, and already are bound to replace it. A step in the right direction, is the application of the European Community Law in England, Sec. 9(1) of which provides that," in favour of a person dealing with a company in good faith, any transaction decided on by the directors shall be deemed to be one which it is within the capacity of the company". Thus as against a third person acting in good faith, the company can no longer plead that the act was ultra vires. It is to be presumed that an application of this principleby the municipal courts will sound the death knell of this doctrine of ultra vires.
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5 CONSTRUCTIVE NOTICE & INDOOR MANAGEMENT

SUB TOPICS 5.1 Introduction 5.2 Constructive Notice 5.3 Doctrine of Indoor Management 5.4 Exceptions to the doctrine 5.5 Conclusion 5.1 INTRODUCTION In the last chapter we have seen how an act is devoid of all effects if it is ultra vires the company, i.e., an act which goes beyond the objectives stated in the object clause of the memorandum is null & void. Sec 13 of the Indian Companies Act, based on the recommendations of the Vivian Bose Committee (1962), states that, in case of a company registered after the 1965 amendment, the objects clause must be divided into three sub-clauses, viz., (i) Main objects - This sub-clause has to state the main objects to be pursued by the company on its incorporation and objects incidental or ancillary to the attainment of the main object. (ii) Other objects - This sub-clasue must state other objects which are not included in the above clause. (iii) States to which objects extend - In the case of non-trading companies, whose objects are not confined to one state, this sub-clause has to mention the states to whose territories the objects extend. Now according to the principle of ultra vires if a particular act of the company does not come under one of these clauses, it is ultra vires the company and so null & void. Now, this raises certain interesting questions - suppose, the third party claims that it had not gone through the memorandum and hence was not aware of its provisions; or that, they knew that the director was authorized to do a particular act provided he followed the given procedure and because he agreed to do the act they presumed that he had followed the prerequisite procedure, etc. To combat with these situations in a manner which would prove to be just & equitable to all concerned, the judiciary came up with two more doctrines: 'constructive notice' and 'indoor management'. We would now deal with each of these in detail. 5.2 CONSTRUCTIVE NOTICE The Memorandum and Articles of Association of every company are registered with the Registrar of Companies. The Registrar's office is a 'public office' and consequently the memorandum and articles become 'public documents', easily accessible to public and open for inspection on payment of a small fees. Every person who deals with the company in any manner , has a duty imposed on him to inspect these documents and to make sure that his contract is in conformity with their provisions. Whether the person has actually read these 108
documents or not he is presumed to have done so and to be aware of the contents of these documents. This kind of presumed notice is called 'constructive notice'. In Mahony v. East Holyford Mining Co. [(1874-80) All ER Rep.427], Lord Hatherly said : Every joint stock company has its memorandum and articles of association.....open to all who are minded to have any dealings whatsoever with the company, and those who so deal with them must be affected with notice of all that is contained in those two documents." Kotta Venkatswamy v. Rammurthy [AIR 1934, Mad. 579], shows the practical effects of this rule. Here, the articles of association of a company required that all deeds etc. should be signed by the Managing Director, Secretary and a working Director on behalf of the company. The plaintiff accepted a mortgage deed executed by the Secretary and working Director only. It was held that, the plaintiff could not claim under this deed. The Court observed, "If the plaintiff had consulted the articles she would have discovered that a deed such as she took required execution by three specified officers of the company and she would have refrained from accepting a deed inadequately signed. Notwithstanding, therefore, she may have acted in good faith and her money may have been applied to the purposes of the company, the bond is nevertheless invalid." Moreover, a person dealing with the company is taken not only to have read those documents but to have understood them according to their proper meaning [Palmer, p.242]. He is presumed to have understood not merely the company's powers but also those of its officers. Further there is constructive notice not merely of the memorandum and articles, but also of all other documents, such as special resolutions, particulars of charges etc., which are required by the Act to be registered with the Registrar. But there is no notice of documents which are filed only for the sake of record, such as returns and accounts. According to Palmer, the principle applies only to documents which affect the powers of the company. One of the suggested approaches is that all documents which are open to public inspection should be regarded as public documents [R. Baxt, (1973) 36 Mod LR, pp. 43-44]. This is in keeping with the disclosure philosophy of company law and things which are required to be disclosed in public office should have public effects. Effect of Constructive notice According to Palmer the various effects of the doctrine of constructive notice are as follows: Acts ultra vires the company The powers of a company are, as has already been pointed out limited to those derived expressly or impliedly from its memorandum of association. By the operation of the doctrine of constructive notice every person dealing with the company is treated as having actual or constructive knowledge of the contents of the memorandum. Consequently, if an act is ultra vires the company, the other party cannot claim relief on the
ground that he was unaware of this : the doctrine of constructive notice invariably operates against him. The only way to avoid this consequence is to examine the public documents beforehand to ensure that the company has power to enter into the proposed transaction - a counsel of perfection which cannot reasonably be practiced in the conduct of normal business transactions.[ But the risks assumed by a person who does not take this precaution are relatively small, due to the wide terms in which companies' objects are commonly drafted. Acts outside the authority of the directors A company, being an artificial person, can only act through agents. A person dealing with the company should therefore, in addition to examining the powers of the company, ensure that the necessary powers have been given by the company to its agent. The agents will normally be the directors or executive employees of the company, and their powers are conferred either directly by the company's articles of association or by an authority under the articles. An example of the former is found in the normal provision of the articles whereby the directors are empowered to borrow money upon the security of the company's assets, subject, perhaps to certain limits. An example of the latter occurs in the usual articles empowering the directors to appoint a managing director and delegate certain powers to him. Where an act is intra vires the company but outside the authority of the director (or other agents) two possibilities exist. The lack of authority may be evident from the public documents of the company, in which case the doctrine of notice, actual or constructive, applies without mitigation, subject to what is said below on ratification. The person dealing with the directors is fixed with notice of the directors' powers and of any limitations and restrictions thereon imposed by the articles or other regulations, and cannot hold the company bound by the directors' act. This would be the case if, for example, the directors gave security on a loan in excess of their specified borrowing powers, or a single director signed a bill of exchange which, by the articles, required the signature of two directors. So, too, if the articles provide that the seal of the company is to be affixed in the presence of two directors, who are to sign their names, a person dealing with the company must see that this is done. On the other hand there may be cases in which the lack of authority of the directors is not evident from the public documents, e.g., where the articles require the directors to obtain the consent of the members by ordinary resolution before exercising their specified borrowing powers or where the powers of the board of directors may be delegated by a resolution of the board to a managing director or a committee. In these cases a person dealing with the company cannot gather from the public documents that a director has exceeded his authority. If such a person honestly and without reason for suspicion thinks that the director with whom he negotiates is authorized to act for the company, the company will normally be bound by the director's act under the rule in Royal British Bank v. Turquand, which is considered in detail later.
Ratification While 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. For example, if directors have without a quorum purported to act in a manner which is authorized for the directors, a proper meeting of the directors can ratify the act. Likewise, if directors purport to act in a manner for which authority has not been delegated to them (i.e., where the power is retained by the company in general meeting) the company in general meeting can ratify it. This does not amount to an alteration of the articles, but an exercise by the general meeting of its powers, so that an ordinary resolution suffices. Inconsistent agreements No agreement can be made by a company with a third party which purports to override any rights created by the articles. Thus, in a case dealing with the rights of a managing director, Harman. J. said : So, everybody who becomes a managing director of this company which has adopted Table A' knows that he has certain rights, and that the board cannot alter them." [Palmer, PP 243245] Concluding remarks Constructive notice is more or less an unreal doctrine, a fiction created through judicial imagination. It is a theory which fails to take into consideration the practical realities of today's world. Firstly, people know a company through its officers and not its documents; and secondly, the businessmen of today rarely have the time to go through these documents to make themselves aware of their contents and to understand them. While entering into a contract, they rely on their contacts and instincts and not on these documents. In such circumstances it seems unfair to saddle them with the knowledge of documents, the existence of which they are barely aware of. Sec. 9 of the European Communities Act, 1972 has abrogated this doctrine. The courts in India also do not seem to have taken it seriously. For example, in Dehra Dun Mussoorie Electric Tramway Co v. Jagmandardas [AIR 1932 All 141], the articles of the company expressly provided that the directors could delegate all of their powers except the power to borrow. Even so, an overdraft taken by the managing agents without approval of the Board was held to be binding on the company, the court saying that such temporary loans must be kept outside the purview of the relevant provision. 5.3 DOCTRINE OF INDOOR MANAGEMENT Rule of constructive notice is applied by the courts, in order to protect the company against the outsider, so that an outsider may not reap benefit from his act of negligence (in not going through the company's documents). Though, the rule was justified, it did result in undue hardship to those outsiders who were aware of the contents of the documents but had no means 109
of knowing whether certain technicalities/procedures (for ex: sanction by the board of directors or general body of shareholders, etc) mentioned in the documents had been followed or not. To rectify this position, a new rule known as 'doctrine of indoor management' was evolved in the case of Royal British Bank v. Turquand [(1856) 119 ER 886]. The brief facts of this case are as follows. The directors of a 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 the company'. The shareholders claimed that there had been no such resolution passed by them authorizing the loan, and therefore, it was taken without their authority. The company was, however, held bound by the loan. Once it was found that the directors could borrow subject to a resolution, the plaintiff had the right to infer that the necessary resolution must have been passed. Lord Campbell, C J, delivering the judgment observed: "If no illegality is shown as against the party with whom the directors contract under the seal of the company, excess of authority is a matter only between the directors and the shareholders at all events, we think that the bond cannot be rendered illegal and void from any irregularity in the proceedings of the company, nor even by an excess of authority, the plaintiff's having acted with good faith, and the shareholders not being prejudiced . The plaintiffs have bonafide advanced their money for the use of the company, giving credit to the representations of the directors that they had authority to execute the bond; and the money which they advanced and which they now seek to recover, must be taken to have been applied in the business of the company and for the benefit of the shareholders. If the plaintiffs must be presumed to have had notice of the contents of the registered deed of settlement, there is nothing to show that the directors might not have had authority to execute the bond as they asserted". On an appeal to the court of Exchequer Chamber, the judgement in favour of Turquand was affirmed, Jerris, C. J., observing: "We may now take for granted that the dealings with these companies are not like dealings with other partnerships, and that the parties dealing with them are bound to read the statute and deed of settlement. But they are not bound to do more. And the party here, on reading the deed of settlement, would find, not a prohibition from borrowing, but a permission to do so on certain conditions. Finding that the authority might be made complete by a resolution, he would have a right to infer the fact of resolution authorizing that which on the face of the document appeared to be legitimately done". The rule laid down in this case was elaborated and applied by the House of Lords in Mahony v. East Holyford Mining Co [(1875) L R 7 H L 869], where Lord Hatherly gave it the name of doctrine of indoor management and stated it in the following words: 110
"....the company entering upon its business and dealing with persons external to it, is supposed on its part to have all those powers and authorities which, by its articles of association and by its deed, it appears to possess; and all that the directors do with reference to what I may call the indoor management of their own concern, is a thing known to them and known to them only; subject to this observation, that no person dealing with them has a right to suppose that anything has been or can be done that is not permitted by the articles of association or by the deed ... But, after that, when there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles of association, then those so dealing with them, externally, are not to be affected by any irregularities which may take place in the internal management of the company" The rule may be summarized in the words of S.C. Sen ( Sen, p.116] as follows"While persons dealing with a company are assumed to have read the public documents (viz., memorandum and articles of association) of a company and to have ascertained that the proposed transaction is not inconsistent therewith, they are not required to do more; they need not enquire into the regularity of internal proceedings (indoor management) and may assume that all this being done regularly". This rule has been widely applied by the Indian Courts. For example, in Sri Kishan Rathi v. Mondal Bros & Co Ltd [AIR 1967 Cal 75], the plaintiff - petitioner claimed a loan of Rs.1,000/ - which had been granted by him to the defendant company on a bill of exchange, being a Hundi, for Rs.1,000/-, made by N.C. Mondal, the then manager and director of the limited company. It was the plaintiff's contention that the Hundi was dishonoured. Articles of association of the defendant company gave the borrowing powers to the Manager and Director provided a resolution had been passed at the meeting of the board as required by Sec. 292 of the Companies Act, 1956, delegating authority to the manager and director which was not done in this case. Holding the company bound to pay the loan, Mukharji J., observed: From a review and analysis of all these relevant articles it is indisputable in the facts of the present case that the director and manager had prima facie authority to draw the Hundi on behalf of the company. The lender who lends money to the company in these circumstances on a promissory note or bill of exchange executed by the manager and director after having found on inquiry from the memorandum and the articles the existence of such power to borrow, need not and cannot, and is not obliged, in my view, to look further in the internal management of the company and embark on an investigation whether a particular manager and director who is given such powers under the memorandum and articles have nevertheless lost it or qualified or limited it by an internal resolution contained in the internal minutes book or resolution of the company's directors and if so what are the terms of such qualification or limitation? This is exactly what is meant by internal management".
This rule of 'indoor management' is based upon obvious reasons of convenience and practicality in business relations. Firstly, the memorandum and articles of association are public documents, open to public inspection. But the details of internal procedure are not thus open to public inspection. Hence 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". The wheels of commerce would not go round smoothly if persons dealing with companies were compelled to investigate thoroughly the internal machinery of a company to see if something is not wrong". People in business would be very shy in dealing with such companies. Secondly, in the words of Prof. Gower, "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 the officials to act on its behalf" [Gower, p.153], The rule is of great practical utility and has been applied to a variety of cases, involving irregularities in internal management. Thus, for example, the rule has been applied, to cover acts done on behalf of a company by defacto directors who have never been appointed [Mahony v. East Holyford Mining Co (1875) 33 TLR 338]; or who having been regularly appointed, have exercised an authority which could have been delegated to them under the company's articles, but was never delegated [Kishan Rathi v. Mondal Bros (1961) 1 Comp LJ 19 (Cal)]; or who have exercised an authority without proper quorum [County of Gloucester Bank v. Rudry Merthyr Steam & House Coal Colliery Co (1895) 1 Ch 629] etc. The Thurquands rule' is an illustration of judicial protest to and erosion of the ultra vires doctrine. It is a rule based on justice, equity and good conscience, and also on the general presumption of law and practical presumption of regularity. But, this doctrine in many of the earlier decisions had the misfortune to be clothed with the title of ultra vires', so that it started being treated as a species of ultra vires transactions'. The net result being, that no sooner had the doctrine been born that pulls and counter-pulls started in different directions leading to subsequent confusion. The pulls were in entirely opposite directions. Those obsessed with the idea of protection of shareholders property were in favour of enforcement of an extension of the ultra vires doctrine and therefore started to whittle down the efficacy of the rule. In other decisions, the beneficial effects of the doctrine were maintained and outsiders dealing with the company protected by not requiring them to see that the 'indoor management' rules were duly complied with. The result of this struggle was that the basic object of this rule was lost sight of by the judges. According to Gower during the last 30 years the tendency has been to" whittle it away notwithstanding the vigorous opposition by judges more familiar with commercial practice" [ Sen, p.125]. 5.4 EXCEPTIONS TO THE DOCTRINE It is nearly a 140 years since the doctrine of indoor management was laid down in the Turquand's case, and since then, a sharp division amongst the judiciary regarding the relative merits of the doctrines of 'ultra vires' and 'indoor management', has
resulted over the years in laying down of several exceptions to this rule of indoor management. These exceptions are as follows: 1] Knowledge of irregularity This is the most basic of all exceptions, that a party who deals with the company and who has knowledge of an irregularity in its internal management in connection with the subject-matter of his dealing cannot claim the benefit of the Turquand's rule. Such knowledge may arise from the fact that the person contracting was himself a party to the internal procedure. Thus, in Howard v. Patent Ivory Manufacturing Co [(1888) 38 Ch D 156], the directors could not defend the issue of debentures to themselves because they should have known that the extent to which they were lending money to the company required the assent of the general meeting which they had not obtained. But, in Hely-Hutchinson v. Brayhead Ltd [(1967) 2 All ER 14] it was held that, the mere fact that a person is a director does not mean that he shall be deemed to have knowledge of the irregularities practised by the other directors. Here, a newly appointed director entered into contract of indemnity and guarantee with the company through a director whom the company had knowingly allowed to hold himself out as having the authority to enter into such transactions, although in fact he had no such authority. The new director had no knowledge of the irregularity. The company was held liable. But the general principle remains that a person who is himself a part of the internal machinery cannot take advantage of irregularities within the company. Any other rule would encourage ignorance and condone dereliction from duty" [Per Lord Simonds in Morris v. Kanssen [1946] AC 459]. 2] Suspicion of irregularity Protection of this rule is also not available, where though the third party has no actual knowledge of any irregularity, the circumstances surrounding the case are such that, they arouse 'suspicion of some irregularity' in the minds of the person. Thus, in Anand Bihari Lal v. Dinshaw & Co [AIR 1942 Oudh 417], the plaintiff accepted a transfer of the defendant company's property, from the company accountant who had no authority to transfer. Holding the transfer void, the court observed, we are not here considering the claim of a transferee who was a stranger to the Bank, but one who had probably been familiar with its character from its very inception, and who knew at least something about its constitution and was acquainted with the fact that its MD had died only 16 days prior to the transfer .... The plaintiff could not have supposed, in the absence of a power of attorney, that the accountant had the authority to effect the transfer of the company's property". 3] Forgery The rule in the Turquand's case does not apply if a document is forged so as to purport to be the company's document. In Ruben v. Great Fingall Consolidated [(1906) AC 439] a share certificate was forged by a secretary who then purported to issue it on behalf of the company, in return for money advanced. 111
The certificate was under the seal of the company with signature of two directors. The company refused to register shares. The plaintiff contended that whether the signatures were genuine or forged was a part of the internal management and, therefore, the company should be estopped from denying genuineness of document. But it was held that the rule has never been extended to cover such a complete forgery. Lord Loreburn observed, "It is quite true that persons dealing with limited liability companies are not bound to inquire into their indoor management and will not be affected by irregularities of which they have no notice. But this doctrine, which is well established, applies to irregularities which otherwise might affect a genuine transaction. It cannot apply to a forgery". An important point to note in this regard is that, the bar against relief being granted against forged instruments applies only when the company refuses to be bound by the instrument. In the words of Andrew R. Thompson [(195556) 11 Toronto Law Journal, p.238], A company may represent that a forged instrument is genuine. In such case, it will be estopped from denying that a forged instrument is genuine as against an outsider who has relied to his detriment upon the representation. Also, a company may represent that the forger has authority to execute the forged instrument. In that event it will be bound by the forged instrument against an outsider who has relied on the apparent authority to execute the instrument". Thus, in Official Liquidator v. Commr. of Police [(1969) 1 Comp LJ 5 (Mad)], a document on which a company borrowed a sum of money was executed by the managing director who was the chief functionary of the company, and, in order to comply with the other requirements of the articles, the signatures of two other directors were forged. The company was not allowed to eschew liability on the document. The court observed, "we hold the company liable as a matter of social and economic policy. The basis of liability is the eminently practical view that if authority is conditioned on facts peculiarly within the agent's knowledge his representation express or implied should bind the principal". 4] Representation through Articles This exception deals with the most controversial and highly confusing aspect of the Turquand's rule. In general, the articles of a company have what is known as the 'delegation clause'. Lakshmi Rattan Lal Cotton Mills v. J K Jute Mills Co [AIR 1957 All 311], explains the meaning and effect of a delegation clause". In this case, one G was a director of a company. The company had managing agents of which also G was a director. Articles authorized directors to borrow money and also empowered them to delegate this power to any or some of them. The company refused to be bound by the loan on the ground that there was no resolution of the board delegating the borrowing power to G. Yet the company was held bound by the loan, the court observing that "even if there was no actual resolution authorizing G to enter into the transaction, the plaintiff could assume that a power which could have been delegated under the articles must have been actually conferred. the actual delegation being a matter of internal management, the plaintiff was not bound to enter into that". 112
Thus, the effect of a delegation clause is that, a person who contracts with an individual director of a company, knowing that the board has power to delegate its authority to such an individual, may assume that the power of delegation has been exercised" [Houghton & Co v. Nothard, Lower & Wills Ltd (1927) 1 KB 246]. Now suppose, that the plaintiff had not consulted the company's articles, before contracting with an individual director and therefore, had no knowledge of the existence of such a power of delegation. Could he in such a situation, assume that the power, the existence of which he did not know at the time had been exercised; and, would the company still be estopped from denying the director's authority in the face of the plaintiff's ignorance of the articles? This question has been time & again debated in the courts with varying results. Thus, in Rama Corporation v. Proved Tin & General Investiment Co [(1952) 1 All ER 554], one T was the active director of the defendant company. He, purporting to act on behalf of his company under which he took a cheque from the plaintiffs. The company's articles contained a clause providing that the directors may delegate any of their powers, other than the power to borrow and make calls, to committees, consisting of such members of their body as they think fit. The board had not in fact delegated any of their powers to T and the plaintiffs had not inspected the defendant's articles and, therefore, did not know of the existence of the power to delegate. It was held that, the defendant company was not bound by the agreement. Slade, J., observed, A person who at the time of entering into a contract with a company has no knowledge of the company's articles of association, cannot rely on those articles as conferring ostensible or apparent authority on the agent of the company with whom he dealt . Justifying his position, he further said, the rule of indoor management' is based upon the principle of estoppel. Articles of association contain a representation that a particular officer can be invested with certain of the powers of the company. An outsider, with knowledge of the articles, finds that an officer is openly exercising an authority of that kind. He therefore, contract with the officer. The company is estopped from alleging that the officer was not infact so authorized. This judgement was subjected to a lot of criticism mostly on two points: (1) everybody is deemed to have a constructive notice of the articles. Brushing this aside, slade J., said, doctrine of constructive notice is a negative one. It operates against the outsider who has not inquired. It cannot be used against the interests of the company; (2) the major criticism is that, even if the plaintiffs had read the articles, all that they would see would be that the directors had the power to delegate their authority, not whether such a delegation had actually been made or not. Moreover, the company may make a representation even apart from its articles, for example, by holding out an officer as possessing certain authority - in which case the company would automatically be estopped from denying the officer's authority. Thus, articles will be relevant only if they had
contained a restriction on the apparent authority of the officer concerned. A better rule of law in this regard appears to be the one stated by Atkin L J, in Kreditbank Cassel v. Schenkers Ltd [(1926) 1 KB 826], "If you are dealing with a director in a matter in which normally a director would have power to act for the company, you are not obliged to inquire whether or not the formalities required by the articles have been compiled with, before he exercises that power". So the deciding test on this point now seems to be - was the concerned act within the ostensible or apparent authority of the officer of not? If it was, then the company is bound by the act irrespective of whether the third part is aware of the contents of the articles or not. 5] Acts outside apparent authority Lastly, if the act of an officer is one which would ordinarily be beyond the powers of such an officer, the plaintiff cannot claim the protection of the Turquand's rule, simply because under the articles, the power to do the act could have been delegated to him. In such a case, the plaintiff cannot sue the company unless the power had, in fact, been delegated to the person or officer with whom he dealt. Thus, in Kreditbank Cassel v. Schenkers Ltd [(1926) 1 KB 826 (CA)], the defendant company, by its memorandum, had power to draw and accept bills of exchange, and, under its articles, the directors were empowered to determine 'who shall be entitled to sign, draw, accept, etc, bills on company's behalf'. The defendant's business was that of forwarding agents. They had a branch at Manchester under a branch manager who, without having received any authority from the company, and in fraud, drew seven bills purporting to do so on company's behalf. The company was sued on these bills as drawers. It was held that, having regard to his position, drawing of bills was not within the ostensible authority or was otherwise precluded from setting up the want of authority. 5.5 CONCLUSION As is evident from Slade, J., observations in Rama Corporation case, the general opinion of the judiciary in England seems to be, that, the rule in Turquand's case is based on the 'principle of estoppel'. The Indian judiciary on the other hand have evolved their own basis for the rule, as evident from various pronouncements for example, in T R Pratt Ltd v. E D Sassoon & Co Ltd [(1936) 6 Comp Cas 122], it was held: The reason for the rule, I take it, is that it would be disastrous in a business community if contracts made with companies could be impeached on account of matters known to the company but not to the other contracting party:.. Similarly, in Iron Traders (Private) Ltd v. Hiralal Mittal [AIR 1962 Punj 277], it was observed: This principle sometimes expressed as the doctrine of indoor management is designed to protect innocent persons who are acting bonafide in the belief that the company is transacting business in accordance with its articles". Thus, in India, the rule is considered to have its origin not in estoppel but on considerations of business convenience and justice. In the words of Sen, to appreciate the correct nature of
the doctrines of 'constructive notice' and 'indoor management' the following points have to be kept in mind: 1) In respect of acts not within the authority of the agent and for which the company is not held liable, the expression 'ultra vires' is a complete misnomer. Unauthorized transactions do not form any species of the true ultra vires doctrine. 2) Unauthorized transactions should be dealt with in the light of the ordinary law of agency including the law relating to holding out. 3) The law of agency is not different in the case of companies. Companies have not been given any special consideration by any statute and are not entitled to any other special consideration. Apart from 'limited liability' of shareholders, no further protection is warranted or justified and the statute has not purported to give any such protection. 4) The judicial obsession apparent in some cases, of safeguarding the shareholders interest at any cost must be treated as out dated and no longer applicable. Though none dispute, that, the shareholders interests should be protected within the bounds of the company law, a further extension of such protection is unwarranted under the statute and is contrary to the rules of justice, equity and good conscience. 5) The doctrine of constructive notice in present times is illogical. In any country, the everyday life would become impossible if customers or persons dealing with a company are called upon to check the articles and memorandum of the company. Though they are public documents, it is impossible and impractical for a person to check them up before entering into a transaction with the company. To impute the purchaser of a tooth-brush with knowledge of the memorandum and articles of the manufacturing company is not only bad law, but, it also reduces the law to the level of ridiculous absurdity. Every society has been industrialized to such an extent, that, practically every action of man is touched by a company somewhere or other. It is absurd to expect every person to go and read the articles and memorandum before every such transaction, and to impute the whole community with notice and knowledge of the articles and memorandum is now completely illogical and should be eliminated in arriving at a judicial conclusion. 6) The Turquand's rule is a wholesome application of the law of agency and rule of justice, equity and good conscience. The exceptions which have tried to whittle down this rule should be considered to be bad law so far as they transgress the norms of equity. Industrialization has brought about a change in social values and behaviour, and 19th century conceptions evolved when the company did not play an important role in an individuals life no longer hold good. Excessive loyalty to the ultra vires doctorine and an obsession with protection of shareholders interests has led to an unfair curbing of the protection accorded by the Turquand's rule, resulting in a general detriment to the society. No statutory modification is necessary, but the judiciary has to check the unnecessary growths and apply correct principles in the light of modern values and conditions.[Sen, pp 138-140]. 113
6. LEGAL INSTITUTIONS UNDER COMPANY LAW

SUB-TOPICS 6.1 Introduction 6.2. Registrar of Companies 6.3. Company Law Board 6.4. Company Court 6.1 INTRODUCTION In the preceding chapters we have seen how the concept of corporate personality, its nature and scope, has been defined, elaborated upon and later limited by means of judicial interpretation, i.e., the courts have played a very important role in defining the area within which the company and its management can play. This raises an important question : which is the court having jurisdiction to decide questions relating to company matters, and what are the other judicial or quasi-judicial authorities which have the power of regulation over the company? Primarily there are three such authorities so involved - the Registrar, the Company Law Board and the Company Court. Previously, sometime in the sixties a Company Law Tribunal was also established, but it did not function for long and was abolished by the Act of 1967. We will now deal briefly with the remaining authorities. 6.2 REGISTRAR OF COMPANIES To that extent, the Act itself specifies the duties of the Registrar, which automatically apply to the Additional, Joint, Deputy & Assistant Registrars. Before the formation of the Company Law Board (CLB) in 1988, the Registrar of Companies performed quasi-judicial functions alongwith administrative functions. But at present, the quasi judicial functions have been transferred to the CLB and the Registrar mainly deals with administrative functions. The duties and powers of a Registrar are extensive and it is beyond the scope of this module to go exhaustively into them, but some of the functions which the Registrar performs are - receive various documents required for incorporation; give a certificate of incorporation to the company, in case of public companies he is also required to give a certificate for commencement of business; maintain registers; in some cases apply for compulsory winding up of a company, etc. He has the power to impose fine in case of infringement of any given provision by the company or the defaulting officer. He also has the power to strike off the name of a 'defunct company' from the Register of Companies and such other powers. All in all, one can say that the Registrar is one of the most important functionary in the company arena. 6.3 COMPANY LAW BOARD
Sec. 2(40) of the Companies Act, defines Registrar as - 'Registrar means a Registrar, or an Additional, a Joint, a Deputy or an Assistant Registrar, having the duty of registering companies under this Act.' Admittedly, this definition leaves a lot to be desired, as it hardly gives a clear view of a Registrar' as an official. The 'Registrar' is one of the most important persons with regard to a company. The Central Government appoints a person as a Registrar of State on such terms and conditions it deems fit. Generally, every state has one 'Registrar of Companies' whose office is situated in the capital of the State. But depending on the amount of work in that particular state, more than one Registrar may be appointed, or the Registrar may be aided in his work by Additional, Joint and Deputy Registrars. In the definition of Registrar, officers of lower rank have been put in a descending order - the common element being, that, so long as each of these officers have the duty of registering companies under the Act, each has to be considered as a Registrar. By virtue of the provision contained in sec. 19 of the General Clauses Act, 1897, read with sec. 2(40) of the Companies Act, it is sufficient for the Act to specify the duties of the Registrar, for such duties would also automatically become to be the duties of Additional, Joint, Deputy or Assistant Registrars. sec. 609(2) enables the Central Government to make regulations with respect to the duty of the Registrars, pursuant to which the Companies Regulations, 1956 were framed. Apart from this, throughout the Act, there are various provisions laying down what the Registrar should do in respect of a particular matter. 114
Section 10 E of the Act deals with the constitution of 'Board of Company Law Administration', nowadays commonly known as the Company Law Board or the CLB. This section was introduced by the Amendment Act of 1963, for creation of a new administrative authority which would exercise certain statutory powers as well as powers delegated by the Central Government. It was conceived as a matter of administrative reform and the CLB was expected to bring greater efficiency, cohesion and dispatch in the administration of the act. Initially the CLB consisted of 5 members which was later increased to 9 by the 1974 amendment, in view of transfer of certain powers exercised by the courts, to the Board, and simultaneously subsections (4C) & (4D) were also introduced clothing the CLB with powers of civil court in order to enable the Board to discharge its quasi-judicial functions, for example, the powers of confirming the alteration of memorandum u/sec. 17 and the consequential powers and functions under Ss. 18 & 19, the power to sanction and issue of shares at discount u/sec. 79, the power to order rectification of the register of charges and the power to extend the time for filing of charges u/sec. 141, and power to call an extraordinary general meeting u/sec. 186. Since the CLB was delegated with powers and functions of the Central Government, necessary amendment was also made to section 637 of the Act. Until the Amendment Act of 1988 came into force, the Board had to function as two separate bodies, one as delegatee of the Central Government and other as an independent body. The 1988 Act, substantially changed the character of the CLB, by increasing the scope of powers and functions of the CLB as an
independent body by amending Sec. 10E on one hand, and, by substituting Company Law Board for the words "Central Government" or "Court as the case may be in several sections of the Act. The CLB has also been clothed with certain new powers which do not strictly fall within either of these two categories, for example, Ss. 58A, 80A, 113(1), 235, 236, 237, 247, 248, 250, 251 (relating to investigation into affairs of the company), 269, 408 etc. The independent character of the CLB can also be gleaned from several other provisions of this section. Thus, new sub-sec (2A) now requires the Central Government to appoint members with prescribed qualifications and experience. Sub-section (5) makes it binding on CLB not only to follow principles of natural justice, but to be also guided by the dictates of its own sense of discretion. Sub-section (6) entitles the CLB to lay down its own procedure for conduct of its business, i.e., the CLB is no longer subject to the control of the Central Government in exercise of its powers or discharging of its functions. Under the new sub-sec (1A), the CLB may exercise and discharge powers and functions conferred on it under 'any other law' as well. Sec 22A of the Securities Contracts (Regulation)Act, 1956 contains one such provision conferring certain powers and functions directly on the CLB. Under the same sub-sec (1A), CLB may also be authorised to discharge powers and functions conferred on it by notification, provided there is an enabling provision in the statute in this behalf. Sec. 2A of the MRTP Act is one such provision under which a notification may be issued authorising the CLB to exercise and discharge the powers and functions with regard to determination of group, inter-connection and on the question of same management which the Central Government discharges but may decide instead to allow the CLB to discharge the same. The CLB is a specialized body with responsibility to watch the working of the corporate process. When it makes a finding of facts, reaches a conclusion and passes an order, it is entitled to prima facie respect unless there are glaring circumstances to the contrary [Union of India v. Swedeshi Cotton Mills Co Ltd. (1979)49 Comp.Cas 74 (SC)]. It is obligatory on the part of CLB to act in accordance with principles of natural justice, as is evident from the provisions of sec. 10E(5). Now that the CLB is vested with powers previously exercised by the High Court, the CLB is required to act as a judicial body while dealing with any matter before it. When the statute provides that the CLB shall act in its own discretion, it indicates that the statute reposes confidence in the board because of the peculiar skills of the members constituting it and the confidence reposed in the Members [who are appointed in accordance with the Company Law Board (Qualifications, experience and other conditions of services of Members) Rules, 1993] or in the Board, and from this it follows that there is a presumption that the Board is required to do the act itself and cannot redelegate its authority [Barium Chemicals Ltd. v. CLB, (1966)36 Comp. Cas. 639 (S.C.)]. Appeals against the CLB orders: The 1988 Amendment also inserted a new section 10F, providing for an appeal to the High
Court against an order of the CLB, on questions of law. No appeal lies on question of facts. So the High Court cannot go into the question of fact in a second appeal, however gross the error may seem to be [Sri Sinha Ramanuja Jeer v. Sri Ranga Ramanuja Jeer, AIR 1961 SC 1720]. But a finding of fact is open to attack as erroneous in law when there is no evidence to support it or if it is perverse. The question may arise as to which High Court has the jurisdiction to entertain an appeal against a CLB order ? The recent Supreme Court decision in Stridewell Leathers (P) Ltd., v. Bhankerpur Simbhaoli Beverages (P) Ltd. [(1993)12 CLA 151], stated that it is the High Court having jurisdiction in relation to the place at which the registered office of the company is situated, which is competent to hear an appeal under this section. 6.4 COMPANY COURT
The last of the legal institutions wielding authority over the companies is the company court. Section 10 of the Act deals with 'jurisdiction of the courts', and provides that (1) The court having jurisdiction under this Act shall be (a) the High court having jurisdiction in relation to the place at which the registered office of the company concerned is situate, except to the extent to which jurisdiction has been conferred on any District court or District Courts subordinate to that High Court in pursuance of Sub-Section (2); and (b) where jurisdiction has been so conferred, the District Court in regard to matters falling within the scope of the jurisdiction conferred, in respect of companies having their registered offices in the district. (2) The Central Government may, by notification in the Official Gazette and subject to such restrictions, limitations and conditions as it thinks fit empower any District Court to exercise all or any of the jurisdiction conferred by this Act upon the Court, not being the jurisdiction conferred (a) in respect of companies generally, by sections 237, 391, 394, 395 and 397 to 407, both inclusive ; (b) in respect of companies with a paid up share capital of not less than one lakh of rupees by Part VII (sections 425 to 560) and the other provisions of this Act relating to the winding up of companies. (3) For the purposes of jurisdiction to wind up companies, the expression "registered office" means the place which has longest been the registered office of the company during the six months immediately preceding the presentation of the petition for winding up. Throughout the Act, wherever the expression Court occurs, it has to be understood to be referring to the High Court except where the Central Government has notified that in respect of certain matters, the expression Court"will refer to any District Court. In exercise of this power, the Central Government empowered all the District courts in the Union of India, except in Jammu and Kashmir, to exercise jurisdiction in the following matters, viz; 115
Sec. 89 - Termination of disproportionately excessive voting rights in existing companies. Sec.113 - Limitation of time for issue of certificates Sec.118 - Right to obtain copies of and inspect trust deed Sec.141 - Rectification of register of charges by court. Sec.144 - Right to inspect copies of instruments creating charges and company's register of charges. Sec.163 - Place of keeping, and inspection of registers and returns Sec.196 - Inspection of minute books of general meetings. Sec.219 - Right of member to copies of balance sheet and auditor's report Sec.234 - Power of Registrar to call for information or explanation Sec.304 - Inspection of the register of directors. Sec.307 - Registrar of directors' shareholding, etc. Sec.614 - Enforcement of duty of company to make returns, etc. to Registrar. Provisions of sec.10 are not derogatory to the ordinary civil and criminal jurisdiction conferred on courts in India in their normal hierarchy. The Company Court [i.e. the High Court or District Court as the case may be] does not have jurisdiction in all company matters. Except in cases where the Act confers jurisdiction on the Company Court or some other authority like the Central Government or the CLB, either expressly or by implication, all other disputes pertaining to a company are to be resolved through the forum of civil courts when the disputes are capable of being so resovled. Under section 9 of the Civil Procedure Code, the civil court has jurisdiction on all matters unless there is a clear provision of law ousting the jurisdiction. Thus, in the absence of any specific remedy against the requisition for an extraordinary general meeting under sec. 169 called with an improper purpose sec. 9 CPC can be invoked [B. Sivaraman v. Egmore Benefit Society Ltd., (1992)9 CLA 48
(Mad.)]. The Company court has no jurisdiction to grant relief in respect of grievances relating to individual rights of members, as distinguished from their corporate rights. Relief can be granted by a civil court for declaration of the proceedings of annual general meeting of a company as void or for compelling a company to hold the annual general meeting [Stat Title Works Ltd. v. M. Govindan, AIR 1959, Ker 254 and R. Prakasham v. Sree Narayan Dharma Paripalan Yogam (1980)50 Comp. Cas. 6119Ker)]. But where the relief sought is such as could be obtained by filing a petition before the High Court, say under sec. 398 [this power is now exercised by CLB], the civil court has no concurrent jurisdiction [Nava Samaj Ltd. v. Civil Judge, AIR 1966 MO 286 (DB)]. So also, the jurisdiction of High Court is confined only to those provisions of this Act where a reference is made specifically to court and does not extend to those matters where prosecution for criminal offenses lies. No jurisdiction is conferred by s.10 as regards matters which may be agitated by or against an company or by or against any officials of the company. Jurisdiction u/s.10 is confined to matters specifically brought before the court by virtue of the provisions of the Act. Thus, for example, if a general complaint is made alleging non compliance with the provisions of sec. .253, the jurisdiction of High Court cannot be invoked, there being no provision in Companies (Court) Rules, 1959 for the High Courts to entertain such a complaint. A complaint filed in such a case must be dismissed and the complainant must be left to seek his relief by way of appropriate civil proceedings. Neither s. 2(11) nor s. 12(1) exclude the jurisdiction of the civil courts either expressly or by implication. In the absence of any provision of law conferring on the High Court exclusive jurisdiction the civil courts will have jurisdiction u/s 9 of CPC. The Andhra Pradesh High Court accordingly, dismissed the petition for a declaration, inter alia, that the removal of a director under s. 253 was illegal, leaving it open to the petitioners to seek appropriate remedy from a civil court having jurisdiction [K.K.Maheswari v. Rockhoar Building Materials Ltd., (1993)12 CLA 140].
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7. CASE LAW
Lee v. Lee's Air Farming Ltd [(1960)3 All ER 420] Lee formed the respondent company to carry on his business of spreading fertilizers from the air. He held 2999 of its 3000 shares, and was by its 'articles' the sole governing director, in which capacity he appointed himself as a chief pilot of the company drawing some salary. He was killed in an air crash while flying for the company. His widow filed a suit for compensation. If Lee qualified as a 'worker' (defined as any person who has entered into or works under a contract of service....with an employer....whether remunerated by wages, salary or otherwise), then his widow was entitled to be paid compensation by his employer i.e. 'the company under the Worker's Compensation Act 1922 (M.Z) Mrs. Lee appealed against the ruling of Court of Appeal of New Zealand, that Lee could not be a 'worker' when he was also in effect the 'employer'. The substantial question to be decided was, whether Lee was a 'worker' within the meaning of the 1922 Act ? Was he a person who had entered into or worked under a contract of service with an employer ? House of Lords held that, any contractual obligations were not invalidated by the circumstances that the deceased was sole governing director in whom was vested the full government and control of company......the capacity of the company to make a contract with the deceased could not be impugned merely because the deceased himself acted as the agent of the company in its negotiation....it is a logical consequence of the decision in Salomon's case that a person may function in dual capacity. Control would remain with the company whoever might be the agent of the company to exercise it. The fact that so long as the deceased continued to be governing director, with attitude of powers, it would be for him to act as the agent of the company to give the order and does not alter the fact that the company and the deceased were two separate and distinct legal persons. If the deceased had a contract of service with the company, then the company had the right to control. Just as company and deceased were separate legal entities so as to permit contractual relations being established between them, so also were they separate legal entities so as to enable the company to give an order to the deceased..... The appeal on the basis of this reasoning was allowed and Mrs. Lee obtained a compensation. Tunstall v. Steigmann [(1962)2Q 593 (CA)]. Mrs. Tunstall (the tenant) carried on a business as a wardrobe dealer in shop premises leased from Mrs. Steigmann (the landlord). Mrs. Steigmann also owned the next door shop, where she carried on the business of a pork-butcher. In April, 1961, she gave the tenant six months notice to quit, relying on S.30(1)(g) of the Landlord and Tenant Act, 1954 which reads as "..... that on the termination of the current tenancy the landlord intends to occupy the holding for the purposes, or partly for purposes, of a business to be carried on by him therein'. Before the matter came up for hearing, Mrs. Steigmann had formed a company, in which she held all except two shares (which were held on her behalf by her nominees), to take over her business. The country court judge held that, she might still intend to carry on the business notwithstanding that it was owned by the company and he refused to grant the tenant a new lease. The tenant filed an appeal against this judgement. Allowing the appeal held, 'I have reached this conclusion with some reluctance, for it seems to me that the construction of S.30(1) (g), which I have been compelled to adopt, may well lead to some very bizarre results. Thus, it will be possible for an absentee landlord, living in idleness away from the holding, to resist the grant of a new tenancy upon proof of an intention to occupy, through his agent or manager, for the purpose of carrying on his business through such agent or manager. On the other hand, a hard-working landlord, who has transferred his business to a company or which he retains complete control, and who genuinely needs to obtain possession of the holding so that his company's business may be carried on there with the aid of his own labour, will nevertheless apparently be without any right to oppose an application for a new tenancy by a tenant however undeserving. It seems, however, impossible to escape the conclusion that this is the effect of what Parliament has enacted, If the results are though undesirable, only parliament can put that right.... ' People's Pleasure Park Co. v. Rohleder [(1908) 109 Va 439] Certain lands were transferred by one person to another perpetually, with an enjoinment or restriction, that, the transferee could not sell the property to coloured persons. The transferee transferred these lands to a company composed exclusively of Negroes. An action was commenced against the transferee by the original transferor of lands, for annulment of the conveyance of lands to the company on the ground that 'all the members of the company being Negroes, the property had, in breach of the restriction, passed to the hands of coloured persons. The court rejected this argument and held that, 'members individually or collectively are not the corporation, which has a distinct existence - an existence separate from that of its shareholders. It leads its own life....if stands apart as a separate subject and, in contemplation of law, as a stranger to its own members'. Re F.G. (Films)Ltd. [(1953)1 WLR 483] An American company produced a film called 'Monsoon' in India technically in the name of a company incorporated in England. The English company had a capital of 100 in 1 shares, 90 of which were held by an American director. The production was financed by the American company. In these circumstances the Board of Trade refused to register it as a British film and their decision was upheld by the court, which observed that : 'it would be a mere travesty of the facts to say or to believe that this insignificant company undertook the arrangements for the making of the film. They acted, in so far as they acted at all in the matter, merely as the nominee of, and agent for the American company'. 117
Freewheel (India) Ltd. v. Dr. Veda Mitra 258]
[AIR 1969 Del.
Mahnoy v. East Holyford Minig Co. Co. [(1875) L. R. 7 H. L. 869] The liquidator of the respondent company sued Mahony as public officer of the National Bank, Dublin, alleging that the bank had paid money from the company's account without due authorization. The bank had acted upon a letter signed by one wall as secretary of the company, enclosing a copy of a 'resolution'of the board of directors. This resolution named three directors, and instructed the bank to pay cheques signed by any two of them and countersigned by the secretary. Specimen signatures were attached. The instruction was entirely in accordance with the company's memorandum and articles, and would have been in order, except that there had never been any proper appointment of the directors or secretary by the company, the roles having been simply assumed by those who had formed the company. The House of Lords held that, the company was bound by cheques which the bank had honoured in accordance with the instructions contained in the letter. It was observed, "Those articles of association and that partnership deed are open to all who are minded to have any dealings whatsoever with the company, and those who so deal with them must be affected with notice of all that is contained in those two documents. After that, the company entering upon its business and dealing with persons external to it, is supposed on its part to have all those powers and authorities which, by its articles and deed, it appears to possess; and all that the directors do with reference to what I may call the indoor management of their own concern, is a thing known to them and know to them only; subject to this observation that, no person dealing with them has a right to suppose that anything has been or can be done that is not permitted by the articles or deed..... A banker dealing with a company must be taken to be acquainted with the manner in which, under the articles of association, the moneys of the company may be drawn out of his bank for the purposes of the company. And the bankers must also be taken to have had knowledge, from the articles, of the duties of directors, and the mode in which the directors were to be appointed. But, after that, when there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles, then those so dealing with them, externally, are not to be affected by any irregularities which may take place in the internal management of the company. They are entitled to presume that of which only they can have knowledge, namely, the external acts, are rightly done, when those external acts purport to be performed in the mode in which they ought to be performed..... If we are not now to hold that the bankers are to be protected in honouring the drafts of these three persons, who they were informed, were authorized to draw the cheques, can be safe against being bound to inquire into all the minute transactions which may have taken place indoors....."
A 52% subsidiary company proposed to issue further capital which, following Sec.81, was offered to the existing holders of equity shares. The holding company requested the court that its subsidiary should be restrained from going ahead with the issue as it would deprive the parent company of their controlling interest and would also depreciate the value of its shares. Kapur, J, refused to issue the injunction prayed for and said: Here the parent holds only a nominal majority in the share capital of the subsidiary. With the meager majority alone I am not prepared to hold, even if it were possible to do so for such a purpose, that the subsidiary company had lost its identity as a separate legal entity". A.G. v. Great Eastern Railway [(1880)5 App.cas. 473] The company was incorporated by statute to acquire the undertaking to two existing railway companies and to construct and run certain other railways. The question before the court was whether it was within its powers, as defined by the incorporating statute, to hire locomotives and rolling stock to another railway company operating in the same area. Lord Selborne, L.C. observed ......I assume that your Lordships will not now recede from anything that was determined in the Ashbury Railway Company v. Riche. It appears to me to be important that the doctrine of ultra vires, as it was explained in that case, should be maintained. But I agree with Lord Justice James that this doctrine ought to be reasonably, and not unreasonably, understood and applied, and that whatever may fairly be regarded as incidental to, or consequential upon, those things which the legislature has authorized, ought not (unless expressly prohibited) to be held, by judicial construction, to be ultra vires...." It was held that the concerned activities were intra vires the company, being within its express powers. Bell Houses Ltd v. City Wall Properties Ltd [(1966)2 All ER 674] The plaintiff company's principle business was the acquisition of vacant sites and the erection thereon of housing estates. In the course of transacting business, the chairman acquired knowledge of sources of finance for property development. The company introduced the financier to the defendant company, and claimed the agreed fees of 20000 for the same. The trial judge held that the contract was ultra vires the plaintiff company and , therefore void. On appeal, the court of appeal reversed this decision, relying on a clause in the memorandum which authorized the company, to carry on any other trade or business whatsoever which can, in the opinion of the board of directors, be advantageously carried on by the company in connection with its general business, and held that,' since the directors honestly believed that the transactions could be advantageously carried on as ancillary to the company's main objects, it was not ultra vires'.
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8. PROBLEMS
1. Some of the partners of a partnership firm carrying on the business of plying buses, formed a private limited company, which they could do under law even while the partnership continued to be running concern. These partners, sold to the company their own buses which were being used by the firm before. The second set of partners who constituted the minority, sued the first group forming the company, for accounts and their share of profits on the ground that, in reality the company was not a different entity from the firm, and that the business carried on by it was the same as that of the firm. Decide. 2. A business concern was converted into a company, and all the shares of the company were held by the persons owning the business concern. They sold certain premises to the new company. The difference between the selling price and cost of the property in their hands was assessed as their income. They contended that this could not be done as there was no commercial sale, but only a transfer from self to self. Decide. 3. Darby and Gyde (both undischarged bankrupts, with a number of convictions for fraud) registered a company 'A'. It had only 7 shareholders and had issued a mere 11 15 s, If its nominal capital of 100,000. Darby & Gyde being the only two directors were entitled to all of its profits. This company, then proposed to float in England a 30,000 company under the name BC Corporation Ltd. and to sell to it a quarrying license and plant, brought for 3,500, at a price of 18,000. The prospectus inviting the public to take debentures in BC Corporation Ltd., disclosed the role of the company 'A' as vendor and promoter, but did not mention the names of Darby & Gyde or the fact that it was they who were to receive the profit on sale. BC Corporation failed and went into liquidation. The liquidator claimed in the bankruptcy of Darby for the secret profit which it was alleged that he, as a promoter, had made. Darby contended that it was not he , but the corporation who had been the promoter. Decide. 4. A company was established to carry on the trade of a 'product merchant' in Western Australia. It entered into speculative contracts with merchants in Calcutta for purchase of jute. The memorandum contained no express power to deal in jute, but clause j reads : 'To carry on any other business whether manufacturing or otherwise' the purchase of jute is intra vires or ultra vires the company. Decide. 5. The memorandum of a company gave power to the directors to 'borrow or raise or secure any sum or sums of money on the security of the property of the company by the issue of debentures, and so on, for the purpose of company's business'. They borrowed 6,250 and used the money to pay of certain outstanding debts. The person lending money was unaware of the purpose for which money was being borrowed. Decide whether the lender could enforce repayment of loan even though the purpose of loan was improper and ultra vires. 6. The copyright in News Chronicle and Star newspapers, together with plant and premises used in their production was sold to Associated Newspaper Ltd. by the defendants. The two papers ceased production and most of the 2800 employees lost their jobs. The defendants, arranged with Associated Newspapers Ltd. that, after payment of the expenses, the whole of the purchase money received should be paid as compensation and pension benefits to these displaced employees. A meeting of the shareholders of the defendant company was called to authorize the directors to distribute the money in accordance with this scheme. One of the minority shareholders brought an action claiming that the proposed payment was ultra vires and illegal. Decide. 7. Directors of a company borrowed money from a bank on the security of a mill situated in Rangoon. The directors had already exceeded the limit (of an amount equal to half the paid-up capital) imposed on their power to borrow by the articles. There was a provision in the articles that, 'the company in a general meeting might by a special vote enlarge the directors power to borrow'. The bank sought to enforce the security relying on this clause, holding that they were entitled to assume that 'the directors power to borrow had been so extended'. The company resists the banks claim. Decide. 8. Richards was chairman of directors of the defendant company and its chief executive or 'defacto managing director', who often committed the company to contracts on his own initiative and only disclosed the matter to the board subsequently. The board acquiesiced in this practice. The plaintiff was chairman and managing director of another company 'Perdio', which it was planned should eventually merge with or acquired by defendants. As part of an agreement to put more money into Perdio, the plaintiff (who had been made director of the defendant company) was given 2 letters signed by Richards, by which the defendants agreed to guarantee the repayment of money owed to the plaintiff and to indemnify him against certain losses. When sued on these undertakings the defendant alleged that Richards had no authority to make the contract in question. Decide.
[Note: Please specify your name, ID number and address while sending answer papers]. 119
9. SUPPLEMENTARY READING
1. Avtar Singh, Company Law, 9th edn. 1986, Eastern Book Company, Lucknow. 2. Gower, L.B.C., Gower's Principles of Modern Company Law, 5th edn. 1992, Sweet & Maxwell Ltd., London. 3. Ivamy, E.R.H., Topham and Ivamy's Company Law, 1974, Eastern Law House Pvt. Ltd., Calcutta. 4. Ramaiya, A., Guide to the Companies Act, 8th edn. 1977, Wadhwa & Company, Nagpur. 5. Schimtthoff, C.M., & Thompson, J.H., Palmer's Company Law, 21st edn.1968, Stevens & Sons Ltd., London. 6. Sealy,L.S., Cases & Materials in Company Law, 1st edn.(rep): 1975, Cambridge University Press, Cambridge. 7. Sen, S.C., The New Frontiers of Company Law, 1971, Eastern Law House, Calcutta. 8. Sangal, P.S., National & Multinational Companies, some legal issues, 1st edn: 1981, N.M. Tripathi Pvt. Ltd., Bombay.
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Course No: III Module No: III & VI
Corporate Management

Materials Prepared by: Prof. N.L. Mitra Ms. Sudha Peri Materials Checked by: Ms. Archana Kaul Materials Edited by: Prof. T. Devidas
National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.
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INSTRUCTIONS
As has already been stated, the structural design of corporation is the most important legal invention to create a legal vehicle of industrial movement. People's participation in the raising of capital made it possible for huge industrial undertakings requiring huge investments. The old concept of joint ownership started changing until a professional management group came into the scene as an independent option of corporate management through the framework of contractual system. Initially it was the movement of corporate democracy to operate inside in order to manage the concern through the elected representatives. During the British Rule, Indian Companies used to experience the management by outside agencies through the instrument of contracts. Taking advantage of the system these managing agency houses created all conditions of managerial anarchy in the corporate system. As a result, in Karachi Congress in early 30s the Indian National Congress declared that the system was to be abolished after independence. Finally, in 1970 the system was completely abolished. But the corporate democracy cannot by itself produce a clear, efficient and competent management system. The BOD can hardly take the responsibility of day-to-day administration of the policy adopted by the Board. It is, therefore, essential for a corporate system to thrive, to design an appropriate professional managerial system. Fortunately, in the last twenty years, thanks to the popularity of management education, a good professional management system is being built up. But still at the top level, there is inadequacy. We have experimented with some other alternate methods. But all experiments failed including that of Secretary and Treasurer. One has to understand clearly the role of BOD in a Corporate set-up. BOD is composed of shareholders, representatives, institutional nominees and Government nominees, in certain cases. It cannot take the position of a top executive. With the development of technology even this type of constitution of the Board is also changing. Professional Managers are necessary in the Board to properly investigate, study and design the appropriate course of action. As such, shareholders' representatives are ipso facto inadequate even to frame up the policy, far less to implement them. Obviously, again the thinking of contractual arrangements in corporate management surfaced. Shareholders want their return on investment. As such, if they want to contract out the management to outside professional agency or person what can be the grounds of objection? Indian investors invest on the name of the promoters many of whom are professional managers. With technological issues becoming more and more important professionalism in management is being demanded more and more. That will mean changes in the structuring of the corporate management system including that of the BOD. In this module we have discussed these issues in details. You have to supplement the literature with books of modern authors specially Prof. Gower, Pennington and Berly. The corporate structure has also presently gone into change. Earlier, companies used horizontal growth for operational economy. Presently vertical growth and management takeover and mitosis in corporate structure are the order of the day. New technology is individual efficiency specific. So modern companies have structure out the operational level though through a claim of 'profit-centre' management structure, the control centre growing very big, so much so that often the ultimate control centre remains invisible. You have to understand the nuances of the modern management system. In the light of the demand the legal position is required to be studied and criticized. You have to make detail side-line note while reading the module and at the end of each chapter prepare check-lists so that you can compare properly the Indian System with any other modern management system of a developed country. I hope you will find the module interesting. N. L. MITRA Course Coordinator
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CORPORATE MANAGEMENT
TOPICS 1. 2. 3. 4. 5. 6. 7. 8. Corporate Control ....................................................................................................... 125 130 141 156 160 164 167 168
Corporate Management ................................................................................................ Board of Directors .......................................................................................................
Oppression & Mismanagement....................................................................................... Investigations ................................................................................................................
Case Law ........................................................................................................................ Problems .......................................................................................................................... Supplementary Readings .............................................................................................
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1 CORPORATE CONTROL
SUB TOPICS 1.1 Introduction 1.2 Legal devices of control A) Through complete ownership B) Majority control C) Control without majority control D) Conclusion 1.3 Extra-legal devices of control A) Minority control B) Management control 1.4 Conclusion 1.1 INTRODUCTION Uptil the 19th century, the stockholders or shareholders were substantially the owners and managers combined in one. The only group of importance within the company was the shareholders and then the directors as the nominees or agents of the shareholders. This was the golden age for the shareholders' democracy, wherein, the management was deemed to be running a business on behalf of their owners. While they did have wider powers than most agents, they were strictly accountable to the shareholders. Although the directors were left in charge of the business, legally speaking they were under the direct control of the shareholders and any one of their decisions could have been vetoed by the shareholders. With the expansion of industry, spread of the economy and popularity of the stock exchanges, share purchasing became more common. Share investment became the most popular method of saving/investment, resulting in a wider dispersal of stocks. This process was further hastened by the growth of giant companies with a capital investment so large that it was impossible for any single individual or group to have 51% holding. Continuation of this pattern of dispersion has resulted in individual stockholding becoming smaller and smaller, with the result that no shareholder is individually important. This position has been further aggravated by the advent of institutional shareholders, i.e. companies, banks, financial institutions, mutual funds etc. The real ownership of shares is not with any individual, but in large groups. The personal element went completely missing from such groups. This change of pattern led to a new state of affairs where the basic concepts got completely changed. These changes according to Berle & Mean were as follows: 1) The position of ownership has changed from active to passive. Instead of actual physical property over which the owner could exercise direct control, the owner now helds a piece of paper representing a set of rights & expectations. But over the enterprise and physical property, the instruments of production in which he has an interest, the owner has little control. 2) The spiritual values that formerly went with ownership have been separated from it. 3) The value of an individuals wealth was coming to depend on forces entirely outside himself and his own efforts. 4) The value of the individuals wealth not only fluctuated constantly but the same happened to most wealth. 5) Individual wealth had become extremely liquid through organized markets. 6) Wealth was less and less in a form which could be employed directly by its owner. The newer form of wealth (ex: shares) was quite incapable of direct use. Only through sale in the market could the owner obtain its direct use. He was thus tied to the market as never before. 7) Finally, in the corporate system, the owner of industrial wealth was left with a mere symbol of ownership while the power, the responsibility and the substance which had been an integral part of ownership in the past were being transferred to a separate group in whose hand lay the control. As property was gathered under the corporate system, and control was increasingly concentrated, the power of this control steadily widened. Briefly, the past century saw the corporate mechanism evolve from an arrangement under which an association of owners controlled their property on terms closely supervised by the state to an arrangement by which many men have delivered contributions of capital into the hands of a centralized control. This was accompanied by grants of power permitting an almost unarticulated permission to deprive the grantors, at will, of the beneficial interest in the capital thus contributed. Thus, in corporations dispersion of shareholdings led to the evolution of control and finally the rise of management as a power. Under the modern corporate system, control over industry began being exercised with a minimum of ownership interest. As the activities of the corporation were exercised through a board of directors for all practical purposes, control lay in the hands of the individual or group, having the actual power to select the board of directors either by mobilizing the legal right to choose them or controlling a majority of votes directly or indirectly through some legal device or by exerting pressures influencing their choice. Hence in addition to shareholders and directors control was recognized by Berle & Means, as one of the most important constituent parts of the modern corporate structure. Let us discuss in detail the various kinds of control which can exist in a corporation.
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FLOW CHART INDICATING VARIOUS FORMS OF CONTROL Control within a Company Legal device By complete ownership By legal device without majority ownership By Majority control By pyramiding By non-voting stock By means of voting trust By weighted voting shares Extra legal device Minority control Management control
1.2 LEGAL DEVICES OF CONTROL As seen in the above flow chart there are three forms of control which rest on a legal base, and revolve about the right to vote a majority of the voting stock. We will now take up each one of these devices in detail. A] Control through almost complete ownership This type of control is found in what may properly be called the private corporation or one man companies where a small group of persons or a single individual own all or practically all the outstanding stock. They are in a position of control, not only because they have the legal powers of ownership, but also because they are in a position to make use of them and, in particular being in a position to elect and dominate the management. In such an enterprise ownership and management/ control is combined in the same hands. Since the 19th century, such companies have been the centre of large scale controversy, usually based on two aspects, viz., (1) whether the one man company had an existence apart from the individual controlling it, and (2) whether, in case of private corporations unchecked power and control could be vested in the hands of a few individuals. In response to the first, way back in 1936, in T R Pratt (Bombay) Ltd v. E D Sasson & Co Ltd [AIR 1936 Bom 62], Kania, J., observed that under the law, an incorporated company is a distinct entity, and although all the shares may be practically controlled by one person, in law a company is a distinct entity and it is not permissible or relevant to enquire whether the directors belonged to the same family or whether it is, as compendiously described as a one-man company. A similar observation was made much erlier, by the House of Lords in Salomon v. Salomon & Co Ltd [(1897) AC 22]. Thus such companies exist with the encouragement of both the legislature and the judiciary and the great majority of them are as bonafide and genuine as in a business sense they are convenient and suitable media for provision and application of capital to industry [Avtar Singh, p.6]. 126
With regard to the second, the position may be clearly understood in the light of Lord Greene M. R.s observation in re Smith and Fawcett Ltd [(1942) Ch 304]. Here, a clause in the Articles of a private company provided: The directors may at any time in their absolute and uncontrolled direction refuse to register any transfer of shares. The issued capital of the company consisted of 8,002 shares of which the two directors of the company S & F held 4,001 shares each. F died and his son applied to have the shares registered in his name. But S, in the exercise of the above power, refused to consent to the registration. He however, offered to accept the applicant upto 2,001 shares, provided the remaining were sold to him at a fixed price. The plaintiff brought an action contending that Ss refusal to register was on a wrong principle since it was not made for the benefit of the company but was rather to preserve his own dominating position. It was held that `Private companies are (no doubt)in law separate entires just as much as are public companies, but from the business and personal point of view they are much more analogous to partnerships than to public corporations ....... The directors must exercise their discretion bonafide in what they consider - not what court may consider - is in the interest of the company. An if they have done that the court cannot substitute its judgment for theirs. B] Majority control The first step in the separation of ownership and control is that of majority control, and it involves ownership of a majority of the outstanding stock by a single/small group of individual(s), gives virtually all the legal powers of control which would be held by a sole owner of the enterprise and in particular the power to select the board of directors. But, in medium - large corporations where there is a larger dispersion of stock, the control of the corporation vests in the hands of the person(s) holding the majority stock. This concentration of control in the hands of the majority, in effect means that the minority have lost most of their powers of control of the enterprise of which
they are part owners. For them, at least, the separation of ownership and control is complete, though for the majority it is still combined in their hands. The majoritys powers of control may be to a slight extent curbed by the existence of a compact minority which is ready, alert and present to question the majority on its policies and acts, either directly at the meetings or indirectly in the courts. But, when the minority stock is widely scattered, then (in the absence of a legal device) majority ownership means undiminished control. Control to the majority group has arisen due to various reasons. It is not really possible for a large group of persons to contribute capital for a common enterprise, without loss of control by some members of the group. It would clearly be impracticable for each member to exercise a major element of control over the enterprise. The disadvantages of liberum veto are too great to make unanimous action predictable. Thus, grant of control to the majority stockholder(s) is a natural and generally accepted progression. This control has been granted on the presumption that, in most (if not all) cases, the minority interest and majority interest run parallel to each other. The problem arises when these interests start conflicting with each other, because it is then that accusation of oppression and mismanagement are levied against the majority. But this particular point will be dealt in detail later at the appropriate place. C] Control through a legal device Among the larger corporations, however, the separation of ownership and control has passed far beyond the separation represented in majority control. In a truly large corporation, the investment necessary for majority ownership is so considerable as to make such control extremely expensive. Among such corporations, majority control is conspicuous more by its absence than by its presence. More often than not, control in such corporations in maintained with a relatively small proportion of ownership, through the use of a legal device. Some of these legal devices are briefly discussed below. (i) Pyramiding: This is the most important of all legal devices used by larger corporations. This involves the owning of the majority of the stock of one corporation which in turn holds the majority stock of another corporation, which further holds the majority stock in still another corporation and so on. There is no limit to the extent to which this process can go on. By issuing bonds and non-voting preferred stock of the intermediate companies the process can be accelerated. By the introduction of two or three intermediate companies each of which is legally controlled through ownership of a majority of its stock by the company higher up in the series, complete legal control of a large operating company can be maintained by an ownership interest equal to a fraction of one percent of the property controlled. The owner of a majority of the stock of the company at the apex of the pyramid can have almost as complete control of the entire property as a sole owner even though his ownership
interest is less than one percent of the whole [Sen, p.33]. Given below is a graphic representation of this concept of pyramiding.
Here A, B, C, D, E, F, G & H are all corporate entities, with A being at the apex of the pyramid, controls a majority stock in B which in turn controls the majority stock in both C & D, which further control E - F & G - H respectively. So, in effect, though A actually holds majority stock only in Corporation B, due to this pyramiding, is able to control six other corporations apart from B. This is the process used by the various business corporates of today. (ii) Non-voting Stock: This method consists in arranging the right attached to different classes of shares in such a manner, that, most of the stock is disfranchised i.e., without the right to vote (at least so as voting for directors is concerned), and only a small class, or a class representing a very small investment is permitted to vote. Ownership of just over half of this privileged class [having the right to vote] is sufficient to give legal control and virtually all the powers of majority ownership [Sen, p. 33]. At present, non-voting preferred stock is a common phenomena in U K and U S A. In India, this mode of controlling device is absent, since the Indian Companies Act specifically lays down the kinds of shares which can be issued by a public company under S. 86, namely: equity or ordinary shares and preference shares. An interesting question which arises is that as there is no restriction on the kinds of shares a private company may issue does it mean that a private company can issue non-voting shares? In theory yet it may do so since the law gives greater flexibility to the private companies in matters of exercising control over their capital but in practice, since this kind of shares is not very popular in India, it is not generally issued. There is a proposal mooted for allowing the issual of non voting shares by companies but the outcome of the proposal is as yet undecided. (iii) Weighted Votes: This may be considered to be a variant of the above legal device. This involves the issue of a large number of shares having excessive voting power [for 127
Ex. one vote may carry the weightage of four votes] i.e., voting power in excess of the capital invested. Such weighted shares result in the person(s) acquiring total control of the company. In India, weighted shares cannot be issued by a company, under S. 88 which states that, shares with disproportionate voting rights cannot be issued. The same position exists in England, as far as quoted or listed companies are concerned. But, this restriction does not apply to private companies. Thus, in Bushell v. Faith [(1969) 1 All ER 1002], a clause in the Articles of a private company which gave three votes for each equity share to a director when a resolution was proposed for his removal has been held valid. (iv) Voting Trust: Apart from these modes of securing control through direct or indirect ownership of the voting majority another device which is widely prevalent in U S A is that of the voting trust. This involves the creation of a group of trustees, often a part of the management, with the complete power to vote for all stock placed in trust with it. When a majority of the stock is held in trust, as is usually the case, the trustees have almost complete control over the affairs of the company with them personally having little or no ownership in the company. The stockholders in turn receive trust certificates instead of regular share certificates, entitling them to share in such disbursements as the directors may choose. Control through a voting trust differs from all other forms of legal or extra legal forms of control, in that, it is fixed, defined and inalienable, with certain definite and well recognized responsibility attached to it. Presumably, it is this open acceptance of responsibility which has reduced criticism of voting trust, and perhaps for the same reason, it is not a device which is used extensively in the larger corporations, since those individuals desiring to control a company may not wish to assume the responsibilities and liabilities which a trust would impose upon them. The courts in U S A recognize such trusts as valid despite the lack of statutory backing, unless such trusts are formed with an improper motive or object, for example, if it exists merely for the benefit of the trustees with no obligations to perform any useful service for the protection of shareholders or creditors, or if it unduly restricts the powers of directors. Position in India: Under S. 153 of the Act, which declares that, no notice of any trust, express, implied or constructive, shall be entered on the register of members, a company is not bound to recognize the existence of a trust, though it may do so for its own benefit, without entering the trust in the Register. For example, in S. Parmeshwari v. K M R Mills Ltd [AIR 1971 Mad 293], a managing directors wife, having quarreled with her husband and to teach him a lesson, brought an action for winding up. All the shares held by her were financed by her husband. The court held that, the company could take notice of this fact and present it to the court for the purpose of showing that her petition was not bonafide, and was brought to exert pressure upon the managing director for settlement of the family dispute. Under S. 158-B(1), the Central Government is 128
authorized to appoint a person as a `public trustee. Any person holding shares in or debentures of a company in trust for another person has to make a declaration to the public trustee, and failure to make such a declaration involves a penalty. But S.187-C of the Amendment Act of 1974 provides that a person whose name appears in a companys register of members, but who does not hold the beneficial interest in the shares, should make a declaration to the company specifying the name and other particulars of the person holding the beneficial interest on the shares. The right to vote on shares held in trust has now been vested in the public trustee [S. 187-B], who may exercise the right either personally or through proxy. He may even abstain from voting, if he feels that the objects of the trust or the interest of the beneficiaries would not be adversely affected by the abstention. This provision, more than all others, would ensure the failure in India of `voting trust as a legal device for controlling the company. D] Conclusion Control based on a legal device, whether by pyramiding or otherwise, is almost as secure, as control through sole or majority ownership, though it involves very little ownership interest. Ofcourse, in case of failure, this control is lost, though it is only under the most unusual conditions that an individual or group in legal control of a prosperous business becomes so entangled in a situation that they can extricate themselves only by surrendering this control. 1.3 EXTRA LEGAL DEVICES OF CONTROL Untill now the discussion involving methods of control, has involved a legal status. In each case, factual control has rested primarily, on the more or less permanent possession of the legal power to vote a majority of the voting stock, though the control itself has been held with different proportions of ownership. At one end of the scale, ownership and control have been wholly combined, while at the other they are totally dissociated. Any degree of combination or separation might be arranged, with the control based on a legal status. In the typical large corporation, control however does not rest upon legal status. Here, control is more often factual, depending upon a strategic position secured through a measure of ownership, a share in management, or external circumstances important to the conduct of the enterprise. Such control is less clearly defined than the legal forms, is more precarious, and more subject to accident and change. It is, however, actual, capable of being exercised over a long period of years, and as the corporation becomes larger with widespread ownership, it tends towards a position of impregnability comparable to that of legal control, a position from which it can be dislodged only by a virtual revolution. As in case of legal control, factual control may also involve varying degrees of ownership, though never more than 50% of the voting stock. It may rest to a considerable extent on the ownership of large minority stock interest, or, when stock interest is widely distributed, it may lie in the hands of the
management. Though no sharp demarcating line can be drawn between the two they may broadly be categorized as minority control and management control, and each of these is briefly discussed below. A] Minority Control This type of control may be said to exist when an individual or small group holds sufficient stock interest within a corporation to be in a position to dominate it through their interest. Such groups are often said to have a working control of the company. Generally speaking, the control of such a group rests on its ability to gather sufficient number of proxies in their favour, which when combined with their substantial minority interest, is sufficient to control a majority of the votes at the annual elections. This automatically means that no other stockholidng is sufficiently large enough to act as a nucleus around which to gather a majority of the votes. This type of control is relatively difficult to maintain in a relatively smaller corporation with smaller stock holding. This is because a rival group may be able to purchase a majority of the stock or a minority large enough to attract the additional votes necessary, to obtain control in a proxy fight. But, larger the company and wider the distribution of its stock, the more difficult it appears to be to dislodge a controlling minority. The reason for this is very simple. The cost of mobilizing the votes of tens or hundreds of thousands of stockholders by circularizing them and perhaps conducting a publicity campaign, is prohibitive, that only the very wealthy can dream of seeking this method of seizing control from an existing minority. Despite its advantages, minority control suffers from a series of limitations - i.e., the possibility of an antagonist management. As long as the corporation functions smoothly, minority control may be quietly maintained over a period of time. But during a crisis or when the interests of the management and controlling group are in conflict, the issue may be drawn and a proxy fight to determine control may demonstrate the extent of dependence of the controlling group on the management. When such a fight for control begins factual power is once more dependent on legal power and the stock holders by their votes or their choice of proxy committees decide the issue. B] Management Control. The last type of control is that in which ownership is as widely distributed that no individual or small group has even a minority interest large enough to dominate the affairs of the company. In such situations, no shareholder is able to exert pressure upon the management by virtue of his holding, or to use his holding as a considerable nucleus for the accumulation of the majority votes essential for control. A shareholder has three alternatives to pursue during election of the board, namely, he can (i) refrain from voting, (ii) attend the meeting and personally cast his vote or (iii) he can sign a
proxy transferring his voting power to certain individuals selected by the management of the corporation, i.e., the proxy committee. Generally speaking, since a personal vote of the shareholder has little or no effect on the election unless he has a large shareholding, he is reduced to opt either for abstaining or going in for proxy voting, by giving his right to vote to individuals over whom he has no control and in whose selection he did not participate. In either case he cannot exercise any control. Conversely, control is in the hands of those who select the proxy committee namely the existing management. Where ownership is sufficiently sub-divided, the management can thus become a self-perpetuating body even though its share in the ownership is negligible. This form of control is called as management control [Sen, 36]. Though resting on no legal foundation, this type of control seems to be comparatively secure especially where the stock is widely distributed. This does not mean that in such cases, no possibility of revolt does exist. A group outside the management may seek control, and if the company has been seriously mismanaged, then, a protective committee of stockholders may combine a number of individual owners into a group which can successfully contend with the existing management and replace it by another, which in turn can be ousted by a revolution. 1.4 CONCLUSION Normally control is exercised quietly over the years without any active contest, which may result in the shareholder to choose between two rival factions. A shareholder mostly plays the role of a rubber stamp, though on occasions he may be in a position to support an effort to seize control, a position similar to the general population supporting a revolution. But, in either case, the ordinary shareholder has little power over the affairs of the company, and his vote is rarely capable of being used as an instrument of democratic control. The separation of ownership and control is total. The bulk of owners have in fact no control over the enterprise, whereas those in control hold only a negligible proportion of the total ownership. Sometimes factual control is not found in the hands of any single group. A controlling minority may be totally dependent upon the management, and similarly a controlling management may have to accede in some measure to the demands of a strong minority in order to maintain its measure of control. It is not unusual for two or more strong minority interests to enter into a working arrangement by which they jointly maintain control [something in the nature of a coalition government of minority political parties]; or a minority and management may combine as the control, or joint control. Corporate control thus appears in many forms relatively defined and stable legal positions, loosely defined and somewhat more precarious factual situations. Each form is not complete in itself, nor is it exclusive of others. Several methods may reinforce each other.
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2. CORPORATE MANAGEMENT
SUB TOPICS 2.1 Speciality of corporate management 2.2 Structure of corporate management 2.3 Evolution of corporate management 2.4 Position of Directors 2.5 Workers participation in corporate management 2.1 SPECIALITY OF CORPORATE MANAGEMENT Meaning of the Term In different parts of the globe, different words are used to designate the managerial setup. British firms and some American businessmen are accustomed to use the term administration, referring to activities, carrying out the policies laid down. Almost in the same meaning the word management` is used. Some of the multinational firms use the word executive`, meaning almost the same thing. A very clear distinction of these terms cannot therefore be underscored. In public service, people are more accustomed to the word administration` which refers to the persons responsible for the functions. Administration is that function of an enterprise which concerns itself with the overall determination of policy and major objectives. Administration sets forth the general purpose of the enterprise, establishes its major policy, formulates the general plan of procedures, inaugurates the broad program, and approves the specific major projects that fall within the general program. [Spriegel and Lansburgh, 1.9]. If one examines the corporate management, one would find that this is exactly what the top management of a corporation does. Theoretically speaking this task is assigned to a collective forum of management in a company set up, democratically designed and popularly and statutorily known as, board of directors`. One can also understand that a top executive of a modern company also does this. Management concerns itself with the direction and control of various activities to attain the business objectives. Management is essentially an executive function; deals particularly with the active direction of human effort [Spiegel and Lansburgh, 1.9]. Spiegel and Lansburg try to explain the term administration and management in terms of policy planning and execution. The following diagram explains the co-relation. In the above diagram, it is shown that higher the level of management, greater is the administrative power and fewer is the management power; whereas lower the level of management higher is the management power and fewer is the administrative power. A top level manager is entrusted with more of policy design and planning and devolution of appropriate authority to the lower scales of management who gets the various activities done with his direction and control. Therefore, the word corporate management here is used to signify the entire administrative and management process of a company. The American management schools have strengthened the idea of this wider context of meaning to the word management, including within it not merely executive functions but also the policy design and planning with strict criteria of objectives. Therefore, presently, the term management includes: i) determination of objectives; ii) designing the policy; iii) determining the plan of action; iv) stipulating the procedure; v) devolving appropriate authority to the lower level of management; and vi) receiving the accomplishment account and fixing the accountability. Corporate management is a team work. It has various levels of functions and co-ordinations. Accordingly, these levels are named as, (a) top management level (affixing the highest planner and executive for getting things done); (b) upper management level [who receives authority from the top management, divided into certain systematic alignment of functions like sales, purchase, secretariat etc. They are accountable for the total function under each alignment respectively to the top boss], (c) middle level management [who gets appropriate authority from upper management to make the details of plan of action, identify the actual grassroot level functionaries, arrange for the training of manpower, provide the adequate instruments and tools as required under the technology and allocate the task to the junior level management]; (d) lowest level management [they are the grassroot level managers who get the things done under supervisional control, and give the accomplishment report to their higher officials. Outcome of the 17th century, gradually redefined by refinement through succeeding statutes. It has been earlier stated in module 1, that by the requirement of huge capital and high technological development in the production processes, the company form of business organization came into being with distinctive characters, the most intricate amongst the being disassociation of ownership and management. In this form of business organization huge capital is collected from equally huge number of shareholders spread over a very wide geographical area. Most of them do not have competence for
Administration
Top Management
Management Lower Management 130

understanding the technology of production and technicality of distribution. Nor can they associate in taking a decision. Therefore, these vast number of shareholders do not possess any direct power of management. Gower, a famous British author, has explained the diminishing value of shareholders democracy in a corporate set up [Gower, 72]. We will be explaining this statement in more detail at the appropriate place. It will presently suffice to know that the management functions in its totality, as enunciated by Spiegel and Lansburgh, is reposed on separate statutory body. In a company, including corporations the statutory bodies are: 1. shareholders in the general meeting; and 2. board of directors. Whereas, the general meeting, specially the annual general meeting, shall have some identified or statutory powers respectively, the entire management power is vested with the board of directors by virtue of Sec. 291. It stipulates that the Board shall be entitled to exercise all such powers, and to do all such things, as the company is authorised to exercise and do. The Companies Act stipulates specific provisions for the following statutory management offices: a) Managing Director; (b) whole time director; (c) manager; According to Sec. 197A a company cannot appoint and employ more than one categories of management from (a) managing director and (b) manager. This is to stop a company from employing more than one type of managerial personnel simultaneously which is needless and expensive [Ramaiya, 1232]. Since Sec. 197A does not contain any other category, a company can have wholetime Director or Executive director with Managing Director or Manager. Besides, as the methods of management by a `director-in-charge or committee of directors or agent under a power of attorney have now come into vogue [Ramaiya, 1232] requiring broadening the scope of Sec. 197A. Presently the use of American terminology for managerial personnel, like President, Vice President, etc., has been adopted in many companies. The Company Law Department did not see any reason to object against the use these terms provide the company used these terms clearly in the Articles as to what they mean in so far as in the context of managing director and in the Companies Act. It is essential for the concerned company to make it clear to the prospective investors what such nomenclature means in terms of the conventional nomenclature of managing director, co-executive director etc., ordinarirly used by the Companies [Company News & Notes; Dec 2, 1963]. The department has also instructed Registrars to be watchful to ensure that all statutory provisions relating to managing directors are complied with by companies which designate the managerial personnel with American equivalent terminology.
SPECIAL FEATURES OF CORPORATE MANAGEMENT a) Division between ownership and management - the most important feature of corporate management is that the owners are not required to be the managers and vice versa. Ownership, known as shareholding, is looked at from the point of view of investment and not from the point of view of enterprise. People buy shares in a company expecting returns. With a higher probability of income they are ready to pay a higher price. So shareholders are not managers themselves. They elect persons with commercial prudence to the board of directors, who run the enterprise to give the owners of the shares higher returns. To become the director of the board, the Articles of association may prescribe certain qualification shares. But it is not an essential qualification for professionals to become whole time directors or employers to become whole time directors in the board. This issue shall be further discussed when we discuss about the qualification of directors. b) Professionalisation of management - Corporate management is now a high technical process which demands professionalism. Management schools from the whole world produce thousands of professional managers in order to run the corporate management at various levels. Professional managers themselves act as a profit centre and maximize the turnover and profit at every level. As a result, at the aggregate level, the productivity and services are increased. Had there been no separation of management from ownership, this professionalisation could not perhaps be so developed. c) Adaptation of technology - Corporate management is based upon the concept of specialization. It involves appropriate planning, proper delegation, development and motivation of human resources, optimal use of material resources followed by profits accountability. At every level there requires to be specialization. The whole process is ideal for micro-level technology-design and technology adaptation at the macro level. The present day technology has overtaken the conventional technology of the industrial civilization. The present day technology generally referred to as high-tech` is more a compatible management approach towards man and his machines, more so, a computer operator and his computer. This 'high-tech' technology requires a rapid development and absorption of information which is the bed-rock of modern scientific corporate management. d) Accountability - A corporate manager at present is fully accountable for whatever he does. He does not take cover under the shield of a principal in a principal-agent design of management. The members of the board of directors no longer function as the agents of the shareholder as they used to do in a joint stock company. As Gower has rightly pointed out that 'they are not mere creations of corporate democracy'. As a matter of fact the corporate management is a creation of an independent contract. As such, they are accountable for the net result but not reviewable on the basis of decisions they take. 131
Kuntz, Odonnel and Weihrich has outlined a system analysis to management in the following diagram. REENERGIZING THE SYSTEM MANAGERIAL TRANSFORMATION PROCESS INPUTS PART 2
PLANNING 1. Human 2. Capital 3. Management 4. Technological Nature of objectives; premising decision making stragegies; policies; effective inputs of
PART 3
ORGANIZING Nature of departmentalisation line & staff ; Decentralization committees & groups decisions; Effective organizing
PART 4
STAFFING Nature of selection of managers; appraisal of managers; Manager & organization development
PART 5
LEADING The human factor; motivation leadership; Communication
PART 6
CONTROLLING System and process of controlling; control techniques; control of overall performance; Effective managing
OUTPUTS
1. Products 2. Services 3. Profits 4. Satisfaction 5. Goal integration 6. Others
COMMUNICATION SYSTEM
1. Employees 2. Consumers 3. Suppliers 4. Stockholders 5. Government
6. Community 7. Others
External Variables 1. Opportunities 2. Constraints 3. Others
from the above figures one can understand the input and output analysis of the management system which comprises a transformation process through various stages. The concerned inputs necessary for a determined output of product services, profits and others are: 1. Human Resources, 2. Capital, 3. Management, and 4. Technology. The transformation process involves planning, organising, staffing, leading and controlling. Each of these stages have multiple functions. Management, as has been already indicated, is a total concept of organic functioning by a team to achieve a determined goal. 2.2 STRUCTURE OF CORPORATE MANAGEMENT Prof. Galbraith divided corporations into two groups for the purpose of study of corporate structures, Firstly, entrepreneurial corporations` which maintained the same classical structure and did not change over the years, and secondly, mature 132
corporations` which came to be known as giants of modern days. According to him these giant corporations are composed of series of concentric circles`. Galbraiths description of these giants in a series of concentric circles is a unique reading. According to him: It is more useful to think of the mature corporation as a series of concentric circles. The band within each pair of circles represents a group of participants with a different motivational system. In the more spacious bands at the outer reaches are the most numerous groups. Such in general is their motivational system that they are the most loosely attached. At the centre is what is now called the top management. There is the finest attachment. Between are the others. With this image in mind the motivational system of the various participants in the corporation can be much more intelligently considered. In the outermost circle in the mature corporation are the ordinary
shareholders. This for all practical purposes is a purely pecuniary association. The typical stockholder does not identify himself with the goals of the enterprise; he does not expect to influence these goals. He has a share in the ownership; normally his only concern is that it return him as much money as possible. If he can get more income or capital gain with equal security elsewhere, he sells and invests there. No group loyalty - no identification with the goals of the enterprise - normally prevents his doing so..... The relation to the corporation of the largest stockholders of General Motors, United States Steel, Standard Oil and like enterprises, with few exceptions, is equally impersonal... In the relation of the ordinary stockholders to the corporation is the present case of pecuniary motivation. The next inward circle is occupied by the production worker...He has no illusion that he can accept the goals of the organization as his own. Yet, in fact, motives are more complex. The worker, unlike the stockholder, lives in immediate daily association with the organization. This itself is inducement to identification; an individual comes to think to himself as an 'I.B.M. man', a 'Corning Glass man' or a 'Sears man'. The element of compulsion the association has needed, and therewith, this barrier to identification. The entrepreneurial corporation sought to maximize the return to the owners. The maximization of the pecuniary return of distant and presumably well-to-do persons was not a goal with which the ordinary worker, human nature being what it is, would be likely to identify himself. The more ambiguous or less visibly egoistical goals of the techno-structure
are less sharply in conflict with identification of the worker. Comparative security of tenure and the physically untaxing and, on occasion interesting, character of modern technological process also lower the barriers to identification... Next as one moves inwards, are foremen and supervisory personnel and the clerical, sales and other routine white collar personnel. There emerge at their inner perimeter the technicians, engineers, sales executives, scientists, designers and other specialists who comprise the techno-structure; beyond these at the centre are the executives or management. As one moves through these inner circles, identification and adaptation become increasingly important"(Galbraith, 62). Anyway, it has been rightly stated that the trend relating to dispersion of shareholdings has become an accepted part of corporations and the trend was continuing and intensifying...Sterility of the shareholder power was found to be an accepted and established feature of the modern corporation (Sen, 25). Adolf Berle very rightly observed that the activities of a modern corporation demonstrate the gradual erosion of even directors power, leave alone the shareholders, in the trend of the rise of the power of techno-structure. A Board cannot take any decision now a days, unless there is a thorough market study and a proper planning by the techno-structure. Shareholders have gone in the background. Berle pointed out how capitalism gallops though the capitalist himself is in the vanishing point. Let us see the general structure of management of an Indian Company. Executive Directors are whole time directors of the company
SHAREHOLDERS BOARD OF DIRECTORS MANAGING DIRECTOR CHAIRMAN
COMPANY SECRETARY
EXECUTIVE DIRECTOR WORKS
EXECUTIVE DIRECTOR PERSONNEL
EXECUTIVE DIRECTOR SALES
MIDDLE MANAGEMENT
MIDDLE MANAGEMENT
MIDDLE MANAGEMENT
MIDDLE MANAGEMENT
LOWER MANAGEMENT
LOWER MANAGEMENT
LOWER MANAGEMENT
LOWER MANAGEMENT
133
who generally rise from the ranks and are professionals. They generally take the assignment of top line executives of the company. Many of the Indian companies have now adopted the management structure of American companies. American
companies provide a positive role to the professional members of the Board who lead the whole team of managers to achieve a result. The management structure of General Motors is given below: Vice-Presidents are like Executive Directors. They hold the
SHAREHOLDERS
AUDIT COMMITTEE
BOARD OF DIRECTORS
BONUS & SALARY COMMITTEE
OPERATION POLICY COMMITTEE
FINANCIAL POLICY COMMITTEE PRESIDENT
EXECUTIVE VICE-PRESIDENT
EXEXUTIVE VICE-PRISIDENT
GENERAL STAFF
ADMINISTRATIVE DIVISION
OTHER OP. DIVISION
FINANCE LEGAL DIVISION
SENIOR EXECUTIVE MIDDLE EXECUTIVES
line-charge as the top executive in each division. In a number of companies Vice-President belongs to the Board as full member from the professional management. But Vice-Presidents may be invitees to the Board as well. 2.3 EVOLUTION OF CORPORATE MANAGEMENT Corporate Management has undergone a sea change in so far as structures, functions and responsibilities are concerned in the last hundred years. Management has become an important area of study and research. Managers started analysing issues related to their management functions from a multi-disciplinary point of view. Management systems started adapting several ways of analysis, specially from various behavioural perspectives. Emergence of industrial psychology, sociology and economics led management as a leading behavioural science. Let us see some of the noticeable changes in the corporate management in the recent times. i) It is now established that the chief executive job in every business (except perhaps the very smallest) cannot properly be organized as the job of one man. It must be the job of a team of several men acting together (Drucker, p.168). As a result most successful companies have chief executives 134
consisting several people. As a result the Standard Oil Company has the chief executive consisting of a fourteenmen Board of Directors composed entirely of full-time officials of the Company. General Electric has a Chief Executive team composed of President, and a number of Deputies and Vice-Presidents engaged in policy formulation and execution. Many other U.S. Companies like Dupont, New Haven Railroad, Union Carbide etc., have such type of management structure. The chief feature of this pattern of management is that full time members of the Board dominate the policy making. ii) Professionalization has gone down to the basics of management. No Board can take a decision on anything, far more in the complex area of marketing, finance and policy execution unless there are thorough research reports placed before them by some professionals. Professionalism is both inside and outside. Professionals dominate in the Board and Board takes decisions only on professional reports. iii) Committee functioning has become another structure adjustment in the present day management. According to Drucker members of the chief executive team who are charged with responsibility for company objectives must
work directly with the Board. One way to achieve this in a large company (applied in several of our large businesses with good results) in the formation of Board Committees in each major area of objectives, with the company office
charged with primary responsibility in that area acting as the Committee Secretary or Chairman. A common example of such a structure is given below:
SHAREHOLDERS BOARD OF DIRECTORS PRESIDENT

VICE PRESIDENT VICE PRESIDENT/ GENERAL MANAGER VICE PRESIDENT/ DIRECTOR: PERSONAL SECRETARY DIRECTOR SALES LEGAL COMMITTEE
FINANCE COMMITTEE
PLANT ADV. COMMITTEE
PERSONNEL ADV. COMMITTEE
SALES ADV. COMMITTEE
ADMINISTRATION ADV. COMMITTEE
WORKS MANAGER MANUFACTURING ADV. COMMITTEE
Each Committee is under the charge of an executive ViceChairman/Director. Though the modern tendency is for a functional and professional Board, Drucker suggested that The Board must be detached from operations. It must view the Company as a whole. This means that working executives of the Company should not dominate in the Board (Drucker, p.180). In several senses corporate democracy has been proved to be a myth. In corporate management the proof has been beyond doubt. Though directors were elected by the shareholders from amongst themselves initially before five decades, at present a director need not be a member of the Company. According to Drucker the Board will be stronger and more effective if it is genuinely an outside` Board... (Drucker, 180). The constitution of the Board has now become the task of the Chief Executives. Drucker has rightly pointed out the responsibility of constituting a really detached and independent Board to evaluate the functions of the Chief Executive, as the task of the function of the Chief Executive. He said it is one of the most important things the chief executive team can do, and one of the major conditions for its own success is discharging its job. Unfortunately at present, the Chief Executive in any Company, is indulging in appointing only psychophant directors (a critique termed them as Ji Hoojoor` directors). Corporate democracy is impossible to function due to (a) wide disposal of shareholders and sharedholdings; (b) shareholders disinterest to perform ownership functions, (c) blind faith on some industrial management houses and satisfaction on return`
on investment; (d) incapacity of the shareholders to manage affairs; (e) difficulty in organising the dispersed shareholders; (f) minimum alternative, and many other reasons. Corporate democracy is not only impossible to achieve, it is not desirable too as per the running philosophy of corporations. That is why, merger and take-overs are put as an enemy of the company and not simply of the existing management. No chief executive will like an active brand of shareholders. 2.4 POSITION OF DIRECTORS Gower has very rightly observed that a company remains an artificial person; its policy can be formulated and decided upon only by individual human beings, and can be put into effect and carried out only by human agencies. Since the Board of Directors formulates the policy and gives effect to the same and since all the assets or properties are put in the hands of the Board of Directors, there is often a confusion about the legal status of the Board of Directors of a company. Directors are described by judges as managing partners, agents or trustees. As for example, Selborne L.C. held in G.E.RLy Co. v. Turner [(1872) L.R. 8 Ch. app 149] that The Directors are the mere trustees or agents of the Company - trustees of the Companys money and property; agents in the transactions which they enter into on behalf of the Company. Master of the Rolls Jessel observed in Re. Forest of Dean Coal Co. [(1878) 10 Ch.D. 450] that ...they are commercial men managing a trading concern for the benefit of themselves and of all the shareholders 135
in it. They stand in a fiduciary position towards the company in respect of their powers and capital under their control. (a) Directors as Agents: The agency power of the Board of Directors of the Company is a statutory one in India. According to Section 291 of the Companies Act the Board of Directors of a Company shall be entitled to exercise all such powers, and to do all such acts and things, as the company is authorised to exercise and do, subject to the provisions of the Act. Under this section the Board has a general agency power. It can do any act which the company can do, to bind the company unless the Act itself prohibits it. The only difficulty of directors acting as the agent of the company, is how can an artificial body like a company appoint an agent ! Gower also raised the question and tried to resolve the dilemma by regarding the decisions of the majority of the company in general meetings as the acts of the company itself`. Directors therefore, act as the agents of the company. But it is to be noted that authority of the company is to be exercised not by individual director as the agent of the company but must be exercised by the Board. The Board, of course, may delegate its authority to a director in which case he acts as the agent of the company. Powers of the company to be exercised by the Board can be exercised by the Board: i) in its meeting, ii) with the consent of the company in general meeting, and iii) either in its meeting or through delegating the same to the Chief Executives. So any power that the company has, its Board can exercise unless the same is required to be done otherwise in view of a clear provision in the Statute. But an act which the company cannot do, cannot be done by the Board; it is ultra vires to the Company and the Board. In general principles of agency the agents power is not only to be within the competence of the principal but it has to be within the authorised power as well. So, an act intra vires to the company can be ultra vires to the Board. As for example, declaration of dividend cannot be done by the Board though the company can do it. In India, of course, these powers are statutorily restricted to be done by the general meeting of the company itself. As such, such powers are statutorily ultra vires to the Board. But generally speaking, all general powers including business and commercial powers of the company can be done by the Board. Powers which are statutorily to be done by the General Meeting cannot he delegated by the company nor can be ratified after the act is done by the Board. So in India excepting these statutory powers of the general meeting all other powers can be done by the Board. Of course by prescription in the Memorandum or Articles same powers can be restricted to be done by the General Meeting itself. Such powers could be delegated by the company to the Board by amending its constitutional documents. But an act ultra vires to the company cannot be authorised or ratified. The principles of ultra vires has been discussed in details earlier. It has been stated that some powers of the Board can be done by the Board in its meeting only. These powers are: i) to make calls [section 292(1)(a)]; 136
ii) to issue debentures or borrow money otherwise [Section 292(1)(b)&(c)]; iii) to invest companys funds and make loans [Section 292(1)(d)&(e)]; iv) to delegate the power to borrow [Section 292(1),(2),(3) and (4)]; v) to fill up a casual vacancy in the Board [Section 262]; vi) to appoint Managing Director or Manager a person who is Managing Director or Manager of another company (Section 297]; and vii) to invest in shares or debentures under the same management (Section 372). The Board can exercise the following powers only with the consent of the company in general meeting: i) to sell, lease or otherwise dispose of the whole or part of the undertaking of the company [Section 293(1)(a)] ii) to remit the debt due by a director [Section 293(1)(b)]; iii) to borrow in excess of capital and reserves [Section 293(1)(d)]; iv) to contribute to charities [Section 293(1)(e)]; v) to invest compensation amounts received in compulsory acquisition of any of its properties [Section 293(1)(c)]; and vi) to appoint sole selling agent [Section 294(2)]. All other powers of the company can be performed by the Board by delegating the same to Chief Executives. Directors are not merely agents because their duties are more serious than an ordinary agent. Gower applied general principles of equity to company directors and derived four principles to be observed. These are (1) that directors must act in good faith in what they believe to be the best interests of the company; (2) that they must not exercise the powers conferred upon them for purposes different from those for which they were conferred; (3) that they must not fetter their discretion as to how they shall act; and (4) that without the informed consent of the company, they must not place themselves in a position in which their personal interests or duties to other persons are liable to conflict with their duties to the company [Gower, p. 553]. (1) Acting in good faith: Directors are required to act in good faith towards the company in their dealings with the company and on behalf of the company. They should not use the companys money or other property or information or other matters in their possession in their capacity as directors, in order to gain any advantage to themselves at the expenses of the company, and if they make any profit for themselves or cause any damage to the company, they will be liable to make good the same to the company [Ramaiya, p. 668]. As for example, in Re W & M Roith Ltd [(1967) 1 WLR 432] the controlling shareholder and director entered into a service agreement with the company so that his widow was entitled to a pension for life after his death. No thought was given to the question whether the
contract was for the benefit of the company. It was held that the company was not bound by the agreement. The test of `whether the act is for the benefit for the company is specified in Charterbridge Corporation v. Lloyds Bank [(1970) Ch 62] as the `honest man in the position of a director of the company concerned could.... have reasonably believed that the transactions were for the benefit of the company. (2) Proper purpose: Gower distinguishes between an act done in excess of authority and act done for improper purpose. He rightfully observed that the former hardly seems to be a breach of the fiduciary duty of good faith; the latter is [Gower, p. 556]. If a director exercises his power for a purpose different from what he was required to take care of, the director may be liable personally. (3) Unfettered discretion: No director can delegate his discretion to others. Any agreement by directors to vote in a determined manner in a Board meeting is invalid. This guiding principle only means that directors have absolute freedom to take any decision freely in order to subserve the interest of the company. A director is not bound by any previous condition like I shall vote with the majority in the Board. Such an agreement is invalid. But that does not mean that a director cannot make a valid contract to take any further action in the Board meeting if that is necessary to make a bona fide decision in a prior contract for the interest of the company. Gower quoted the judgment of the Australian High Court decision in this respect. According to the judgment in Thorby v. Goldberg [(1964) 112 CLR 597], there are many kinds of transactions in which the proper time for the exercise of the directors discretion is the time of the negotiation of a contract and not the time at which the contract is to be performed .... If at the former time they are bona fide of opinion that it is in the best interests of the company that the transaction should be entered into and carried into effect, I can see no reason in law why they should not bind themselves to do whatever under the transaction is to be done by the board. The principle is o be applied to the best interest of the company and to the freedom of decision making by a director to subserve the interest of the company and not of a group of persons. (4) Resolution of conflicting duty and interest: The equitable principle of the common law is that directors must not place themselves in positions where there will be a conflict between their duty to the company and their self interest or duty to any other person. Such a situation can arise when in transactions with the company a director has a personal interest involved. Lord Chancellor Cranworth explained the principle in the most appropriate manner, thus: A corporate body can only act by agents, and it is, of course, the duty of those agents so to act as best to promote the interests of the corporation whose affairs
they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect..... So strictly is this principle adhered to that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into.... [quoted in Gower, pp. 559 - 60]. The issue comes clear on the question as to whether a director of a company can have any interest directly or indirectly, in the business of another competing institution. Gower critiqued the decision in Bell v. Lever Bros [(1932) AC 161] holding that it is impossible to support the view that a director cannot be restrained from acting as a director of a rival company. Gower observed: It has been held that the duty of fidelity flowing from the relationship of master and servant may preclude the servant from engaging, even in his spare time, in work for a competitor, notwithstanding that the servants duty of fidelity imposes lesser obligations than the full duty of good faith owed by a director or other fiduciary agent. How then, can it be that a director can compete whereas a subordinate employee cannot [Gower pp.571]. Lord Denning in Scottish Co-op Wholesale Society v. Meyor [(1959) AC 324] observed that one who is a director of two rival concerns is walking a tight-rope and at risk if he fails to deal fairly with both. Excepting in the case of whole time Director or Executive Director, a restriction against being appointed in two competing concerns as a Director is not legally possible. It is only provided in Sec. 299 of the Companies Act, 1956 that a director is under a duty to declare his interest in a contract with the company. The errant director is liable to be fined. In Guinew v. Saunders [(1990) 2 AC 663] the House of Lords decided that if a director fails to disclose his interest, the transaction becomes voidable at the option of the company and the benefits received by the director are recoverable by the company. Conversely, it is also suggested that if the interest is disclosed earlier, the transaction is not voidable and the personal benefit not recoverable. In the above case, declaration of interest prior to the transaction contracted for, was prescribed in the article. In the absence of that prescription, the situation cannot be different on the ground of fiduciary obligation of the director. The provision of Sec. 297 of the Companies Act is clearer than the provision of Sec. 317 of the English Act in so far as the following: i) that the English Act, 1985 contains nothing prejudicing the operation of any rule of law restricting directors from having an interest in transactions with the company but in the Indian law, except with a resolution specifically made by the Board in its meeting, no contract can be entered into by any director of the company or his relative, a firm in 137
which such a director or his relative is a partner, or a private company of which the director is a member or director for (a) the sale, purchase, or supply of goods and services and (b) undertaking the subscription of shares or debentures of the company. But the restriction shall not be operative if it is done in cash at the prevailing market rate and the trade is regularly done, and the service cost does not exceed in a year rupees five thousand; ii) that in the English Act, a prior declaration of interest is enough to make the contract binding, otherwise it is voidable. In Indian law the consent of the Board is to be obtained for the transaction, otherwise the contract shall be voidable at the option of the Board. Sec. 299 of the Indian Companies Act 1956, makes the disclosure of interest mandatory. He has to disclose the nature of his concern or interest at a meeting of the Board or personally by serving a notice. If a director fails to comply with the provision, he shall be punishable with fine upto rupees five thousand; iii) that according to Indian law, this disclosure rule does not apply to directors of a company who do not hold together not more than two percent of the paid up capital of the contracting company; iv) that the interested director is restrained from participating or voting in the proceedings of the Board [Sec. 300(1)]; v) that the company shall keep a register to record the contracts in which directors are interested specifying all stipulated information and the nature of concern or interest of the directors and the particulars of interest [Sec. 301(1)]; and vi) that where a company enters into contract for appointment of a manager or managing director in which any director has any concern or interest, the company has to disclose the interest of the concerned director to the members of the company within 21 days from the date of entering into the contract by sending an abstract of the terms of contract [Sec 302(1)]. Directors duties of care and skill as an agent of the company: The standard of care and skill that a director must exercise while functioning as an agent has been aptly identified in Re City Equitable Fire Insurance Co [(1925) Ch 407] thus: 1) A director is not required to exhibit in discharging his function any greater degree of skill than may reasonably be expected from a man of his knowledge and experience. 2) A director is not bound to give continuous attention to the affairs of the company. His duties are intermittent in nature while only attending the meeting of the Board or of any Committee. Though he is expected to attend these meetings whenever he is reasonably able to do, he is not bound to attend all such meetings. A director is justified in placing reliance on the officials of the company in the absence of any grounds of suspicion. He has to leave the execution of the policy in the hands of the officials and in the absence of any doubt, he may rely 138
on their action to be presumed to have been done within the statutory limit or as prescribed by the Articles. While examining the duties of directors as per the Indian law we will make detailed observations, but it is sufficient here to note that directors as the alter-ego of the company are required to discharge their duties bona fide and without any willful default. b) Directors as trustees: Directors are not ordinary trustees of the company in the strict sense of the term. But courts have often held them as trustees of the company by way of analogy in order to underscore the fiduciary relation with the company. In Re City Equitable Fire Insurance Co [(1925) Ch 407] it was rightly observed that to describe directors as trustees seems to be neither strictly correct nor invariably helpful. Directors are agents of the company with fiduciary relationship. This fiduciary capacity is the ground of confusion between the two institutions, viz., directors and trustees. Gower [at p. 551] explains these fiduciary relationship under two heads: (1) fiduciary duties of loyalty and goodfaith analogous to the duties of trustees (strictu sensu) and (2) duties of care and skill (differing fundamentally from the duties of normal trustees). Since directors have a special position vis-a-vis a corporate personality, they while acting as an agent of the company, have some fiduciary duties, such as, (i) duty to act bona fide (ii) duty to disclose self interest (iii) duty of unfettered discretion and (iv) duty to confine within the purposes of the company for which it was constituted. These duties are similar to the fiduciary duties of a trustee. Hence the issue. Directors have fiduciary relation with the company but not with the shareholders or creditors. The most appropriate decision is given in Percival v. Wright [(1902) 2 Ch 42]. Here, a shareholder approached a director offering his share to be sold to the director for a price. The director knew that there was a deal with another company for selling the entire concern at a higher value. The director purchased those shares. While holding that the director does not have any fiduciary relation with a shareholder, the court held that there is no question of unfair dealing in this case. The directors did not approach the shareholders with the view of obtaining their shares. The shareholders approached the directors and named the price at which they were desirous of selling. Had the director approached the shareholder urging upon him to sell those shares at a price to facilitate amalgamation, they would be accountable to give back the profit made on those shares from the amalgamating shares. Here the directors would be acting as agent of the shareholders as well [Allen v. Hyatt (1914) 30 TLR 444]. Directors while giving advice to the shareholders in a take-over situation have a fiduciary duty to act in good faith [Frudential Assurance Co Ltd v. Newman Industries Ltd (No. 2) (1980) 2 All ER 841]. Is Company Director an officer of the company: According to Sec. 2(30) officer of a company includes directors. But the director of a company cannot be called as an officer of the
company in the sense that director of a company is not an employee. Justice Romar rightly described the position of the director as the prudent businessman of trust elected by the shareholders to function for and on behalf of the company. A director elected in the Annual General Meeting (AGM) of a company is said to be appointed by the company. In so far as the liabilities are concerned under the Companies Act, a director of the company shall be liable as if an officer of the company though he is not an employee. 2.5 WORKERS PARTICIPATION IN MANAGEMENT (COMPANY LAW PERSPECTIVE) Companies Act 1956 does not include anything directly regarding workers participation in management. According to Article 43A [inserted by the Constitution (42nd) Amendment) Act 1976 vide s.9] of the directive principles of State policies contained in Chapter IV of the Constitution of India, the State shall take steps, by suitable legislation or in any other way, to secure the participation of workers in the management of undertakings, establishments or other organization engaged in any industry. The frame of this basic principle of workers right to participate in the management is generic in nature which includes all enterprises both in the public as well as in the private sector. But ever since 1976 not much has been done in this regard. Some of the Banking Companies have such type of provision to allow employees participation in management. As for example, according to sec.19 of the SBI Act, one director is to be nominated by the Central Government from among the employees (a provision inserted by Act 48 of 1973). In some financial institutions like IDBI such a provision does exist. But in so far as the companies Act is concerned, there is no general or particular provision for this. Indirectly, there are certain provision for the employees to enable them to become shareholders of the company and then possess right to participate in the management. Some of these provisions are given below: (1) According to sec. 77(2)(b) a company may give directly or indirectly financial assistance in accordance with any scheme for the purchase of fully paid up shares in the company or its holding company to be held by or for the benefit of the employees of the company. Such a provision shall not be hit by the general provision to restrict power of the company to buy its own shares or to assist in buying own shares. (2) While placing the Finance Act, the Finance Minister announced the opening of Stock Option Scheme (SOC) that while proposing a further issue of capital, they should make a reservation of 5 percent of the further issue to their employees/workers on an equitable basis. In the case of public issues, shares not taken up by the employees/workers may be issued to the public. In case of right issues an additional offer has to be made simultaneously with the
offer to the shareholders at a price fixed. Unsubscribed portion by the workers wont lapse if not taken up by the employees. Sec. 81 of course require special resolution for issue of a right share in any other manner other than to the existing shareholders on equitable basis. Such a resolution should be produced for reservation to employees while submitting the proposal. Where loans or advances have been given to the employees/ workers by the company to buy shares under Stock Option Scheme, the shares issued may be hypothecated against such loans, to the company. Prior approval is necessary for such arrangement. Guidelines were issued for the purpose of allowing the Stock Option Scheme under Employees Convertible Debenture System. The guidelines are as under: 1) The scheme is extended to all public limited companies. 2) It is a voluntary scheme both for employer and employee. As such employer can offer share to his employees and employees can take the same. 3) It is applicable to all regular/permanent employees. 4) Employees would be given three options of saving at three different rates (say Rs.500, Rs.1000/- and Rs.2000/- per amount) under the savings cum SOS. It shall be for a period of 5 years. 5) At the start of the operation of the scheme, a convertible debenture is to be issued which shall earn maximum rate of interest under the guideline by CCI. 6) On completion of the 5th year, the ECD (Employees Convertible Debenture) shall be converted into equity shares at a price to be determined in the year in which the scheme is introduced. According to CCI share price can be 80 percent of the average market price of the share or the fair value as determined by CCI, which ever is less but can not be less than the face value. 7) The total number of shares which an employee can get depends upon the total equity the company is willing to offer under ECD scheme. If the employees option exceeds the number allowed by the company, the company has to issue shares on the basis of pro-rata and the balance of the ECD is to be returned in cash. 8) The equity shares issued against the ECD scheme are not transferable within 3 years from the date of issue. 9) No employee can obtain more than 50 shares of Rs.100/each or 500 shares of Rs.10/- each. According to SEBI guideline dated 11-6-1992, it is voluntary on the part of the company to encourage employees to have higher participation in the equity of the company. Suitable percentage of reservation can be made subject to maximum of 5%. Participation upto maximum of 200 shares is permitted subject to theses being non-transferable for a period of three years. It therefore means that SEBI has kept the old CCI 139
guidelines in operation. Similarly SEBI guideline of 11-6-1992 sec. H(1)(a) provides that reservation to employees of the company (including Indian directors) is permitted subject to a ceiling of 5% in a public issue. These are provisions to encourage the employees participation in the stockholding and an indirect way of provoking employees to participate in the management. In a wider context, professional management is possible only when managers are employees. The present constitution of Board of Directors allow employees to become members of the board
and they are not required to have qualification shares. At top management level only employees become members of the Board. Democratization at the level of employees to elect some members in the Board is not what is contemplated under the present form of legal prescription. At the lower level of management, there are provisions in labour laws (say, Factories Act) for workers to participate. As for example, workers representatives are required to be in Works Committee. In all provisions regulating collective bargaining there is provision for workers participation. But there is no such concept of management under the Corporate Law.
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3 BOARD OF DIRECTORS
SUB-TOPICS 3.1 Constitution 3.2 Appointment 3.3 Retirement 3.4 Removal 3.5 Remuneration 3.6 Compensation for loss of office 3.7 Powers 3.8 Duties 3.9 Disabilities 3.10 Liabilities of the directors 3.1 CONSTITUTION OF BOARD OF DIRECTORS The Board of Directors of a company can be only a policy making organ or a policy-cum-control function organ. Most of the British companies have policy making Boards who keep it as far as practicable, away from day to day executive functions which are given to the top executive of the company, generally known as a Managing Director or a Chairman. American companies on the other hand, keep a Board which is both the apex policy making and controlling body. Professional executives play a very important role in the Board itself. They place reports on various issues like marketing, material purchase, human resource development and utilization etc., and help the Board to formulate policies. The team of whole time directors take responsibilities of control functions. Indian companies are in the transition specially after the abolition of the Managing Agency system with effect from 1960. Under the Managing Agency system the company used to contract the management out to an external agency who was given the responsibility of the top executive as well as dominative authority in the constitution of the Board. This is now a matter of the past. At present a Board in India is constituted with Directors, both whole time and part time; a Managing Director/Chairman, institutional Directors, additional directors and nominated directors. (i) Managing Director: Sec 2(26) defines a managing director as a director who is entrusted with 'substantial powers of management' and includes a director occupying the position of a managing director, by whatever name called. He exercises such powers subject to the superintendence, control and direction of the Board of Directors. Such an appointment and entrustment of power can be done by virtue of (i) an agreement or (ii) a resolution in the general meeting or by its Board of directors or (iii) by virtue of memorandum or Articles of Association. But specific powers entrusted to a Director to affix the common seal, draw and endorse cheque or any negotiable instrument or sign a certificate of share, do not mean substantial powers of management by virtue of those specified powers alone. A chairman of a company performing this substantial powers of management is deemed as the managing director. (ii) Whole time Director: Whole time directors are employees. They are professional directors who are also called executive directors or Vice Chairman in charge of operations. In some companies, these whole time directors are invitees to the Board or are non-voting members. In other cases they have equal responsibilities to participate freely in the board meetings. Though whole time directors are now an established feature, yet the Companies Act has neither defined the term and position nor it has provided for any special position excepting including an explanatory note to Sec. 269(1) explaining whole time director as a director in the whole time employment in the company. He is an employee of the company and he discharges such functions as may be assigned to him by the Board or the Managing Director. These whole time directors are not elected members of the Board and are not liable to retire after three years in the office. Whole time directors get salaries. Though the rationality of it can be questioned, but the approval of the Government is required for appointing a managing Director or a whole time director of a public limited company or a private limited company which is subsidiary of a public limited company. The approval is granted only when such a appointment is to the interest of the company and the person so appointed is a fit and proper person and his appointment is not against public policy. The terms and conditions are also required to be reasonable [Sec. 269(3)]. Then directors are not required to hold the qualification shares as may be prescribed in the Articles of the company. (iii) Elected Directors: Elected directors are those who are elected by the members to the post in every annual general meetings (AGM). They are part time directors who are to attend the Board/Committee meetings and devote some time to do some specific things in relation to the management of the company. The definition given to director in Sec. 2(13) is inclusive of any one occupying the position of director, by whatever name called. These directors are entitled to sitting fees for attending the meetings and such other remuneration as may be stipulated by the Articles of the company. (iv) Institutional Director: Institutional Directors are those who are nominated by the institutional members such as LIC, UTI, IDBI, IFCI or SFC. These institutional members are either mutual funds or development and industrial banks supplying equity capital to the company. These members are not required to acquire qualification shares as may be prescribed by the Articles, nor are they required to retire by rotation. (v) Nominated Directors: Institutional directors are all nominated directors and not elected. Sometimes, commercial banks or government may nominate a director in the Board for the supply of loan capital or infra structural facilities or for any other reasons including public policy. These nominee directors also do not retire. 141
(vi) Worker Director: If Articles so provide, workers may nominate/elect their representative on the Board. Though ensuring workers' participation in management is a directive policy of the State as stated in Art of the Constitution of India, yet there is nothing in the corporate law to insure such representation. The company may ensure such a representation by its Articles. (vii) Manager: In Indian law there is hardly any definitional distinction between a managing director and a manager, both being the chief executive of the company excepting that a Managing Director is himself a director, to be precise, the leader of the Board of directors, whereas a manager may or may not be a director, Sec. 2(24) of the Act defines a manager as an individual, who subject to the superintendence, control and direction of the Board, has the management of the whole, or substantially the whole, of the affairs of the company, and includes a director or any other person occupying the position of manager by whatever name called, and whether under a contract of service or not. Thus the definition is very wide and denotes the top executive position of the company. He has to be an individual and not a firm or a body corporate. Here the manager is different from the managing agent who used to be running the management of a company before 1970. (viii) Additional Director: An additional director is one who is appointed by the Board to hold the position upto the date of the next AGM of the company. In Krishna Prasad Pilani v. Colaba Land & Mills Co [(1959) 29 Com. Cas. 273] the court held that the meaning of the clause upto the date of the next Annual General Meeting of the company' means upto the date when the next annual general meeting ought to be held at the latest as per Sec. 166 of the Act. As such, additional directors hold office only for a maximum period of time between one AGM to the next AGM. This power is given to the Board subject to the fact that the total number of members of the Board including the additional director so appointed does not exceed the maximum strength fixed for the Board by the Articles of the company. (ix) Alternate Director: The Board may appoint an alternate director if so authorized by its Articles or by a resolution in the general meeting in place of the original director who remains out of the State for a period longer than three months. The alternate director cannot therefore hold office for a period longer than that permissible to the original director [Sec. 313 of the Act]. 3.2 APPOINTMENT (I) Managing Director/Whole time Director (a) General principles: Companies (Amendment) Act, 1988 has rewritten the whole of Sec. 269 concerning the appointment of these officials. According to Sec. 269(1), every public company, or private company subsidiary to a public company, having a paid-up share capital of such sum as may be prescribed, shall have a managing director or a whole time director or a manager. No such appointment shall be made so without the 142
approval of the Central Government unless such appointments are made in accordance with the conditions specified in Schedule XIII. Schedule XIII, Part I relates to some additional qualifications which shall be explained afterwards. Part II relates to remuneration. Part III relates to provisions applicable to Part I and Part II. (b) Qualification: There is no positive qualification prescribed in the Act. In Schedule XIII of course, the following positive qualifications are included; (1) He has to be one resident-inIndia or one who is in India for not less than twelve months immediately preceeding the date of appointment and who has come to stay in India for taking up employment or carrying on business or profession in India; (2) He must have completed the age of twenty five but not attained the age of seventy or the age of retirement a specified by the company; and (3) If a managerial person in more than one company, he has to opt for drawing remuneration from only one company. Sec. 267 provided for three negative qualifications. A person so appointed (1) cannot be an undischarged insolvent; or (2) he must not have suspended payment to creditors or made any time any composition with them; and (3) must not have been convicted by a court of an offence involving moral turpitude. Part I of Schedule XIII included two more negative qualifications: (1) he must not have been imprisoned or fined in a sum exceeding one thousand for an offence under any of the fifteen economic legislations including the Stamp Act, Foreign Trade Act, Essential Commodities Act, Income Tax Act, and Wealth tax Act; and (2) must not have been detained under COFEPOSA. Sec. 316 provides for another negative qualification. Accordingly a person who is managing director or manager of any other company cannot be appointed as such in any public limited company or in a private limited company subsidiary to a public limited company. If such a person is required to be appointed, the Board must take a resolution with the consent of all the directors present in the meeting and this meeting requires a special notice to be convened. If a person is appointed in more than two companies as managing director or manager before the commencement of the Act, he has to opt for only two. The Central Government may permit any person to be so appointed in more than two companies provided it is satisfied that it is necessary for the proper working and functioning of the companies as a single unit. The basic philosophy behind these provisions is that the top executive of any company must be a professional though in letter such a qualification is not stipulated. The emphasis is given on the whole time need of the company for the managerial leadership. It is also emphasized that the corporate managerial service has to attach individual responsibility and accountability unlike the managing agency system. The managing agents existed prior to 1970 were not employees of the company, nor were they personally accountable. Besides there were no restrictions on the number of assignments, term of office as well. There were no prescriptions on qualifications and terms for the managing agent.
The general qualification prescribed for a director is also applicable to the managing director because he is a director first. According to Sec. 253 no body corporate, association or a firm can be appointed as the director of a company. So, these bodies cannot be appointed as managing director or manager as well. (c) Who can appoint: A managing director is firstly a director. He is appointed as a director in the shareholders meeting. The Companies Act does not include any particular method of appointment of a managing director excepting as mentioned in Sec. 316(2). It is statutorily provided that a managing director is to be appointed by the Board. In a given situation if a person who is already a managing director of another company, he can be appointed by the Board with consent of all directors present. The Act otherwise empowered the board to be entitled to exercise all such powers, and to do all such acts and things as the company is authorized to do. The board is therefore empowered to appoint one of the directors as the managing director. If the board thinks that a professional/technical man is to be appointed as the managing director, he is first required to be appointed as an additional director under Sec. 260 or as a director in the general meeting under Sec. 255 and then appointed/employed by the board as the managing director. Irrespective of the terms of appointment as the managing director, as soon as the person ceases to be director he also ceases to be the managing director. According to letter No. 8/212(60) dated 17th March, 1977 written by the Department of Company Affairs [Ramaiya, 635] to the Institute of Company Secretaries and Administrators of India Association, Calcutta, if such a person while he was additional director of a company has been appointed as the managing director, the latter appointment also ceases simultaneously with the cessor of the directorship at the commencement of the AGM. However, if such a person is reelected as a full-fledged director at the AGM, he continues as a director of the company, and he shall continue as a managing director also for the period for which he is so elected by the AGM and for the period for which his appointment has been approved by the Central Government under Sec. 269". Directors are representatives of the shareholders and as such, are required to be elected in the AGM (excepting nominated, and additional directors). But a managing director is an appointed employee of the company and, therefore, he is required to be appointed by the Board unless the Articles of Association provide otherwise (II) Directors a] General principles: According to Sec. 252, a public company should have a minimum of three directors and a private company (which is not a subsidiary of a public company) should have a minimum of two directors. The Articles of a company may prescribe a different minimum but this cannot be less than three the statutory minimum, i.e., the Articles of a public company may prescribe that the minimum number of directors should be five, but in no case can they prescribe that the
minimum, number of directors of a public company will be two. Further, only natural persons can be appointed as directors, i.e., corporate bodies, associations, firms etc., cannot be appointed as director of the company, though such bodies may be the members of a company. Generally, the subscribers to the memorandum become the first or initial directors of a company, till the election of regular directors under Sec. 255E [s. 254]. But, this provision can be negated, by some specific provision in the Articles of a company, i.e., the Articles may make some provision for the appointment of the first directors by naming certain specific persons. A public company usually has two kinds of directors - whole time directors and directors who are liable to retire by rotation. According to Sec. 255, a minimum of two-thirds of the total number of directors are to retire annually by rotation. This retirement and subsequent election to fill up the vacancies takes place in the AGM of the company. The other directors of the company are also appointed in the general meeting. The basic objective of this section seems to be to give the owners of the capital (i.e., the shareholders) a real and substantial say in the appointment of the management of the company, since in the appointment of the first directors they usually do not have any say. The first directors do not automatically become eligible for reappointment, though they have to retire en masse in the first AGM of the company. Sec. 255 does not apply to companies whose Articles provide for the retirement of all directors of more than two-third of them retiring. It only provides for a statutory minimum which can be increased by the Articles. When 2/3rd of the directors are required to retire by rotation, the remaining 1/3rd may be required to retire or may be permanent. The identity of this 1/3rd of the directors may either be specified by their names [ex. Mr. X and Mr. Y shall be wholetime director......] or by designation [ex.The Chairman shall be whole-time director.......]. Where no specific provision has been made in the Articles regarding this 1/3rd of the directors, they are presumed to be non-retiring or permanent. Sec. 255 does not apply to a Government Company, i.e., a company whose entire share capital is held by the Central or some State Government(s) or both, and to private companies. The directors who retire by rotation are the senior most in the company, but if two directors join service on the same day then a lot is drawn as between these two to decide on the name of the person required to retire by rotation. The vacancy created by such retirement is as far as possible filled up in the same meeting, by electing new directors or reelecting the retiring directors. Each director seeking appointment shall be voted for individually i.e., there is no collective voting for appointment of directors i.e., if X & Y are to be appointed as directors then, each will have to be appointed by voting on separate motions, ex. that X be appointed as a director and that Y be appointed as a director. A common motion in the form of that X & Y be appointed as directors will be invalid. Voting is in the first instance by a show of hands, and 143
a poll is taken only if requested by the some member or the Chairman feels it necessary to take a poll. If for some reason, a director is not appointed in the meeting, the meeting is adjourned, to be reconvened on the same day and time a week later. If even in the adjourned meeting an appointment is not made, nor is a resolution passed that the vacancy caused by the retiring director shall not be filled up, then, according to Sec. 256(4)(b), it will be presumed that the retiring director has been reappointed, unless (i) such retiring director had sought to be re-elected but lost the election in the reconvened meeting or prior meeting; or (ii) the retiring director has given in writing that he is unwilling to act as a director; or (iii) he is either not qualified or has been disqualified form acting as a director; or (iv) a resolution either ordinary or special is required for his appointment or reappointment, by virtue of some provision under the Act; or (v) the proviso to Sec. 263(2), stating that no provision for the automatic reappointment of the retiring director in default of another appointment shall apply, applies to his case. A person cannot be appointed as a director unless he expresses his willingness to act as such in writing and submits it to the Registrar. Further, if the Articles provide for a director to have a prescribed number of qualification shares before being appointed as a director, a person not possessing such shares cannot be appointed. In other cases, a director can become disqualified from acting as such if he fails to acquire the requisite shares within the prescribed time limit. Sec. 265 provides that, a company through its Articles may provide for the appointment of 2/3rd of its total number of directors according to the principle of proportional representation either through means of single transferable vote, cumulative voting or otherwise. The appointments in such cases are made once in three years and, if any vacancy occurs in between, it can be filled byfollowing the procedure u/Sec. 262. The basic requirement of this section is that the shareholders are given a proportional representation, whatever the method of voting be. Hence, directors cannot be chosen for certain qualifications, like regional, ethnic, biological, economic background, by giving a wide interpretation to the phrase 'or otherwise' in the section. This phrase has to be read ejusdem generis with the phrases single transferable vote or cumulative voting, and cannot be interpreted to suit the needs of the situation. Single transferable vote: Here, the names of all candidates contesting the election are noted on the ballot paper, with each person having one vote only. The member has to indicate his choice in order of preference, with the person he prefers most ranking first till he has covered all the candidates. The election of a candidate is based on a certain number of votes known as quota being received by the candidate. The quota is arrived at by dividing the total number of votes polled by number of 144
candidates to be elected plus one and then adding one to the result so arrived at. Thus, any candidate who gets votes equal to the quota is elected. Surplus votes received by him are then transferred to the other candidates. Cumulative voting: In this, the total number of votes cast would equal the total number of shares multiplied by the total number of directors to be elected. Thus if there are 500 shares and 10 directors to be elected, the total number of votes cast would be 500 X 10) 5000. A candidate getting 500 votes would be declared elected. Suppose, the minority faction holds 10% shares i.e. 50 shares, total votes cast by the minority would be 50 X 10 = 500, i.e., their representative gets elected if all of them vote in his favour alone. This method of proportional representation though highly democratic is capable of being abused by the 1/3rd faction of directors who are not subjected to this voting because they may see to it that atleast 1/ 3 of the remaining 2/3rd chosen by proportional representation are also their representatives, i.e., in effect they have the entire board in their control with 2/3rd majority (1/3 + 1/3) and can run the company according to their own whims and fancies. (B) Qualifications of Directors The Companies Act has provided three types of regulations of the qualifications of directors, viz., (1) Share qualification (2) Disqualification (3) Restrictions on appointment of directors (1) Share qualification: The qualification for a director is prescribed in the Articles of Association. Article 66 of Table A, Sch. I, for example, provides for a share qualification for a director. According to Sec. 270 every director has to hold a qualification share as mentioned in the Articles of the company or, in case he does not already hold it, he must acquire it within 2 months of his appointment as a director. Sec. 270(4) stipulates that holder of a share warrant shall not be deemed to be the holder of the shares specified in the warrant. Qualification shares as prescribed by the Articles of Association cannot exceed a nominal value of Rs.5000/- taken together; where the nominal value of a single share exceeds Rs.5000/- the Articles cannot prescribe the holding of more than one qualification share as the basic requirement to qualify as director. The Articles cannot also stipulate that a director must possess the qualification share before his appointment or within a shorter time than 2 months of his appointment. Such a provision shall be treated as void u/ S270(2). If a person does not hold the prescribed qualification share even after the expiry of the said 2 months period, he shall be punishable with a fine to the extent of Rs.50/- per day from the day of expiry of time [Sec. 272]. The resolution of the board of directors shall not be vitiated merely by participation of a director whose appointment has become invalid due to the absence of his qualification shares [Sec. 290]. But a director acting singularly under some power delegated to him and continuing as such even after the defect/disqualification is pointed out shall compensate the company in an action for damages (if any). Only individuals can hold the office of
directors, i.e., a body corporate or firm can not be appointed as a director. (2) Disqualifications: No person can be appointed as a director if (i) he is found to be of unsound mind by a court of competant jurisdiction and continues to be of unsound mind; (ii) he is an undischarged insolvent; (iii) he has applied to be adjudicated as an insolvent and his application is pending; (iv) he has been convicted by a court of an offence involving moral turpitude and has been sentenced to imprisonment for a period not less than 6 months and five years period has not elapsed from the date of expiry of the sentence; (v) the court has passed an order disqualifying a person from being appointed as a director under Sec. 203; or (vi) he has not paid the call amount within 6 months from the day fixed for payment of that amount. A private limited company which is not a subsidiary of a public company may by its Articles prescribe any other disqualification [Sec. 274]. (3) Restrictions on appointment of directors - According to Sec. 275 no one can hold the office of director in more than 20 public companies simultaneously. If a person who is a director in 20 companies already accepts appointment as director in another company, the new appointment shall not take effect unless he effectively vacates his office of director in some other company with in 15 days, and on his failure to do so, at the expiry of such 15 days the new appointment shall become void [Sec. 277]. Of course such a director can hold the office of director in private or unlimited companies or Sec. 25 companies i.e., those not engaged in carrying on business for earning of profites, without attracting this provision. He may also hold the position of alternate director in excess of 20 companies. No person can be appointed as a director or a proposed director through Articles or Prospectus unless by himself or by his authorized agent he gives his consent in writing, and the same is filed with the Registrar and either - (i) signed the memorandum for shares not being less in number to the qualification shares prescrbed or paid their value; or (ii) taken the qualification shares or has agreed to take; or (iii) signs and files with the Registrar an undertaking to take the qualifcation shares and pay for them. or (iv) filed with the Registrar an affidavit that the qualification shares are registered in his name (Sec. 266). These restrictions are not applicable in the case of a private company or a company not having a share capital or where a prospectus has been issued by the comapny after the expiry of 1 year from the date on which the company was entitled to commence business. (c) Who can appoint the directors (i) The members of the first Board of directors are usually appointed by Articles of Association or by the Prospectus. In the absence of the same, the signatories of the Memorandum become the members of the first Board of Directors [see Sec. 255]. (ii) Unless the Articles provide that all directors shall retire in every AGM, not less than two third must retire in every AGM they are known as Directors by rotation. The directors shall retire by rotation on the basis of seniority
i.e., on the basis of date of appointment. In case two directors are appointed on the same day and one is required to retire, the selection shall be made either on the basis of agreement or by lot. These directors are elected in the AGM by the shareholders. The retiring directors may be reappinted. So in course of time at least two-third of the members of the Board will be appointed by the shareholders. (Sec 255-256). (iii) Non-retiring members of the Board are nominated members of the institutional investors or the central government. They are also qualified to be appointed to the seats of the retiring members to be elected by shareholders. Ofcourse, the nonretiring members do not retire in the ordinary way. They hold office at the pleasure of the institutions nominating them. (iv) Casual vacancies may be filled by the Board of Directors subject to regulations in the Articles (Sec 262) such a director appointed in normal vacancy shall hold office during the unexpired part of the original director in whose place he is appointed. Additional directors are also appointed by the Board of Directors subject to the regulations in the Articles, who shall remain in office until the next AGM (S. 260). (III) Appointment of Manager Under Sec. 2(24), a manager is a person who has been entrusted with the whole or substantially the whole of the affairs of the company and who works under the supervision and control of the Board of Directors. Under S.3 the Act, a company may have only one manager, though it may have more than one managing or whole time director. The reason for this restriction is that, an MD is entrusted only with a substantial powers of management, whereas a manager is entrusted with the management of whole or substantially the whole or the affairs of the company. It logically ensues that, two or more persons cannot be entrusted with whole/ substantially the whole affairs of the company, because then the affairs entrusted to each one of them would neither be the whole nor substantially the whole of the company's affairs. Sections 384-386 relate to the appointment of a manager and are mostly by way of being negative conditions, i.e., they basically specify as to who cannot be a manager rather than who can be appointed as a manager. A person may be appointed as a manager if: (1) he is an individual, and not a firm etc.; (2) he is neither an undischarged insolvent nor has been within the preceding 5 years ever been adjudicated an insolvent; (3) he has not suspended payment to his creditors nor has he at any time in the preceding 5 years suspended such payment or arrived at a composition with his creditors; (4) he has not been convicted of any offence involving moral turpitude in the preceding 5 years period; and
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(5) he is not employed as a manager or the MD of any other company unless a unanimous resolution of his appointment is passed by all the directors present in the board meeting, a notice of which along with the intended resolution has been circulated amongst all the directors present in India. A peculiar provision relating to appointment of a manager is the special powers given to the Central Government, viz.: Sec. 385(2) The Central Government may, by notification in the official Gazette, remove the disqualifications incurred by a person in items 2,3, and 4 above. Similar to the power of the Central Government to appoint a MD for more than 2 companies, is the power of the Central Government to appoint managers for more than 2 companies u/ Sec. 386(4), provided that the Central Government is of the opinion that such companies would work better as an integrated unit under the managership of one person. 3.3 RETIREMENT The Companies Act speaks about 2 types of retirement, as well as vacation of the office on specific grounds. The two types of retirement are : (1) retirement by rotation, with a right to reelection and (2) permanent retirement. Sections 280-282 dealing with retiring age of directors were omitted by the Companies Amendment Act, 1965 on the logic that the age of retirement should be left to the institution concerned. So age of retirement may now be regulated by internal rules vide the Articles. In so far as the general principles are concerned, the Amendment Act dispensed with the regulatory stipulation. Presently atleast twothirds of the members of the board of directors are required to be filled up by directors retiring by rotation. At every annual general meeting of the company atleast one-third of the members or nearest to one-third shall retire from office on the basis of seniority i.e. the date of appointment. In case two directors were appointed on the same day the retirement is to be determined either by agreement or by lot. The retiring director may be re-appointed. If the place of the retiring director is not filled up and the meeting has resolved expressly not to fill up the vacancy, the meeting shall stand adjourned till the same day next week, at same time and place. If the adjourned day is a public holiday, then to the next day. If in the reconvened meeting also the position can not be filled up and there is no specific resolution for not filling the vacancy the retiring director is deemed to be re-elected, unless the reappointment has been put to vote and lost or the retiring director expresses his unwillingness to be re-appointed or he is disqualified or a specific resolution required for the purpose under the Act could not be passed. The other type of retirement is by vacation of office in any one of the following cases, viz: i) not fulfilling the conditions u/Sec.270 (i.e. failure to acquire qualification shares); or ii) becoming disqualified u/Sec.274 (for example, due to unsoundness of mind, insolvency, etc.); or 146
iii) violating the provision of Sec.295 (i.e. extending loans to directors in contravention); or iv) acting in contravention of Sec.299 (i.e. the director not disclosing his interest when asked for); or v) becoming disqualified u/Sec.203 (i.e. on account of being convicted of an offence as mentioned); and vi) removal from office u/Sec.284 In all the above cases as laid down in Sec.283 the position becomes vacant by compulsion and of law not retirement. One should not therefore confuse between retirement and vacation. 3.4 REMOVAL Removal of a Director The general principle that the authority which appoints also has the right to remove also holds good in the case of appointment & removal of directors. Sec. 284 gives the general body of shareholders the right to remove any director by passing an ordinary resolution, unless the said director is one who has been appointed by the Central Government u/Sec. 408. This section also does not allow the removal of a director holding office fir life in a private company, nor does it apply to a public company which has adopted the mode of appointing 2/3rd of its director by means of proportional representation. The ordinary resolution to remove a director needs a special notice, which has to be given to the concerned director also, so that he gets an opportunity to prepare a reply to that resolution, and speak to the shareholders at the meeting. In Escorts Ltd v. Union of India [(1985) 57 Comp Cas 241 (Bom)], it was held that, a directors right of representation would be a mere formality if the director does not know the grounds on which he is sought to be removed, because he will not then know as to what representation he should make. So, the notice of the meeting must be accompanied with a copy of the resolution alongwith an explanatory statement, so that, the remaining body of shareholders also come to know of the reasons as to why a director elected by them is being sought to be removed before completion of his term. Further, the power of removal must be exercised by the shareholders in good faith, in the bona fide interest of the company and not for any other reason. On appeal [LIC v. Escorts Ltd, (1986) 59 Comp Cas 548 (SC)], the Supreme Court observed that there was no necessity for a statement of reasons to support a resolution for removal of a director. In this case, the major concern of the supreme Court was to see that, a minority group of shareholders in power could not thwart the decision of majority shareholders to remove the directors from the Board, and whether a meeting of shareholders convened for this purpose should be restrained merely on grounds that sufficient reasons did not support the resolution for removal. Hence this decision cannot be taken as conclusive on the issue whether a statement of reasons should support a resolution of removal or not. Exceptions: Though in general directors can be removed by the shareholders, there are certain directors who cannot be
removed by them. A director who is not appointed by the shareholders cannot be removed by them. thus, a director who has been appointed as a representative of the Central Government or the financial institutions cannot be removed by the shareholders, though such a director can be removed by his appointing authority. Thus, the Central Government can make a reference to the CLB for removal of a director appointed by it, and, if the CLB disposed of the reference in its favour, can remove the director under Sec. 388E. Similarly, the court can remove a director under Sec. 402 even if he has been appointed by the shareholders, in order to prevent oppression and mismanagement. Section 284 itself contains three exceptions to the general rule that shareholders can remove a director by passing an ordinary resolution, viz.: (i) directors appointed by the Central Government u/Sec. 408 (ii) directors holding office for life as on 1.4.1952 in a private company; and (iii) directors appointed by a system of proportional representation under Sec. 265. The mode of removal envisaged under Sec. 284 is in addition to any other special method of removal specified in the Articles of the company. thus, in Shindler v. North Raincoat Co Ltd [(1960) 2 All ER 269], the Articles of the company provided for the removal of a director by the chairman of the company. A director on being so removed challenged the validity of this provision in the Articles. It was held that, a director who accepts appointment subject to such a provision in the Articles cannot subsequently complain. But, a director is not bound by such a provision if it is introduced subsequent to his appointment, by an amendment of the existing Articles. Private Company: Section 284 applies to both private as well as public companies. A private company can have two kinds of directors, directors for life and ordinary directors. Now under Sec. 284, even director for life can be removed unless he was holding office as such on or before 1.4.1952. But, a director for life can successfully thwart any attempt at his removal, by introducing a clause in the Articles giving weighted votes to that director who is being remove. Thus, in Bushell v. Faith [(1970) 1 All ER 53], a small private company consisted of three persons C, K and G each having 100 shares of 1 pound each. C and G were directors. Clause 9 of the companys Articles provided that, when it was proposed to remove a director he would on a poll, have the right to three votes per share. C and K, being dissatisfied with G as a director proposed to remove him. G demanded a poll, where he was entitled to cast 3 votes for every 1 vote of C and K. Thus G polled 300 votes on his hundred shares against the 200 votes against him, on the 200 shares held by C and K. G thus defeated the motion for his removal. C and K challenged the validity of such a poll. The trial court held that, a clause which gave a shareholder treble voting power was invalid as it would make a mokery of Sec. 184. On appeal, a majority of the House of Lords reversed this decision. Lord Donoval observed, the Parliament, being fully aware of the phenomenon of Articles of association carrying weighted votes had made no provision against it
and had left it to the companies and their shareholders liberty to allocate voting rights as they pleased. Though this decision has been widely criticized, it is not without its merits. A private company is more in a nature of partnership firm and is needed to be treated differently. In the words of R. C. Beuthin, in this particular field it may be highly desirable that partners should be safeguarded in directorships, whether by means of special voting rights or by means of shareholders voting agreements [Beuthin, (1969) SALJ 489]. Removal of a Managing Director/Whole time Director There is nothing in the Act specifically which relates to the removal of a MD. But since a MD is also a director, the provisions applicable to the removal of a director would also apply to the removal of a MD, unless there is some specific provisions made in the Articles in this regard. Sec. 318(3) also makes an indirect reference to the grounds on which a MD can be removed from his office without the company becoming liable for compensation. These grounds are as follows: (a) where he has been guilty of fraud or breach of trust; (b) he has been guilty of gross negligence or gross mismanagement some additional ground on which he may be removed are provided in Sec. 274 providing for disqualification of directors viz: (i) he has been found to be of unsound mind by a Court of Competent jurisdiction; (ii) he is an undischarged insolvent; and (ii) he has applied to be adjudicated as an insolvent and his application is in force. The mere fact of removal of MD from his office does not operate as removal from the office of director also unless otherwise specified, i.e., a person may cease to be MD but may still act as a director, unless the grounds on which he has been removed from his managing directorship also disqualify him from acting as a director. Removal of a Manager Once again nothing is specifically mentioned in the Act relating to the removal of managers. Since a manager works under the supervision and control of the Board and as his appointment is by the Board it is to be presumed that the power of his removal is given to the Board, though the exact procedure may be specified in the Articles of the company. An important point to be noted is that the manager of a company need not be a director of the company (unless so specified in the Articles). Hence, in cases where a director acts as a manager also, the mere fact that he has vacated office as a director will not prevent him from acting as a manager, unless the grounds of his removal as a director also disqualify him from acting as a manager. 3.5 REMUNERATION The rigid rule on managerial remuneration is not going a out of fashion. In normal situations the fixation of remuneration to management personnel is left in the hands of the company. But here too, the old philosophy of the governmental regulation is 147
still continuing though the stringency is gradually in the way out. Managerial remuneration is discussed under three subheadings, viz., (a) managerial remuneration (b) remuneration to directors and (c) remuneration to managing director and manager. (a) Managerial remuneration Sec. 198 which provides the basic rule on fixation and payment of managerial remuneration stands as follows after the Amendment in 1988. (a) Total managerial remuneration payable by a public limited company or a private limited company subsidiary to a public limited company cannot exceed 11% of the net profit for the respective financial year computed on the norms laid down in ss. 349-351. Remuneration to Directors shall not be deducted form the gross profit for this purpose [Sec. 198(1)]. (b) The above percentage shall not include fees payable to the Directors [Sec. 198(2)]. (c) Subject to the above limitation of 11% of the net profit, a company may pay a monthly remuneration to its managing or whole time director as stipulated in Sec. 309 or its manager on stipulated in Sec.387. (d) If the company does not have net profit, or inadequate net profit, it can not pay any managerial remuneration (excepting fees to the directors) to its directors, managing director, whole time director or manager except with prior approval of the Central Government. Let us first understand what is and what is not included in the managerial remuneration. According to Sec. 198 if managerial remuneration includes:(i) remuneration payable to directors including managing director, and whole time (executive) directors; (ii) remuneration payable to manager. It also includes perquisites like rent free accommodation or any other benefit or amenity free of charge or at concessional rate and expenditure incurred by the company to effect any insurance on life or for gratuity or pension or for any other service which, but not for the company paying, would have to be paid by the above listed officials. While ceiling to managerial remuneration is related to the net profit, the concept of net profit remained as only a common accounting practice. Of course ss. 349-351 and Schedule VI provided for methods for calculating the net profit. According to Sec. 349, in computing the net profit, credit is to be given to subsidies given by the government but not for capital profit due to share premium, share forfeiture, or selling of assets. From the gross profit thus ascertained, deduction has to be made for (a) usual working charges (b) bonus and commission to workers, (c) Central taxes (d) corporate tax, (e) interest on loans and debentures (f) depreciation as stipulated in Sec. 350 and Schedule XIV, (g) insurance premium and (h) compensation and damages paid. 148
Ceiling of managerial remuneration: According to the Amendment Act, 1988 if appointments of managing director, whole time director and manager are made as per the provision laid down in Part I of the Schedule XIII and the remuneration is paid to them as per Part II, there is no necessity for prior approval to be taken from the Central Government. If, however, (i) the company in a financial year has no profit, or its profits are inadequate, the company cannot pay any remuneration to its management (exclusive of fees payable to directors) without prior approval of the Central Government. This relates to the minimum level of remuneration in the absence of adequate net profit; [Sec. 198(4)]; (ii) The company intends to pay remuneration to the managing director or whole time director exceeding five percent of the net profit where there is one such director, or ten percent where there are more than one such directors, prior permission from the central Government must be obtained [Sec. 309]. (iii) the company increases the managerial remuneration which exceeds the provision in Schedule XIII prior approval is necessary to be taken from the Central Government [Secs. 310-311]. Whereas Sec. 198 provides for maximum remuneration. Part II of Schedule XIII provides for details in the maximum as well as minimum managerial remuneration. Schedule XIII has to be read in addition to Sec. 309. According to Sec. 309 and Schedule XIII (i) a director who is neither a whole time nor a managing director may be paid remuneration either by way of periodical such as monthly remuneration or by way of commission on the basis of specified percentage of the net profit provided that such remuneration to such director, or where there are more than one such directors, all taken together remuneration not exceeding (i) one percent of the net profit if the company has managing director or whole time director or manager or (ii) three percent if it does not have a managing director, or a whole time director or a manager [Sec. 310(4)]; (ii) A managing director or a whole time director may be paid remuneration in monthly payments or at a specified percentage of net profits or provided the ceiling for one is 5 percent, and for more than one 10 percent [Sec. 309(3) and Section I of Part II of Schedule XIII]; (iii) If a company does not have net profit or adequate net profit, it may pay remuneration to a managerial person by way of salary and prerequisites not exceeding a ceiling limit of Rs.10,50,000/ a year or Rs.87,500/ a month calculated thus: Where the capital of the company i) less than rupees one crore ii) Rs. one crore to five crores iii) Rs. five crores to fifteen crores iv) Rs. more than fifteen crores Monthly ceiling Rs. 40,000/Rs. 57,000/Rs. 72,000/Rs. 87,500/-
b) Remuneration to Directors According to Sec. 309 remuneration to directors is determined either by Articles of association or by a resolution or, if the Articles so provides, by a special resolution. A director may receive remuneration by way of a fee for each meeting of the Board and the committee thereof. The previous practice of paying fees on monthly basis was dispensed with by the Amendment Act of 1960. But by the Amendment Act of 1965 the same was reintroduced subject to the approval of the Central government. Directors remuneration includes: (i) remuneration received in any other capacity excepting in professional capacity; and (ii) monthly, quarterly or annual payment with the approval of the Central Government; and/or (iii) Commission on the basis of percentage on net profit. A director, or all of them taken together if there are more than one, shall receive not exceeding one percent of the net profit, if the company has a managing director or whole time director. But if the company does not have a managing director or whole time director the remuneration can go up to three percent. The company in the general meeting may, with the approval of the Central Government, authorize the payment of a higher rate. If the directors receive remuneration higher than the prescribed limits without the prior approval of the Central Government, that excess amount shall have to be refunded or be held in trust for the company. The company does not have the right of waiver of the recovery of such sum. A private limited company which is not a subsidiary to a public limited company is, however, free to provide any remuneration to the members of the board. c) Remuneration to Manager Subject to the provision of Sec. 198 regarding the overall ceiling on managerial remuneration, the manager of a company may receive either by a monthly payment or by way of specified percentage of the net profits or partly by one way and partly by the other, one percent of the net profits unless the Central Government proposes a higher percentage of remuneration. According to Rule 20A the Secretary has to submit an application to the Central Government with form 25A filled in [Sec. 387]. Conclusion The managerial remuneration of a company is therefore dependent upon the type of the management that the company has, and the provisions can be summarized as follows: 1. Company managed by its board of directors: 3% of the net profits is the ceiling unless on a resolution passed by a general meeting, the Central government permits a higher rate percent. In case of the company not making adequate profits, or incurring loss, directors are entitled only to the fees for attending meetings of the board and of the committee thereof [Sec. 309(2)]. Any remuneration exceeding that amount shall require approval of the Central Government. 2. If the company is managed by the board of directors
including a managing director or a whole time director, the directors remuneration is limited to 1% of the net profit or to the fees for attending meetings in the event of absence of adequate profits, and the managing director or the whole time director is entitled up to 5% of the net profit, or in the absence of adequate profit, the amount stipulated as per the scale specified in Section II of Part II of Schedule 13. 3. If the company is managed by a board of directors including more than one managing director and/or whole time directors, the members of the board are entitled up to 1% of the profit or, in the absence of adequate profit each of them entitled up to the specified sum as mentioned in Section II of Part II of Schedule 13. 4. If the company is managed by a board of directors in addition to a manager the members of the board are entitled up to 3% of the net profits and the manager up to 5% of the net profits. In absence of net profits, of course, the directors are entitled to fees and the manager is entitled to the scale amount as is specified in Schedule 13. 5. If the management of the company is in the hands of a board of directors with one or more managing directors and/or whole time director and also the manger the directors are entitled to 1%, the manager is entitled up to 5% and the managing director and/or whole time director up to 5% of the net profit . In case of the absence of adequate profit the above principle of scale of remuneration is applicable to all managing directors, whole time directors and the manager, where as the directors are only entitled to sitting fees. 3.6 COMPENSATION FOR LOSS OF OFFICE In some cases a managing director or a whole time director or a director holding the office of a manager may be required to surrender the office not on account of winding but for any other reason, before the term of the office is completed. According to Sec. 318 in such cases such a person is entitled to compensation for loss of office, or consideration for retirement from office. This payment shall not exceed the remuneration which the concerned person could have earned for the unexpired portion of his term, or for three years, which ever is shorter. The calculation is to be made on the basis of average remuneration actually earned during the previous three years or for the period for which he was engaged to the office if the period was less than three years [Sec. 318(4)]. Of course if the company is in the winding up within twelve months after the date on which he ceased to hold the office, he is not entitled to any compensation unless the shareholders are completely paid off. In the following circumstances no such compensation is payable:1. Where the director resigning on account of reconstruction or amalgamation, and has become the managing director the manager or other officer in the reconstructed company;
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2. Where the office has been vacated by the director on account of a fraud perpetrated by him and he has been found guilty u/s 203 of the Companies Act; 3. Where the company is being wound up provided the winding up was due to the negligence or default of the director; 4. Where the director was guilty of breach of trust or gross negligence or gross mismanagement of the conduct of the officers of the company or its subsidiary or holding company; and 5. Where the director has instigated or has taken part directly or indirectly in bringing about the termination of the office. No director of a company shall receive any payment by way of compensation for loss of office or as consideration for retirement from office if it is done in connection with the transfer of the whole or part of the undertaking or property of the company [Sec. 319(1)]. Similarly no director of a company shall receive any payment by way of compensation on account of transfer of all or any of the shares in a company having on transfer resulting from: (i) the offer is made to the general body of shareholders; (ii) the offer is made by a body corporate with a view to making the company a subsidiary; (iii) an offer is made by an individual with a view to obtain the control over not less than one third of the total voting power; or (iv) the offer is conditional on exceptance given extent. In case he receives any payment it shall be deemed to have been received by his intrust for any persons who have sold their shares a result of the offer made [Sec. 320]. 3.7 POWERS It has already had explained that the company being a sui juris requires a person in fact to represent it in dishcarging all its powers and functions. The persons composing the board of directors are those who exercise various powers both general and specific for and on behalf of the company. Therefore it is necessary to understand general powers and specific powers of the board and the limitations to such powers. All powers of the company are devided into two groups. Some statutory powers forming a group are reposed in AGM. All other functional powers are vested in board of director. These powers are generally known as general powers of the board. Some times on account of specific statutory provision or due to certain stipulations in the memorandum and Articles of association some special power is required to be discharged by the board. General Powers of the board According to Sec. 291 all powers of a company which the company is authorised and can do are vested in the board of directors excepting : (a) powers specifically provided by the Act for the AGM, (b) power particularly conferred by memorandum and Articles of association on the company in general meeting; (c) powers specifically determined by regulation passed by the 150
company to be exercised by the company in the general meeting. But in the last power and operation as mentioned above i.e., power conferred on the company in the general meeting in view of any corporate regulation passed by the comapny in general meeting, shall not invalidate any prior act of the board which could have been valid if that regulation had not beeen made [Sec. 231(2)]. All these functional powers of the board can be either directly performed by the board or can be performed through delegation of power to the chief executives who would discharge these functions under the supervision and control of the board. According to the recommendation of company law committee some of these powers are non-delegative. According to Sec. 292 the baord of directors of the company shall exercise the following powers by means of resolutions passed in the meetings of the board. These functions are: (a) power to make calls; (b) power to issue debentures; (c) power to borrow money; (d) power to invest funds; and (e) power to give loans. But according to the Amendment Act, 1960 the company may delegate by specific resolution in the board meeting power mentioned in (c), (d) and (e) to the cheif executive, on such term and conditions as may be determined by the board. The resolution has to specify the total amount which may be borrowed by the delegate official or the total amount to which the funds may be invested by him. The powers are specific powers of the board. The powers of the board have been grouped under three heads in Ramaiya as follows: 1) Powers exercisable at the meetings of the board Besides the five powers mentioned above in (a) to (e) the following are other such powers: a) filing the casual vacancies in the board [Sec. 262]; b) appointing as Managing Director or the Manager a person who is holding such position in another company [Sec. 316 & 386]; c) consenting to a contract of the company with any director or his relative or parties [Sec. 297]; and d) investing in shares or debentures of a company under the same management. 2) Powers exercisable only with the consent of the company in general meeting a) power to sell, lease or otherwise dispose off the whole or part of the undertaking of the company [Sec. 293(1)(a)]; b) power to remit debt due by a director [Sec. 293(1)(b)]; c) power to borrow in excess of capital and reserves [Sec. 293(1)(d);
d) power to contribute to charities; e) power to invest compensation amounts received on acquisition of properties [Sec. 293(1)(c)]; and f) Power to appoint sole selling agent [Sec. 294(2)]. 3) Powers can be exercised by the board of through delegation: All other powers are exercisable by the board through the delegatory process. Since the general power of functions of the company are vested in the board courts are reluctant to grant a generic injunction restraining the directors from exercising their functions. In Rajapalayam Industrial and Commercial Syndicate Ltd. v. K.A.Veeraprakasham [(1989) 2 Comp L.J. 236} the judicial bench set aside the order of a temporary injunction because the companys business had thereby become paralysed to the prejudice of the company and many others. The general management power vested in the board cannot be usurped by the shareholders. In Automatic Self-cleaning Filters Syndicate Company v. Cunningham [(1906) 2 Ch. 34] it was held that the directors cannot be compelled to do a job by a specific resolution in a general meeting. If the shareholders are not pleased with the management they may remove them from the office and appoint others in their place. In a number of cases, however, it was decided that general meeting of shareholders may make regulations for the guidance of directors, but cannot invalidate their prior actions. The principle has been very aptly stipulated in Scott v. Scott [(1943) 1 All ER 582], that the resolution of the members opposing the commencing of the action by the directors could be a nullity, for, the powers vested in the directors they and they alone can exercise this power. The subject was fully discussed the Morarka Paint and Warnish Works Pvt. Ltd. v. Morarkko [(1961) 31 Com. Cas. 301] where the court held that the powers of the management being vested in the board and in exercise of these powers the board instituted a case, shareholders had no right to question the directors decision in this respect. Shareholders may, of course call a requisitioned meeting for removing the directors as provided in Section 284 [Escorts Ltd. v. Union of India (1985) 57 Com. Cas. 241]. If one examines carefully the provision of Section 291 one understands that the board of directors cannot act beyond the power as constitutionally provided for the company to discharge - Such powers are ultra vires to the board as well to the constitution of the company. The corporate capacity is created by the state through the process of incorporation to distinctly empower the body corporate for a specific objective. Therefore the board of directors cannot exceed that limit. This application of the principle of ultra vires has already been explained earlier. Here it is suffice to note that an act ultra vires to the company and necessarily ultra vites to the board cannot be permitted by the shareholders even with a special resolution in a general meeting. But an act which is ultra vires the company cannot be invalidated only on the ground that the board does not have the power unless such restriction is imposed upon the board by
virtue of the statutory provision or constitutional provisions in the companys basic documents. Special Powers of the Board Special powers of the board are those which cannot be discharged by the board through delegatory process, that is to say, powers which are exercisable by the board only by means of resolutions passed in its meetings. Some of the powers are: (a) power to make calls; (b) power to issue debentures; (c) allotment of shares and debentures; (d) refusal to register share transfer; (e) issue of bonus shares; (f) further issue of shares; (g) filling of casual vacancies on the board; (h) appointing Managing Director or the Manager; and (i) investing shares and debentures of company under the same management. Derivated actions According to Section 291 the board of directors is empowered to exercise all powers of the company. It includes the power of suing for and on behalf of the company. No power is given to any individual or group of shareholders to represent the company in any corporate litigation unless the shareholder himself has his direct interest involved, or in other words, he has a lis. But sometimes in very special situations where the board of directors fail to protect the interests of the company the courts have been authorising a shareholder or some shareholders to sue on behalf of the company for ascertaining the companys rights. The relief is given to the company on the application of the shareholders. This is known as derivative action. Sometimes shareholders in general may have grievance against the company which is taken up by a few. This is known as representative action. Interestingly you have to note that in derivative action an individual share holder derives you authority of representing the company when the actual authorised person i.e., the board fails to take the action. In Estmenco (Killer House) Ltd. v. Greater Indian Council [(1982) 1 WLR 2;] (1982) 1 All ER 45] it was held that a derivative action is called as such because it enforces the rights derived from the company as the corporate body. In Indian law Central Government is authorised to allow such proceedings on the ground of oppression and mismanagement or conduct prejudicial to public interest [See Sections 399-401]. In Brich v. Sullivan [(1958)1 All ER 56] the court observed that a person filing a derivative claim has to show that the company in a given situation has the right to sue but being indulgent in the matter is unlikely to sue and therefore he gets a derivative authority to sue. Derivative actions are counter to the rule Foss v. Harbottle [(1843) 47 ER 189]. In this famous case two of the shareholders of the company took legal proceedings against the directors to compell him to make good the loss sustained by the company by reason of other fraudulent acts. In this case the court held that as the act was capable of conformation by the majority the court would not interfere. Thus it was left to the majority to complain or condone. The principle is known as the majority rule in the corporate structure. Derivative action therefore does not arise in a situation where majority may complain or condone the act itself. In the following cases however derivative actions are allowed: 151
a) Ultra-Vires acts: Lord Justice Romer observed very aptly that the shareholders are entitled to have the affairs of a company conducted in the way laid down by the companys Constitution [See, Re H.R.Harmer Ltd. (1959) 1 WLR 62 CA]. So whenever the companys functionaries used to ......the functional limit of the company as laid down in the objective clause of the memorandum shareholders are given the derivative power to go to the court to come heavily on the functionaries of the company for restraining them to carry on ultra-vires activities. This principles has been explained in detail in a separate module. b) Acts required to be done by special resolution: The Companies Act itself stipulates that some of the activities of the company can be done only by special resolution requiring special majority. The last do not permit the company to transact such activities by the company in any other manner. In such a case any shareholder is allowed to draw the attention of the court by a derivative action. c) Fraud-Majority cannot commit fraud on the minority: The Court cannot allow any managerial powers to be exercised for perpetuating fraud on minorities. Through a derivative action any shareholder can take such matter to the Court. d) Exclusion from management: Majority of directors cannot arrange the meeting in such a manner that the minority dissenting directors cannot attend the meeting. If some of the directors plan to exclude the minority directors from attending the meeting, any shareholder can take the matter to the Court on derivative action. e) Wrongdoers in control: Where illegalities are committed in the conduct of the companys business any shareholder shall have the derivative power to go to the Court [See Prudential Assurance Co. v. Newman Industries Ltd. (No.2), (1982) Ch.204]. f) Transfer of control: Where a resolution has been passed in the company for transfer of controlling shares in a company which involves complete structural changes of the company, a shareholder does have a derivate action. g) Further issue of shares: When the shares are alloted for improper purpose or not for the bona fide interest of the company, a member may bring an action to prevent the proposed allotment [See Needle Industries (India) Ltd. v. Needle Industries Nowky (India) Holding Ltd. (1981)51 Comp. Cas. 743]. h) Discriminating against a class of shareholders: In Griffith v. Paget [(1977)5 Ch.D. 894] it was held by the Court that a shareholder shall have derivative right if a resolution is passed in the course of winding up to divide the proceeds in such a way so as to prejudice a class of shareholders with same interest. i) Improper rejection of vote: Right to vote in any manner is the inherent right of a shareholder. If the Chairman of a meeting improperly rejects the vote of a shareholder, he has a right to have his vote recorded. In some other situations like, oppression and mismanagement; appropriation of corporate property by the majority holders; 152
breach of duty of good faith and where personal rights of shareholders are affected, a shareholder shall have the derivative right to bring an action. But where issues are related to manner of presentation of accounts, or stipulating the place of the meeting or application of funds by the directors application of issue proceeds or making a call, the Court refused to allow derivative action. Powers of a Director: A director does not have any power excepting those which he can enjoy as a shareholder and those which he has as a member of the Board. As a member of the board he has a right to attend the meeting; participate freely in the deliberations; right to vote whenever a voting is made in the meeting on any issue and right to receive remuneration. He has also right to receive all reports, explanations and copies of accounts relevant to take decision in the meeting. But a director does not have any other managerial power. All powers are vested in the Board of Directors by virtue of Section 291. That is the real legal position and the board of directors generally speaking cannot delegate the power based upon the principle delegatus non potest delegare. Exception to this rule is permissible wherever delegation is expressly provided for by the Articles of association or by the statute. In Nibro Ltd. v. National Insurance Co. Ltd. [AIR 1991 Del 25] it was held that the director was only one of a body of directors and alone he has no power except such as may be delegated to him under the provisions of Articles of association. In this case a director instituted a suit on behalf of the company which was held to be not merely a technical matter. Unless the board has specifically authorised a director by a resolution he would not be called as an authorised person. In Ferruceio Sias v. J. Mangaram Mukhi [(1994) 1 Com. L.J. 345 (Del)] one single director brought an action against a company to prevent merger questioning the validity of the decision of board of directors at the direction of the holding company and ignoring the interests of the subsidiary company. He was neither authorised by the board nor under the Articles. The Court refused to interfere in the business judgement of the directors. The provision of Section 291 vesting power in the board which may be exercised according to the view of the majority of the members of the board reflects that the statutory demand is the collective wisdom of the board and not individuals decision. So unless the Articles otherwise provide the powers of the board cannot be delegated. Besides it has been already stated that directors cannot fetter their direction so as to act for the benefit of a section of the share holders. So they cannot place any restriction on their power by a contract. If Articles of association has the provision of delegation and a director or committee of directors acts on behalf of the company then outsider may presume that the delegation has been properly made. In Royal British Bank v. Turquand [(1856) 6 ENB 327] it was held that a person dealing with a company through the medium of some persons managing its affairs is not effected by internal irregularities. This is generally known as doctrine of indoor management'. The principle is applicable where the constitutional documents permit the delegation and speak about
a formality of delegation. An outsider is not effected by the absence of the formality became he may presume that a right of representation is vested in the person as per the regulations stated in the Articles. But if the Articles do not provide for any delegation of authority by the board no one can presume the authority of the director. 3.8 DUTIES The fact that the directors are fiduciaries imposes on them: (1) Subjective duties of honesty and good faith, and (2) Objective duties not to place themselves in a position where their duties might conflict with their private interests. Each of these can be subdivided resulting in four general principles: First directors must act bona fide i.e., in what they believe to be in the best interest of the company. Secondly they must exercise their powers for the particular purpose for which they were conferred and not for some extraneous purpose even though they honestly believe that to be in the best interests of the company. Thirdly, they must not fetter their discretion to exercise their powers from time to time in accordance with the foregoing rules; and Fourthly, despite compliance with the foregoing rules, they must not, without the consent of the company place themselves in a position in which there is a conflict between their duties and their personal interests [Gower, pp. 576-77]. This is perhaps the most apt summary of the duties of the directors. The duties of the director varies according to the nature and size of the company and have to be ascertained as per the facts of each case. Justice Romer in City Equitable Fire Insurance Company [(1925) Ch 407] gave three limits to duty to care: (1) he is not expected to exercise greater degree of skill than what is needed from a person of his experience and knowledge, (2) he is not bound to give continous attention to the affairs of the company and is not also bound to attend all meetings, and (3) in the absence of any ground of suspicion he is bound to trust the company officials. Directors must act honestly and ensure that the companys funds are properly invested. They are not to indulge in dangerous speculation. They are not bound to examine individual book entries though they are empowered to inspect book of accounts. While acting as directors they are bound to faithfully implement the policies framed by the board. 3.9 DISABILITIES There are several limitations imposed upon directors, some of which are as follows: 1. According to Section 312 a director cannot assign his office. Supreme Court had made distinction between assignment and appointment. According to the Court an appointment to the office can be made if the office is vacant. As such appointment by a director to the office which previously he used to hold was not included within the purview of the section [See Oriental Metal Pressing v. Bhaskhar Kashinath Thakur (1961) 31 Com. Cas. 143]. An agreement made by the directors of a private limited
company appointing one of them as Managing Director through a resolution passed in the meeting was not held to be assignment of the office. 2. Any provision in the Articles of association or in an agreement with a company exempting any director or an officer from any liability or indemnifying him from any liability shall be void unless of course Judgment is in his favour or he is acquitted or discharged or in connection with any application u/s 633 in which relief is granted to him. No company shall grant any loan to its director without obtaining prior approval of the Central Government, nor can it stand a guarantee or place a security in connection with such a loan. This is of course not applicable in case of a private limited company or a banking company or a holding company to its subsidiary. The Central Government has specified guide lines for sanctioning such loans. In Totalal v. The State [AIR 1963 Raj 6] the court held that for the purpose of this section there is no distinction of a loan from a deposit since the relationship of a debtor and creditor is created in both the cases. 3. According to Sec. 297 except with the consent of the board of directors, a director of the company or his relative, a firm in which a director or his relative is a partner or a private company of which director is a member or director, shall not enter with any contract with the company (a) for the sale, purchase or supply of goods, materials or services or (b) for underwriting the subscription of any shares or debentures of the company. This limitation does not apply to the following cases: 1) purchase or sale of goods and materials from or to, as the case may be at the market price; 2) contract between the company and a director or his relative or related persons for sale or purchase of goods or services in which the company or the director regularly trades provided the cost does not exceed five thousand; and 3) transactions in the usual nature of the business of banking and insurance companies The object of the provision is that the Board should have information of the extent of interest of the directors in any contractual dealings with the company. In Fatch Chand Kad v. Hidsons (Paliala) Ltd [(1957) 27 Comp Cas 340] it was held that the consent contemplated in not general but must refer to particular situation and it requires complete information to be given and not a general informatin to be given through a circular with abstract information. The Central Government delegated this power of approval to the Regional Directors by notification no. GSR 563(E) dated August 19, 1993. 4) Sec. 293A prohibits and restricts political contribution by a company. No Government company and no company having less than three years standing shall contribute any amount to any political party or for any political purpose. Other companies can do it provided the amount does not exceed 5% of the net profit in any financial year. 153
5) Sec. 294 relates to the appointment of sole selling agent. No company shall, after the passing of theCompanies (Amendment) Act 1960 shall appoint a sole selling agent for any area for a term exceeding five years at a time. The agent may, however, be reappointed at the end of the term. Of course the Central Government may direct the company to furnish such information about the appointment of sole selling agent as may be necessary to consider whether or not such terms and conditions are prejudicial to the interest of the company. In the event of the companys refusal or neglect to furnish the information, the Central Government may appoint an investigator to investigate and report on the matter. In case a company has more than one selling agent for an area, the Central Government may examine the terms and conditions of appointment for the purpose of ascertaining whether one of the agents can be declared as sole agent. According to Sec. 294A the Central Government may notify that in certain category of goods and services, sole selling agent can not be appointed. According to Sec. 294A, a sole selling agent is not entitled to any compensation for loss of office in the following circumstances: (a) if the company in the general meeting disapproves the appointment; (b) if the agent resigns; (c) if the agent is guilty of fraud or breach of trust; and (d) if the agent instigates the termination of his office. 6) No director shall hold any office or place of profit except with the consent of the company in the general meeting by way of special resolution [Sec. 314(1)]. No person related to him in family or trade can also hold any office or place of profit without the consent of the Board. Of course, the post of managing director, manager or whole time director are excepted. According to Sec. 299 a director has a duty to disclose his interest in any contract made by the company or in any of its transaction. This is a natural requirement because a director has a fiduciary relation with the company. Interested director is required not to take part in the meeting dealing with the transaction nor can he vote in the affairs. If he is present in the meeting, he cannot be considered for the purpose of calculating quorum of the meeting for that purpose. The company has to maintain a register of contracts in which directors are interested which shall record the nature of their interest. The whole purpose is to provide for transparency in the policy formulation and functioning of the Board so that the directors position is clearly vindicated and their interest is known to all directors before the decision is taken. In Needle Industries (India) Ltd v. Needle Industries Newly (India) Holding Ltd the Supreme Court held that the interest involved on any issue of the companys management is not merely a sentimental interest. The relation of frindliness of a director is not sufficient an interest which may disqualify a director to participate in the meeting and the voting under Sec. 300.
If a director has acquired an interest in any transaction of a company after the company enters into the contract he has to disclose his interest in the meeting of the Board at the earliest opportunity. Similarly if a director having an interest in any transaction of the company becomes director afterwards, he has the liability of disclosure the moment he accepts the directorship [M. O. Verghese v. Thomas Steaphen & Co Ltd (AIR 1971 Ker 223)]. The proposition laid down in Imperial Mecantile Credit Association v. Coleman [(1871) LR 6 Ch App 558] that if all the general body of directors are aware of the interest of the director in any contract of the company, no disclosure is necessary,does not hold good because, as per the clear provision of Sec. 299 the statement making disclosure is necessary in that event as well. Non disclosure makes the contract voidable at the option of the company and makes the defaulting director liable to account for the secret profit. Non-disclosureby itself is not penal, but if the director contravened the provision of Sec. 300 by attending the meeting and voting on the resolution, he is punishable with a fine upto Rs.5,000/-. (i.e., a partner, or a relative, or a firm in which the director or his relative is a partner or a private limted company in which he is a director or a member) is appointed to an office or to hold a place of profit before the person becomes a director, this restriction is not applicable. If any contravention is made, the person concerned shall vacate the office from the date next following the holding of the general meeting in which the special resolution was passed approving the appointment. 3.10 LIABILITIES OF THE DIRECTORS Directors both as policy makers of the company as well as some of them being officers of the company have both personal, civil and criminal liabilites. They have liabilities to the contracting parties as well as to the company. Some of the liabilities are discussed here under. Civil Liability to the company Directors liability to the company may arise where (1) the directors are guilty of negligence, (2) the directors committed breach of trust, (3) there has been a misfesance and (4) the director has acted ultra-vires and the funds of the company have been applied for such an act. 1. A director is required to act honestly and diligently applying his mind and discharging the duties as a man of prudence of his ability and experience would do. It has been explained in the duties of a director as to what is standard or due care and diligence expected of him as explained by Justice Romer in Re City Acquintable Fire Insurance Company [(1925) Ch 4007]. But if the director acts with negligence he is liable to compensate the company. According to Sec. 201 this liability of the director cannot be excused by any provision of the articles of association. According to Sec. 633, if it appears to the court in any suit filed against the director on the ground of negligence, default, breach of duty, misfeasance or breach of trust that he acted honestly and reasonably the court may wholly or partly relieve him from his liability. But in a criminal
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proceedings the court shall have no power to grant relief from any civil liability. In the case of negligence there is no necessity of proving fraud. The burden of responsibility of proof that a director has acted negligently lies on the plaintiff. But when the negligence is apparent the burden of proof is shifted. As for example when the directors have made calls on other shares their failure to make call upon shares held by themselves was held to be so negligent that the bureden of proof was held to have shifted. (2) Directors have fiduciary relation with the company and as such they have to discharge their duties as a trustee. For any breach of trust resulting in the loss or damage to the company they have to make good the loss. So if the director makes any secret profit out of any transaction of the company, he has to return the whole amount to the company. Similarly, a director must account to the company for any form of gift or bribe received by him from a supplier of goods or vendor of properties to the company. (3) Directors are liable to compensate against any act of misfeasance. Any wilful misconduct or culpable negligence falls within the category of misfeasance. If the directors use the company property for personal gains they are guilty of breach of trust and malfeasance. If a company is in the process of winding up, the remedy for misfeasance lies in a summons under Sec. 543 of the Act, which can be issued within five years. The summon is to be based on the information of specific acts of commission and omission. As such, in Off. Liquidator v. Raghava Deshikachar [AIR 1974 SC 2069] it was held that the report of the official liquidator has to contain a detailed narration of the specific acts of omissions and commission on the part of individual directors to proceed against them individually. If the directors delegate their functions to the management and blindly accept whatever is reported, they would be acting negligently. 4) If the directors act ultra vires to the authority of the company itself, the same cannot even be ratified by all the shareholders agreeing to it. A company is a separate legal entity and not an aggregation of interests of all the shareholders. As such, what a company cannot do, the Board of Director also cannot do. In such a case if the directors used the corporate resource for an ultra vires act, directors have to make good the loss to the company. Civil Liability to Outsiders Directors position to a third party is to be examined on the basis of the principle of agency. Director act for and on behalf
of the company and therefore, they are not personally liable or accountable to any third party. Even in case of any act ultra vires to the company, directors are not personally binding because every one has a constructive notice about the powers of the company in regard to any contract as stipulated in the memorandum and Articles of association. In this case one has to distinguish acts ultra vires to the company and act ultra-vires to the Board of Directors or a director when powers have been delegated to him. As for example, if a director has taken loan from another exceeding the amount which is within his power, he is doing something which is ultra vires to his power but not of the company. In such a case the principle of indoor management as laid down in the case of Royal British Bank v. Turqnand [(1856) 6 E & B 327]. In such a case third party can presume that the companys internal management of delegation and authorisation is adequately done as represented by a director. As such, the person can hold the company liable and the company in turn may hold the director liable for reimbursement. But suppose, the money borrowed is beyond the power of the company, the third party (contracting party) may treat the same as a breach of warranty of authority and hold the director personally liable to pay the same. In case of contracts by a director entered personally keeping the name of the company undisclosed, the director shall be personally liable for such contract ascertaining to the general principle of law of agency. Even if the director discloses that he is a director but does not use words sufficient to bind the company, he may be held personally liable to the contracting party. Directors are personally liable under Section 62 of the Act for false statement in the prospectus to a third party on an action of damages. Directors are personally liable to pay compensation to the allottee (i) for irregular allotment [Section 71(3); (ii) failure to pay application money if minimum subscription is not received [Section 69(5); (iii) failure to repay the application money if the application for listing is not made or if made, is refused. Besides, directors are liable to pay damages primarily if a fraud is committed or there is a tort. Criminal liability of the Directors: Companies Act 1956 fixed criminal liability on the directors on several issues. There are more than 150 sections dealing with criminal or penal liability of the directors and offices of the company. As for example section 63 fixes criminal liability for mis-statement in a prospectus. Similarly Sections 68, 75, 95, 113, 144, 192, 303, and many other sections fix such criminal or penal liability on director and officials of the company.
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4. OPPRESSION AND MISMANAGEMENT

SUB-TOPICS 4.1 Rule in Foss v. Harbottle 4.2 Prevention of Oppression 4.3 Prevention of Mismanagement 4.4 Powers of the CLB 4.1 RULE IN FOSS V. HARBOTTLE We have seen in the earlier chapters, the ways and means by which a determined group of individuals could acquire control over the company. Once they acquire control, they can for all practical purposes do whatever they want with the company with practically no supervision or control, because even if they are questioned on their acts in the general meeting, they always come out winners because of their greater voting strength. Generally speaking the Courts are loathe to interfere in the internal administrative matters of a company unless the matters are those which fall under the general scope of indoor management`. This rule was laid down in 19th century in the case of Foss v. Harbottle [(1843) 67 ER 189], where two of the companys shareholders filed an action against the directors of the company charging them with collaborating and effecting numerous illegal transactions by which the company property was misapplied and wasted. They prayed that the concerned directors should be asked to make good the losses which had occured due to their action. The Court rejected the action in respect of all those transactions for which the majority shareholders had a right or power to confirm, holding that: The conduct with which the defendants are charged is an injury not to the plaintiff, exclusively, it is an injury to the whole corporation. In such cases the rule is that the corporation should sue in its own name and in its corporate character. It is not a matter of course for any individual member of a corporation thus to assume to themselves the right of suing in the name of the corporation. In law the corporation and the aggregate of members of the corporation are not the same thing for purposes like this. This rule known as the rule in Foss v. Harbottle was restated in simpler terms in Edwards v. Halliwell [(1950) 2 All ER 1064] as: The rule in Foss v. Harbottle comes to no more than this. First, the proper plaintiff in respect of a wrong alleged to be done to a company is prima facie the company itself. Secondly, where the alleged wrong is a transaction which might be made binding on the company by a simple majority of members, no individual member of the company is allowed to maintain an action in respect of that matter for the simple reason that, if a mere majority of the members of the company is in favour of what has been done, then cadet quaestio. So the question arises, in such an unequal division of power what happens to the interests of the minority group of shareholders? How can their interest be protected? One thing has to be clearly understood here is that when we talk about the 156
protection of the minority group we do not talk about numerical minority but of minority voting strength. The reason for this distinction is that a small group of shareholders may hold the majority shareholding whereas the majority of shareholders may between them hold a very small percentage of the share capital. As for example, suppose a company has 500 shareholders. 5 of the shareholders belonging to the same family hold nearly 70% of the shares, whereas the remaining 495 shareholders have the rest of 30% shares distributed amongst them. In such a situation, though 495 does form a large body of shareholders, in effect they are totally helpless in the face of their meager shareholding. It is their interest which has to be protected in the face of such a strong opposition. It is for this purpose that certain exceptions to the above rule were recognized and applied. These exceptions are as follows: a) Ultra vires acts b) Fraud on the minority c) Acts requiring special majority d) Wrongdoers in control e) Individual membership rights f) Oppression and mismanagement Most of these exceptions have been dealt with at some point or other in the earlier modules. Individual membership right means the right which accrues to a shareholder by virtue of his being a member and can be availed against the company and the rest of the shareholders. For example, the right to vote on a motion is an individual membership right and a shareholder can approach the Court if he has wrongfully been denied the right to vote by the majority. But by far the most important exception recognized is that of oppression and mismanagement`, i.e., when the majority action results in either oppression of minority or mismanagement of company affairs any shareholder can approach the Court to seek appropriate relief. We would now deal with this last exception in detail. 4.2 PREVENTION OF OPPRESSION The term oppression has been explained by Lord Cooper in Elder v. Elder & Watson Ltd [1952 SC 49 (Scotland)] as, The essence of the matter seems to be that the conduct complained of should at the lowest involve a visible departure from the standards of fair dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to the company is entitled to rely. Here, the allegations were that the petitioners who were two shareholders in a small family company, were removed by the majority shareholders from their position as directors of the company and were also removed from their employment as secretary and factory manager of the company. A relief was denied to them, because they had not suffered as shareholders but in different capacities i.e., in their capacity as director and employees of the company.
Under Sec. 397, shareholders are granted relief from oppression if the affairs of the company are conducted in a manner which is, (1) either prejudicial to public interest or oppressive to any member(s), (2) which would entitle the court to order winding up under the just and equitable clause, but (3) such order of winding up would unfairly prejudice such member(s). Let us now take each of these conditions separately. 1 Oppression Though it is easy to define oppression as, a persistent unjust conduct resulting in an unduly harsh burden to the complaining shareholder, it becomes more difficult to categorize the kinds of acts which would result in such oppression. In the English case re H. R. Harmer Ltd [(1958) 3 All ER 689], it was held The result of applications under Sec. 210 in different cases must depend on the particular facts of each case, the circumstances in which oppression may arise being so infinitely various that it is impossible to define them with precision. Sec. 210 of the English companies Act corresponds with our Sec. 397. Merely because the majority has indulged in minor acts of mismanagement will not be deemed to be oppression. Thus, in Lalita Rajya Lakshmi v. Indian Motors Co [AIR 1962 Cal 127], the petitioners alleged that the board of directors were guilty of certain acts detrimental to the minority of the shareholders. The acts complained of were that, the income was deliberately being shown less by inflating expenditure, not maintaining a check either on petrol consumption or on ticketless travel, disposal of second hand buses at very low prices, declaring low dividends etc. The court held that, even if each of these allegations was proved there would still be no oppression. Further, to attempt to get a majority by lawful means is not a fact or circumstance which justifies winding up of the company. What would amount to oppression has been well explained in Kalinga Tubes Ltd v. Shanti Prasad Jain [(1964) 1 Comp LJ 117] as, There must be an unfair abuse of the powers and impairment of confidence in the probity with which the companys affairs are being conducted as distinguished from mere resentment on the part of a minority at being outvoted on some issue of domestic policy. It is not lack of confidence between the shareholders per se that brings the section into play .... oppression involves atleast an element of lack of probity or fair dealing to member in the matter of his proprietary right as a shareholder. Persons connected with management of the companys affairs must in connection therewith be guilty of fraud, misfeasance or misconduct towards the members. It does not include mere domestic disputes between directors and members or lack of confidence between one section of members and another section in the matter of policy or administration. Much less it covers mere private animosity between members and directors. Oppression of majority Though this section is generally applicable to cases where there is an oppression of minority, in special cases if the court feels it just, the section may be brought to apply on application made by the majority who have been rendered helpless by the acts of the minority. Thus in re Sindri Iron Foundry P Ltd [(1963)
69 CWN 118] it was observed, if the court finds that the companys interest is being seriously prejudiced by the activities of one or the other group of shareholders, that two different registered offices at two different addresses have been set up, that two rival boards are holding meetings, that the companys business property and assets have passed to the hands of unauthorized persons who have taken wrongful possession and who claim to be the shareholders and directors, there is no reason why the court should not make appropriate orders to put an end to such matters. Oppression qua members The section comes into force only when the aggrieved member is able to show that he has suffered an injustice in his capacity as a shareholder of the company and not in any other capacity. Thus, in re Lundie Bros Ltd [(1965) 2 All ER 692], a minority shareholder of a private company was removed from his position as a working director. He would have gained nothing from the company if he had been merely a shareholder, because the company didnt pay any dividends, so that the only return he got on his investment in the company was the remuneration he drew as a director. Despite this he was not granted a relief under this section, because he had suffered as a director of the company and not as a member. This decision has been criticized severely as being unrealistic, because being elected as a director is one of the privileges of being a member, and a deprivation of this privilege should amount to oppression of a members right. 2 Facts must justify winding up Unless and until the facts alleged as being oppressive, justify an order of winding up under Sec. 433(f) as being just and equitable, Sec. 397 will not apply. A linking of Sec. 397 with 433 may result in some deserving cases being denied relief, because Sec. 433(f) is itself fraught with difficulties and it is difficult to categorize the cases which would come under it. But, in general this clause is used to provide an alternative remedy to winding up i.e., when the CLB feels that an order of winding up will unfairly prejudice the petitioner or that such an order would be worse than the malady. 3 Oppression of continuing nature Lastly, the section will come into play only when the oppression is of a continuous nature, i.e., isolated incidents of oppression will not suffice. The wording of the section itself makes this clear because it says that, the affairs of the company must be conducted in an oppressive manner - manner implying something carried on over a period of time. This requirement also prevents the court from taking into account any oppressive behaviour in the past. Who can apply under Sec. 397? Sec. 399 specifies the requisite number of persons required to sign an application alleging oppression u/s. 397 as follows: (a) where the company has a share capital, the application must be signed by atleast 100 members of the company or by members holding one-tenth of the issued share capital of the company; 157
(b) where the company is without sharecapital, the application has to be signed by one-fifth of the total number of its members; (c) the Central Government may on application allow any member or members to sue if it feels its just or equitable to do so. If the requisite number of persons consent, then the application may be made by one or more members on behalf of all of them. Consent here has the same meaning as in section 13 of Contract Act, i.e., people agreeing to the same thing in the same sense. Thus, in M. C. Doraiswami v. Sakthi Sugars Ltd [(1980) 50 Comp Cas 154 (Mad)], a petition under Sec. 397 was rejected by the Court, because the consenting members had been merely told their signatures were needed for requisitioning a meeting. The court held that, the signatories must be told of the specific facts which are alleged to be constituting oppression. There cannot be a blanket consent. Under Sec. 401, even the Central Government has the power to apply for relief under this section. Once a petition is admitted by the court, then it can be withdrawn or compromised only with the permission of the court. Such a permission is granted only if the court is assured that such compromise would be in the best interests of both the company and its shareholders [In re Kelly and Henderson P Ltd, (1980) 50 Comp Cas 646 (Bom)]. 4.3 PREVENTION OF MISMANAGEMENT Power corrupts - and more power corrupts even more: Once control is acquired over the company, it is easy to give in to temptation and start managing the affairs of the company in such a manner that the best interests of the management rather than the company are served. In short, there is ample scope for mismanagement if the management is lacking in either the will or capacity or both to manage. Sec. 398 of the Act provides statutory relief against mismanagement. For this section to apply it has to be proved that: a) the affairs of the company are being conducted in a manner prejudicial to the public interest or to the companys interest; or b) by reason of change in management or control of the company there is every likelihood of the company affairs being conducted in the aforesaid manner. On a petition being made to the CLB, if it is convinced of the genuineness of the petition make a suitable order with a view to either bringing an end to such mismanagement or according a suitable relief. It is beyond the scope of Sec. 398, to consider or look at the legality or illegality of an action, because the alleged change may be perfectly legal, but it may still be prejudicial to the company [re Thakur Paper Mills, 1975 Tax LR 1955]. Whenever there is a mismanagement, any member of company can file a petition with the CLB. A petition u/Sec. 398 cannot be filed for past msidemeanours or acts of mismanagement 158
the act complained of must be in the present and continuing, except when the acts in the past project themselves as a continuing wrong pervading the present conduct of the company [C. B. Pardhanani v. M. B. Pardhanani (1990) 69 Comp Cas 106]. Rajmundry Electric Corporation v. A. Nageshwara Rao [AIR 1956 SC 213], is a good illustration of what constitutes mismanagement. Here, some of the shareholders of a company filed a petition alleging mismanagement by the directors. It was found that, the vice-chairman had been grossly mismanaging the company, he had drawn large amounts for his personal purposes, a considerable sum was owed to the Government against supply of electricity, the factory machinery was in urgent need of repairs, that the directorate had become greatly attenuated and a powerful local junta was ruling the roost, and those shareholders who didnt belong to the chairmans faction were helpless and unable to set things right. The court held this to be sufficient evidence of mismanagement, and accordingly appointed two persons for a period of 6 months to act as administrators to take over the management of the company and invested them with all the powers of the directorate. 4.4 POWERS OF THE CLB Initially the jurisdiction to hear petitions against oppression or mismanagement was vested in the company court, but now this jurisdiction has been transferred to the company Law Board by virtue of 1988 amendment. Sections 397 and 398 vest wide powers in the CLB in this regard. As observed by the court in Lord Krishna Sugar Mills Ltd v. Abnash Kaur [(1974) 44 Comp Cas 210 (Del)], in fact the Board may make any order for the regulation of the conduct of the companys affairs upon such terms and conditions as may, in the opinion of the Board, be just and equitable in all the circumstances of the case. While making an order the Board has of course to keep in mind the objectives of these sections, and so the order must be such as would end the oppression or mismanagement. Sec. 402 makes an attempt to define the powers of the Board while making an order under ss. 397 and 398. These powers are as follows: 1) Regulating the future conduct of the companys affairs, as for example, in Bennet Coleman & Co v. Union of India [(1977) 47 Comp Cas 92 (Bom)], the court ordered that the Articles of the company be so amended as to ensure that all the directors appointed by shareholders will retire annually though such a provision was against the provision of Sec. 255. 2) Allowing purchase of shares or interest of members by other members of the company, or by the company itself. 3) If the company is allowed to purchase its own shares, then the power to allow the consequential reduction of capital. 4) The rescission or alteration of any agreement between the company and its managerial personnel. 5) In case, any fraudulent preference had been made within a period of 3 months prior to the petition, then the power to set aside such transaction.
6) The rescission, setting aside or modification of any agreement with any person, after giving reasonable notice to him and obtaining his consent. 7) Any other order which in the opinion of the CLB would be just and equitable. Wherever the CLB orders an alteration of the memorandum or the Articles, the company is not at a liberty to alter it in a manner which would be in contravention of the order. Similarly, whenever an agreement between the company and one of its managerial personnel is terminated, the person would not be entitled to any compensation or damages, & nor will he be capable of joining employment in the company in any managerial capacity for a period of 5 years unless the CLB expressly permits him to do. Under Sec. 406, CLB can also start misfeasance proceedings against the guilty officers, even if the company is not being wound up. The powers of the CLB under these sections are not affected by the presence of an arbitration clause, though it may by its own discretion refer the matter to arbitration, and exercise its own powers only after such arbitration is concluded.
Under Sec. 408, the Central Government has the power to appoint directors to the board, on recommendation from the CLB. The CLB can take up the matter to give such direction either on a reference by the central Government or on an application by not less than 100 members or by members holding 10% of the voting power. On an application being made, the CLB makes the requisite inquiry in order to ascertain whether such an appointment is necessary for better management of the company. If it decides that it would be just and equitable to appoint such a director, it would also have to specify the time period for which such an appointment is to be made. For the purpose of such additional directors to be appointed, the CLB may also order a suitable amendment to the companys Articles and memorandum, and such an alteration may be in contravention to the provisions in Sec. 265 etc. After such appointment, no changes can be made in the board of directors without the consent of the CLB. Under Sec. 409, the Central Government has an additional power to prevent any proposed change in the Board if it feels that it would be in the best interest of the company. This power can be exercised on a complaint by the managing director or any other director.
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5. INVESTIGATION
SUB TOPICS 5.1 Introduction 5.2 Mandatory Provisions 5.3 Permissive provisions 5.4 Certain other investigations 5.1 INTRODUCTION In any industrial society, incorporated enterprises form the very backbone of economy, and are the best mode of channelising and increasing limited capital. In the beginning, shareholders or suppliers of capital were in a position to exercise effective control over the managerial abuse or misuse of power, but slowly with increasingly diffused stockholding and the gradual eroding of the effect of doctrine of ultra vires, shareholders today have reached a stage where they were either entirely disinterested in the management or are in hopelessly inadequate situation to act in any constructive manner. In the words of A.A.Berle, further the shareholders are ill-equipped to challenge the widsom and expertise of officers [(1960) 60 Col. LR4]. This basically means that any mode or remedy provided in the Act for prevention of corporate abuse, and requiring the shareholder to act is neither very practical nor effective for the following reasons, viz: 1) Highly diffused stockholding resulting in disjointed shareholders having practically no contact with each other, i.e., lack of cohesion amongst the shareholders. 2) Change in basic interests of shareholders - from initially being interested in every aspect of the company, they are at present interested only in the amount of dividend they will receive, i.e., the shareholders identification with the company is purely economic, and as long as they get regular dividends they are not interested in how the company is being run. 3) Lack of adequate information about the actual running of the company, and more importantly lack of necessary skills to interpret the information given to them and pick out the lacunae or loop-holes in that information. 4) The formalities and expense involved in going to the Courts makes the shareholders reluctant to approach the Court for relief, even when there is a just cause for them to do so. Further, in most cases the shareholders are not even aware of the reliefs available to them, for example relief against oppression and mismanagement. This ignorance of law is blatantly taken advantage of by the powers that be who can act in any manner they want without being hindered or hampered by Court actions. To prevent this unhampered course of action which may result in gross misuse of power the Act provides for a secondary check on the managerial powers, i.e., where the shareholders fail to act the Central Government or the CLB can order an investigation into the affairs of the company either suomotto or on an application by the requisite number of members. These provisions are mainly given in Sections 235-251 and may be split up into mandatory provisions and permissive provisions. The following flow chart gives an idea of the circumstances in which these provisions come into play.
Investigations
Mandatory provisions On special resolution by a court order On members application
Permissive provisions On report by Registrar Suo motto by CLB
Fraud, Oppression or illegality information
Fraud Misfesance or misconduct
Inadequate
We would now deal with these provisions in detail.
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5.2 MANDATORY PROVISIONS Under Section 237 the Central Government is bound to appoint inspectors to investigate into the affairs of a company in the following two cases, viz: i) When the company by a special resolution (i.e., one passed by three-fourth majority) demands an investigation; or ii) When the Court passes as Order declaring that the affairs of a company ought to be investigated and directs the Central Government to appoint an inspector for the purpose. The section does not specify the person(s) who can approach the Court for such an order. In re Alembic Glass Industries Ltd. [(1972) 42 Comp. Cas. 63 (Guj)], the Court holding itself as not being subject to the provisions of sections 235 or 237(b) observed: The Legislature in its wisdom has not put any such condition before the Court can make an order, though the Court may in its wisdom expect prima facie proof of some of these conditions. While conferring jurisdiction on the Court to direct the Central Government to appoint an inspector, the Legislature have not thought fit to circumscribe the discretion or jurisdiction in any manner. It would, therefore, be utterly inappropriate to curtail or circumscribe or fetter the jurisdiction of the Court by reading into the section something which is not there. This obviously does not mean that the Court can arbitrarily order the Central Government to investigate into the affairs of the company. There would have to be some really concrete, viable reasons for it to make such an order. In . V. Purie v. E. M. C. Steel Ltd [(1980) 50 Comp Cas 127 (Del)], the court observed that, the section should be so interpreted as to enable relief to be obtained only by some person whose rights have been affected by the manner in which the affairs of the company have been conducted or accounts mintained and has, therefore, a grievance in the eyes of the law. Accordingly the court rejected the application made by the landlord of the company who wanted investigation into the company affairs on the grounds that he had paid some amount to the managing director with a view of inducing him to vacate the premises and the managing director (or MD) had misappropriated the money, or that the MD was using his political contacts for promoting the company business or that he had misappropriated the money which he had borrowed from the bank. 5.3 PERMISSIVE PROVISIONS Under Ss. 234, 235 and 237(b), the Central Government or the Company Law Board may appoint inspectors to investigate into the affairs of the company. These provisions are discretionary or permissive in nature i.e., there is no compulsion on them to conduct such investigation. Another point to be remembered is that the purpose of an investigation be it mandatory or discretionary is merely the gathering of information and such an investigation is in no sense a judicial proceeding for purposes of trial of any offence. A permissive investigation can be ordered in any one of the following situations:
1. On members application: Under Sec. 235, the Central Government or the CLB may appoint an inspector to investigate the affairs of the company on the application of: a) two hundred members or members holding one-tenth of the total voting power; or b) if the company has no share capital then, one-fifth of the total members. Under the 1988 amendment, the requisite number of members have to file their application with the CLB, along with evidence showing that they have a good reason to seek such investigation. If the CLB feels it necessary they may even be required to furnish a security (not exceeding Rs.1000/-) to cover the costs of investigation. After giving the parties to the application an opportunity to be heard, if the CLB feels that the affairs of the company need to be investigated, it gives a declaration to that effect. On such a declaration being made the Central Government appoints one or more inspectors who are required to submit a report on the completion of the investigation. 2. On report by the Registrar: Sec. 234 confers on the Registrar the power to call either information or explanation in respect of documents submitted to him, and on the failure of supplying of such information he can make a report to the Central government for necessary action. Further, if a creditor or member or such other interested person places before him material showing that (a) the business of the company is being carrited in fraud of its creditors etc., or (b) otherwise for a fraudulent or unlawful purpose, the Registrar can ask the company to furnish relevant information after giving it an opportunity to present its case. On the Registrar making a report that the companys affairs need to be investigated the Central Government appoints competant persons as inspectors for the purpose. In Barium Chemincals Ltd v. CLB [AIR 1967 SC 295], Hidayatullah J., observed, A further power is conferred on the Registrar, who may, after being authorised by a Presidency Magistrate or a First Class Magistrate, enter any place, search or seize any document relating to the company, or its managerial personnel, if he has reason to believe that it may be destroyed or tampered with. 3. By the Company Law Board: Under Sec. 237(b) the CLB may suo motto appoint inspectors to investigate into the affairs of the company or ask the Government to act in the following three situations: i) Fraud, Oppression or Illegality That is either when the company is formed for any unlawful or fraudulent purpose or when the affairs of the company are being conducted in such a manner as to constitute fraud on the creditors or oppression of some members. ii) Fraud, Misfeasance or Misconduct: That is the promoter while discharging, their duty, or the managerial personnel of the company have been guilty of fraud, misfesance or misconduct towards the company or the members. In 161
relation to these words a jurist observed, These seem to be words of very wide import: in Selangor United Rubber Estates Ltd v. Cradock [(1967 1 WLR 1168], Goff, J., held, withdrawing some of his dicta in an earlier case [S. B. A. Properties Ltd v. Cradock (1967) All ER 610], that other misconduct is not to be construed ejusdem generis with fraud and `misfeasance and that the statutory workding quoted above does not include moral turpitude. In veiw of this, it seems that [the] section ...... [would] extend to wht was called in Re B. Johnson (Builder) Ltd [(1955) Ch 634] as common law negligence. The Board of Trade, however, are of opinion that this head does not include mere mangerial inefficiency [Avtar Singh, pp.398, 399]. iii) Inadequate Information: That the members hav ebeen deprived of relevant information which they could reasonabley expect from the company, for example, information relating to the remuneration payable to the managing director or director etc., or the contracts entered into with them. Manner of exercising discretion Specifying the grounds on which the CLB can order investigation effectively limits the CLBs powers to order such investigation, i.e., it cannot go on a fishing expedition in the hope that it might be able to find some irregularity in the way the company's affairs are being managed. CLB can order an investigation only if it has some justifiable belief in the irregularity of the company's affairs. In the Barium Chemical Ltd case it was observed, No doubt the formation of opinion is subjective ... [but] the existence of circumstance is a condition fundamental to the making of an opinion, the existence of circumstances, if questioned, has to be proved atleast prima facie. It is not sufficient to assert that the circumstances exist and give no clue to what they are because the circumstances must be such as to lead to conclusion of certain definiteness. The conclusion must relate to an intent to defraud, a fraudulent or unlawful purpose, fraud or misconduct or the withholding of information of a particular kind. We have to see whether the chairman (of the CLB) in his affidavit has shown the existence of circumstances leading to such tentative conclusions. If he has, his action cannot be questioned because the inference is to be drawn subjectively and even if this Court would not have drawn a similar inference that fact would be irrelevant. But if the circumstances pointed out are such that no inference of the kind stated in Section 237(b) can at all be drawn the action would be ultra vires the Act and void. 5.4 SOME OTHER INVESTIGATIONS Apart from the above types of investigations, there are two other situations discussed below, where an investigation may be ordered, viz: i) Investigation of ownership of a company Sometimes the Central Government may feel that it would in the interest of the general public to ascertain the actual persons 162
in control of the company either financially or by materially influencing the policy making of the company. In such cases, the Government may appoint one or more inspectors under Section 247 to investigate and report on the membership of the company and other matters relating to it. The 1988 Amendment empowers the CLB while dealing with any matter before it to declare that the affairs of the company need to be investigated and on such a declaration being made the Government appoints inspector(s) to carry out the investigation. Where the company is being managed by managing agent, secretaries etc., the inspector will have the power to investigate into the ownership and control of shares. He also has the power to find out as to who else had shared the remuneration of such managing agents or secretaries etc. The cost of investigation is borne by the Government out of the money provided by the Parliament, but it may order the recovery of such expenses from persons on whose application the investigation was ordered. ii) Investigation of ownership of shares If it appears to the Government or the CLB that there is a good reason to investigate the ownership of shares in or debentures of a company etc., it may undertake an investigation under Section 248, but it is not necessary that they appoint an inspector for that purpose. The Government or the CLB itself may require the following persons to give information, viz; a) a person who is or was interested in those shares; b) a person who acts or has acted, in relation to those shares or debentures as the legal adviser or agent of the person interested in such shares or debentures. Such a person would be required to give all relevant information regarding those shares including the names and addresses of those persons who had acted in his behalf in relation to such shares or debentures. Section 248(4) makes a person guilty of giving false information liable to punishment, even if the false information was given out not deliberately but merely recklessly. If as a result of any of the above investigations the CLB comes to a conclusion that there is a justifiable reason for ascertaining the complete facts about any share(s) of the company, it may if necessary, impose certain restrictions, on these shares under Section 250, viz: a) Any transfer of such shares would be void. b) If the shares are yet to be issued, they shall not be issued, and if they are issued in contravention of the order the issual would be void. c) No voting rights can be exercised in respect of those shares. d) No rights shares` can be issued in respect of those shares. e) Except in case of liquidation, no money will be paid by the company in respect of those shares either in the form of dividend or capital or otherwise. The maximum period for which these restrictions may operate is 3 years. Further, if the CLB fears that as a result of transfer of some shares there might be a change in the constitution of the board of directors and such a change may not be in the best
interests of the public, it may restrain such a change from taking place without the CLBs prior approval, and may also direct that voting rights on those shares cannot be exercised for a period of 3 years. Section 250-A provides that an investigation may be initiated even when an application for prevention of oppression or mismanagement is pending or the company has passed a special resolution for voluntary winding up. Similarly, an investigation which is in progess will not be stopped or suspended by reason of the fact that an application for prevention of oppression or mismanagement has been made or a special resolution for winding up has been passed [Avtar Singh, p.407]. 5.5 POWERS AND DUTIES OF THE INSPECTORS An inspector has the following powers intended to facilitate his smooth discharge of duty, viz: a) He may wherever necessary investigate the affairs of other companies in the same management or group. But in certain situations under Section 239(2) he is required to take the permission of Central Government before doing so. b) He may require the managerial personnel or any other person to produce before him all the relevant books, papers and documents of the company. c) He may require the personal attendance before him of any concerned person and examine such a person on oath. d) Failure of a person to produce the said books etc., or to appear in person is a punishable offence.
e) If he wants to examine a person on oath but lacks the jurisdiction to do so, he may apply to the Central Government for necessary orders. f) If he has reasonable grounds to suspect that some relevant material may be destroyed or falsified, he may apply to the Magistrate under Section 240-A for seizure of such material. Functions i) When he examines a person on oath he has to take down notes in writing. ii) He has to act in a fair, reasonable, impartial and just manner through out the proceedings. iii) On completion of the proceedings, he has to make a report under Section 241 to the Government in the required manner. The Government is required to forward a copy of the report to the interested parties. Status of the Report In Maxwell v. Department of Trade [(1974)2 All ER 122 (CA)], the inspectors report was highly critical of the conduct of the Chairman and the chief executive of the company. The latter challenged the report, alleging that it was unfair on the ground that he was not accorded an opportunity to be heard and so it was a violation of the principles of natural justice. Rejecting the petition the Court observed that, the report of the inspector is not an evidence in the real sense of the word and, therefore the persons hit by the report have every chance to disprove its contents. But without doing so they cannot ask the Court not to act on it.
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6. CASE LAW
Barium Chemicals Ltd v. The Company Law Board [(1966) 36 Comp Cas 639]. The CLB issued an order appointing four persons as inspectors under Sec. 237(b) to investigate into the affairs of the appellate company. The company challenged the order on grounds that, (a) it was malafide and (b) the board had taken into consideration materials extraneous to the scope of Sec. 237(b), and had based its order on such material. The CLB chairman in his affidavit order alleged that as a result of delay, faulty planning and bungling of the project, there had been double expenditure, and continuous losses over a period of time wiping out one-third of the share capital. Further, the shares of the company were being quoted at half their face value and severance of their connection by some eminent persons. Rejecting the CLBs contention the Supreme Court held that these circumstances cannot by themselves suggest an intent to defraud or fraudulent management ....... Mere bungling or faulty planning cannot constitute either misfeasance or misconduct. Shanti Prasad Jain v. Kalinga Tubes Ltd [AIR 1965 SC 1535]. A private company was controlled by three groups of share holders (i.e., the petitioners and the two respondents) holding equal proportion of shares and having equal representation on the board. They had also entered into a written agreement to maintain this equilibrium, but the said agreement was not incorporated in the Articles of the company. Later, so as to avail of loan facilities, the company was converted into a public company, and there was a proposal to issue 39,000 additional shares. As per Sec. 81, these shares should have been primarily issued to the existing shareholders on rights basis, but the respondents forming the majority group, passed a resolution and offered the new shares to outsiders. The petitioner challenged the issue of shares to outsiders on the ground that the allottees were friends of the majority group and the allotment had been deliberately made to them with a malafide intention of increasing their voting strength and squeezing out the petitioner. This they contended was oppression within the meaning of Sec. 397. The issue to be decided was, whether the resolution offering shares to the outsiders was passed in good faith for the benefit of the company or merely to capture a absolute majority and to squeeze out the petitioner? Barman, J., held this conduct to be oppression of minority. Reversing this judgment on appeal the Orissa High Court observed, private agreement between the parties to maintain a equilibrium was not binding on the company. ..... The fact that the affairs of the company were managed with holding of shares in equal proportion amongst the three groups for a period of four years by itself cannot create a right in favour of the petitioner that it must continue in the same manner even when the company becomes public. To compel the majority shareholders, in these circumstances, to offer the new shares only to the existing shareholders would, far from being an oppression of the majority, be to deprive the majority of a right conferred upon them by Sec. 81 entitling them to direct free issue of shares. It would also not be compatible with dynamic concept of industrial expansion. For instance, the expansion scheme would require large capital in crores and any one of the groups may not be in a position to subscribe its proportionate shares as any one or both or residual groups can do. The balance is bound to be disturbed and equilibrium lost even if the affairs of the company be conducted bonafide. The Supreme Court supporting this decision observed, .... it is not enough to show that there is just & equitable cause for winding up on the company ..... It must further be shown that the conduct of the majority shareholders was oppressive to the minority as members and this requires that events have to be considered not in isolation but as a part of a consecutive story. There must be continuous acts on the part of the majority shareholders....... showing that the affairs of the company were being conducted in a manner oppressive to some part of the members ..... and such oppression must involve at least an element of lack of probity or fair dealing to a member in the matter of his proprietary rights as a shareholder. Re Five Minute Car Wash Service Ltd [(1966) 1 All ER 242]. The company was incorporated on 13th May, 1958 with a share capital of 2,351 shares of one pound each of which Mr. E held 1240 shares and was the chairman and MD of the company. In December 1964, a further allotment of 750 shares was made of which Mr. E did not acquire any. The petitioners alleged that before Dec, 64 Mr. E had been conducting the affairs of the company in a manner oppressive to the minority completely disregarding their interests, and that since Dec 64 two of shareholder companies [holding 748 & 801 shares respectively] had failed to use their voting powers to curtail the actions of Mr. E and had permitted and condoned his oppressive conduct. The alleged acts of oppression were stated to be differences of opinion on matters of policy, inefficient conduct of companys affairs. Dismissing the petition, Buckley, J., held: To succeed in obtaining relief under Sec. 210 (i.e., Sec. 397 of the Indian Act): First the matters complained of must affect the person or persons alleged to have been oppressed in his or their character as a member or members of the company. Harsh or unfair treatment of the petitioner in some other capacity, as, for instance, a director or a creditor of the company, or as a person doing business or having dealings with the company or in relation to his personal affairs apart from the company cannot entitle him to any relief under Sec. 210. Secondly, the matters complained of must relate to the conduct of the affairs of the company. Thirdly, they must be such as not only to make the winding up of the company first and equitable, but also lead to the conclusion that the affairs of the company are being conducted in a manner which can properly be described as òppressive of the petitioner, and, it may be, other members.
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The mere fact that a member of a company has lost confidence in the manner in which the companys affairs are conducted does not lead to the conclusion that he is oppressed; nor can resentment at being outvoted; nor mere dissatisfaction with or disapproval of the conduct of the companys affairs, whether on grounds relating to policy or to efficiency, however well funded. Those who are alleged to have acted oppressively must be shown to have acted at least unfairly towards those who claim to have been oppressed. Dr. V. Sebastian v. City Hospital P. Ltd [57 Comp Cas 453]. A petition of mismanagement u/s 398 was filed against the respondent company. One of the grounds for the petition was the removal of a person from office of secretary by the board of directors. Dismissing the petition the court observed: It is not correct to say that this provision comes into play only when there is actual mismanagement and that `mismanagement in the context must mean maladministration of the day to day affairs of the company......The business of a company may be running smoothly in a commercial sense and there may be nothing wrong with the day-to-day business management...... Relief cannot be moulded in advance on the basis of mere apprehensions, till a change of management actually takes place, and the aggrieved parties move the court under Sec. 398(1)(b). There is no presumption that every majority in every company would oppress and mismanage, and a mere attempt to get a majority or to assert majority rights in accordance with law will not attract ss. 397 and 398. The normal rule in proceedings under chapter VI is that the state of affairs complained of should exist at the time the petition is presented, and the apprehension based on a possible change of management yet to take shape cannot justify remedial action at this stage. R S Vishwamitra v. Amar Nath Mehrotra [59 Comp Cas 854]. The requisitonist passed resolutions removing the three sitting director and electing new ones in their place, nut this resolution could not be given effect because of an interim order of the court. Later on the sitting directors moved for quashing the resolutions on the ground that the management and control will go to the hands of the opposite parties. Rejecting the application it was held, The new directors have not yet taken over the charge of the affairs of the company. Unless the new directors take over charge and they conduct the affairs of the company, in any manner, has affected the company or the conduct of the directors is prejudicial to the public interest or prejudicial to the interest of the company, it can be judged as to whether an application under Sec. 398 should be entertained and a relief granted to the petitioners. In my opinion, so far as Sec. 398 is concerned, the petition is not maintainable at this stage. It is wholly premature. Viswanathan v. Tiffins B. A. & P. Ltd [AIR 1953 Mad 520] A clause in the Articles of the company authorized the directors to fill casual vacancies and also to increase the number of directors subject to the maximum number prescribed in the Articles. Some casual vacancies occurred and were promptly
filled up in the general meeting by the shareholders. These appointment were challenged on the ground that once the power to appoint had been delegated to the board it could not have been exercised at a general meeting. Upholding the appointments the court held, A company has inherent power to take all steps to ensure its proper working and that, of course, include the power to appoint directors. It can delegate this power to the board and such delegation will binding upon it, but if there is no legally constituted board which could function or if there is a board that is unable or unwilling to function then the authority delegated to the board lapses and the members can exercise the right inherent in them of appointing directors. The court found that at the time of the general meeting there was no director validly in office and, therefore, the members had the right to elect. Alok Prakash Jain v. Union of India [(1973) 43 Comp Cas 68 (Cal)]. The Central Government under the powers granted to it under sections 388-B to 388-E, made a reference to the CLB for the removal of the directors of a company. This reference was challenged on the grounds that the government had no real basis to arrive at that conclusion and also challenging the constitutional validity of the section itself. The court observed, It seems to us that in the facts of this case, it cannot be said that there was no material to justify the opinion, which the Central Government formed. The charges are sufficiently grave and serious, namely,fraud, misappropriation, manipulation of accounts, diversion of the companys funds, illegal declaration of dividends and unlawful payment of traveling expenses. Full particulars with dates and amounts involved have been furnished....... The power of the Central Government is not of discriminatory nature, for the word may couples power with duty and, therefore, when the circumstances justify a reference; that the delegation of the power to the CLB is not invalid as the Board functions subject to the control of the Central Government and that the resignation by the director either before or after the reference does not make it infructuous. The power is not merely to remove from an existing office but is also to restrain from future conduct. Marshalls valve Gear Co Ltd v. Manning Wardle & Co Ltd [(1909) 1 Ch 267]. A and 3 other persons were the directors of M. Co. and they held substantially the whole of the subscribed capital of the company. A was the majority shareholder, but held less than three-fourth of the share capital. N. Co. was committing an infringement of M. Co.s trade mark and the other three directors had personal interest in N. Co. As a result, in a board meeting they passed a resolution declaring to start any proceedings against N. Co. Hence, A at a general meeting of shareholders resolved and commenced an action against N. Co. to restrain the alleged infringement. The other 3 directors applied for striking down the name of the company on the ground that as the Articles had left the power of management with the board, the shareholders could not interfere by a simple resolution. Holding that the majority of the shareholders had the right to 165
control the action of the directors in the matter the court observed, Now it is obvious that in the position in which they (directors) have placed themselves on this question their duty and their interest are in direct conflict. On the once hand, it is their duty as directors to protect the interest of the original patent which is the property of the company; on the other hand, their personal interests are clearly to maintain the validity of the patent which belongs to them. And, therefore, the majority shareholders are entitled to decide whether or not an action in the name of the company shall proceed. Barron v. Potter [(1914) 1 Ch 895]. There were only two directors in a company and both of them refused to act with each other. There was no provision in the Articles enabling the shareholders to increase or reduce the number of directors in a general meeting, and so they approached the court. It was observed that, as there was a deadlock in the administration resulting from the fact that the directors were unwilling to act and exercise their powers, the company had inherent power to take necessary steps to ensure the working of the company and to appoint additional directors for the purpose.
Raymond Engineering Works v. Union of India [AIR 1970 Del 5]. The prospectus of a company disclosed that it had purchased its managing agents property for six and half lakhs, but refrained from mentioning that the managing agent himself had paid only rupees three and half lakhs for it, i.e., a profit of Rupees three lakhs was concealed from the shareholders. The company brought no action, but applied to the Government for approval of the appointment of the same managing agent as managing director. The Government granted approval subject to the condition that he refunded Rs.2,75,000/- to the company, the balance allowed to him as reasonable expenditure. This condition was challenged on the grounds that it was unjustified and that the government did not have any power to impose such restrictions under Sec. 637-A. Upholding the condition the court observed, the profit may not be illegal. But the Government was entitled to think that it was an unconscionable profit.
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7. PROBLEMS
1. The merchant shipping Act of 1874 provide that a ship owner would not be liable to make good a loss or damage to the goods unless he was actually at fault. A merchant suffered heavy losses when he sent his goods by a ship owned by a company. The loss occurred due to the negligence of the managing director of the company. The merchant filed a claim against the company for the loss suffered by him. The company contends that it being an artificial person was incapable of actual fault and hence could not be made to pay. Decide. [See, (1914-15) All ER 280]. 2. The Articles of a company delegated the power to appoint directors to the board of directors and further added under no circumstances shall the general body of shareholders have the power of appointment of directors. There were some casual vacancies in the board which were promptly filled up by the shareholders in the general meeting. These appointments were challenged by the board as being unauthorized and unlawful. The shareholders relying on the decision in Viswanathan v. Tiffins B. A. & P. Ltd uphold the appointment. Decide. [See, AIR 1950 PC 81]. 3. Of the two directors of a company, one died and the other submitted his resignation. There was no provision in the Articles relating to resignation by a director. The company refused to accept the resignation. The director seeks your advise. [See, (1977) 47 Comp Cas 652 (Mad)]. 4. Mr. A. was appointed as Managing director of a company for a period of 5 years; at a monthly salary of Rs.5,000/-; annual increment of Rs.500/-; commission on profits @1% subject to the ceiling of half the annual salary; gratuity, medical allowance, house rent allowance etc. The Central Government approved the appointment by reduced the term to 2 years and also slashed the salary and other emoluments, but failed to give any reasons for these changes. Discuss the validity of this order. [See, (1980) 50 Comp Cas 437 (Guj)]. 5. At a company meeting a resolution was passed to elect some directors by a separate election. Mr. X was a candidate in the election by he lost the election. He was again proposed as a candidate to fill up a second vacancy, but the chairman keeping in mind his first defeat, rejected his candidature. Mr. X files a suit questioning the chairmans right to refuse. Decide. [See, (1964) 1 Comp LJ 105; AIR 1932 Mad 100]. 6. A public company doing forward contract business amended its Articles under a statutory direction so as to deprive its nontrading members of their right to vote, to call meetings, to elect directors and to receive dividends. The deprived members challenge the action as being oppressive. Decide. [See, AIR 1961 Punj 485]. 7. A society created a subsidiary company to enable it to enter the rayon industry. Subsequently, when the need for the subsidiary ceased to exist, the society adopted a policy of running down its business which depressed the value of the shares of the subsidiary. The managing director and another shareholder challenge this action of the society as being oppressive. Decide. [(1958) 3 All ER 66]. 8. There was continuous infighting among the directors of a company who were also the shareholder. The interest of the company were being totally ignored, as a result of which the company started incurring losses from year to year. The directors started their own separate business, and even proper records of the company were not available. Decide whether this would amount to mismanagement u/s 398. [See, 55 Comp Cas 702]. 9. Mr. A being the majority shareholder and director of a company wants to sell the sole undertaking of the company at a price well below the real value of the undertaking. The undertaking is presently running at a loss but is capable of earning huge profits under proper management. Discuss whether the minority shareholders can approach the court under ss. 397 or 398. [See, AIR 1964 Ker 114]. 10. There has been a successive fall in the profits of a company over the years. The directors relatives have been appointed to high positions and paid high salaries. The company has formed 2 other subsidiaries which are being managed by the directors relatives. The parent company has given huge loans to these subsidiaries, but no interest has been realized on these loans. Discuss whether these facts warrant an investigation into the affairs of the company under Sec. 237. [See (1975) 45 Comp Cas 33 (Del)].
[Note: Please specify your name, address and ID No. while sending in your answers] 167
1. Avtar Singh: Company Law, 1986, Eastern Book Co., Lucknow. 2. Chakraborti, A M: Taxmans Company Law, 1994, Taxman Allied Services (P) Ltd., New Delhi. 3. Drucker,P., The Practice of Management, 1900, Allied Services (P) Ltd., New Delhi. 4. Gower, Modern Company Law, 1992, Sweet & Maxwell. London. 5. Galbraith, New Industrial Estate, 1967, Prentice Hall, New York. 6. Goyle, L C: Statutory Remedies for Oppression & Mismanagement in Companies, 1990, Eastern Law House, New Delhi. 7. Koontz, et. al., Management, 1983, McGraw Hill International, New Delhi. 8. Landsbrough, Industrial Management, 1955, Asia Publishing House, Bombay. 9. Ramaiya, A: Guide to the Companies Act, 1995, Wadhwa & Co., Nagpur. 10. Sen, S C: The New Frontiers of Company Law, 1971, Eastern Law House, Calcutta. 11. Schmitthoff (ed), Palmer's Company Law, 1982, Stevens, London. 12. Wright, D, Touche Ross, Rights & Duties of Directors, 1986, Butterworths, London.
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Course No: III Module No: IV
Company Law and Secretarial Functions

Materials Prepared by : Ms. Sudha Peri Dr. N. L. Mitra Materials Checked by : Dr. P. C. Bedwa Ms. Archana Kaul Materials Edited by : Mr. V. S. Mallar Mr. T. Devidas
National Law School of India University Published by : Distance Education Department National Law School of India University Post Bag No. 7201 Nagarbhavi, Bangalore - 560 072
170
INSTRUCTIONS
In our second module on corporate law we have seen that one of the basic attributes of a company is that it is a legal person with an existence which is separate and distinct from those who were instrumental in forming the company. A legal person is one who is recognized by law as having certain rights and imposed with certain liabilities. In most major matters the law does not treat a legal person any differently from a natural person. Though, a legal person has a status which is more or less on par with that of a natural person, there is one area where it differs from a natural person. A natural person can conduct all his business on his own - he does not have to depend much on other persons to do something for him. But a legal person; being a creation of judicial imagination is unable to act or think on its own. Although the consequences of the acts [be they advantageous or disadvantageous] are attributed to the company - the act itself has to be done by the natural person. So a legal person acts vide the agency of human beings. The natural person acting on behalf of a company come under various categories, namely shareholders (who act as financiers), workers, employers, technicians, administrative staff and the management. The smooth and efficient running of a company is dependent upon the amount of cohesion and cooperation amongst these various categories of human beings. The more all of them are involved in the working of the company, better would be the results. To achieve this cooperation and cohesion - the Companies Act has made provisions to see that every person in the company family is kept informed of the various developments within the company by holding meetings at regular intervals and whenever needed. So we have, meetings of the shareholders, of the creditors, of the board of directors, of their committees etc., where relevant information is given, necessary proposals put forward, debated upon, voted and passed in the form of resolution, and further action taken on those resolutions through allocation of powers and responsibilities and appropriating accountability. In short, one may say that majority of the policies of company business are conducted through these meetings. In this module we are discussing the responsibility of the company official, known as Secretary, who co-ordinates all such corporate decision making bodies; helps in supplying all necessary information; passes on the relevant policy formulated to appropriate management authority to functionalize those decisions and builds up linkages of various stages of management bodies and finally prepares reports and returns and submits the same to appropriate authorities. Secretary is the person who heads the accounting and legal decision in a company. In fact an author makes an analogy between the heart of a human body and the function of the office secretary. Several routine functions of the Secretary are included in this module with appropriate annexures. You will benefit if you read some basic book on Company Secretary along with this module in order to properly appreciate the key functions of this officer. N. L. MITRA Course Co-ordinator
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COMPANY LAW AND SECRETARIAL FUNCTIONS
TOPICS 1. Introduction ........................................................................................................................ 2. Company Secretary ........................................................................................................... 3. Meetings .............................................................................................................................. 4. Reports, Applications, Approvals ...................................................................................... 5. Checklist of important functions ....................................................................................... 6. Case Laws ............................................................................................................................ 7. Problems ............................................................................................................................. 8. Supplimentary Readings ................................................................................................... 173 174 180 201 211 215 218 219
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1 INTRODUCTION
Overs the years in company law the procedural matters have become extensively important. This is because of domination of positive structure of law in company matters. Regulations, rules, orders, guidelines dominate the whole working environment of the corporate sector. The procedural matters have become so complicated that a professional secretary for the company became inevitable. The Companies Act therefore had to be amended to incorporate the compulsory appointment of a professional secretary in order to oversee the administrative set up and take care of the regulatory mechanism. A company secretary plays a key role in the corporate administration. He is placed in a staff authority relationship with the board of directors of the company. In many of the companies he is the chief of the finance division as well. He is responsible for the detailed functioning of the secretariat. A company generates the systems of reporting and accountability. Some are for in-house consumption and some are required to be disclosed to the public. The corporate functioning is mostly composed of H planning G a plural policy making board and execution of a singular top executive with his team of professional managers. The Secretariat of the company functions as heart of the company pumping its resources to various limbs with adequate communication of instructions and guidance. The following diagram presents the importance of the secretariat and secretarial functioning:
General Meeting
Capital Market Regulation
BOARD
Governmental Regulation
Top Executive Managing Director
Company Secretary Secretariat
HRD Committee
HRD Director
Marketing Management Middle Management
Company Auditor
Lower Level Management
Finance Committee
Therefore it is quite evident that policies are laid down in meetings in the form of resolutions. The chief executive prepares instructions for the execution of the policies and the secretariat ensures that the company adheres to the governmental rules, regulations, guidelines and orders. Therefore the secretariat has two types of functioning, namely, co-ordinates the internal information system between various functionaries of the
company and see only between the company and outsider including the governmental agencies. This module therefore incorporates various types of meetings of different organism of the company, different types of resolutions and the business transacted in various systems of resolutions and various types of reports that are considered in the meetings of various organis and submitted to various authorities. 173
2. COMPANY SECRETARY
SUB TOPICS 2.1. Introduction 2.2. Definition 2.3. Qualifications, Appointments and Removal 2.4. Rights of a Secretary 2.5. Duties and Liabilities 2.6. Legal Status 2.1 INTRODUCTION In the present age of mega industries with extensive business operations the majority of a company's work is done through meetings. A meeting cannot be arranged at the drop of a hat. A lot of spade work has to be done before a company meeting can be conducted or held. The question thus arises, who is the person who is responsible for getting this work done? Who sees to the paper drafting, circulation of notices? Who checks the quorum? Who takes down the minutes? Who files the copies of the minutes, etc., with the Registrar? All these seemingly unimportant functions alongwith a myriad other functions are all performed by one of the most important officers in the company, known as the 'company secretary'. 2.2 DEFINITION The term 'secretary' owes its origin to the Latin word "secretarius" meaning a "confidential officer". Thus the use of secretaries has been prevalent since the ancient past. In fact, even in those days any organization worth its name had a secretary. For example, in ancient Rome a secretary had an important say in the affairs of the State, and besides writing for his masters or maintaining their accounts, a secretary also acted as a historian. It has been said that the profession of secretary is one of the oldest in the world, and that wherever there was a man of action, there too was a man of the pen to record his deeds. Much of our knowledge of ancient times is derived from the Scribes, who were the secretaries of their day." [Kapoor, p.42]. The Oxford Dictionary defines the word secretary as a person" whose office it is to write for another; especially one who is employed to conduct correspondence, to keep records and to transact various other business for another person or for a society, corporation or public body." The question now arises, who is a company secretary? Section 2(45) of the Act states that, "secretary means a company secretary within the meaning of clause (c) of sub-section (1) of section 2 of the Company Secretary Act, 1980, and includes any other individual possessing the prescribed qualifications and appointed to perform the duties which may be performed by a secretary under this Act and any other ministerial or administrative duties." Further, section 2(45-A) provides, "secretary in whole-time practice" means a secretary who shall be deemed to be in practice within the meaning of sub-section (2) of section 2 of the Company Secretaries Act, 1980 and who is not in full-time employment. 174
The original definition of the secretary stated that, "secretary means any person, if any, who is appointed to perform the duties which may be performed by a secretary under this Act". This definition (i) excluded the firms and body corporates from the office of the secretary, and (ii) the duties of the secretary were not specified. The present definition under the Amendment Act, 1988 drops the word "purely" before the words ministerial or administrative duties" so as to enlarge the scope of the functions of the secretary. The present definition specifies three thing namely: 1. An individual alone can be appointed as a secretary of a company and a firm or a body corporate cannot be appointed as a secretary. 2. The company secretary should now possess prescribed qualifications. Under the previous Act no specific qualifications were laid down under the law. The Central Government now, under the Company (Secretary Qualification) Rules 1975 has laid down that a person to be qualified as a Secretary should possess the membership of the Institute of Company Secretaries of India. 3. The duties of the secretary are purely ministerial or administrative duties. They are not executive or managerial though limited managerial powers may be delegated by the board. The duties of the secretary are sometimes laid down by the board of directors and sometimes defined by the articles of association. But the board cannot alter the duties of the secretary as determined by the law. Besides, the general duties imposed by the board or the articles, the secretary has to perform a number of statutory duties. It should be noted that the present definition has been further amended by the Amendment Act, 1988 so as to bring the definition under Section 2(45) of the Act in line with the definition of the "Company Secretary" contained in the Company Secretaries Act, 1980. According to Section 2(1)(c) of the Company Secretaries Act, 1980, "Company Secretary" means a person who is a member of the Institute of Company Secretaries of India constituted under the Act. The Companies (Amendment) Act, 1974, under Section 383A laid down that, every company having a paid-up share capital of not less than Rs.25 lakhs shall have a whole time secretary and where the Board of Directors of any such company comprises of only two directors, neither of them shall be the secretary of the company." Under the Amendment Act of 1988, the limit of paid-up share capital of rupees twenty five lakhs has been deleted and is provided that the said amount shall be such as may be prescribed by the Central Government. Other companies whether public or private whose paid-up share capital is less than the amount so prescribed need not appoint a whole time secretary.
It should be noted that the Companies (Amendment) Act, 1988 provides that only an individual can be appointed as the company secretary as was provided under old Amendment Act, 1974. Secondly, a company secretary must possess qualifications as prescribed by the Central Government. The Act further provides that a company can appoint a secretary with 'limited executive powers of management' delegated by the Board of Directors in addition to his routine duties. If the secretary is entrusted with routine duties he is called "Routine Secretary" while he will be termed as "Executive Secretary" if he is entrusted with limited executive managerial powers. It should be remembered that in practice, the secretary will be the manager of the company when he is delegated with general managerial powers. In case, he acts as a director he may be the Managing Director in the eyes of the Company Act, [Acharya, pp.2-3]. 2.3 QUALIFICATIONS, APPOINTMENT AND REMOVAL A] Qualifications A company secretary must possess the following qualifications as per the Companies (Appointment & Qualification of Secretary) Rules, 1988: i) If the paid-up share capital of the company is Rs.50 lakhs or more the company has to appoint a whole-time secretary, the person to be appointed as a secretary must be a member of the Institute of Company Secretaries of India [S. 383A]. Accoriding to S. 383A any idnvidual holding office of Secretary in more than one company having a sharecapital of Rs.25 lakhs or more must vacate the office of Secretary in all other companies excepting one to which he selects to act as the secretary. Therefore if one reads Sec. 383A with Rule 2(3) of the above Rules, it may be concluded tht a company having share-capital worth Rs.25 lakhs and more upto 50 lakhs shall appoint only whole time secretary with the qualification as prescribed under Rule 2(4) stated below. And a company having less than Rs.25 lakhs worth of sharecapital can have a part time secretary but with qualification as stipulated in Rule 2(4). If the paid-up share capital of the company is less than Rs.50 lakhs, the company may appoint any individual as a whole time secretary provided he has atleast one of the following qualifications, viz: i) membership of the institute of Company Secretaries of India constituted under the Company Secretaries Act, 1980, or ii) passed the Intermediate examination conducted either by the earlier or present Institute of Company Secretaries of India, or iii) M. Com. or post-graduate in company secretaryship from a recognized university; or iv) LL.B. from any university; or v) membership of the Institute of Chartered Accountants of India, or
vi) membership of the Institute of Cost and Work Accountants of India; or vii) post-graduate diploma or degree in management from either a university or one of the IIM's in Ahmedabad, Bangalore, Calcutta or Lucknow, or viii)post-graduate diploma in company law and secretarial practice from Udaipur University, or ix) post-graduate diploma in company secretaryship from Institute of Commercial Practice, Delhi Administration or diploma in corporate laws and management from Indian Law Institute, New Delhi, or x) membership of the Association of Secretaries and Managers, Calcutta. The proviso to this section states that, the moment the paid up share capital of the company increases to Rs.25 lakhs or more, the company should comply with provisions of Rule 2(1) and (2), within a year of such increase. These rules do not apply to those persons who have been in service as a whole time secretary immediately before 30.10.1980. Apart from these prescribed qualifications, it is desirable for a company secretary to possess certain other general qualifications, namely: a) A general education of moderately high standard, with a proficiency in English and the vernacular in use. b) A thorough knowledge of Taxation Laws, Accountancy and Company Law and sufficient knowledge of the basic principles of management, manpower planning etc. c) He must have a good knowledge of office management and administration. d) He should possess a pleasing personality, since he forms a link between the management and employees and management and third parties etc. He should be able to communicate and cooperate with all kinds of people. e) He should have atleast a working knowledge of the technical side of his employer's business. To put it briefly, "Attention, application, accuracy, method, punctuality and despatch are the principal qualities required for the efficient conduct of business of any sort." (Chakraborti, et.al., p.17]. B] Appointment The first secretary of the company is appointed by the promoters at the pre-incorporation stage, in the same manner as the first directors are appointed. Such a secretary is generally called as the pro-tem secretary, and he holds office till the incorporation of the company or appointment of a regular secretary. The regular company secretary is appointed by the board of directors in their first meeting. Even if the person to be appointed as secretary is mentioned in the articles, he cannot take charge till his appointment is confirmed by the board, and a contract of service finalized between the company and the secretary. The Companies (Amendment) Act, 1974 prohibited appointment of firm or body corporate to be the secretary of a 175
company. According to Sec. 383A(2a) firm or body corporate holding the office of a secretary had to vacate the office within six months from the commencement of the Amended Act. Therefore, only individuals can be appointed as secretary of a company, i.e., unlike membership in a company which can be acquired by an association, firm or incorporated body, the post of a secretary is reserved only for natural persons and legal persons can neither aspire nor be appointed as a secretary. A director of a Company can be appointed as a secretary, provided he discloses his interests and does not participate in the discussion or subsequent voting on the motion 'appointing him as secretary' (Sections 297-299). In cases, where the director or his relative is to be appointed as a secretary, the appointment can only be through a special resolution passed in a General Meeting. The terms and conditions of service of a secretary are also fixed up in the board meeting. Where however, only two directors are there, then, neither can be appointed as a secretary [383A(1)]. The procedure for appointment is broadly as follows: a] Passing of a resolution by the board of directors [in case the person proposed to be appointed is not a director of the company or a relative of such director]. b] Contract of service to be executed between the company and the secretary. c] The appointment to be recorded in the relevant register. d] A return in duplicate in Form No.32 to be filed with the Register within 30 days of appointment. C] Removal Since the Secretary is an employee of the company, he can be removed from service or dismissed from office under the general law governing the employer-employee relationship. In general, the power of removal is given to the authority having the power of appointment i.e., in this case the board of directors has the authority/power to remove a secretary from service. A secretary may be removed from service on any of the following grounds, viz: a) when the time period for his service elapses; or b) when he has been given a proper notice for dismissal as required under the contract due to i) making a secret profit; or ii) being convicted of an offence involving moral turpitude on his part, for ex., fraud, negligence, etc. Before being removed from service, the principles of natural justice should be followed, i.e., ( i) he should be given a notice and (ii) he should be given an opportunity to be heard, if the contract requires that a notice of specified period (say 3 months) should be given before he can be removed, then such a notice should be given before removing from service. A notice can be dispensed with, where the secretary has acted in a manner justifying his instant dismissal, for example, when he is guilty of misconduct, wilful disobedience, fraud, negligence or other acts of misfeasance of substantial magnitude. Even when the secretary is struck by permanent disability either mental or 176
physical leaving him incapacitated, he can be instantly dismissed. Where the power of dismissal is given to the board, removal by the managing director on his own initiative is bad [Haryana Seeds Devp. Corp. Ltd. v. J.K.Aggarwal, (1989) 65 Com. Cas. 95 (P & H)]. 2.4 RIGHTS A company secretary enjoys rights both under the statute and under his contract. Some of these rights are as follows: a) He has the right to supervise and control the secretarial department of a company. b) He has the right to sign all documents which require an authentication by the company. c) He has a right to claim remuneration for his services, and in case of wrongful dismissal he can also claim damages for the same. d) The board of directors have the authority to delegate some of their powers to the secretary. In case of such delegation, the secretary has the right to exercise the powers of the board to the extent of delegation. e) Being the principal officer of the company, he has the right to keep the common seal of the company in his possession and to use the seal whenever needed. But these rights of a secretary are restricted. A secretary thus does not have the following rights, viz: i) He cannot represent the company or enter into any contract on behalf of the company unless authorized to do so. ii) He has no right to either allot shares or register a transfer of shares unless so authorized by the directors. iii) He has neither the right to borrow money nor lend money on behalf of the company. 2.5 DUTIES AND LIABILITIES a] Duties A secretary has duties both under the statute and those arising from a contract, apart from certain general duties of ministerial or administrative nature which attach to him because of his position as a secretary. Statutory Duties a) Companies Act: He is responsible for proper maintenance of books and registers; issue of notice, preparation and authentication of agendas, resolutions and minutes of the meeting; filing of relevant documents with the Registrar, supervising the issue, allotment, transfer and registration of shares, custody and use of common seal, etc. b) Income Tax Act: He is responsible for the deduction of the requisite income tax from dividends and salaries, timely filing of returns, issual of income-tax paid certificate to every employee/shareholder.
c) Indian Stamp Act: He is responsible to see that all legal documents bear adequate stamp as required under this Act, or under any other relevant statute. d) Sales Tax Act: He is responsible in ensuring the timely submission of tax-returns to the authority. e) Other Acts: He is responsible to ensure the compliance with all regulations under any other Act (for ex: FERA, MRTP, etc) and which may apply to his company. He should also see to the compliance of various labour legislation regulations for example, Minimum Wages Act, Workman's Compensation Act, Factories Act, etc. General Duties Agent to Director: Under law, a company secretary being under total control of the board is an agent of the directors, and as such must carry on their instructions to the full (since his acts would impute to the directors). He can exercise only such powers as have been specifically delegated to him by the board. He may sometimes act in an advisory capacity to the board especially on administrative or ministerial matters. Duties towards Shareholders: Despite being for all practical purposes an agent to the directors, a secretary is expected to act in the best interests of the shareholders and to safeguard their interests amongst themselves as well as vis-a-vis the company. This duty is imposed on him because of two possible reasons: (i) he is an officer of the company and as such is obliged to act in the best interests of the company and shareholders; and (ii) the directors being in a fiduciary duty vis-a-vis the shareholders and he being an agent of the directors the fiduciary duty is also passed on to him. Being the primary link between the board and the shareholders, he keeps them informed of the board decisions, and also passes on their complaints, grievances etc., to the board. He is also responsible for circulating notices, convening and conducting meetings, maintaining records, issuing 'call' letters, registering allotment/transfer of shares, supplying information and document copies if so required, payment of dividends etc. Liaison Officer: He is the person who acts as a liasion or link between the board, employees, all the shareholders and the outsiders and is the main source of information for each of these groups i.e., he is the person who keeps each category informed about the activities or problems etc., of the remaining. This liasioning may be done by him either orally or by means of circulating letters, notices etc., or by use of mass media i.e., through advertisements etc. Office Executive: Being the chief administrative head of the company, he is responsible for organizing, supervising and controlling/co-ordinating the office work for which he is directly responsible to the M.D. and the board. His duties include, correspondence, filing, accounting, taxation, registration etc., and in case there are different departments/personnel dealing with each one of these, he is required to coordinate with each one of these for a smooth and efficient functioning. Duties vis-a-vis Stock Exchange: It is essential for a public company to have its shares listed in at least one stock exchange.
This listing essentially requires that the stock exchange should be fed with some relevant and upto date information and it is the duty of the secretary to supply them with this information. Even before that, being the person who deals with important correspondence, it is he who would have to apply to the stock exchanges to seek their permission for listing the shares of his company at their exchange. In general, a secretary's duties are largely of ministerial or administrative in nature and he does not have the power to negotiate contracts, borrow money or make policy decisions, or acknowledge a debt/liability on behalf of the company [Lakshmi Rattan Cotton Mills Co. Ltd. v. Aluminium Corporation of India Ltd., [(1967)37 Comp Cas 586 (All)]. The functions of the secretary of a company have considerably expanded during the past eighty and more years. He is no more a mere clerk or servant as was stated in several decisions of the English Courts such as Barnett Hoares and Co. v. South London Tramways Company, [(1887) 18 QBD 815 (CA)]; George Whitechurch Ltd. v. Cavanagh, [1902 AC 117]; K.A.Krishnan v. Indo Union Assurance Co. Ltd., [(1944) 14 Com Cases 10 (Mad)]. Short of managerial functions his powers and duties extend to the whole field of administration of the affairs of the company, so that an outsider dealing with him may assume that functions and duties other than managerial, are normally within the ambit of the secretary's powers unless there are circumstances to show that they are limited in respect of particular matters." HALSBURY'S LAWS OF ENGLAND, paras 540-548 (4th Edn., Vol.7). In England the duties of secretary are thus described: The duties of the secretary will depend on the size and nature of the company and of the arrangement made with him. But in any case he will be present at all meetings of the company and of the directors and will take proper minutes of proceedings, he will issue under the direction of the Board all notices to members and others that may be requisite; he will conduct all correspondence with shareholders in regard to calls, transfers, forfeiture and otherwise, and will keep the books of the company or such of them as relate to the internal business thereof, e.g., the register of members, the share-ledger, the transfer book, the register of mortgages, etc. He will also make all necessary returns to the Registrar of Companies (PALMER'S COMPANY GUIDE, 122-123 (36th Edn.). The company secretary performs many of the administrative duties imposed upon companies, such as delivering documents to the Registrar of Companies and engaging office staff. In Maidstone Buildings Provisions Ltd. Re, (1971)1 WLR 1085: (1971)3 All ER 363, PENNYCUICK V C said: 'So far as the position of a secretary as such is concerned, it is established beyond all question that a secretary, while merely performing the duties appropriate to the office of secretary, is not concerned in the management of the company. Equally I think he is not concerned in carrying on the business of the company. On the other hand, it is equally well established, indeed it is obvious, that a person who holds the office of secretary may in some other capacity be concerned in the management of the company's business.[Ramaiya, p.50] 177
B. Liabilities Once again the liabilities of a secretary can be studied under two headings, namely, statutory and contractual. Statutory Liabilities Being the Chief administrative head of a company, a secretary of the company has certain liabilities imposed on him under the various sections of the Act. Briefly he made be liable for the following acts or omissions, viz: a) Default in filing and circulating of Statutory Report or in holding the Statutory Meeting. b) Default in holding Annual General Meeting. c) Default in circulating member's resolution's, due notice of which has been given. d) Failure to submit to the Registrar relevant documents [like copy of balance sheet; annual returns etc] as per the requirements of the Act. e) Failure to duly notify a board meeting. f) Failure to file certain resolutions and agreements with the Registrar. g) Failure to take down or file the minutes of meetings, or in allowing inspection of the minutes book when requested. h) Failure to have the name and address of the registered office of the company painted or affixed outside every office/place of business, or failure to have the company name engraved on the common seal or printed on the letterheads etc. Contractual Liabilities This as the name itself indicates arise by virtue of his contract of service with the company. But these liabilities can be broadly categorized as under: i) Being the agent of the directors' he is responsible for the proper discharge of his duties and exercise of power-in case of failure to do so he becomes liable to them. ii) He is liable if he leaks out confidential information however inadvertantly, except where such a leak is warranted in the proper exercise of his duties. iii) In case the company suffers any loss or damage due to his acting beyond his authority, then he becomes personally liable for such loss or damage. iv) In performance of his duties he is expected to exercise reasonable care and skill, and failure to do so or the negligent performance of duty would render him personally liable for any loss occasioned by such conduct. v) He is liable to account for any secret profits made by him in course of duty. vi) In case of misfeasance, like fraud, then he becomes personally liable alongwith the company vis-a-vis the aggrieved party who can sue him instead of the company. But if he has acted innocently and within the scope of his authority he also has the right to be indemnified by the company, whenever such third party sues him. Further, the secretary cannot be made personally liable for a fraud 178
committed by his assistant etc., unless he was also a party to such a fraud. 2.6 LEGAL STATUS OF A SECRETARY The secretary is only a subordinate officer and he has no managerial functions. He performs such functions and exercises such powers as the Board may delegate to him, and these powers may be extensive or limited according to the terms of appointment in each case, and there is nothing to prevent their being extended to the sphere of managerial functions also. But no one entering into contractual relations with the company can assume without further enquiry that the secretary as such, has authority to make representations or do anything binding on the company. Barnett Hoares and Co. v, South London Tramways Co., [(1887) 18 QBD 815]. This view, however, has been modified in Panorama Developments (Guildford) Ltd. v. Fidelis Furnishing Fabrics Ltd., [(1971) 3 All ER 16 (CA)], by the Court of Appeal where LORD DENNING M.R.,t Petiti thus describes the present position of the company secretary: Times have changed, a company secretary is a much more important person nowadays than he was in 1887. He is an officer of the company with extensive duties and responsibilities. This appears not only in modern Companies Act, but also by the role which he plays in the day-to-day business of the companies. He is no longer a mere clerk. He regularly makes representations on behalf of the company and enters into contracts on its behalf which come within the day-to-day running of the company's business. So much so he may be regarded as having been held out as having authority to do such things on behalf of the company. He is certainly entitled to sign contracts in the administrative side of the company's affairs, such as employing staff and ordering cars and so forth. All such matters now come within the ostensible authority of a company secretary. SALMON,J. has concurred in this judgement and emphasized that the secretary is the chief administrative officer of the company and in respect of matters concerned with administration he has ostensible authority to sign contracts and do all things within the ambit of administration. Even in the light of this decision it cannot be assumed, in the absence of facts or special circumstances in any case, that the powers of a secretary have expanded to any extent over the area of managerial functions. Functionally, a secretary as such can only being secretarial duties and exercising secretarial powers. He cannot be equated with a manager whose powers and functions are distinct from those of secretary as understood by the business world. It may be noted that his remunerations not taken into account for purposes of calculating overall managerial remuneration under section 198. Though a secretary as such has limited powers, there is nothing in the Act to prevent a company entrusting him with wider powers and responsibilities. If managerial powers are given to him and they extend to the management of the whole affairs of the company,the secretary though called by that name, will really be the manager or if he is also a director, the managing director or whole-time director for purposes of this Act.
Under the scheme of the Act, it would be seen that where a company appoints a secretary, it is his duty and responsibility to see that the affairs of the company are conducted in accordance with law and the requirements of the Company Act and other laws (tax laws, factory laws, etc.), are duly complied with. Accordingly in all cases where for contravention of any law by the company, an officer of the company is punishable as an officer in default, the secretary will be liable. See Section 5(d). His true legal position is that he is an agent in the same position as any other agent of the company. If his dealings are such that the company is not bound by them, he may himself be liable as in the case of a director (as regards this see Notes under sections 291 and 293) on the ground of breach of warranty of authority. If he does any unauthorized acts or makes unauthorized representations the company is not bound by them). Although the secretary of a company is treated for civil purposes as a mere administrative assistant of the Board with a very limited authority to engage in transactions on the company's behalf, statutes creating new criminal offences often make him responsible for the company's crimes to the same extent as the directors. In this respect criminal law is more in accordance with reality, because the secretary is often a full-time director as well, and he may be as influential in managing the company's affairs as his fellow directors. Illustrative cases of a Secretary's role: Certain English cases have considered different aspects of a secretary's role; these cases are being set out below:
i) The knowledge of directors is in the ordinary circumstances the knowledge of the company, but the knowledge of a mere official such as the secretary, would only, be the knowledge of the company if the thing of which the knowledge is secured is a thing within the ordinary domain of the secretary's duties. Houghton and Co. v. Nothard, Lowe and Wills Ltd. [(1927) All ER Rep 97 (HL)]. ii) The secretary is not liable or accountable, as the directors are, for loss which may be incurred by the company by reason of any mis-application of funds of the company even with his knowledge unless the said mis-application was due to his own fraud or negligence. (Joint Stock Discount Company v. Brown, [(1866) LR e Eq 139]. iii) The offices of a director and secretary are so incompatible that one and the same person cannot hold both. (Boschoek Proprietary Ltd. v. Fuke, [(1906) 1 Ch 148)]. iv) Where the same person is the secretary of two companies, knowledge acquired by him for one company is not notice to the other. Fenwick, Stobart and Company [1902 1 Ch 507]. v) If the acts of the secretary are done within the scope of his authority, it has been laid down that the principal (i.e., the company) is liable for the fraud of the secretary acting within the scope of his authority whether the fraud is committed for the benefit of the principal or for the benefit of the agent. [Lloyd v. Grace Smith and Co., (1912) AC 716 (HL)] [Ramaiya, pp. 52-53].
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3. MEETINGS
SUB-TOPICS 3.1. Introduction 3.2. Nature of Meetings 3.3. Kinds of Meetings 3.4. Notice for Convening Meetings 3.5. Chairman 3.6. Quorum 3.7. Agenda, Resolutions, and Minutes 3.8. Motions and Amendments 3.9. Voting 3.10. Adjournment and Dispersal 3.11. Conclusion 3.1 INTRODUCTION Meetings are the best example of 'democratic functioning' within a society. We have come to a stage where very rarely in an institution is a decision reached without a meeting of all the concerned persons being called, wherein the relevant matter is discussed. A stage is now reached where even within families, decisions are reached only after a meeting is held between the concerned persons. To put it succinctly, 'meetings have come to stay'. There are various kinds of meetings presently in vogue - from legislative assemblies, municipal councils etc. i.e., meetings of the elected representatives of the people to meetings of group (for example meetings of NGOs working in the field of 'child labour', to meetings between two or more individuals. To differentiate between various kinds of meetings we have come up with a varied nomenclature and we now call them as, conferences, seminars, summits, convocations, congregations, get-togethers, congress, assembly, gathering etc., each implying 'a coming together of various people for a specific purpose'. Just as we have various kinds of meetings, we have various kinds of people participating in these meetings from school going children to the Chairman and Managing Director of a company to the members of Parliament/Legislative Assemblies depending on the venue and purpose of the meeting; which also decides the issues to be dealt within that particular meeting. The history of 'meetings' in their present form can be traced back to the reign of King Henry VIII, when Thomas Cromwell transferred the government machinery into an administrative set up, where departments functioned in conjunction with the royal power. Each morning a meeting used to be held at the 'Board of the Green Cloth' to exercise budget supervision and control over expenses of the various government departments. Then, in Queen Elizabeth I's reign the parliamentary debate 180
format of meeting was evolved, which forms the basis of modern day meetings. The parliamentary mode of meetings has been adapted to suit the general needs and conveniences of everyday meetings. Broadly speaking, a meeting can fall in any one of the following categories: a) Formal Meeting:- Which is convened either under a statute or by a person in authority, usually presiding over an institution (ex: a parent-teacher meeting in a school). Such meetings are governed by the rules and regulations given under the statute or under the bye-laws of the institution. b) Informal Meeting:- Which is either convened by a person for some specific purpose (ex: a public meeting) or may take place without any formal planning (ex: meeting between friends). There are no set guide lines governing these meetings. It is possible to fit any meeting within one of these categories. As may be guessed - meetings under Company Law are usually formal meetings, with specific norms laid down in the Act itself. We would now see the nature and scope of meetings under Companies Act in detail. 3.2 NATURE OF MEETINGS In Sharp v. Dawes [(1876)2 QBD 29] it was held, the word 'meeting' prima facie means a coming together of more than one person. It is of course possible to show that the word 'meeting' has a meaning different from the ordinary meaning but there is nothing here to show this is be the case..." This case established a fundamental rule relating to meetings i.e., it required the coming together of atleast two persons. But like every rule, even this has an exception. Thus, in East v. Bennet Bros. Ltd. [(1911)1 Ch. 163], all the preference shares of a company were held by one single person. A meeting of preference shareholders was attended by him alone. It was held that the meeting was proper. For the purposes of this module, a proper definition would be, ordinarily an assembly of two or more persons, properly convened and constituted, coming together for discussion of defined topics, the transaction of business of a common interest or some other lawful purpose, and presided over by a properly appointed Chairman [Taggart, p.111]. The act itself does not define the term meeting' as such. 3.3 KINDS OF MEETINGS There are various kinds of meetings dealt with under the Act. These meetings of various interest groups are shown in the following diagram grouped around the Company Secretary because he is the person who has to see that the meeting is held properly and also has to keep the records.
Annual General Meeting S. 166
Extraordinary General Meeting
Statutory Meeting S. 165
Convened by CLB S. 186 Share holders' Meeting
Requisition Meeting S. 169
Other Class Meetings
Preference Shareholders' Meeting
Debenture Holders' Meeting
Company Secretary
Creditors' Meeting
EmployerWorkers' Meeting
Board of Director's Meetings
Committee Meetings
NOTE: An important point to be remembered is that though all these various kinds of meetings are called under the statute [i.e., Companies Act] it is only one meeting which is called as 'statutory meeting' as such. The remaining kinds of meetings are called by different names. We will now discuss each of these meetings in detail.
Shareholders Meetings 1) Statutory Meeting Section 165(1) states that, every company limited by shares, and every company limited by guarantee and having a share capital, shall, within a period of not less than one month and not more than six months from the date at which the company is entitled to commence business, hold a general meeting of the meeting of the members of the company, which shall be called "the statutory meeting". For this meeting to be fruitful, the shareholders or members should have all the relevant information relating to the company on hand. For this purpose, section 165(2) provides that, the
directors should send to every member a detailed report known as statutory report atleast 21 days before the day of the meeting. This report must be certified by atleast two directors one of them being the managing director and the auditors, for purpose of verifying that the contents of the report are true to their best knowledge. A copy of this report is also to be sent to the Registrar, and a default in filing of the report or holding of the meeting makes the company and the responsible person(s) liable to a fine which may extend to Rs.500/- (sections 165(9)]. A delay in sending the report to the shareholders can however be condoned by the unanimous vote of all members present and voting. 181
The importance of 'statutory meeting' cannot be better stated than in the words of Palmer, The obvious purpose of a statutory meeting with its preliminary report is to put the shareholders of the company in possession of all the important facts relating to the new company, what shares have been taken up, what money received, what contracts entered into, what sums spent on preliminary expenses, etc. Furnished with these particulars the shareholders are to have an opportunity of meeting and discussing the whole situation, the management, methods and prospects of the company. [Palmer, Pp.455-456]. Holding of a statutory meeting is in fact held to be of such paramount importance that failure to hold the meeting may be a ground for the court to order compulsory winding up under section 433(b). Since the basic purpose of this meeting is to keep shareholders informed - the provisions of section 165 do not apply to private companies [section 165(10)]. 2) Annual General Meeting Section 166(1) states that, every company shall in each year hold in addition to any other meetings a general meeting as its annual general meeting and shall specify the meeting as such in the notices calling it; and not more than fifteen months shall elapse between the date of one annual general meeting of a company and that of the next. There are two provisions to this sub-section, the first saying that, if the first annual general meeting (or AGM) is held within 18 months of incorporation it shall not be necessary for the company to hold any other AGM in the year of incorporation or the next year. Thus, for example, a company is incorporated in May 1994. If its first AGM is held within 18 months i.e., say in September 1995 then no other general meeting will be necessary either for 1994 or 1995. The second proviso, says that in special circumstances the Registrar may extend the time for an AGM to be held by 3 months provided it is not the first AGM. Two consequences follow the failure of not holding an AGM. Firstly, the CLB can order the holding of an AGM on an application made to it by any member under Section 167 of the Act. While making such an order the CLB can pass any other consequential or ancillary order or directions, in relation to the calling/conduct of the meeting. A meeting called in accordance with the CLB directives will be deemed to be an AGM [section 167(2)]. This power to call an AGM vests exclusively in the CLB and the Court cannot exercise it even under its inherent powers. Secondly, failure to call this meeting either in the regular course or in pursuance to the CBL directives, would make the company and every officer responsible for the default liable to a penalty under section 168, which may extend to Rs.5000/- and in case the default continues then Rs.250/- per day for every day of default. The facts of Sree Meenakshi Mills Co. Ltd. v. Asst. Registrar of Joint Stock Companies [AIR 1938 Mad 640] provide a good illustration on this point. Here, the company called one general meeting in December 1934, which was adjourned to March 1935 and then held. The next AGM was
held in February 1936. The company was prosecuted for failure to hold a meeting in the year 1935. On behalf of the company it was contended that an AGM was held in March 1935 and so the prosecution was invalid. The Court held that, the meeting held in March 1935 was the adjourned meeting of 1934. There should be one meeting per year and as many meetings as there are years. The company was accordingly fined. But in Kastoor Mal Banthiya v. State [AIR 1951 Ajm 39], a private company had only two members the accused and his brother, both being the directors also. The brother was critically ill during the period when an AGM was to be called, and hence the accused did not call an AGM. In these circumstances, failure to hold the meeting was not held to be a wilful default and consequently the accused was held to be not liable for a fine. Under section 166(2), an AGM should be held during business hours, on a working day and at the registered office of the company or at any place within the town where the registered office is situated. The Central Government may exempt a company from the application of these provisions. The time for an AGM may be fixed through the articles of the company or by a resolution passed in the AGM, i.e., in the first AGM a resolution may be passed fixing the time for the second AGM and so on. Need for an Annual General Meeting An AGM is an important institution provided by the Act for the protection of the shareholders rights. The present day companies as seen in an earlier module, represent a sharp division between ownership and control. The shareholders being the capital investors have an interest in knowing that the persons in whom they have vested the management and control of the company are not misusing their authority or mismanaging the funds. An AGM gives the shareholders a place and opportunity to review the working of the 'management' and the 'company'. It is also the place where some directors retire and others are elected in their place. Theoretically atleast this is one means by which a shareholder can exercise effective control i.e., by refusing to re-elect a unsatisfactory director. So also the company auditors retire at this meeting and the question of their reappointment or replacement decided upon. The company declares its dividends in the AGM. The Chairman of the company delivers a speech on the occassion listing the achievements made and setbacks suffered by the company in that year. The accounts of the company are put before the shareholders for their information and scrutiny and the shareholders can ask any question in relation to such accounts. All in all, an annual general meeting is an occassion where the investors of capital (i.e., the shareholders, and the managers of the capital (i.e., the directors and other officers) meet on neutral ground to review the working of the company during the year and to form broad plans for the working of the company in the next year. Since it provides a means by which the arbitrary working of the management can be effectively kept in check, the compulsion to hold the AGM once a year cannot be done away with.
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Let us now examine the situation from a practical view point. The shareholding of a modern industry is extremely widespread both in terms of the geographic area and populationwise. For a major company you will find people in various parts of the company holding shares - the number of shares varying from the minimum number of shares allotted [or in some cases just one single share] to a really sizeable chunk of the total shareholding. Now let us consider an example of TELCO having its registered office in Bombay. Now consider a person A in Hyderabad, one B in Calcutta, one C in Gauhati, one D in Nagpur, each having 10 shares, each of face value of Rs.10. The following figure gives a fictitious representation of some of the shareholders in TELCO, and let us assume that each person has not less than 5 shares and not more than 50 shares, each share of face value of Rs.10/-.
Madras 418 Shareholders Amethi 18 Shareholders Trichur 15 Shareholders Bombay 250 Shareholders Jorhat 3 Shareholders
Guahati 10 Shareholders
forms with names given in the form itself and forget about the meeting feeling that they have done their duty. Their only interest in the meeting is in the amount of dividend being declared in the meeting and this information they can obtain sitting in their homes. So they fail to see the necessity of stirring themselves up to go and attend some dull meeting. In reality an AGM has become a routine matter with just 50-100 persons attending out of a total shareholder strength of say 3-5 thousand. The entire proceeding is conducted by means of proxies - and in this manner the faction of directors having a majority back-up are able to get away with all their whims and fancies in the AGM. Today, an AGM instead of being a tool in the hands of the shareholders to be wielded for exercising control over the management, has become a mere formality to be complied with in pursuance of statutory requirements and in some cases a tool in the hands of the majority backed management to exercise their control over the remaining management. 3) Extraordinary General Meeting According to Table A, Reg. 47, any general meeting other than an annual general meeting will be deemed an extraordinary general meeting. As seen earlier in the flow chart - an extraordinary general meeting can be of three types - called by the board; on requisition, or called by the CLB. We will now take up each one of these in detail. a) Meeting called by the Board Regulations 47 and 48 of Table A of the Act, give the power to the Board to call an extraordinary general meeting whenever they think it is needed. It is further provided that any director or any two members of the company can convene the meeting, if sufficient number of directors are not there in India to form the quorum. Though the directors have the right to convene such a meeting they don't have the right to postpone it once it is called. Notice specifying the time, date and place of meeting should be given to all members required to be present and voting of the meeting. When some special business is to be conducted, then a text of the proposed business etc., should also be attached to the notice. Once convened, the proceedings of the meeting will be in the same manner as in an AGM. b) Meeting convened on requisition Section 169 of the Act deals with the provisions related to the calling of an extraordinary general meeting on requisition by the members. The procedure to be followed is given below. a] A minimum number of persons holding 1/10th of the total voting power of the company (where there is no share capital) are entitled to requisition a meeting, in writing and signed by them and addressed to the Board and deposited at the registered office of the company. b] Where shares are held jointly, the requisition should be signed by all the joint owners of the shares. c] Each requisition should deal with one matter only, if 2 or more matters are to be mentioned then they should be each requisitioned separately. 183
TELCO AGM on 1.6.1995 at 10 am in Bombay
Delhi 128 Shareholders Meerut 26 Shareholders
Hyderabad 60 Shareholders
Burdwan 11 Shareholders Calcutta 100 Shareholders
Jamshedpur 440 Shareholders
Now the question is - how many of these persons would have an interest or be in a position to go for the AGM ? A person holding 1 share or even 10 shares will be having a weightage of say .0001% of the total votes cast. In such a case - how can he influence any decision taken by the Board. Further he will incur an expense of over Rs.1000/- in merely going to the meeting and coming back and to naturally he would wonder whether attending the meeting is worth the amount of expenses and inconvenience involved ? Logically - the answer to this question is 'no' and so most of the shareholders especially the ones with minor shareholding do not attend the meeting. Now with every notice of a meeting a proxy form is also sent and 90% of the shareholders of the company simply fill in these
d] The requisition itself may consist of several documents, each signed by atleast one requisitionist. e] The Board of Directors is required to call a meeting within 21 days of deposit of a valid requisition. In case they fail to do so, then, the requisitionists may call for a meeting within 45 days from the date of deposit of the requisition. f] The requisitionists can make a call for meeting in the same manner as the Board would do, and the meeting should not be held later than 3 months from the date of deposit of requisition. g] The Board is liable to recompense the requirements for any reasonable expenses incurred by them in the calling of the meeting as a result of the Board defaulting to do so. h] The company can recover the above mentioned sum from the defaulting directors. 4) Meeting convened by the CLB When it becomes impracticable for a company to hold a general meeting, not being an AGM, it can approach the CLB under Section 186. In such cases, the Board can either on its own or on application of the directors or members order a meeting to be called and held in accordance with its directions. 'Impracticable' means 'not practical' from a reasonable point of view. This power to call a meeting was previously exercised by the company court, but later transferred to the CLB vide amendment of 1974. The manner in which the court should proceed in such matters has been well explained In re Ruttonjee and Company Ltd. [(1968)2 Comp. L.J. 155]. Here, the board of directors of a company were divided into two groups, and, each group claimed that the others were not the lawful directors. Neither group made an attempt to requisition a meeting. An application was made to the Court by one of the groups to order a meeting. The Court refused, and advised them to requisition a meeting themselves and ascertain the reaction of the other group. Giving reasons for its refusal the court observed that this power should be used sparingly with caution so that the court does not become either the shareholder or a director of the company trying to participate in the internecine squabbles of the company. The court should interfere only when it is convinced that the application to it has been made bonafide in the larger interest of the company, and for the purpose of removing a deadlock which otherwise prima facie appears to be irremovable, and there exists proof which on the face of it atleast shows that a meeting called in an ordinary manner would be invalid or unfruitful. Since the Company Law Board is now required to exercise this function, it is logical that the CLB should also act in the above stated manner and interfere only when genuinely required to do so. An important point to be remembered is that in such meetings even one member present in person or by proxy will constitute the quorum for the meeting. Class Meetings These are meetings of one particular class of shareholders, as for example, meeting of the preferential shareholders etc. The 184
main objective of such meetings is to discuss and vary any rights or obligations related to those shares. The articles of association usually provide not only for the various classes of shares but also the rights and liabilities attached to each class. They also make provision of such specified shareholders of a class to hold meetings and the quorum for such meetings as also that manner in which these meetings can be called and conducted. If not less than 10% of the issued shareholders of that class object to the variations made, they may apply to the court to have the variation cancelled [section 107], and, in cases where such an application is made the variation shall not have effect till the Court confirms it. Such applications have to be made within 21 days of the resolution confirming the variation has been passed, and may be made by such members who are authorized in writing. The courts order is final. After a court order is made a copy of the decision has to be forwarded to the Registrar for his records within 15 days of receipt of order. Board of Directors Meeting Under section 285 of the Act, the Board of Directors should meet atleast once in 3 months and a minimum of 4 times in a year. This provision was introduced to ensure that the directors met at reasonably frequent intervals and remain in constant touch with the affairs of the company. Though a director is not obliged to attend all the meetings of the Board, he is required to whenever he can reasonably do so. Section 283(9) ensures the attendance of the directors by stating that, the office of the director stands vacated if he wilfully absents himself from three consecutive board meetings or all meetings held within 3 months whichever is longer, without obtaining prior leave of absence from the Board. Further, frequent absence from the meetings may be indicative of negligence on the director's part and may make him liable for a penalty. The reason for this was given by the Courts in a very early case Charitable Corporation v. Sutton [(1742)26 ER 642] as, [I]f some persons are guilty of gross non-attendance, and leave the management entirely to others, they may be guilty by this means if breaches of trust are committed by others. The general practice however is not to hold a director liable for things happening in his absence at the board meeting. Notice of board meeting has to be in writing and given to every director who is in India. There is no prescribed format for the notice, nor is there a specified mode of service of the notice. If notice is not given to even one director, the meeting will be invalid, and the business transacted in such an invalid meeting would naturally be void. The business can be validated by ratification in a subsequently convened regular meeting. The notice may not specify the agenda of the meeting and even if is specified it need not be adhered to. Unlike an AGM a board of directors meeting is relatively informal, for example, no specified notice period is given i.e., it is not necessary to give a 21 days clear notice for holding a board meeting. Even a few minutes notice is sufficient - what is required is that each director should be informed - how long ago the information was given is immaterial. Thus in Smith v. Paringh Mines Ltd. [(1902)2 Ch 193], there was a vacancy in the board of directors and a
meeting of the board was called to fill the vacancy. The board consisted of only two directors T and B who was also the Chairman. T did not attend the meeting. B went towards T's personal office and chanced to see T in the passage outside his office. After a few minutes talk standing there in the passage itself, B proposed F's name for the vacancy, and T objected. B being the Chairman gave his casting vote in favour of F and declared F elected. T went to court claiming the election of F was invalid. Upholding the election as valid the court observed There is no reason why a meeting should not be held in a passage." But, in Barron v. Potter [(1914)1 Ch 895], with similar fact situation the Court gave a totally opposite decision. Here, there were only two directors P & C in a company and they were not on speaking terms with each other. It became impertinent that certain other persons were appointed to the Board as additional directors to remove the impasse. P waited at the railway station for C, and, on his alighting from the carriage proposed 3 names. C kept silent, whereupon P gave his casting vote in favour of the 3 persons named by him and declared them elected. C went to court. Holding the appointment of these directors as invalid the court observed, A director cannot have a board thrust upon him without his consent and against his will." Leaving aside the seeming contrariness of these decisions, what is to be noted is that in neither case was the meeting itself held to be invalid despite the extremely informal circumstances in which they were held. Thus, the Act only requires that the Board should meet regularly at specified intervals, but how it meets and where it meets is left to the discretion of the Board members themselves. Meeting of the Creditors There are not company meetings in the real sense of the word, but involve meetings in which the company calls its creditors in order to arrive at some desired to arrangements or compromise. Sections 391-393 deal with these kinds of meetings, where not only is the power to compromise with creditors is given but also the method in which such compromise can be reached is given. Whenever Court may issue relevant directions and orders for a meeting between the company and the creditors. If at this meeting the proposed compromise is agreed to by a majority of 3/4th creditors present and voting, the court may sanction the scheme and it then becomes binding on all the concerned parties. The court order takes effect only after a certified copy of the order is filed with the Registrar. Such copy should also be attached to every copy of Memorandum issued after such an order has been passed. Meetings of Debenture Holders Whenever a company issues debentures and appoints trustees for them, it also provides for the holding of meetings by such debenture holders, giving them the power to vary the terms and conditions of the security or to vary their rights in respect of such debentures, in certain cases; for example, in order to enable the company to raise funds by issuing fresh debentures; to vary rate of interest payable etc. The decision of requisite majority is binding upon the minority.
Rules and regulations regarding the holding of meetings of such debenture holders are mentioned either in the Trust Deed or endorsed on the Debenture Bond, and they are binding both on the company as well as the debenture holder. Some of the rules relate to format of notice, length of notice, place of meeting, Chairman, quorum, passing of resolution etc. Thus, all rules which may be needed for conducting a valid meeting are provided for in these rules. Meeting in Winding-up Whenever a company decides to go in for winding-up it may call a meeting of its contributories (in case of members' voluntary winding up) or its creditors (in case of creditors' voluntary winding up). These meetings are generally held to ascertain broadly the total value of assets of the company and the total debts/liabilities of the company, and then to pass a special resolution for winding up of the company. A liquidator(s) may also be appointed at such a meeting, who on appointment takes charge of the assets and affairs of the company and manages them in a manner which would prove beneficial to the interests of the company, the shareholders and the creditors. He is required to have regard to any resolution passed by the creditors or contributories and for this purpose he may call a general meeting. He is also bound to call a general meeting whenever the creditors/contributories by resolution direct or when 1/10th in value of the creditors or contributories request him to do so [section 460(3) and (3)(6)]. 3.4 NOTICE 'Notice' as such has not been defined in the Act, but may be loosely defined 'as a document providing information about a specified event.' Most of the work in a company is done through 'meetings' and every meeting is preceded by a 'notice'. A meeting held without giving a valid notice is invalid and any business transacted at such a meeting is void. Further, if a notice is not properly drafted or served it is invalid which in turn makes the meeting invalid. A valid notice consists of the following essential elements. a) Form of notice In general a notice convening a meeting is in writing and may sometimes be advertised in the paper. The Act however does not prohibit 'oral notice' from being given. In general, the byelaws or bye-laws of the company themselves specify the format of a notice since the Act itself is silent. The word 'Notice' must be written at the top proclaiming the nature of the document. b) Contents A notice to be valid must contain the following: i) Nature of meeting, (ii) date, time and place of the meeting; (iii) agenda of the meeting, (iv) any other relevant detail, (v) if it is a notice of a 'statutory meeting' then the relevant documents mentioned in the Act must also be annexed to the notice. c) Notice to be signed by proper authority In general it is the company secretary who has the common seal in his possession and is authorized to send notices under its 185
signature. In cases where there is no secretary to perform these functions, the principal officer of the company is deemed to be the proper/competent person to perform this job, provided he has been so authorized by the management. A notice issued by an incompetent person has no validity. d) Length of notice This is one of the most important ingredients of a notice. The Act itself provides that a notice of 21 days should be given in case of statutory meetings or AGM. In other cases, reasonable time should be given. Time period is provided so that persons receiving the notice may have the time to attend the meeting. Where a time period is mentioned, say 21 days, then these 21 days are to be computed from the date of receipt of the notice by the members and the notice shall be deemed to have received by the person at the expiry of 48 hours from the time of posting. So also the notice should be of 21 clear days i.e., the day and date of posting should be excluded from computation. Thus, in N.V.R. Nagappa Chettiar v. Madras Race Club [(1949)1 MLJ 662], a meeting was proposed to be held on November 7th for which the notices were posted on 16th October. It was held that, the notice period fell short by a day as in computing the 21 day interval the date and day of posting was to be excluded. The notice period can be shortened by the consent of the members. Thus under Section 171 in case of an AGM all the members can voluntarily consent to a shorter notice period either before or after the meeting. In case of other meetings, consent of 95% of the paid up share capital, or consent of 95% of the total strength of members would be necessary to validate a reduced notice period. e) Service of notice Service of notice incorporates two aspects - the mode of service and the persons to whom it should be concerned. If the articles provide for a specific form of serving the notice, then such a mode has to be strictly adhered to. Notice must be sent to the registered address of the concerned person. Notice should be sent to each and every member or person entitled to be present at the meeting. Deliberate or willful failure to send the notice to even one single will invalidate the notice and the meeting. But accidental omission of service does not invalidate the notice. This is based on the logic that the acts of a corporation are those of the majority of the 'corporately assembled', i.e., the meeting should be held after giving a notice which would enable every corporator an opportunity to be present. f) Clear and unambiguous The notice should be clear in its language, so that the reader is left in no doubts as to its meaning. The language should be simple, to the point, and unambiguous leading to a clear understanding. g) Agenda A notice which does not give the purpose of the meeting is not very valid. Every meeting is held for a definite agenda and a notice convening the meeting should also give the receiver a 186
clear and frank understanding of the matters to be discussed in the meeting and on which he would be required to vote. Section 173 specifies two kinds of businesses conducted at a meeting, viz: a) General Business - that is the routine business which is conducted at regular meetings, for example, in an AGM the general business is placement and discussion of accounts, declaration of dividends, the retiring and election of directors, auditors etc. b) Special Business - that is any business which does not come under the above category. A notice must specify any special business which is intended to be transacted at the meeting, and should include all the material facts concerning each item of the special business, including the interests of the directors or managing agents in the subject matter. Thus, in Narayanlal Bansilal v. Maneckji Petit Mfg. Co. Ltd. [(1931)33 Bom LR 556], a company had managing agents, whose terms and conditions of appointments were sought to be changed by means of adopting new articles. The notice which was sent out, gave the particulars of the proposed special resolutions but not the details of the important changes sought to be effected. Hence, the resolutions passed on the basis of the above notice were held to be invalid. So also in Kaye v. Croydon Tramways Co. [(1898)1 Ch 358], a notice calling a meeting stated that the purpose of the meeting was to adopt an agreement for the sale of one company's undertakings to another, but failed to specify that the directors would be making a substantial profit out of the transaction. The court held that the notice did not make a fair disclosure of the purpose for which the meeting was convened. But, where a shareholder by his conduct shows or proves that he was aware of the true nature of the business to be transacted at the meeting, he cannot complain of the insufficiency of particulars provided in the notice [Parsuram v. Tata Industrial Bank Ltd. [AIR 1928 PC 180]. Given below is a specimen notice of the annual general meeting.
THE MYSORE PAPER MILLS PVT. LTD., BANGALORE NOTICE Notice is hereby given that the Forty-second Annual General Meeting of the company will be held on Tuesday, the 8th of May 1994, at Mysore Chamber of Commerce Buildings, Kempegowda Road, Bangalore City, at 10.00a.m. to transact the following business: 1. To receive and adopt the Audited Accounts and Balance Sheets for the year ended on 31st March 1994, and the reports of the Directors and Auditors. To declare dividends. To elect as Director: (i) Mr.A.R.Rao, one of the Directors, who retires by rotation under Article 44 of the Articles of Association of the Company and is eligible for reelection, will be 68 years at his next birthday on October 1994, and a resolution that the age limit prescribed in Article 69 of the Company shall not apply to him is necessary. Special notice of the following resolution for exempting him from the age-limit is hereby given: "RESOLVED that Mr.A.R.Rao who has completed 67 years of age be and is hereby re-elected a Director and that the age-limit prescribed under
2. 3.
Article 69 of the Company shall not apply to him." Explanatory statement is annexed to the Notice posted to the shareholders separately. NOTE: Special Notice signifying intention to move the above resolution has been received from a shareholder. 4. To appoint Auditors for the current year and for their remuneration. The Share Transfer Books of the company will be closed from 25th April 1994 to 8th May 1994 (both days inclusive). NOTE: A member entitled to attend and vote at the meeting is entitled to appoint a proxy to attend and vote instead of himself and a proxy need not be a member of the company. By Order of the Board Sudha Peri Secretary Asiatic Buildings Kempegowda Road P.B. 570, Gandhi Nagar P.O., Bangalore-560 009. Dated 7th March 1994. N.B.- The Board of Directors have recommended payment of dividend at 7% plus Bonus 4% on every share of Rs.10 for the year. The dividend when declared will be made payable at the Bank of Mysore Ltd., Bangalore, or its Branches on and after the 24th May 1994. The dividend warrants will be posted to those shareholders whose names stand on the register on 8th May 1994.
qualifications for a person to act as a director. Though no academic qualifications can be prescribed, there are a few general characteristics or traits which a person should possess for him to be able to act as a good Chairman. It is to be noted tht lack of these traits will not disqualify a person from acting as a Chairman since no basic qualifications are prescribed as such. These traits which a Chairman should possess are as follows: i) He should be well educated and be well versed in the rules and regulations governing the conduct of a public meeting. ii) He must have a command over the language in which the meeting is proposed to be conducted. iii) He must not have a fear of public speaking and should be able to address the meeting clearly and with confidence. iv) He must be a man with a clear vision and integrity. v) He should be rational in his approach and be impartial. vi) He should be good nurtured but firm so that he can bring the meeting to order without being rude or offensive. vii) He should be tolerant and patient and should interfere in an ongoing debate only when genuinely necessary. viii)He should be capable of hearing both sides of a debate with an open mind and not let his personal biases or prejudices influence his decision or vote. As a Chairman he may sometimes be acting in a quasi judicial manner and will be expected to act in an appropriate manner. Chairman's qualifications are better described in the words of Crew, the ideal Chairman should be a man of infinite tact and practice, possess judicial mind, be able to command respect of the meeting, be absolutely impartial in rulings, never allowing to be questioned - and always ready and resourceful when difficulties arise. He should be firm yet courteous, able to govern men, not allow himself to be carried away by party or other feelings, able to endure bores cheerfully. A Chairman should possess a calm, placid temparament, have a proper sense of the dignity of his position, not be garrulous (talkative) and be accustomed to rule without fusiness, hauteur, or bullying." [Chakraborti, A.P., 169]. APPOINTMENT: As stated earlier, in general the articles make a provision for the appointment of a Chairman. If no such provision is made, then he is elected by the members present at the meeting (Sec. 175). Where there are more than one persons interested in the post then a Chairman pro term is selected by a show of hands, who would then conduct a poll to elect the Chairman for that meeting. If the meeting has been convened either by the Government under Section 167 or by the CLB under Sectiokn 186, then the Chairman may be appointed by the Government or the CLB as the case may be. STATUS: Being the presiding officer he holds an important position in any meeting. He is the person in authority who has absolute control over the proceedings of meeting and who is responsible for the orderly conduct of the meeting. The question arises, where does the Chairman derive his authority from, because in many cases a person's selection to Chairmanship 187
3.5 CHAIRMAN A meeting cannot be conducted unless there is a person to preside over it, someone who would channelize the meeting into the specified area and maintain a control over the proceedings. The person who presides over the meeting is known as the 'Chairman' of the meeting. He may be either elected before convening the meeting or at the time of the meeting itself. Section 175 of the Act states that, if the articles of a company do not specify the person who is to act as the Chairman, than, the members present and voting at the meeting shall elect someone from amongst themselves to act as the Chairman, than, the members present and voting at the meeting shall elect someone from amongst themselves to act as a Chairman. The election shall be either by a show of hands or by poll. But in general, the promoters or directors of the company decide before hand that one of them would act as a Chairman and the normal practice is that the Chairman of the Board of Directors would act as the Chairman of the meetings. Regulation 51 of Table A provides that, if there is no such Chairman or the Chairman does not come within 15 minutes of the starting of a meeting or he proclaims his unwillingness to act as a Chairman, the directors present at the meeting should elect some other director to act as a Chairman for that meeting. If no director is present within 15 minutes of the start of meeting then any member of the company may be chosen by the other members to act as a Chairman for that meeting. QUALIFICATIONS: The Act itself is silent as to the requisite qualifications for a Chairman, though it does give some
may be just by way of an accident i.e., he does not plan on assuming the authority - but he still exercises it. The answer to the question is simple - he derives his authority from the meeting. In the words of Jervis, LCJ in Taylor v. Nesfield, Public meetings must be regulated somehow, and where a number of persons assemble and put a man in the chair they devolve upon him by agreement the conduct of that body. They attorn to him as it were, and give him the whole power of regulating themselves individually. This is within reasonable bounds. The Chairman collects as it were, his authority from the meeting. [Bhal, p.244] POWERS: A Chairman has the following powers accruing to him by virtue of his position as the presiding officer of the meeting. These powers are mainly those which would prove helpful to him in conducting the meeting in a smooth orderly manner. These powers are as follows: 1. To decide points of order: It may happen sometimes that when one member is speaking on some issue, another may get up and enquire whether the statement being made are in order. This is known as stating a point in order. When such a point in order is raised, the Chairman has the power to give his ruling on it, and his ruling is final regardless of whether it be right or wrong. 2. To decide on priority of Speakers: If several speakers get up at the same time and also want to speak at the same time, the Chairman has the power to decide on who would speak first, who would be second and so on. 3. To stop discussion on a matter: Whenever the Chairman feels that a discussion on some issue is being prolonged needlessly and is leading nowhere, he has the power to make a ruling that all discussions on that matter would lease forthwith, and to put the motion/issue to vote, so to eliminate further discussion. 4. To have disorderly persons ejected: In case certain members in the meeting start behaving in a disorderly manner and refuse to pay heed to the Chairman's requests or warnings, he has the power to save them physically removed (using minimum force) from the meeting. 5. To exercise a casting vote: Sometimes the articles of a company may provide that in case the meeting is equally divided on some issue i.e., there is a tie then the Chairman will have casting vote. Exercise by the Chairman of his casting vote would decide the issue one way or other. This power cannot be exercised if the power is not specifically granted under the articles. 6. To declare a resolution passed: After the voting is over he has the power to declare that a particular motion has been carried. His declaration is a conclusive proof of the fact. 7. To adjourn the meeting: He has the final right to adjourn the meeting either at the end after all the business for the day has been concluded or in exceptional circumstances in the middle of the meeting itself. Adjournment is usually given with consent of the members present at the meeting. 188
DUTIES: Being in such a responsible position also entails certain liabilities or duties. The duties of a Chairman are as follows: i) To see that meeting is duly convened and conducted: To see that it is being convened only after giving a valid notice to the concerned persons, and that the necessary quorum is present for the meeting. ii) Confirming the minutes: He has to read the minutes of the preceding meeting and sign them after they have been approved as correct by the members. iii) Business conducted as per agenda: In general, he is required to take up the issues for consideration in the order set up in the agenda for the meeting. He may with the consent of the members, change this order if the circumstances so require. iv) To maintain order in meeting: This may be set to be one of his primary duties, as without order no serious business can be conducted in the meeting. For maintenance of order he is authorised to issue strict warnings to the concerned persons and if the warnings are not heeded he can have the disorderly person physically removed from the meeting. v) To decide whether motions/amendments are in order: Sometimes a member may make a motion or propose an amendment which is not in strictu sensu within the scope of that particular meeting. It is the duty of the Chairman to refuse/reject such motions/amendments as otherwise the meeting may become highly unchannelised. vi) To disallow discussion except on specific motions: There may be a tendency on the part of some members to start a discussion even without a definite motion put before the meeting. The Chairman is duty bound to put a stop to such premature discussions as they may result in waste of precious time. vii) To see that minority are not oppressed or suppressed: In every meeting there are bound to be person(s) whose views do not coincide with the views of the majority. It is the duty of the Chairman to see that these persons in the minority have sufficient opportunity to state their views and as far as possible give them as much time to speak as has been accorded to the majority. viii)To ascertain the sense of the meeting: Ascertainment of the sense of meeting is another important duty, and means that the Chairman is required to properly ascertain whether the majority of persons present and voting in the meeting are in favour of a motion or are against it. For this purpose, he is required to put every motion or amendment to vote by show of hands, and if required or demanded, by a poll later. In either case, he is required both to record the votes and to declare the results of the voting. ix) Not to adjourn the meeting: The Chairman is duty bound not to adjourn the meeting, till such a move is demanded by the members. x) General duty to regulate: He is duty bound in general to see that the meeting is conducted in a smooth and orderly manner, and to act as an impartial arbitrator while solving
disputes or squabbles which may have arisen, to give a patient hearing to all persons, and be scrupulously honest in the discharge of his specific duties and eminently reasonable and impartial in the exercise of his powers. 3.6 QUORUM No meeting can start without the requisite 'quorum' being present, i.e., a meeting can start only if the prescribed minimum number of persons are present. Thus quorum is the minimum number of persons required to be present in person or by proxy for conducting a meeting. In general, the quorum for a meeting is fixed by the articles itself. Where the articles do not make a provision then sec 174(1) of the Act becomes applicable, which provides that: Unless the articles of a company provide for a larger number, five members personally present in case of public company (other than a public company which has become such by virtue of section 43-A) and two members personally present in the case of any other company, shall be the quorum for a meeting of the company. Thus the articles can provide for a larger quorum but cannot reduce the quorum below the statutory minimum. If within half an hour of the start of meeting the quorum is not present the meeting stands adjourned to reassemble a week later on the same day and time [sec 174(3) and (4)]. If at the reassembled meeting also the requisite quorum is not present the persons actually present shall constitute the quorum [section 174(5)]. An interesting situation may arise where at the reassembled meeting only one person is present will it mean that a single person shall constitute the quorum and that he shall convene the meeting himself and have a meeting with himself ? A situation of this kind arose in Sharp v. Dawes [(1876)2 QBD 26], where a meeting was called by the company to make a call on the shares. Only one person attended the meeting but he had proxies of the other shareholders. He presided over the meeting, passed a resolution for making calls, proposed and gave a vote of thanks and then adjourned the meeting. The validity of the call was questioned in the Courts. Holding the call invalid the court observed, The word meeting prima facie means a coming together of more than one person...This was not a meeting within the meaning of the Act." There are two situations where the business transacted at a meeting attended by a single person would be held valid, viz: a) When the single person belongs to a 'class' all by himself, i.e., he may be the only equity shareholder or only preferential shareholder etc. In such cases, a meeting for that 'class' would be valid though he is the only person present [See, East v. Bennet Bros. Ltd., (1911)1 Ch 163]. b) When the CLB calls a meeting either under sec 167 or under sec. 186 it may be directed that even a single person attending the meeting in person or by proxy shall constitute the quorum. The next question which arises is - whether the quorum should be present at the beginning of the meeting or should it be present throughout the meeting ? The English courts have given contradictory decisions on this issue. Thus, in Henderson v.
Lontit and Co. Ltd. [31 Scottish Law Reports 555], it was held that, it must be a quorum of effective members i.e., members qualified to take part in and decide upon questions brought before the meeting" and such a quorum should be present when the business is actually being transacted, and not quorum being present merely at the beginning of the meeting. Then in re Hartly Baird Ltd. [(1954)3 All ER 695], it was held that it was sufficient if the quorum was present at the beginning of the meeting, and it was not necessary for a quorum to be present throughout. But later still, in re London Flats Ltd. [(1969)2 All ER 744 (Ch D)], it was held that, if at the time when the business was being transacted if the requisite quorum was not present then the business which was transacted became invalid. A very confusing state of affairs to be sure. Regulation 49 in Table A of the Companies Act, 1956, requires the quorum to be present at the time when the meeting proceeds to do business, i.e., under the Indian law, mere presence of a quorum at the beginning of the meeting is not sufficient. In the American Encyclopedia Dictionary of business it is stated that, A quorum must be present not only to begin a meeting, but to transact business. Thus, if, during the meeting a number of stockholders depart, leaving less than a quorum present the meeting must be discontinued by adjournment. However, if a meeting is once organized and all the parties have participated, no person or faction, by withdrawing capriciously and of the sole purpose of breaking the quorum, can render the subsequent proceedings invalid. This view point also effectively answers the criticism levied against the judgement in re London Flats Ltd. by Avtar Singh, Should it be the law that minority shareholders, realizing that they cannot defeat a resolution by constitutional process of voting against, it, should be able to frustrate the wishes of the majority by walking out of the meeting? Thus, whenever the members walk out of a meeting, leaving it short of quorum the business transacted becomes invalid, but if the members walk out deliberately and with mala fide intentions, then lack of quorum does not effect the validity of transactions. So also in County of Gloucester Bank v. Rudry Merthyr Steam and House Coal Colliery Co. [(1895)1 Ch. 629] it was held that, third parties not having notice of the fact that quorum was not present when business affecting them was transacted at the meeting, will not be affected by such lack of quorum. Unless specifically questioned or the lack becomes apparent on the face of record, a quorum is always presumed to have been present at a meeting. A representative of a corporate body appointed under sec. 187 or representative of the President or Governor of a State under sec. 187-A is deemed to be a member personally 'present' for the purposes of quorum. Similarly, if two or more corporate bodies who themselves are members of a company are represented by one single individual, then for purposes of quorum each of these body corporates will be treated as being personally present through the individual representing them. This raises interesting possibilities suppose A, B, C, D, and E are corporate bodies who are members of 'L & T Co. Ltd.' Suppose each one of A, B, C, D, and E is represented by 189
the same person 'X'. In a meeting called by 'L & T Co. Ltd.' X attends as representative of A, B, C, D & E and each of these body corporates is deemed to be personally present. Even if no other person attends the meeting, the quorum will be still satisfied as X' is representing 5 persons so legally there are 5 members present, though factually only a single person is attending. So, though it has been held that a meeting of one person is not valid etc., in cases like this the meeting will be valid though attended by only one person. On the other hand, in case of several joint owners of a share, they will be collectively regarded as one person for the purposes of quorum and only one of them will be entitled to vote on the shares held jointly by them. Ramaiya has however given a illustration of a Punjab High Court case Jarnail Singh v. Bakshi Singh [AIR 1960 Punj. 455] where an Australian case was cited. The court observed, Our attention has also been drawn to an Australian case Transcontinental Hotel Ltd., In re,ld be a machinery to strike d own su 1947 SASR 49, referred to in volume I of Palmer's Company Precedants, p.488 (17th edn.) in the footnote. In that case the articles of association of a limited company required that a quorum of two members should be personally present of a meeting of the company to pass a special resolution. It was held that the presence of two persons who were registered as joint holders was a sufficient compliance with the articles of association. In other words, for purposes of quorum, two joint holders were treated as two members of the company [Ramaiya, p.1124]. Even in re Saunders (T.H.) and Co. [(1908)1 Ch. 415] it was held that, the joint holders can insist on having their names registered in an order they prefer, and can also insist on their holding being split into several joint holdings with their names in different orders i.e., on priority basis [ex: No.1 - Mr. X; No.2 - Mr.Y...], so that each one of them may get a right to vote as first named holder in one or other of the joint holdings. The same position should be tenable in India under sec. 41 of the Act. 3.7 AGENDA, RESOLUTIONS, AND MINUTES A] Agenda Agenda means 'things to be done' or 'matters to be discussed'. A meeting called without fixing the objective of the meeting would be totally infructous. Thus for a meeting to gain validity the subject matter should be decided before convening the meeting. Fixing of agenda is also essential for the smooth conduct of the meeting, in an orderly manner and to be assured of the fact that no important matter has been left out of discussion. For this reason, it is deemed essential that, for any meeting be it of shareholders or creditors or of board of directors to put down the business intended to be transacted on a piece of paper called as "Agenda Paper" or simply "Agenda". In general, it is usual practice to put the routine matters at the top of the agenda and the special matters at the bottom so that more time for discussion on special matters is available after a quick disposal of the routine matters. It is also considered desirable that similar matters should be grouped together for a more fruitful discussion. 190
There are two ways of preparing an agenda, viz: 1] By giving only a brief reference to the business intended to be discussed, as for example: i) Reading of minutes ii) Approve the transfers iii) Election 2] By giving slightly more details about each item of business, as for example: 1. To read and sign the minutes of the last meeting held on 1.5.1994. 2. To discuss and approve the transfer of shares bearing Nos.164-198. 3. To elect the directors to fill up the vacancy left by retirement of 2 directors in the last meeting. This second mode of agenda preparation is more helpful to the secretary in drafting the minutes. Generally speaking, for any meeting there are two kinds of agendas prepared - one meant for the use of the Chairman and secretary, which has the complete wordings of the resolutions to be passed alongwith the names of the proposer and seconders (if fixed before hand) and some space in the margin for them to make notes, and, the second meant for circulation amongst the members of the meeting. Though not necessary, it is desired to affix a copy of the agenda to the notice calling the meeting, so that members come totally prepared to the meeting. In case a meeting has been adjourned, it is neither necessary nor desirable to prepare and send a fresh agenda for the adjourned meeting, which in general is nothing more than the old meeting continued after an interval. In case a new agenda is prepared, then care should be taken to see that it is properly headed, and as far as practicable it is limited to the unfinished business of the previous meeting. Though, 'agendas' have no legal significance as such, it is better to preserve the copies of the agenda as they provide ancillary evidence of the business conducted at the meeting, and in analyzing the background circumstances resulting in a particular decision being taken, if such decision becomes a matter of controversy sometime in the future. B] Resolutions A resolution in broad terms is a proposal which has been put to vote in the meeting and passed. A major part of the company's work is done vide resolutions. Under the Act, there are three kinds of resolutions which are recognized, viz: i) Ordinary Resolution (sec. 189): This is a resolution which has been passed by the numerical majority of the members present and voting, either personally or by proxy. Generally, most of the company business is transacted through ordinary resolutions, except where the Act specifically lays down that a special resolution' would be needed. Some of the business which may be transacted through an ordinary resolution is:
a) b) c) d) e) f) g)
Adoption of a statutory report (sec. 165). Adoption of the Balance Sheet and Profit and Loss Account at the AGM (sec. 210). Election of directors. Appointment of auditors and fixing of their remuneration (sec. 224). Declaration of dividends and sanctioning of the amount which is to be carried over to Reserve. Issual of shares at discount (sec. 79). Authorizing the Board of a public company or a private company which is a subsidiary of a public company to sell or dispose of the undertakings of the company (sec. 293).
Wherever it is provided that, the company in general meeting may do some act, it is presumed that the act is to be done by means of an ordinary resolution. On the effect of an ordinary resolution, it was observed in North-West Transportation Co. Ltd. v. Beatty [(1887)12 AC 589 (PC)], unless some provision to the contrary is to be found in the charter or to other instrument by which the company is incorporated, the resolution of a majority of shareholders, duly convened, upon any question with which the comp.any is legally competent to deal, is binding upon the minority, and consequently upon the company, and every shareholder has a perfect right to vote upon any such question, although he may have a personal interest in the subject-matter opposed to, or different from, the general or particular interests of the company." Given below is a specimen ordinary resolution relating to the appointment of a director. "That Mr. M. N. Nair who is an additional director appointed under article 128 of the Articles of Association and who holds office till the date of next Annual General Meeting, but being eligible offers himself for election, and for whom a notice proposing him as a director has been received from a member, be and he is hereby appointed a director of the Company". ii) Special Resolution (sec. 189): A special resolution is one which has been passed by a majority of not less than 3/4th of the members present and voting at that meeting of which an advance notice that a resolution is intended to be proposed as a special resolution has already been given to the members. A special resolution has the following characteristics, viz: a) atleast 75% of the voting members must be in favour of it, b) the resolution in the exact form in which it is passed should have been set out in the notice convening the meeting. c) the notice should also specify that that particular resolution is to be passed as a special resolution; d) a notice period of 21 clear days has been given for the meeting; and e) an explanatory statement under sec. 173(2) was duly attached to the notice for conducting special business.
A special resolution is an important tool in the company mechanism, by the use of which many important things within the scope of company's powers are done. The reason why so many conditions are attached to the passing of a special resolution seems to be, that, the members and the company should be given sufficient time to think over and apply their minds to the important changes/activities proposed to be taken up, and further that such major actions should have the approval of a majority of persons being affected by the change. Some of the business which are transacted by means of special resolution are: i) Alteration of Memorandum of Association for purpose of changing its registered office from one State to another (sec. 17). ii) Alteration of the name of the company after obtaining prior approval of the Central Government (sec. 21). iii) Alteration of articles of association (sec. 31). iv) Creation of a Reserve share capital (sec. 99). v) Reduction of share capital if so authorized under the articles (sec. 100). Such reduction is of course subject to approval of the Court. vi) Appointment of inspectors to inspect the affairs of the company (sec. 237). vii) Remuneration payable to a director, if so required under the articles (sec. 309). viii)To render the liability of directors, managing agents, secretaries and treasurers or managers unlimited (sec. 323). ix) Appointment of managing agents or his associates as buying or selling agents for places outside India (sec.s 356 and 358). x) Voluntary winding up of company (sec. 484). Given below is a specimen of 'special resolution making additions to the objects clause of the Memorandum of Association (Sections 16, 17 & 18). "Resolved that the following objects be added in the Memorandum of Association and the Memorandum be altered to that extent:(1) To acquire or establish and operate and carry on business of Textile Mills, Woolen Mills, Rayon Mills and Silk Mills. (2) To acquire or establish and carry on the manufacture of buttons, hooks, needles, zippers, sewing machines and machine parts for Industrial and Domestic purposes. (3) To acquire, establish and carry on the business of manufacturing cardboard cartons and packing boxes of all types and varieties for Industrial and Domestic purposes. (4) To acquire, establish and carry on any other business which in the opinion of the Directors can be profitably undertaken alongwith manufacture, sale and export of textiles. 191
(iii) Resolutions requiring special notice: Under sec. 190 of the Act, a new provisions has been introduced, that transacting of some special kinds of business can be only through resolutions for which special notice has to be given. The notice period is now 14 clear days. On receipt of such a notice, the company should give a notice to its other members of this resolution alongwith a notice of the meeting, or atleast 7 days before the meeting, by way of an advertisement or in any other manner permitted by the articles. The matters in which a resolution with special notice must be given are: a) A resolution at AGM proposing to appoint a new auditor instead of the reappointment of retiring auditor(s) (sec. 225). b) A resolution at the AGM expressly forbidding the reappointment of a retiring auditor (sec. 225). c) A resolution that a particular person shall not be eligible for reappointment as a director who is liable to retire due to rotation of directors (sec. 261). d) A resolution to remove a director before his term expires (sec. 284). e) A resolution to appoint a director to fill in the vacancy caused due to (d) above (sec. 284). The articles of a company may add other matters for which a special notice would be required. The basic objective of giving a special notice of a resolution is to invite specific attention of the company and the members to the matter in hand, so that they realize it is something more important and that they have to apply their minds to it. Even where it is the company itself i.e., the Board of Directors themselves want to move a resolution on any of the matters mentioned above, they may be required to give a special notice under this sec.. In such cases, the company may either give the required special notice by including it in the 'meeting notice' itself or may give a separate 14 days notice to the shareholders as the sec. provides. Apart from these three kinds of resolutions which have been specifically provided for in the Act, two other kinds of resolutions are also used by the kinds of resolutions are also used by the companies, viz: Unanimous resolution - This phrase in strictu sensu means that it has been passed by every member present in the meeting,i.e., every person present and entitled to vote, has voted in favour of the resolution. The word 'unanimous' meaning 'of one mind' is sometimes improperly used to indicate resolutions carried without dissent i.e., say if 100 persons are present at the meeting, 80 vote in favour of the resolution and 20 abstain from voting, the resolution is termed as being carried 'unanimously'. This is an improper usage of the term. Such resolutions should properly be recorded as having been passed 'without dissent'. "Nem Con" (short of nemine contradicente i.e., no one saying otherwise) or "nem dis" (short of nemine dissentiente i.e., no one dissenting) are two other ways commonly used to indicate resolutions passed without dissent. Though a 'unanimous resolution indicates that the entire body of voters is in favour of the resolution, a company cannot take 192
the help of a unanimous resolution to validate an ultra vires act. As Lord Cairns, L.C., observed in Ashbury Railway carriage and Iron Co. Ltd. v. Riche [1875)44 LJ Exch 185], 'If every shareholder of the company had been in the room and had said: that is a contract which we desire to make, which we authorize the directors to make" the case would not have stood in any different position from that in which it stands now. The shareholders would thereby, by unanimous consent, have been attempting to do the very thing which, by Act of Parliament they were prohibited from doing. Written resolution: In general, the motions are proposed orally and then voted upon either by show of hands or by poll. A resolution in writing is possible only if a provision to that effect is made in the company's articles. Such resolutions are valid, though no meeting is held to pass them, and usually applies to board of director's proceedings or to a company having very few shareholders. A written resolution is usually required to be signed by every person entitled to vote on it. The rules may provide for a written resolution to be passed only 'unanimously' or may provide that the persons signing should specify whether they are 'in favour' or 'against it, and if a majority are in favour the resolution is passed. This kind of resolution is not much in vogue, and is generally used, when it is known that there is no/ not much difference of opinion on the proposed resolution and where holding of a meeting would result in an inconvenient/ impractical delay. Passing of a resolution should always be by a clear majority [either simple or three-fourth as the situation demands]. If the voters are equally divided, then the motion is not carried. In such situations, the articles sometimes provide the Chairman with a right to exercise his 'casting vote' which is helpful in breaking the tie. But in cases, where no such casting vote is provided for, a motion ending in a tie has to be abandoned atleast for that time. It may again be proposed in a later meeting with or without amendments and again put to vote. As soon as a resolution has been passed or a motion is lost, the result should always be declared firmly by the Chairman, so that the people present are clearly aware of the results. If it is required to be passed by a special majority, then the Chairman is also required to announce the votes for and against the motion and these have to be specifically recorded. The Act requires that some kinds of resolutions (ex: special resolutions) should be registered with the Registrar within a specified time limit - in such cases a copy of the resolution has to be filed with the Registrar within that time and failure to do so entails a penalty. C) Minutes We have seen earlier that one of the duties of the Chairman is reading and signing of the 'minutes' of the previous meeting. The word 'minutes' is derived from the Latin 'minutes' meaning made small. The shorter Oxford English Dictionary defines minutes as a brief summary of events or transactions, especially (usual plural) the record of the proceedings of an assembly, committee etc." In Osborn's A concise Law Dictionary, minutes
has been explained as, (1) Notes or records of business transacted at the meeting. (2) Copies of a draft order or decree before being embodied in a formal judgement of the court." Thus, 'minutes' can be defined as a brief or short summary of a business transaction. Under Common Law there is no requirement of maintaining the minutes of a meeting, but sec. 193(1) of our Companies Act provides that: Every company shall cause minutes of all proceedings of every general meeting and of all proceedings of its Board of Directors or of every Committee of the Board, to be kept by making within 30 days of the conclusion of every such meeting concerned, entries thereof in books kept for that purpose with their page consecutively numbered." The provisions of this sec. embody the suggestions of the Company Law Committee in para 79 of their Report: Our attention was drawn to the failure on the part of the management of some companies to record in the minutes a fair summary of the proceedings of general meetings, inclusive of material questions asked and replies given and comments made. This, in our view, is not a healthy practice and should be discouraged by positive provisions inserted in the sec.. In view of the fact that general meetings are usually very sparsely attended, a practice has grown up of circulating the minutes of such meetings to all shareholders. It is, therefore, essential that these minutes should contain a brief but authentic record of all that happens at general meetings, so that the absentee shareholders may be in a position to form some reliable idea of what transpired at these meetings. We, therefore, recommended that the provisions of this sec. should be so amended as to provide explicitly that the minutes of the general meetings should contain a fair summary of the proceedings of such meetings and, in particular, of all material questions asked or comments made. We further recommended that such minutes should not be circulated or advertised at the expense of a company, unless they contain the matters mentioned above. It will be necessary for the chairman of the meeting to decide what is fair summary of its proceedings or what questions asked or comments made would be deemed to be material for the purposes of the meeting, but a statutory obligation to cast the minutes in a particular manner will, we trust, be a useful safeguard against the manipulation by dishonest and unscrupulous persons. "As regards the minutes of directors' meeting, the only recommendation that we make is that they should record the names of those directors, if any, who dissent from any decisions arrived at these meetings. Some witnesses questioned the desirability of such a provision. They argued that the decisions taken by a Board of directions partook of the nature of a collective decision, and if it was made obligatory to record the views of dissentient directors, differences on a board might be encouraged. We have given due consideration to this point of view, but are unable to accept it. The concept of the collective responsibility of directors, however, attractive in theory is warranted neither by the facts about company management in this or other countries nor by the fundamental postulates of company law. On the contrary, we feel that our suggestion will
promote rather than hinder the sense of responsibility among directors and will provide a useful check on the errant elements among them, who now find it easy to hide the undue influence which they exercise over the affairs of companies under the cloak of unanimity." [Ramaiya, p.1217]. The 1960 amendments to sec. 193 were made in order to ensure the authencity of the minutes of proceedings of general meeting or meetings of the Board of Directors. For this purpose, sec. 193(1-A) and (1-B) provides as follows: 1. that all minutes should be entered in consecutively numbered pages (to be kept in the form of a book - that is the pages should follow each other serially but need not be bound within 30 days of each meeting, and 2. that apart from initialing every single page, the last page of the recorded proceedings should also be added and signed by the Chairman of the meeting. The 'minutes' for a period of say 6 months or so may be bound and kept as record. The Department of Company affairs gave a clarification in this regard vide their File No.8/16/(1)/61-PR) by saying - 'In view of the provisions of sub-sec. (1B) of sec. 193, which prohibits attaching of the minutes of a meeting in the minutes book by pasting it or otherwise every company has, apparently to maintain the minutes in a bound book only. However, this provision is not incapable of a different interpretation. Maintenance of minute books in loose-leaf form, whereby loose leaves which were serially numbered could be taken out and re-inserted after the proceedings had been typed on them would not, strictly speaking, amount to 'attachment' within the meaning of the sub-sec.. In view of this and also in view of the fact that the use of loose-leaf forms for minutes books is a convenient modern technique for neat and expeditious recording of the minute, specially for big companies where the minutes may run into many pages. Field Officers are advised not to insist on minutes being kept in a bound book. No general advice in this regard need, however, be issued by them to the business community, on the contrary companies which may approach the Field Officers in the matter may be given the suggestion that it would be preferable for them to keep bound minute books. No action, however, need be taken if a company is found to be keeping loose-leaf books, unless there is any interpolation in the minutes'. Contents of Minutes: Minutes should contain a record of the names of all members present, and, if needed even the names of the persons who were absent. Further, minutes should provide a fair and accurate summary of the proceedings of the meeting. In case of Board meetings it should also contain the names of the directors voting in favour of a resolution and those against it. It should also contain a record of the names, etc., of the persons who may have been employed. If in a Board meeting, some director either arrives or leaves during the proceedings then a mention should also be made of that particular fact. Need for Minutes: A question may arise - why should one maintains a record of the proceedings of any meeting ? What is the use of such a record ? The answer to these questions is 193
provided under sec. 194 of the Act which provides, Minutes of a meeting kept in accordance with the provisions of sec. 193 shall be evidence of the proceedings recorded therein." In Escorts Ltd. v. Sai Auto [(1991)72 Comp. Cas. 483 (Del)] it was held that, district who was bound to acknowledgethe only way to prove the passing of some particular resolution at a meeting was to produce the minutes book in which the concerned resolution was recorded as passed. The mere fact that the proceedings are recorded in a minutes book is not conclusive evidence of the proceedings being regular, and the court can inquire into the validity of the notice convening the meeting [Betts and Co. v. Macnaghten, (1910)1 Ch 430]. The minutes of a meeting are merely prima facie evidence of the proceedings, not conclusive evidence and the minutes may be rebutted or supplemented by other evidence. For minutes to act as prima facie evidence they have to be signed by the Chairman (or in his absence by any other director authorized in this regard). For the application of sec. 194 it is essential that the minutes book be kept in proper form and shape and in accordance with the requirements under sec. 193. Further, according to sec. 195, where minutes of' the proceedings of any general meeting of the company or of any meeting of its Board of directors or of a committee of the board have been kept in accordance with the provisions of sec. 193 then, until the contrary is proved, the meeting shall be deemed to have been duly called and held, and all proceedings there at to have duly taken place, and in particular, all appointments of directors or liquidators made at the meeting shall be deemed valid." Thus, the minutes book not only results in being a permanent record of the proceedings of the meeting, but also gives rise to a presumption that the proceedings at the meeting were regular and valid and that the meeting itself had been called in the prescribed manner. A properly kept minutes book gives rise to a presumption of validity and regularity. Presumption means that - it will be accepted by the Courts as proved unless evidence is brought to show that the presumption is false or invalid. Thus, a party may bring in additional/outside evidence to show that the meeting was not convened in the regular manner, or that the proceedings in the meeting were irregular, or that the appointment of some director is invalid etc., but till such evidence is brought to prove conclusively the irregularity of the meeting or some proceeding in the meeting, the presumption under sec. 195 will act in favour of the regularity of meeting/proceedings. 3.8. MOTIONS AND AMENDMENTS I] Motions The term 'motion' can be best described in the words of Erskine May as: The term "motion" which in its wide sense means any proposal made for eliciting a decision of the House covers several distinct forms of proceedings. Motions may be divided into: 1. Independent or Substantive Motions; and 194
2. Dependent or Subsidiary Motions. The former term explains itself. The latter kind of motions cover: 1. Ancillary motions dependents on an order of the day, such as a motion that a bill be now read a second time, or that the House agrees with a report of the Committee; 2. Motions made for the purpose of superseding questions, such as motions for the adjournment of a debate; 3. A motion dependent on another motion, such as an amendment. Stated generally, substantive motions require notice, whereas dependent or subsidiary motions do not [Taggart, p.37]. Curzon's dictionary of law defines 'motion' as, (1) Formal proposal made at a meeting, (2) Oral application to a judge or court requesting an order directing performance of an action in the applicant's favour. To put it briefly, a motion is a proposal put before a meeting for either a discussion or a debate. A motion indicates the discussion on some term in the agenda. Thre are basically two kinds of motions, viz: (i) Formal Motion: This includes all motions moved by the members with the object of: (i) adjourning the meeting, (ii) dropping an item on the agenda, from discussion, (iii) adjourning the debate on a motion, (iv) applying closure to the motion. Thus for example, when a motion is moved to adjourn the meeting it takes the form: "that this meeting be now adjourned." A motion should always be in writing and necessary notice should be given before a motion is proposed: Though a motion is generally seconded it is not necessary. A motion should always relate to a matter within the scope of the meeting and should be phrased in a clear and unambiguous manner. A motion should always be in the affirmative and commence with the word 'That', so that when it is passed and is converted into a resolution it may read as...'Resolved that - A formal motion may be moved in any of the following forms: (a) The Closure: Suppose, a member feels that enough time has been spent on discussing a particular motion, he may move that the 'question be now put'. This motion is known as closure. If this motion is allowed by the Chairman, the discussion on the motion stops and the motion is put to vote. But if the motion is disallowed, the discussion on the main motion keeps continuing. (b) Previous Question: The object of this motion is to prevent further discussion on the main motion under discussion if he feels that to take a decision on that point at that moment would be unwise or inconvenient; but cannot be put when an amendment to the motion is under discussion. If the motion is carried, the main motion is dropped otherwise it is continued with. (c) Proceed to next business: Having a similar objective to the 'previous question', this motion is put in the form, that the meeting do proceed to the next business." This motion is resorted to whenever a member feels that the motion
under discussion is of lesser importance, than some other matter pending discussion. If the motion is carried, the discussion shifts to the next topic on the agenda otherwise it continues with the original motion. (d) Adjournment: This motion is resorted to when a member wants the entire proceedings of the meeting to be suspended either indefinitely or for a particular period. A motion of adjournment takes precedence over every other motion of the house. Such motions have to be seconded, before being put to vote. If the motion is carried, the proceedings of the meeting cease from that moment. (ii) Substantive motion: Whenever a member feels that some motion is unacceptable/unsuitable in the form it is presented, may propose an amendment to it. Such amendments immediately become embodied in the original motion, and, this altered motion is known as a 'substantive motion'. A substantive motion cannot be further amended in a manner, where it would be recovered into its original form. Apart from these basic forms of motions which may also be termed as the 'valid motions' you have certain other kinds of motions, namely: Lapsed Motion: If by the rules of the company, some particular motion is required to be seconded, then such a motion lapses if it is not so seconded. Such a lapsed motion is also known as a dropped motion in parliamentary language. Unacceptable Motion: This is a motion which the Chairman of a meeting declines to accept on grounds of it lacking certain essential elements. Following are certain basic elements which a motion should contain, failing which the validity of a motion is in jeopardy. These elements are: i) A motion should be within the scope and ambit of the Constitution, rules and articles of association of a company. A motion which is ultra vires these documents is invalid as being contrary to law. ii) A motion should comply with any statutory requirements made as to regulate the form/content etc., of the motion. iii) A motion must be within the scope and ambit of the meeting in which it is being prompted. iv) A motion should be relevant to the subject matter or business to which it relates or to the business for the conduct of which the meeting has been convened. v) A motion must neither directly nor indirectly try to negate the results of a prior motion which has already been put to vote, ie., a motion cannot try to be a negative of a motion already passed or be a reverse of a motion which has been lost (i.e., not passed). vi) It should not be a redundant motion i.e., a mere repetition of a prior motion or decision or policy. If a motion contradicts any one of the first two conditions, the motion is ab initio invalid, but in the remaining cases if not totally invalid, its validity would certainly be in jeopardy as the Chairman may refuse to accept the motion.
Invalid Motion: Sometimes an unacceptable motion may be carried through in a meeting and thus become a resolution. For example, a motion which is ultra vires the Companies Act may be passed by the meeting and so become a resolution. But merely because it has been approved by a majority - it does not become binding on the company. Such motions are deemed to be ab initio invalid and cannot be ratified especially if it contravenes the Act, the provisions of the memorandum or articles of association [Ashbury's Case]. But if a resolution has been passed in a meeting convened without a proper notice or in a meeting without the requisite quorum, or being outside the scope of the meeting where it was passed, then it may be possible to ratify such a resolution in a subsequently convened meeting. The possibility of ratifying an invalid motion would depend on the nature of the invalidity - i.e., if it is inherently invalid then it cannot be ratified, if it is invalid due to a mere technical irregularity then it is possible to ratify it. Motion vis-a-vis Resolution Generally speaking, the terms 'motion' and 'resolutions' are used interchangeably, giving the impression that these terms are synonymous. But such an impression is not correct. A motion is a proposal on the subject matter under discussion, which is put to vote. If after the voting, a motion receives a favourable response from the majority of the members present and voting (either personally or by proxy) i.e., if it is passed by a majority, then such a motion becomes a 'resolution'. Thus, 'resolution' is a passed motion - a motion which lapses or is deemed invalid cannot become a resolution, even if in the latter case it has been voted in favour by a majority of the members present at the meeting. Unless a resolution is passed, the meeting fails to attain its objective, or we may say that a meeting where no resolution is passed achieves or accomplishes nothing - because, though a debate or discussion might have taken place, nothing of legal value ensues unless and until a resolution is passed, because it is only a resolution which is legally binding and not a motion or a debate. Characteristics of a Motion A motion being the basis of legally binding decisions, should incorporate within it certain essential characteristics. Apart from the substance or subject matter of a motion, even its form may be important because a motion may be rejected by the Chairman atleast in the form it has been presented. Some of the points to be kept in mind while framing a motion are as follows: i) Form: It should always be in a positive and affirmative form, unless and until a negative form would achieve a special benefit or advantage, e.g., to ensure that a disallowance of a request or rejection of a proposal is specifically recorded in the minutes. Generally speaking, care should be taken to see that a 'yes' vote does not support a 'no' proposal. ii) Content: It should be complete and plain so that the resulting resolution can be plainly identified with the objective and substance of the motion. As far as possible, a motion should be short, concise and to the point, but 195
comprehension and clarity should not be compromised with in favour of brevity. If needed, two or more motions can be proposed on the same subject, instead of one single, lengthy or complex motion. iii) Wording: Every motion should commence with the word that, and it should be precise and definite both in its language and import. A motion should be devoid of any traces of vagueness, ambiguity or uncertainty [Harrey v. Adelaide and Hindmarsh Tramway Co. Ltd., (1884)15 SALR 136, cited in Taggarts at p.410]. iv) Drafting: A motion should be so framed that it enables the voter to conveniently vote a 'yes' or a 'no' on it, i.e., the motion should be so drafted as to facilitate the decision making of a member. Once a motion is moved, it is put to 'debate', i.e., before putting it to vote the members are given an opportunity to discuss or put forward their views on the motion. Generally speaking, every person except the moves of the motion is given only one opportunity to speak. The mover may be given a second chance so that he may be able to reply to some of the querries on the motion. But, the Chairman has a discretion to allow a member to speak a second time if he deems it necessary. Further, the seconder of a motion may reserve his right to speak to the end where he may be able to reply to all the doubts or questions raised in the debate. But a seconder's right to speak is on par with the right to speak of any other member i.e., to say, if the motion has been 'put to vote' before the seconder has had his say then he looses his opportunity to speak. A motion which has been moved and accepted by the Chairman becomes the property of the meeting, in the sense that, the mover has no further control over it, and, such a motion has to be put to vote, unless, (a) the members consent to the withdrawal of the motion, or (b) one of the formal motions of 'previous question' etc., is passed in order to prevent voting on it, or (c) certain amendments to the motion are moved in which case, if the amendments are passed they become embodied in the original motion and what is then voted is the new and changed motion i.e., the motion in its original and unamended form is lost. II] Amendments When a motion is put to debate, it may be debated in the form it has been moved, or some member may propose an alteration or change either in the form or content of the motion. Such an alteration though termed an amendment is strictly speaking only a 'proposed amendment' to the main motion, and is moved not to defeat the main motion but merely to modify it in some respect. Characteristics of an Amendment: As far as possible an amendment to a motion should possess the following characteristics, viz: i) It should be in writing and submitted to the Chairman. A written amendment facilitates greater understanding, and avoids waste of precious time which may result if the 196
amendment is oral or not clear. Unfortunately, though desirable and highly conducive to the efficient functioning of a meeting is rarely followed or insisted upon - unless a 'written amendment' is required under the standing orders or statute etc. ii) The format of an amendment should not be a 'direct negative' of the main motion. ii) It should not raise a point which has already been debated/ disposed of in an earlier vote. iv) It must be moved before the main motion is put to vote by the Chairman. Unacceptable Amendments Just as a motion may be declared unacceptable or invalid, an amendment to a motion may also be declared invalid/ unacceptable by the Chairman under the following circumstances, viz: a) It does not incorporate the essential characteristics of an amendment i.e., it either negates the motion or raises a point already discussed or i.e., moved after the motion is put to vote. b) It is inconsistent with a prior approved amendment to the same motion. c) It is inconsistent with a prior resolution passed at the meeting. d) It is beyond the scope, purpose or notice of the meeting. e) It is beyond the scope of the question or matter under consideration, i.e., it does not relate to the motion. f) It is immaterial, irrelevant or offered in a spirit of mockery. g) It is proposed with a specific intention of preventing the meeting from reaching a decision. h) It is proposed only with an intention to delay or defer the progress of the meeting. i) All amendments have to comply with the requirements of the statute, bye-laws, standing orders etc., which apply to the meeting in question. A Chairman should accept an amendment if he is in doubts about the acceptability or otherwise of the amendment, since a rejection by him of a valid and material amendment may result in a legal action and a consequential invalidation of the resolution on the motion [Henderson v. Bank of Australasia, (1890)45 Ch D 330]. Though an amendment cannot be so worded as would result in a complete alteration of the original motion so as to turn it into a totally new motion, it can be so worded as to change the entire wording of the original motion - so long as it is relevant to the text and terms of the original motion and such redrafting does not result in negating the original motion. Once an amendment is moved, it is debated on in the same manner as a debate on the motion is carried on. While discussion on an amendment is going on any discussion on the main motion is suspended, and, this discussion takes a priority over all others
- and must be strictly material/ relevant to the proposed amendment. After the debate is brought to an end, it is put to vote, and, if carried by a majority, the said amendment is incorporated in the main motion in such a manner that it becomes part and parcel of the motion i.e., the original motion changes into the new amended version. if the proposed amendment is 'lost' in the voting, then the original motion revives and is open to further debate or amendments before being put to vote. 3.9 VOTING We have been repeatedly using the phrases 'put to vote' or 'members present and voting' or in person or in proxy etc., we will now deal with the meaning of these phrases and terms. One of the primary duties of a Chairman is to ascertain the 'sense of the meeting', which he does by putting a motion to vote. 'Voting' may euphemistically be described as 'the registering of one's decision in favour of or against a proposal'. After a motion is put to vote, the Chairman counts the votes in favour of the motion and those against it, and if the majority are in favour of the motion, he declares the motion as passed and a resolution is framed. Thus 'sense of the meeting' is to check whether the majority of the voters favour the proposal or not. There are five modes of voting which are generally recognized, namely: i) By Voice or Acclamation: Here, all those who are present indicate their approval or disapproval by saying 'yes' or 'no' or by cheering/ applause when the motion is put to vote. This mode is usually used when the Chairman is of the opinion that there would be unanimous voting either in favour or against a particular motion. He hears both the voices and then declares whether the 'Ayes' have it or the 'Noes' have it. ii) By Division: Here, the Chairman asks the meeting to divide themselves into two blocks - one block consisting of members in favour of the proposal and the other block consisting of members against the proposal. The number of members in each block are then counted and the result declared accordingly. Voting through proxies is disallowed under this mode. iii) By Ballot: Here members are required to record their decision on a ballot/voting paper given to them, and after marking on it they deposit the paper in the ballot box. A counting is done later and results declared accordingly. iv) By Show of Hands: Here, when the motion is put to vote, the Chairman first asks those in favour of the motion to raise their hands (only one hand to be raised by one person), and the number of hands in favour are counted. Next, the same procedure is repeated to ascertain the number of hands against the proposal, and the results declared by the Chairman. His decision on the voting is final and conclusive. v) By Poll: Here, the members votes are counted by referring to their voting rights under the articles of the company.
This method differs from the above methods, because when a poll has been properly demanded and granted, every person has a right to vote in proportion to the number of votes he has - generally 'one vote per share' is the accepted norm. Voting by proxy is allowed under this mode. Under the Act, a poll may be demanded by: a) the Chairman of the meeting suo motto, (b) in case of a public company by atleast 5 persons having voting rights and present in person or by proxy; (c) in case of private companies by one member having the right to vote and present in person or proxy when the strength of the meeting is 7 or less than 7 members; but if the strength is more than 7 than poll can be demanded by atleast 2 persons present in person by proxy; (d) by member(s) present in person or by proxy and holding not less than one-tenth of the total voting power on that resolution or on which not less than Rs.50,000 has been paid or (e) by member(s) holding shares equivalent to one-tenth of the paid up capital on the shares conferring the right to vote. Under the Companies Act, only the last two modes of voting i.e., by show of hands and by poll are recognized. sec. 177 in fact provides as follows: At any general meeting, a resolution put to vote of the meeting shall, unless a poll is demanded under sec. 179, be decided on a show of hands." Thus, priority is given to voting by show of hands, though a poll may be demanded without going through the formal procedure of a show of hands [Holmes v. Keyes (lord), (1958)2 All ER 129 (X)]. In case two or more resolutions are to be put to vote, the Chairman may put them to vote en bloc, unless a separate voting is demanded by some shareholder. Voting by show of hands is basically a crude if convenient method of voting and hence the Act makes provision for voting by poll under sec. 179. When a poll is demanded and ordered, any prior results obtained by show of hands come to nought. Whenever a poll is duly demanded it has to be taken, unless the person demanding the poll withdraws his demand. The meeting continues till the poll is conducted. A Chairman may fix the time of taking the poll, but cannot declare the poll closed as soon as the time is over, if the votes are still coming. He can close the poll only after waiting a reasonable time in order to ascertain that no more votes are forthcoming. If he improperly excludes a voter or prevents him from voting, the poll will be invalidated [Shaw v. Tati Concessions Ltd., (1911-13) All ER Rep 694] unless he can prove that the excluded members votes would not have made any difference to the results [Ex Parte Hawby, (1854)3 E & B 718]. Time for taking poll: Sec. 180 provides as under: i) A poll demanded for adjournment shall be taken immediately; and ii) A poll on any other question, should be taken within 48 hours of the demand being made. But if there is a breakdown of the poll arrangements and it could not be taken at the time fixed by the Chairman, he is duty bound to take the poll at a later time though the 48 hours time limit specified under sec. 180 has lapsed. He is required 197
under these circumstances to fix and notify a new date and time for the poll and give the voters an opportunity to poll on that day. He cannot refuse to grant the poll. [M.K.Srinivasan v. W.S.Subramaniya Iyer, AIR 1932 Mad 100]. Who can vote ? A company is allowed to issue two kinds of shares: Equity or ordinary shares and preference shares. Every holder of equity shares is entitled to vote in a meeting [sec. 7(1)]. A preference shareholder can exercise his right to vote only on those resolutions which affect his rights attached to the preference share [sec. 87(2)] i.e., he does not have a general right to vote. Under sec. 181, a shareholder can be prevented from exercising his right to vote if he has not paid the call-money on his shares or there are other sums due from him to the company. A shareholder cannot be prohibited from voting on any other ground, for example, that he had not held his shares for a specified period etc [sec. 182]. Voting as such is not the only mode of company action, though it is the most prevalent one. An agreement unanimously agreed to by the members is sufficient to express corporate will, though a formal vote may not have been taken. Thus, in re Beiley Hay and Co. Ltd., [(1961)3 All ER 693], a meeting was attended by all the five members of a company. Two members held half the voting power and the remaining half was held by the other three members. On a resolution for voluntary winding up of the company, the two members with half the voting right voted in favour and the other three abstained from voting. It was held that the resolution was passed unanimously by the members. Brightman,J., held, It is established law that a company is bound in a matter, intra vires the company, by the unanimous agreement of all its corporators. Quoting Astbury,J., he further said, Where a transaction is intra vires the company and honest the sanction of all the members of the company, however expressed, is sufficient to validate it." Explaining his reasons for holding the resolution unanimous, he said, Admittedly three of the five corporators did not vote in favour of the resolution, but they undoubtedly suffered it to be passed with knowledge off their power to stop it... If corporators attend a meeting without protest, standby without protest while their fellows purport to pass a resolution, permit all persons concerned to act for years on the basis that the resolution was duly passed and rule their conduct on the basis that the resolution is an established fact, it is idle for them to contend that they did not assent to the purported resolution". Just as a voter is entitled to abstain from voting, under sec. 183, a voter may split his votes in favour and against the proposal, when a poll is taken. He has the right to distribute his vote in any manner be wants or desire. 3.10 VOTING BY PROXY When a meeting is convened, a person has two options either to be present personally or to ask someone else to do it on his behalf. When he is present personally, he can exercise his right 198
to vote in person, but when he abstains from attending the meeting, he can vote on a resolution through the hand of another. A person who votes on someone else's behalf is known as a 'proxy'. Generally speaking, a voting by proxy is allowed only in case of a 'poll', though the articles may provide for proxy voting even in case of voting by show of hands. This mode of voting has become very popular and common in the present context of large companies with extremely dispersed shareholding. Voting by proxy is provided for under sec. 176 of the Act, and the section also provides for various rules governing such a voting, namely: i) A proxy has to vote in accordance with the directions issued to him. ii) He does not have the right to speak on the motion. iii) The instrument appointing a proxy must be in writing and signed, and should be deposited with the company atleast 48 hours before the meeting. iv) Proxy forms in blank should be supplied to the members alongwith the notice of the meeting. v) A proxy being in effect a contract of agency is always revocable, even if its terms provide otherwise, but such revocation is always subject to the provisions of the articles. Thus, in Narayan Chettiar v. Kaleeswar Mills [AIR 1952 Mad 515] a proxy had exercised his votes in the first poll of a meeting. Before the final poll was held, the proxy was revoked and the member cast his vote personally. There was no provision in the articles prohibiting such a revocation. The Chairman rejected the revocation. The court held, that in the absence of a specific provision in the articles, the revocation was valid and rejection of it by the Chairman was therefore untenable. Under sec. 187-B, right to vote on shares held in trust is now vested in the public trustees who may exercise the right personally, or appoint someone to vote on his behalf or he may abstain from voting altogether if he feels that the interests of the trust would not be adversely affected by such abstinence. Similarly, where a company is a member of another company it may appoint a representative to look after its interests. So also, in case of any government being a member, it has the power to appoint representatives to attend the company meetings on its behalf. Such nominees hold the position of a proxy. The question arises - who can be appointed as a proxy ? The Act itself remains silent on this issue the only mention made in the Act is that any person entitled to attend and vote at a meeting can appoint another person to vote on his behalf. Thus, only a member of the company can appoint a proxy, but any person can act as a proxy regardless of whether he is a member of the company or not. Unless the articles of the company prescribe some qualifications for a proxy, there is no restriction under the Act for anyone to act as a proxy - only requirement being that 'a proxy should be an individual', whether the individual is a minor, lunatic or physically disabled makes no difference to his right to act as a proxy. But in practice, since a proxy is required to vote on someone's behalf and may sometimes have
to exercise this right using his own discretion, it would be more logical and practical to appoint an adult as a proxy - one who is able to understand the proceedings and the consequences of his vote. Appointment of a Proxy Generally, alongwith the notice convening a meeting a blank proxy form is also issued to the members. If a member intends to appoint a proxy, he should do so in writing (in the prescribed format), sign the form either personally or his duly authorised attorney should sign it for him, and deposit the form with the company atleast 48 hours before the meeting. If the member appointing a proxy is a body corporate, then the proxy from should be under its seal and signed by a person authorised by the company in this regard (such authorisation is usually given to the company secretary). If the articles of a public company or of a private company being the subsidiary of a public company, prescribe a longer period than 48 hours for the deposit of the proxy, then such longer period will be treated as invalid, and it will be deemed that only 48 hours requirement has been specified [section 176(3)]. If the signature on the proxy form does not coincide with the signature in the members'register, the proxy can be rejected by the company, unless the person is authorised to write his name differently. The articles of a company may provide that the member's signature on a proxy form should be attested by two witnesses. If such a clause is there, then a proxy form can be rejected if such an attestation is not there. If the proxy is executed outside India it must be properly stamped within 3 months after being received in India, else such a proxy is treated as invalid. If shares are held jointly by persons, then the proxy should be signed by all such joint holders. Execution of proxy by any one or only some of the joint holders of shares will make the proxy invalid, unless and untill such person had an authority from all the other joint holders to execute the proxy on his own. Given below is a specimen of blank proxy form. Form of Proxy Name of the Company I/we..........................of.....................in the district of........................being a member/members of the above named company hereby appoint....................of.....................in the district of....................or failing him................of.................... proxy to vote for me/us on my/our behalf at the meeting of the class members of the company to which I/we belong to be held on the .....................day of...............,19.....and at any adjourned meeting thereof. Signed this...........day of...............,19............ Appointment of more than one Proxy As mentioned earlier, a proxy can be revoked any time by the member/shareholder concerned. His revocation may be in anyone of the following ways,viz:
i)
Express revocation - By annulling the proxy issued and informing the company, that, Mr.A....would no longer be acting as proxy on behalf of...... ii) Implied revocation - This may be done in two ways, namely: a) by the member himself attending the meeting and exercising his right to vote personally; or b) by the member depositing a fresh proxy with the company appointing someone else as a proxy. In case of more than one valid proxies being appointed by the same person, the later in time will prevail over the former i.e., the former proxy is automatically revoked. Thus, if X appoints 'A' as a proxy by a form dated 12.7.1994 and appoints 'Y' as proxy through a form dated 13.7.1994 and both have been deposited with the company 48 hours before the meeting, the appointment of 'Y' will prevail over that of 'A'. If two proxies are appointed on the same date but different times, then, the one later in time will prevail. If more than one proxies are appointed on the same date and time then all of the proxies will be invalid. Position of proxy in case of the member's death In case of the death of a member/shareholder appointing a proxy, the authority of the proxy is revoked if the company has notice of such death prior to the meeting. Regulation 63, Table 'A' makes a provision in this regard as follows: "A vote given in accordance with the terms of an instrument of proxy shall be valid, notwithstanding the previous death or insanity of the principal or the revocation of the proxy or of the authority under which the proxy was executed, or the transfer of the shares in respect of which the proxy is given. Provided that no intimation in writing of such death, insanity, revocationor transfer shall have been received by the company at its office before the commencement of the meeting or adjourned meeting at which the proxy is used." Blank Proxy Proxys have started being used as an important tool in the passing of a resolution in which a director is interested, and more often than not such a director or other person collect blank proxy forms. A blank proxy form, even if duly signed and dated by the member is not of much use, unless the proxy form complete in all respects is deposited with the company before the specified time. A proxy not being a contract deed, is valid, though a blank form is handed over to the agent for filling up the particulars and submitting it. Such an instrument is not complete till it is filled up and affixed with proper stamp (present stamp duty is about 30np. stamp). An unstamped proxy is invalid. Thus, there is nothing irregular in a member handking over a blank-signed proxy to a director to be filled up by the later; but if the company circulates a proxy complete in all respects but needing only the member's signature on it, then such a practice is illegal and the officer etc., instrumental in circulating such a filled proxy form is liable to be fined - the 199
amount extending to Rs.1000/-. The reason for this seemingly contradictory provisions is simple - when proxy forms are circulated in the blank by the company a member is given an option to fill the form with the name of his choice or to simply sign it and give it to his agent to fill up the details, but when the name is filled in by the company - the option is no longer available to the member and he would be forced to accept the person mentioned in the form as his proxy whether he likes it or not, and this would amount to an interference with his right to vote and appointment of proxy. It should be noted that, though a company can not circulate a filled in proxy form it can circulate a blank proxy form alongwith a list of names forming the 'panel of proxies', from which the member can choose the proxy of his liking. The company is required to maintain a register for recording the lodgement of proxies along with relevant details. 3.11 ADJOURNMENTS AND DISPERSAL Sec. 165(8) of the Act provides that every meeting may be adjourned from time to time, on a motion for adjournment being passed by the meeting. The Chairman cannot suo motto adjourn a meeting unless the power to do so has been granted to him under the Articles. As far as possible, whenever an adjourned meeting is reconvened either on the same day or at some later date no fresh business should be dealt with at such a meeting, i.e., at the reconvened meeting only the unfinished business of the adjourned meeting should be taken up. If a meeting has been adjourned for 30 days or more a fresh notice has to be given to the members as if it is a regular meeting. If a meeting has not been adjourned, and the specified business for which the meeting was called with has been satisfactorily dealt with and the requisite resolutions have been passed, then the meeting is dispersed after a vote of thanks has been proposed and given. A meeting cannot disperse, in cases where a poll has been demanded on some issues, till the poll has been taken and the results declared. In such cases, the meeting is only adjourned and is dispersed only after conclusion of the poll. 3.12 CONCLUSION Let us now try to summarize the procedure involved in convening and holding of company meetings. The various steps involved, is given below in the form of a check list: 1. Notice is to be circulated amongst all the members having a right to be present at that meeting. The notice should contain - (a) date, time and place of meeting; (b) nature and objective of meeting; (c) any other necessary information needed for the meeting; (d_ proxy forms in blank wherever needed.
2. Preparation of Agenda. 3. On the day of meeting, if a Chairman is not already appointed, then a Chairman is to be chosen to preside over the meeting. 4. Checking if quorum is present. If quorum is absent even after half an hour of the start of meeting, the meeting stands adjourned, to be reconvened a week later on the same day and time. 5. The Chairman to take up each business on the agenda as far as possible in a serial order. 6. Each item to be put in the form of motion by a member in the form, for example, 'that Mr.A be elected a director'. 7. Each motion to be then put to debate where every member is to be given one opportunity to speak in favour of or against the motion. 8. In case, any amendments are proposed to the motion, then the amendments are to be debated on - while suspending the debate on main motion. 9. The amendments (if any) are then put to vote. If passed the amendment becomes embodied in the main motion. 10. The main motion in its original/altered form is put to vote. If passed by requisite majority [either simple or three-fourth majority as the case may be] the motion becomes a 'resolution' passed by the meeting. 11. Voting in the first instance to be by show of hands, and if demanded by a member then a poll to be conducted on the motion. Poll may be taken at any time fixed by the Chairman but within 48 hours of the demand being made. Further a person may vote either in person or through a proxy. 12. On conclusion of the entire business, a vote of thanks to be proposed and given and the meeting dispersed. 13. Before final dispersal any member can seek an adjournment of the meeting and if the motion is passed, then the meeting is adjourned to a specified later time and date. 14. On dispersal or adjournment, the secretary is required to prepare the minutes of the meeting within 30 days of the meeting and to file it in the 'minutes book'. Minutes form a prima facie evidence of the proceedings of the meeting and the resolutions passed therein. 15. A copy of the minutes is to be filed with the Registrar of Companies within specified time limit alongwith copies of resolutions passed etc. Failure to file them involves a penalty.
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4 REPORTS, APPLICATIONS, AND APPROVALS

I] REPORTS Under the Act, the officers of the company are required to present various reports to the shareholders on different occasions, giving a concise summary of either the activities undertaken by the company, or the decisions of the board of directors or the stating of the company accounts etc. These reports are presented not merely for 'information purposes' but also to accord the shareholders etc., to question the concerned persons on that report. Reports thus form an effective check on arbitrary action and impose 'accountability' on the persons preparing and presenting them. Some of the important reports are briefly discussed below. a) Statutory Report As mentioned earlier, at every statutory meeting a statutory report has to be presented, to provide the shareholders with up to date information from the time of incorporation to the time of meeting. A statutory report has to include the following informations: i. The total number of shares allotted, categorizing them as fully paid or partly paid, and the total amount of cash received by the company against them. ii. An abstract of receipts stating the sources and the payments made, the balance cash in hand, estimated preliminary expenses, commission/brokerage etc., to be paid on the shares. iii. An up-to-date information about the names, addresses and occupations of the directors, managers, secretary of the company. iv. The particulars of any contract to be submitted to the members for their approval alongwith proposed amendments. v. The details of any underwriting contract entered into by the company and the extent to which such contract has been fulfilled. vi. Details of any arrears which may be due from the directors etc., on call on their shares. vii. If any commission or brokerage has been paid to the directors, managers etc., for issue/sale of shares, the details of such payments made. A specimen statutory report is given below to have a clearer understanding. STATUTORY REPORT (Pursuant to Section 165) The name of the company: Synthetics and Chemicals (India) Ltd. Date of Notice for holding Statutory Meeting:15th December 1990. Date and Place of the Statutory Meeting:15th January 1991, at Resham Bhavan Hall, 78, Veer Nariman Road, Bombay-1, at 3.00p.m. Presented by: Ms.Padma Bhushan, Director of Synthetics and Chemicals (India) Ltd. The Board of Directors submit this Statutory Report to the members in pursuance of Section 165 (i.e., within 7 days of the Report)
Cash received upto
Nominal value of each share
Particulars
of Shares Number
Called up per share
Rs. a) Allotted subject to payment thereof in cash: i) ii) iii) Equity Redeemable Preference Shares Preference Shares other than Redeemable Preference Shares b) Allotted as fully paid up otherwise than in cash and the consideration which they been have allotted: Nil Nil 4,50,000 Nil 100 Nil
Rs.
Rs.
75 Nil Nil
2,58,26,500 Nil Nil
19-12-60
201
i) ii) iii) c)
Equity Redeemable Preference Shares Preference Shares other than Redeemable Preference Shares
Nil Nil Nil
Nil Nil Nil
Nil Nil Nil
Nil Nil Nil
Allotted as partly paid up to the extent of Rs. Nil per share and the consideration of which they been allotted: i) ii) iii) Equity Redeemable Preference Shares Preference Shares other than Redeemable Preference Shares Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil
d)
Allotted at a discount of Rs. Nil per share: i) ii) iii) Equity Redeemable Preference Shares Preference Shares other than Redeemable Preference Shares Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil Nil
2.
Expenses as estimated in the Prospectus:Rs. Preliminary Expenses Brokerage Other Expenses Rs. 1,65,500.00 1,75,000.00 3,40,500.00 5,00,000.00 Rs. 1,59,500.00
Preliminary expenses actually incurred upto aforesaid date (i.e. 19-12-60) Rs. Law charges Other charges in connection with the preparation of the Memorandum and Articles of Association of the Company Printing expenses Registration charges Advertisement charges Commission on issue or sale of shares Discount on issue or sale of share Miscellaneous expenses Rs. Nil 78,873.49 38,717.50 77,382.50 Nil Nil 1,85,480.22 4,05,703.71 25,250.00
Preliminary expenses estimated to be incurred after the aforesaid date (i.e. 19-12-60) Rs. Nil
Nil 30,000.00 Nil Nil 1,65,500.00 Nil 2,00,000.00 3,95,500.00
202
Receipts Shares: 4,50,000 Equity Shares of Rs. 100 each of which Rs. 75 per share called up Less: Allotment monies in arrears Rs. 93,000 Unpaid Call (1st Call of Rs. 25 per share is made and is payable on or before 31-12-60) Rs.78,30,500
Rs.
Rs.
3,37,50,000
79,23,500
2,58,26,500.00 24,15,59,725.00
Application Money Refundable Other Receipts: Interest on Short Term Deposits Miscellaneous receipts Amount Received and payable to Messrs. Kilachand Devchand and Company Private Ltd. 12,99,501.96 1,638.48
13,01,140.44 73,481.28
Total Rs.
26,87,60,846.72
203
Payments Preliminary and Issue Expenses: Registration Charges Other Issue Expenses Application Money Refunded
Rs.
Rs.
38,717.50 3,66,986.21 4,05,703.71 24,15,59,725.00
Capital Expenditure Land Building Office Furniture and Equipment Motor Vehicles Advances and Deposits: Land Building Plant and Machinery Railway Siding Other Accounts Sundry Deposits Other Items: Salary and Wages Printing and Stationery Postage and Telegrams Rent Rates and Taxes Motor Car Expenses Directors Fees Travelling Expenses Commitment Fees Disclosure Fees Professional Fees Payment to Promoters as per agreement Miscellaneous Expenses Balances: In Hand At Banks in Current Account At Banks in Short Term Deposits 501.48 50,14,346.59 93,80,375.00 1,43,95,223.07 95,946.95 9,743.65 64,719.33 4,053.00 4,622.74 16,000.00 96,000.06 83,256.25 14,26,500.00 1,72,638.67 15,00,000.00 62,328.77 35,35,809.42 3,24,767.91 .. 69,77,834.85 8,52,000.00 1,04,850.00 16,698.00 82,76,150.76 4,14,529.71 76,025.04 97,680.01 5,88,234.76
Total Rs.
26,87,60,846.72
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4.
Names, addresses and occupations of the Companys Directors, Auditors, Managing Agents, Secretaries and Treasures, Manager and Secretary. A. DIRECTORS
Particulars of changes, if any, in entries in columns
Sr. No.
Names
Address
Occupation
(1), (2) & (3) since the date of in corporation
Date of the change 5
1. 2. 3.
Mr. Tulsidas Kilachand Ms. Padma Bhushan Mr. Elton H. Schulenberg
95, Napean Sea Road, Bombay 6 95, Napean Sea Road, Bombay 6 1200, Firestone Parkway, Akron, 17, Ohio, U.S.A.
Merchant Merchant Director, VicePresident and Treasurer The Firestone Tyre & Rubber Co.
Nil Nil Nil
Nil Nil Nil
B. AUDITORS
Sl. No. Name Address Description Particulars of changes, if any Date of the change
1. 2.
Dala And Shah Nanubhai And Co.
49, Apollo Street, Bombay 1. 51, M. G. Road, Bombay 1.
Chartered Accounts Chartered Accountants
Nil Nil
Nil Nil
C. MANAGING AGENT, SECRETARIES & TREASURES

Nil Nil Nil Nil Nil
D. MANAGER
Nil Nil Nil Nil Nil
E. SECRETARY
1. Mr. K. B. Dabke Warden Court, .. Nil Nil
Cumballa Hill, Bombay 26
205
5. 6. 7. 8.
The Particulars of contract which is to be submitted to the Statutory Meeting Underwriting Contracts The arrears if any due on calls from Directors, Managing Agents, Secretaries & Treasurers and Manager Particulars of any commission or brokerage paid or to be paid in connection with the issue on sale of shares to any Directors, Managing Agents or Manager or if Managing Agents is a firm, to any partner thereof, or if the Managing Agents is a Private Company to any Director thereof
Nil Nil Nil
Nil
We hereby certify that the above Report is true. TULSIDAS KILACHAND RAMDAS KILACHAND B. K. DAPHTARY K. M. PREMCHAND Bombay, Dated this 23rd day of December 1960. We hereby certify as correct so much of the Report as relates to the Shares allotted by the Company and to the cash received in respect of such shares and to the receipts and payments. DALAL & SHAH NANUBAI & CO. Chartered Accountants Auditors Bombay, Dated this 23rd December 1960. Chairman Directors
b) Annual Report This is the report which is presented at every annual general meeting held in pursuance of section 166 of the Act, wherein, the board lay before the company, a balance sheet, and profit and loss account for a period beginning the day following the previous AGM and ending not more than 6 months prior to the present meeting; boards' report; auditors' report; Chairman's speech etc. Given below is a specimen of the Agenda of an AGM of a company. 1) 2) 3) 4) AGENDA Secretary to read the notice convening the meeting. Secretary to read auditor's report. Ask the meeting whether the director's report, and accounts as printed and submitted shall be taken as read. Chairman's speech, after which he will i) move that the report and accounts as audited and certified by the company's auditors, and placed before the meeting, showing the position of the affairs of the company as on 30th March, 1994 be approved, adopted, and ii) Call on Ms.Padma Bhushan to second the motion. iii) Invite discussions. v) Reply to questions, put the motion to vote and declare the results.
5) Shareholder to move, and second That Mr.Y.L.Reddy, having expressed his willingness to continue as director for another term, be reelected as director for a period of 3 years, on the same terms and conditions of service as before". 6) Shareholders to move, and second "That Kichha and Co. Ltd. having expressed their willingness to continue as auditors, be reappointed as auditors for the company for the year 1994-95, on the same terms and conditions as before." 7) Vote of thanks To have a better understanding of the proceedings let us have a look at how the 'minutes' of this particular meeting would appear. Minutes of the Above Agenda The Annual General Meeting of the Synthetics and Chemicals (India) Ltd., was held on 30th May, 1994 at 3.00p.m. at Resham Bhavan Hall, 78, Veer Nariman Road, Bombay-400 001 (Registered Office). Present Shri. A.S.Menon in the Chair Ms.Padma Bhushan Mr.Y.L.Reddy Directors
206
Mr.S.S.Ghosh Mrs.Radha Menon Shri.K.Lal, Solicitor Shri.T.Devidas, Secretary and 58 shareholders. 1) The notice of the meeting was read by the secretary. 2. The auditor's report on the company account as at 30th March, 1994, was read. 3) The reports of directors and accounts duly certified by the company's auditors were also taken as read. 4) RESOLVED that the reports and accounts as audited and certified by the company's auditors, now placed before the meeting showing the position of the company's affairs as on the 30th March 1994, be approved and that the dividends recommended to be paid by the director's in their annual report, @ 7% on preference shares and 9.5% on equity shares for the year, be approved." 5) RESOLVED that Mr.Y.L.Reddy be re-elected as director for a period of 3 years, on the same terms and conditions as before." 6) RESOLVED that Kichha and Co. Ltd., be reappointed as auditors for the year 1994-95, on the same terms and conditions as before. 7) The meeting was dispersed with a hearty vote of thanks to the board. (Signed) A.S.MENON Chairman. c) Director's and Auditor's Reports Two of the major components of an Annual General Meeting are the reports presented by the board of directors and the auditors of the company relating to the affairs of the company, financial or otherwise, during that financial year. Specimen's of these meetings are reproduced below: SYNTHETICS AND CHEMICALS (INDIA) LTD. BOMBAY DIRECTOR'S REPORT For the third Annual General Meeting of the Shareholders to be held on 8th May 1994. To THE SHAREHOLDERS, SYNTHETICS AND CHEMICALS (INDIA) LTD. Gentlemen, Your Directors have pleasure to present for your consideration the report on the working of the Company during the year ended 31st March 1994, the Profit and Loss Account for the year and the Audited Balance Sheet as at 31st March 1994.
Production during the year was further increased over the previous year's level by 14% sales of your company's products amount to Rs.108,57,895 as compared with Rs.98,69,545 for the previous year. Satisfactory progress was achieved in your company's business during the year 1993-94, and operations for the year show a net profit of Rs.6,27,541.73 as compared with Rs.4,61,739.98 for the previous year. A sum of Rs.1,85,972.70 was paid as interest on the loans obtained from the Industrial Finance Corporation of India and the State Bank of India, and Rs.12,50,515 is set aside for Depreciation on Fixed Assets calculated in accordance with the rates allowed for normal depreciation and extra shift allowance as per Income-Tax Act. Your Directors have made a provision of Rs.3,00,000 in addition to the sum of Rs.80,000 made last year, to meet the liability of payment of retirement gratuity to the employees. Further, your Directors have set apart Rs.2,50,000 towards cost of repairs and replacement. No provision has been made for Income-Tax this year also as the company has no assessable Income. The balance left after making the above provisions, including the carry over, is Rs.9,66,819.10.7 and your Directors have decided to transfer Rs.2,50,000 to the I.F.C.I. loan Redemption Fund and to recommend appropriation of the balance of Rs.7,16,819.10.7 as follows: 1. To declare a dividend of 9.5% or at the rate of 95np. per share of Rs.10 absorbing Rs. 5,38,610 2. To carry forward Rs. 1,78,209.10.7 With the installation of the auxillary equipments, namely Vacuum Filters and additional Chippers, the current programme of expansion is completed. Your Directors are taking action to further the production of sulphuric acid and nitric acid to a tune of about 10,000 tonnes a year. Sri. K.Nagaraj, IAS, Director of Industries and Commerce, a Director on our Board, resigned in April 1994 and Sri.P.Bhaskar, IAS,M.P., has been appointed a Director on our Board in his place as representative of Industrial Finance Corporation of India. Under Article 109 of our Articles of Association, Sri.A.M.Rao, Sri.G.Sivareddy reitre by rotation and being eligible offer themselves for re-election. Under Article 151 (1)&(2) of the Articles of Association, the Auditors of the company Kichha and Co. Ltd. retire and are eligible for re-election. Yours faithfully, for and on behalf of the Board of Directors, Chairman Secretary Dated: 31st April 1994.
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REPORT OF THE AUDITORS TO THE SYNTHETICS AND CHEMICALS (INDIA) LTD. We have audited the annexed Balance Sheet of the Synthetics and Chemicals (India) Ltd., as at 31st March 1994, and also the annexed Profit and Loss Account of the Company for the year ended on that date in which are incorporated the audited returns from Sri Lanka and report that:1. We have obtained all the information and explanations which to the best of our knowledge and belief was essential for the purposes of our audit; 2. In our opinion proper books of account as required by law have been kept by the company, so far as it appears from our examination of the books, and proper returns adequate for the purposes of our audit have been received from works and other offices in India; 3. The Balance Sheet and Profit and Loss Account dealt with in the report are totally in agreement with the books of accounts and the returns; 4. In our opinion and to the best of our information and according to the explanations given to us, the Accounts read with the notes thereon give the entire information required by the Companies Act, 1956, in the requisite manner and provide a true and fair view a) in the case of the Balance Sheets of the state of affairs of the company as on 31st March, 1994. b) in the case of Profit and Loss Account, of the profits for the year ending on that date. Kichha and Company Chartered Accountants Bombay, 30th April 1994.
Company to financial institutions - for underwriting commissions, for getting loans etc. Some of these applications may be in the form of advertisement in mass media or otherwise and are more in the nature of invitation to offers' for example - those inviting public to offer for shares in the company. Given below are two specimen applications, one for registration of Financial Institutional Investors (FIIs) with SEBI and another for offering shares on a private placement basis in a new company. Application for registration of FIIs with SEBI and the permission of RBI under FERA, 1973 1. Form FII-R-1 Name, address, telephone no. telex no. and fax no. of the Registrant. In case of Registrant already has an office in India, the particulars may also be given for that office. Please indicate whether the Registrant belongs to any one or more or the following categories. Pensions Fund, Mutual Fund, Investment Trust, Asset Management Company, Nominee Company and Incorporated/Institutional Portfolio Manager or their power of attorney holder (providing discretionary and nondiscretionary portfolio management services). (a) The date and place of incorporation of the Registrant. (b) Brief description of the principal activities of the Registrant and the year of commencement of such activities. (c) Brief description of the Group to which the registrant belongs. Name, address, telephone, telex and fax numbers of the Securities Commission/Self-Regulatory Organisation/the relevant statutory authority for the securities market with whom the Registrant is registered in the country where the Registrant is incorporated or in the countries of its operations, and the registration number and period of registration. Please also state whether there has been any instance of violation or non-adherence to the securities laws, code of ethics/conduct, code of business rules, for which the registrant, or its parent/holding company or affiliate may have been subject to economic, or criminal liability, or suspended from carrying out its operations, or the registration revoked temporarily. (a) Please indicate the names of the clients on whose behalf you propose to invest in India. (b) Please provide the following details regarding the clients: i) Date and place of incorporation and Constitution (i.e., Partnership Firm, Private Company, Public Company, Holding Company, Subsidiary, Pension Fund, Mutual Fund, Investment Trust etc); ii) Whether the client is registered with any regulatory agency; if so, the name and address of the regulatory agency, registration number and date of registration.
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II) APPLICATIONS Just as a number of reports have to be submitted, the secretary of a company has to submit to the Registrar various applications for differing purposes. In fact, the submission of applications begins even before the company is incorporated i.e., from submitting the application for incorporation. From then it is a long stream of applications be it for equity participation or for listing of shares or for NRI investment etc. In general, all these applications have to be made in a fixed format, under the company seal and signed by the secretary or any other person authorised in this regard. It is not necessary that all such applications have to be only from company to Registrar - in fact depending on the purpose of the application the second party to whom it is addressed keeps differing, for example: Company to Registrar - for incorporation etc. Company to general public - public issue of shares or private placement of shares. Company to stock exchange - for listing of its shares. 208
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Objectives and principal activities of the clients (investment/fund management, finance company, investment company, mutual fund, pension fund, etc). iv) Number of types of shareholders (i.e. individuals, institutions, etc.) % distribution of assets between groups of shareholders may also be provided. v) Volume of assets. (In case of Registrant is itself a Fund the information in regard to 5(b) may be provided for itself). 6. Please indicate the manner in which you propose to conduct your investments in India i.e., whether through an establishment in India or through any other office outside India. Please give details, and also the name of the contact person/compliance officer. 7. Name and address of the designated bank branch in India through whom investment is proposed to be made. 8. (a) Name, address, telephone no., telex no., and fax no. of the domestic custodian. Please also present the background information on the custodial including volume of business handled, organisational infrastructure and the number of investment companies for which it is acting, or has acted, as custodian. (b) Please state whether the Registrant has entered into an agreement with the domestic custodian. Documents to be enclosed with the application a) Copies of Memorandum and Articles of Association and Investment Management Agreements or any other agreements authorising the Registrant to invest on behalf of its clients. b) Audited financial statements and annual reports for the last 5 years. c) Documents to support registration with a securities Commission and/or Self-Regulatory Organisation. d) Copy of the custodian agreement with the domestic custodian. e) Declaration Statement (to be given as below). We hereby agree and declare that the information supplied in the application, including the attachment sheets, is complete and true. And we further agree that we will notify Securities and Exchange Board of India and Reserve Bank of India immediately any change in the information provided in the application. We further agree that we shall comply with, and be bound by the Guidelines relating to Foreign Institutional Investors, as announced by the Government of India, and such other guidelines/instructions which may be announced by the Government/Securities and Exchange Board of India/Reserve Bank of India from time to time. We further agree that as a condition of registration, we shall abide by such operational instructions/directives as may be issued by Securities and Exchange Board of India/Reserve Bank of India from time to time.
iii)
For and on behalf of......................................................... (Name of the registrant) Authorised Signatory......................................... .......................... (Name) Date: Place: Notes1. Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI) reserve the right to call for any further information from the Registrant regarding its applications. 2. Applications, superscribed Application for Registration of Foreign Institutional Investor, shall be submitted in duplicate in sealed enveloped, at SEBI's office. 1. Letter offering shares on a private placement basis in a new company Regd. Office...................... PRIVATE AND CONFIDENTIAL Dear Sir/Madam, Sub: Private preferential offer of ........equity shares of Rs.10 each for cash at a premium of Rs.......per share to Directors, their friends, relatives and associates. and will be financed partly by a loan from and............consortium and partly by issue of equity shares to the Directors, their friends, relatives, associates and to Indian resident public. On completion of the project the production of about........MTS per annum. The project is in advanced stage of implementation. We now have the pleasure to offer the shares of this Company to you out of the preferential offer by private placement on the terms set out in the enclosed application form. If you are interested in availing of this offer, please return the enclosed application from duly filled and signed alongwith the remittance in the manner indicated in the form to the registered office of the Company. Allotment of shares however, will be at the discretion of the Board of Directors of the Company. Unsubscribed portion out of this private preferential offer, if any, will be subscribed by..........kindly note that the shares so allotted shall be subject to the guidelines and clarifications issued thereof from time to time by the Securities and Exchange Board of India (SEBI), including, in particular, as to the lockin period. Please also note that this offer is meant for your acceptance only and it cannot be renounced by you in favour of (Signature)
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any other person. You may however accept the offer jointly with any other person in which case you must be the first named applicant. By Order of the Board ............. Chairman III) APPROVALS The purpose of some of the applications mentioned above is to get an approval of the concerned institution or the government, for the particular act. Thus, for example, if a company had to change its name or its registered office from one state to another, or to reduce its share capital it has to take the prior approval of the Central Government. Similarly, if it wanted some FIIs to participate in its equity issue, or wants some NRI investment or wants to go in for a Euro Issue etc., then it has to seek the
approval of SEBI and the Reserve Bank of India under FERA. As a direct consequence of the liberal policies under the new economic policies, most of the approvals in the latter case are automatically given by the RBI. The basic objective of making it mandatory on the company to seek approval of the concerned authority whenever it contemplates a major change, is merely to provide an impartial and trained authority an opportunity to ascertain tht the best interests of the company, the shareholders, creditors, and in some cases the country, would really be served by such a change. The need to seek an approval also ensures that a company does not take momentons decisions at the drop of the hat, but takes the time to really think of all the consequences which would ensue from such a change. The time required for the granting of an approval also has an added advantage that if the company has second thoughts about the whole matter then it can withdraw the application (wherever allowed by the statute) and no harm would be done to anyone.
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5 CHECK LIST FOR A COMPANY SECRETARY

1. Pre and Post Incorporation issues (a) For obtaining certificate of Incorporation - Memorandum prepared in the appropriate format given in table B, C, D and E of Schedule I of the Companies Act. - 'Memo' and 'Articles' printed. - These documents to be stamped properly according to the Stamp Act of the State before signature. - Subscribers to the documents signed in their own hand and added their description. - Lodged with the Registrar following documents : Memorandum and Articles Declaration of compliance Statement of authorized capital with appropriate fees List of persons who have consented to be the Directors If qualification share is to be subscribed, did Directors subscribe or agreed to subscribe to it. A copy of ROC's letter approving the name - Collect certificate of incorporation from ROC - Obtain seal, registers and form of share certificate - Steps taken to appoint full time directors if not appointed by articles Prepare agenda paper for the BoD meeting (b) For obtaining certificate of Commencing Business (i) Company having share capital and going for public issue - Appoint lead manager, co-manager, Registrar to the issue, brokers, underwriters, bankers to the issue and for receiving application money. - Prepare draft prospectus in consultation with the lead manager, and send the draft to all concerned. - File initial listing application with the stock exchange. - Hold board meeting to finalize the prospectus, authorize opening of account, appoint an auditor. - Send the prospectus to SEBI and the stock exchange for vetting. - Apply to RBI if shares are to be issued to NRI's, FII's under Section 19(1)(d) of FERA, and to open bank accounts abroad for collection of application money. - Advertise the prospectus and print the share application forms. - Register to the issue to arrange for collection of application forms and bank schedules. - Fulfill the criteria of stock exchange listing, where the issue is for Rs.3 crores or more and listing is proposed and confirm salient features of prospectus, viz: a) Every prospectus must be accompanied by a application form. An expert whose opinion is indicated in the prospectus, should not be interested in the promotion, formation or management of the company. c) A copy of the prospectus duly signed to be delivered to the ROC. After closing of the share application hold the board meeting for share allotment. Ensure that minimum subscription is raised. Ensure application and allotment money is paid by the directors. Obtain permission from stock exchange for listing. Pay the requisite stamp duty on shares. File declaration in Form 19 duly verified with ROC holding all conditions are fulfilled. Obtain certificate to commence business. b)
ii) Company having share capital but not going for public issue - Prepare statement in lieu of prospectus and get it approved in the board meeting. - Submit statement in lieu of prospectus with ROC in accordance with Schedule 111 of the Act. - Arrange for payment of application and allotment money in cash by the directors. - Ensure total shares not allotted within 3 days of filing the statement in lieu of prospectus. - File a declaration in Form 20 stating all conditions fulfilled with the ROC. - Pay requisite stamp duty. - Obtain certificate for commencement of business. (c) Alteration to Memorandum of Association (i) Objects and Registered Office Call a board meeting to decide the proposal, determine date and time of GM and the notice therefor. - Serve the notice to shareholders for the GM and to auditors and stock exchange where the company is listed (3 copies); - Pass a special resolution in the GM - File a certified copy of the special resolution with explanatory notes and Form No.23 with the Registrar within 30 days of passing of the resolution. - Forward six copies of the amendments in the object clause to the stock exchange. - File petition with the Regional branch of the CLB in Form No.1 of Annexure II of the CLB Regulation, 1991. - Publish notice at least a month before the filing of petition to CLB, once in an English daily and once on a regional language newspaper. - Receive copies of objections within 21 days of publication of notice. 211
File petition as per Regulation 14 of CLB, 1991. Serve copy of petition with the ROC. File certified copies of the CLB orders with the ROC in Form 21 within 90 days of the passing of order. Obtain certified copy of the order from ROC. Apply to CLB for extension of time for filing of documents whenever necessary. Serve a copy of the notice along with the petition on the Chief Secretary of the Government where the registered office is situated (if change of registered office is needed). File certified copy of the CLB order with the printed copy of the memorandum with ROC's of both the states (in case of change of registered office. Register the order with the ROC of both the states within a month of filing. Make necessary changes in all records, letterheads, etc. Arrange for the adoption of a new common seal.
File with the ROC a certified copy of the special resolution and explanatory statements in Form 23 within 30 days. Effect the necessary changes in all documents.
2. Checklist on Rights Issue (a) Pre-Issue - Decide on scheme of issue - Check if memorandum permits the rights issue, else alter it suitably. - Ensure board has sufficient borrowing powers under section 293(1)(d) else pass suitable resolution. - Ensure arrears on calls on existing shares are collected before rights issue. In case of failure of payment forfeit shares. - Notify stock exchange of the decision of board and its date to issue rights share. - Convene a general meeting for consideration of matters relevant to rights issue. - Appoint lead manager to the issue. - Obtain approval from RBI if securities are to be issued to NRI's. - Ensure standby arrangements for subscription to issue. - Draft letter of offer and composite application form. - Lead manager to forward letter of offer and application form to SEBI for vetting alongwith diligence certificate and inter se work allocation (if there are more than one lead managers). - Fix record date/book closure for the issue after vetting, SEBI. - Incorporate unaudited financial results upto last but one month prior to date of letter of offer. - Incorporate SEBI observations and finalize letter of offer. - Send letter of offer to stock exchange for approval. - Convene board meeting to approve of letter and its issual to shareholders, and opening of bank account. - Print letter of offer and application forms. - Send 6 copies to the stock exchange. - Appoint bankers to the issue, and arrange for acceptance of application money at centres having recognised stock exchanges. - Ensure issual of instructions from controlling bank branch to collecting branches. - Apply to relevant stock exchange. - Finalize advertising campaign. (b) Post Issue - Get certificate from lead manager confirming receipt of minimum 90% subscription. - Submit certificate to regional stock exchange for permission to utilise proceeds. - Issue letters to controlling branches for withdrawl of issue proceeds.
(ii) Name Clause - Call a board meeting to decide on change of name. - Get the clearance of the new proposed name from the ROC in Form No.1A. - Send notice of the general meeting to the shareholders, auditors and the stock exchange. - Hold a general meeting and pass a special resolution. - File a special resolution in Form No.23 with the ROC within 30 days of passing the resolution. - File six copies of the amended memorandum with the stock exchange. - Apply for approval of ROC with the following documents: a) reason for change of name; b) certified copy of the amended memorandum and articles; c) certified copy of the annual report of the last year; d) certified copy of the clearance of name by the ROC; e) certified copy of the special resolution; and f) treasury challan of payment of fees. - Seek fresh certificate of incorporation from the ROC. - Make changes in all documents. - Arrange for the new common seal (d) Alteration of Articles - Hold board meeting to decide on alteration, and check that proposed alteration is not inconsistent with the provisions of memorandum or the Companies Act. - Issue notices for a general meeting to all members, auditors and stock exchange. Hold the general meeting and pass the resolution. - File 6 copies of amendment with the stock exchange where the company is listed. 212
Ensure collection of application forms, schedules and final certificates by the registrar from collecting branches. When needed, obtain inward remittance certificate/bank certificate for NRI collections. If oversubscribed, prepare scheme of allotment with the registrar. If undersubscribed, obtain development amount from underwriters if any. Convene board meeting to approve. a) scheme of allotment b) fixing last date for payment of allotment money c) printing and issue of letter of allotment/share certificate etc. d) opening of bank account for acceptance of allotment money e) opening of account for refund of excess application money. Seek RBI approval in Form ISD(R) for share allotment and issue of share certificates etc., to NRIs. Seek approval from regional stock exchange for specimens and printing of i) letter of allotment/share certificate/debenture certificate. ii) allotment advice-cum-refund order iii) allotment advice-cum-allotment money due notice. Arrange for autographic signature on share certificate and refund of excess amount. If needed, issue cheques for underwriting commission. Despatch allotment-cum-refund orders, share certificates, money due notice etc., within 6 weeks of closing of issue or within 10 weeks of issue closing if permitted by stock exchange. Pay service charges to lead managers, registrars and advertising agents. Ensure issual of instructions from registrar to controlling banks for acceptance of allotment money; and from refund bankers to paying branches for payment of refund orders. File with stock exchange; listing application; distribution schedule; Analysis Form for new issue (Table 1A) and confirm that register of members/debenture holders is open for registering transfers. Advertise in two national newspapers about date of despatch of refund orders, letters of allotment, share certificates and date of filing of listing application. File return of allotment of shares alloted in Form 2 with ROC. Obtain pay orders from collecting banks against amount collected by them. Obtain final proceeds certificate from bankers to the issue. Update register of members.
Submit to SEBI a report alongwith compliance certificate from a CA etc., within 45 days of closure of issue. Submit final report to SEBI within 90 days of issue closing. If debentures issued, complete formalities and create security.
3. Checklist on Registration of Charges - Ensure that the relevant charge is covered within section 125(4). - File particulars of charge with ROC in Form 8 within 30 days, alongwith certified copy of instrument creating the charge and required fees. - File with ROC Form 13 giving particulars of existing charges (with modifications) and particulars of new charges and fee of Rs.10/-. - If unable to file the charge within 30 days then file it within 60 days giving reasons for delay, and pay extra fees. - If charge not filed within 60 days, apply to CLB for extension of time. 4. Checklists for Appointments (a) Of Directors of public company - Under the articles all directors are to retire at the AGM; or - 2/3rd of the total board strength was to retire by rotation at each AGM; - such 2/3rd directors had been appointed at AGM ? (b) Of Director of private company - Check provisions of articles. (c) Whole-time Secretary a) Check whether paid-up capital of the company is such as prescribed (Rs.50 lakhs) by Central Government ? If so, whether the company has appointed a whole-time secretary who is a member of the Institute of Company Secretaries of India? b) In other cases if secretary was appointed by the Company, check whether he possesses qualifications prescribed in the Companies (Appointment and Qualifications of Secretary) Rules, 1988 ? c) Check whether Form 32 has been filed with the Registrar ? (d) Manager 1. In the case of the public company or subsidiary of a public company with a paid-up capital of Rs. 5 crores or more, ensure that a managing director, whole-time director or a manager is appointed. 2. Convene a Board meeting to decide on the appointment of manager and approve the draft agreement to be entered into with him. 3. Ensure that the person proposed to be appointed as manager does not suffer from any of the disqualifications or disabilities mentioned in Sections 385, 386 and 388. 4. In the case of a public company and its subsidiary, where the proposed manager is already a manager or managing 213
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director on another company, ensure that notice of the Board meeting and resolution to be moved thereat are given to all the directors and the resolutions should be unanimously approved by all the directors. In the Board meeting, fix up the date, time, place and agenda of the general meeting and approve the notice of the general meeting to approve appointment of manager. Send the notice of general meeting to the members, the legal representatives of deceased and insolvent members and the auditors. Send 3 copies of the notice of the meeting to all the stock exchanges where the shares of the company are listed. Hold the general meeting and pass the resolution for appointment of manager. In the case of a public company, or its subsidiary, the appointment shall be effective only on approval of the Central Government if it is not in accordance with the conditions specified in Schedule XIII to the Companies Act. Where the approval of the Central Government is not required, file the particulars of appointment in Form 25C with the Registrar of Companies within 90 days from the date of appointment in general meeting, duly certified by the auditors of the company, the company secretary or a secretary in whole-time practice. Where a director of the company is interested in the contract for appointment as manager, send a copy of the contract to all the members within 21 days of the date of the contract along with a memorandum specifying the nature of interest.
12. File Form 32 in duplicate with the concerned Registrar of Companies within 30 days of appointment. 13. Ensure that the manager notifies about his appointment to other companies in which he is a director, managing director, manager or secretary within twenty days. 14. Make necessary entries in the Register of Directors and Managers. 15. Execute the agreement with the manager and get it notarised. 16. Make application to the Central Government in Form 25A within 90 days from the date of appointment, with the enclosures mentioned in the Rules. 17. Forward a copy of the memorandum to the stock exchanges where the shares of the company are listed. (e) Manager for number of Companies Check whether the company employed a manager, who was either the manager or managing director of any other company? If so, check that: i) the resolution for the appointment was duly passed at a meeting of the Board with the consent of the directors present at the meeting; ii) the total number of companies in which he was manager/ managing director did not exceed two; iii) Central Governments permission obtained, if the person concerned was the manager of more than two companies. Note: GM - General Meeting ROC - Registrar of Companies CLB - Company Law Board
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6. CASE LAW
Gopal Vyas v. Sinclair Hotels and Transportation Ltd. [(1990)68 Comp Cas 516 (Cac)]. The petitioner proposed the name of one N as director of the respondent company at its 14th AGM, and gave notice of the fact under sec. 257 of the Act. The company refused to inform the other members of the said proposal on grounds of noncompliance with provisions of sec. 188 of the Act. The petitioner contended that the company was under an obligation to inform its members of such proposal. It was held that, sec.s 188 and 257 covered different fields. Section 257 was a specific provision giving a right to an individual member to give notice thereunder. The specific right that has been given under 257 does not provide that the implementation of such a right will have to be in accordance with the procedure laid down in Section 188 of the Act. So an order was given to the company to consider the notice given by the petitioner at its AGM. P.C.Bohra and others v. National Sports Club of India: [(1991)71 Comp Cas 333 (Delhi)]. The plaintiffs were members of a registered society. By two separate undated notices, the Secretary-General of the society convened an ordinary general meeting (AGM) and an extraordinary general meeting (EGM) respectively, both to be held on the same date, the former for adopting the audited statement of accounts and the annual reports, and the latter for certain amendments to the society rules. The plaintiff filed a suit for a declaration that the notices and proposed amendments were invalid and sought an interim injunction on the grounds that: (1) the executive committee had not authorized the Secretary-General to call the general meeting on that date; (2) the executive committee having authorized the SecretaryGeneral to call an EGM on a different date, the change of date at the instance of the Central Council, was prejudicial to the personal rights of the members; (3) the corrections in the minutes of a previous meeting were carried out by the Central Committee not unanimously but only by a majority; (4) the resolution approving the proposed amendments was not passed by all members of Central Council, and (5) hence, the notice proposing amendments without approval of the Central Council was invalid. Held that, (i) the Central Council had much wider powers than the Executive Committee, and looking to all the circumstances, prima facie the decision of Central Council in authorizing the Secretary-General to convene the AGM and EGM on the same date was not against general human conduct. (ii) Though the notice convening the meeting had to be issued by the Secretary-General, the decision to hold the meeting had to be taken by the Executive Committee or the Central Council. What was important was the decision and fixing of the date was a mere formality, and the only requirement was that a 15 days clear notice had to be given. (iii) Despite the fact that notice was undated, the fact that plaintiff received the notice on 31.12.1989 for a meeting to be held on 18.2.1989 (i.e., more than 15 days later) satisfied the requirements and notice was within rules and plaintiff's personal rights were not infringed. (iv) If an error was committed by the Secretary on the 'draft minutes', it could be corrected by the members at the next meeting, as happened in this case. Thus there was nothing to invalidate the procedure. (v) It was not open to the plaintiff's to challenge the meetings of the Central Council on the ground that the existing council did not have its full strength. B.Sivaraman and others v. Egmore Benefit Society Ltd. [(1992) 75 Comp. Cas. 198 (Mad)]. The applicants-plaintiffs were shareholders of the respondent company, and had been elected as its directors at the AGM, and had since been functioning as such directors. Defendants no.2 to 5 were directors of the company earlier to this meeting and were to retire by rotation and accordingly defendants 2 to 4 stood for being re-elected as directors of the company as well as fill up the vacancy caused by the retirement of one of the directors. Defendants 4 to 13 were the requisitionists who had requisitioned an EGM of the company and notice had accordingly been given. As per the memorandum and articles of the company, the board of directors was to consist of 12 members of whom 1/3rd were to retire at every AGM by rotation, and they were eligible for re-election. Thus, in this meeting 4 directors were to retire by rotation and a fifth vacancy was caused due to retirement of one director. Accordingly all the applicants were nominated for the 5 posts of directors. Voting was held at the AGM by show of hands and the plaintiffs were declared elected. The Chairman suo motto ordered a poll to be conducted on the same date, and the results were announced on 29.12.1991, where all the applicants were declared to be duly elected. Resolutions to that effect were passed and entered in the minutes book. The applicants were intimated of their being elected and after giving their written consent, they started acting as directors. Defendants 4 and 5 having lost the election, started writing to the company, falsely alleging some support to call an EGM on April 2, 1991, and for which a notice dated 7.3.1991 was given. The applicants averred that the EGM was illegal and in fact void, and fearing that their rights might be prejudiced by the proposed EGM, they sought an interim injunction order restraining the EGM from being held. It was held that, by virtue of the record of proceedings in the minutes book duly made and filed with the Registrar the applicants were validly elected directors, since the defendants had produced no evidence to dislodge the presumption under sec. 195 of the Act, and that the scrutineers' report contained no evidence of manipulation of the poll. Since the applicants were duly elected as directors, the respondents were not entitled to convene an EGM for purpose of removing the applicants and declaring themselves as directors of company. Balwant Singh Sethi v. Sardar Zorawarsingh Hushnak Singh Anand [(1988)63 Comp. Cas. 310 (Bom)]. A requisition calling for an EGM was challenged by the first respondent, as being invalid and unlawful and hence not capable
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of being acted upon. Further he also sought a permanent injunction restraining the appellant defendant 2 and other requisitionsts from convening the EGM. The trial court granted the injunction and feeling aggrieved defendant 2 preferred an appeal alongwith a civil application for stay of order passed by the trial court pending hearing of the appeal. The objection to convening the meeting was based on the following grounds: (a) One of the signatories to the requisition was not a member of the company; (b) no explanatory note required under sec. 173 and so requisition was invalid, (c) the venue was deliberately fixed at a far of place so that most members could not attend it, (d) subject no.3 in the requisition regarding constitution of an adhoc committee was not as per the Act or bye-laws; (e) the notice for requisition was signed by only one of the requisitionists; (f) it was not made clear in the notice as to whether the voting could be by proxy; (g) the notices were posted on 2 consecutive days and so some of the members could not have a clear notice of 21 days. Held, under sec. 53(2)(b)(i) of the Act, notice of a meeting is deemed to be served at the expiration of 48 hours after the letter containing it is posted. When notices for a meeting to be held on September 21, 1987 were posted on August 31 and September 1, 1987, they could be deemed to have been received on September 2 and 3rd respectively. The members could not therefore be held to have had 21 days clear notice of the meeting. The appellants had thus been unable to make out a prima facie case so as to interfere with the impugned order of the trial judge - the appeal was dismissed. In re, Swadeshi Polytex Limited, [(1988)63 Comp. Cas. 709 (Delhi)]. The AGM of the defendant company was held on 15.3.1986, and the board of directors elected with many shareholders voting in proxy. The plaintiff filed a suit against the Chairman of the meeting and the company, alleging that the proxies in favour of R were all dated 13.3.1986, and that the dating had been done, not at the time of execution of instruments by the shareholders, but by the proxy holder at the time of submission of instruments to the company, with the object of making those the last proxies of the shareholders. Some shareholders had also issued proxies in favour of M. The petitioner sought a declaration that the proxy executed last by the members of the company should prevail over those executed earlier, regardless of the date mentioned on the instruments of proxy, and an injunction restraining defendants from permitting any person declared elected as member of its board to act as director. The plaintiff also filed an application seeking interim relief during pendency of suit. Dismissing the application it was held, (1) that there was nothing wrong with the practice prevalent among interested parties of obtaining blank proxy forms from shareholders unable to attend the annual general meeting and then depositing the forms duly filled up, with the company before the meeting, (2) if there were two or more proxy instruments given by a shareholder iro the same shares, the proxy bearing the later date would supercede the earlier ones. The later date had to be taken as date of signing of proxy forms by the shareholders, (3) such a 216
grievance could be made only by a person who had executed a blank proxy form, and since none of the shareholders had complained that their proxies had been misused, the plaintiff had no basis to raise objection on behalf of them. (4) the plaintiff would suffer no irreparable injury if an injunction was refused as all decisions were to be taken by the board in regular procedure - but if it were granted the affairs of the company would be brought to a stop, resulting in a loss to the company and the shareholders. The balance of convenience was in favour of the defendants, (5) no prima facie case had been made out for grant of ad interim injunction restraining the newly elected board from exercising their rights and obligations. T.L.Arora v. Gangaram Agarwal [(1988)63 Comp. Cas. 736 (Delhi)]. The plaintiff filed a suit for declaration that plaintiff no.1 was director of the company, validly re-elected at the AGM, alleging that, plaintiff 1 was the sole representative of the NRI group of shareholders and had the support of other local shareholders in the form of proxies, but that defendant 1 in conspiracy with other directors and support of bogus shareholders had forged the proceedings on the minutes book to show that plaintiff 1 had not been reelected. The defendants filed an application contending that the plaintiffs other than plaintiff no.1 had no grievance, and they therefore had no cause of action and were not necessary or proper parties to the action. Dismissing the appeal it was held that, the plaintiffs as shareholders had a right to have a board of directors of their choice, and a right to vote by proxies under sec. 176. Where these rights were adversely affected, the shareholders certainly had a right to challenge the proceedings of the rman with a right tomeeting where these rights had been denied. This right was joint and several, and all such aggrieved shareholders could join together as plaintiffs in the same suit. The fact that all such shareholders were out present at the AGM held for electing the board of directors was of no consequence, so long as they were present through proxies. The suit was therefore properly maintainable by the plaintiffs. Subal Dutta and Sons Pvt. Ltd. v. Asst. Registrar of Companies [(1986) 59 Comp. Cas. 823 (Cal)]. The AGM of the petitioner company for the year ending on 14.4.1983, was called for 12.10.1983. Since the auditor's report and audited accounts had not been received till then, the meeting was adjourned and held on 7.1.1984 i.e., within 15 months of the AGM of earlier year. In the adjourned AGM, the balance sheet and profit and loss account of the company were laid and adopted and copies thereof filed with the Registrar on 13.1.1984. The Registrar filed a complaint alleging that an offence under sec. 220(3) of the Act had been committed by the company in relation to the year ending on 14.4.1984. The company applied to the High Court to have the criminal proceedings quashed. Held, the AGM was held initially within the stipulated time and the adjourned meeting was held within 15 months as envisaged under sec. 166(1). Thus, the AGM for the year ending on 14.4.1983, was held by the latest date on or before which that meeting should have been held in accordance with the provisions of the Act. Since in that meeting the balance sheet
and profit and loss account were laid and copies thereof sent to the Registrar within 7 days, there was no violation of sec. 220(1), and the prosecution was not maintainable and had to be quashed. Joseph Michael v. Travancore Rubber and Tea Co. Ltd. [(1986) 59 Comp. Cas. 898 (Ker)]. In 1979, the appellants had purchased through brokers some shares in the respondent company and had lodged the transfer deeds and share certificates with the company for transfer registration. The board declined to register the transfer in exercise of their powers under Article 24 of the company as amended in 1965 and duly registered with the Registrar. The appellants thereupon filed a petition in the High Court under sec. 155 for rectification of the register of members, challenging the validity of article 24 on the ground that it gave the board the right to refuse to a register a transfer of even fully paid up shares, whereas prior to the 1965 amendment, Original registration 20 permitted the board to exercise such a right only in respect to partly paid up shares, on the ground that the explanatory statement to the notice for the meeting held in 1965 for adoption of new articles fell short of statutory requirement. A single judge of the High Court dismissed the petition holding that the appellants were not competent to challenge the validity of Article 24 in the proceedings before the company court. On appeal it was held that, sec. 173 of the Act was mandatory and not directory. But whether the statement annexed to the notice of the meeting contained full and frank disclosure of the material facts concerning each item of business must essentially depend on the facts of each case. A minor defect arising out of absence of strict conformity with provisions under sec. 173(2) might not render an amendment of the articles of association null and void. Appeal dismissed. In re Moorgate Mercantile Holdings Ltd. [(1980)1 All ER 40]. A notice was circulated amongst the members, specifying the intention of holding an extraordinary general meeting for the purpose of passing a special resolution to cancel the company's share premium account on the ground that the amount credited to the account had been lost. Later it was realized, that the amount in question also included a small amount arising from a recent issue, and this small amount was not lost. At the meeting, the special resolution had to be suitably amended in order to provide that the entire account had not been canceled, but had been reduced to a certain amount. The resolution in its changed form was challenged in the court as being invalid. Upholding the challenge, the court confirmed that the resolution had not been passed validly. Laying stress on sec. 189(2)(a) the court held, intention to propose the resolution as a special resolution means that the resolution passed at the meeting must be the same as that specified in the notice. In principle however the Court agreed that a genuine need for an amendment may arise and it should be allowed within reasonable limits. It is to be noted that here the persons concerning the meeting were aware that an amendment would be necessary and should have taken proper steps prior to the meeting itself.
Panorama Development (Guildford) v. Fidelis Furnishing Fabrics [(1971)3 All ER 16]. The plaintiff ran a business of 'hiring cars'. The Secretary of the defendant company hired cars from the plaintiff ostensibly on behalf of the company by telling him that these cars were needed for being used as conveyance by important clients of the company. The negotiation was done through letters etc., written on Company stationery and he signed as Company Secretary. The cars in fact were for the personal use of the secretary and not the company. The plaintiffs sued the company for the 'hire charges'. The company refused to pay saying the secretary had no authority to hire the cars. The plaintiff filed a suit. Holding the company liable for the hire charges as the act was one within the ostensible authority of the secretary. Lord Denning M.R. observed: "But times have changed. A company secretary is a much more important person nowadays than he was in 1887. He is an officer of the company with extensive duties and responsibilities. This appears not only in the modern Companies Act, but also by the role which he plays in the day-to-day business of companies. He is no longer a mere clerk. He regularly makes representations on behalf of the company and enters into contracts on its behalf which come within the day to day running of the company's business. So much so that he may be regarded as held out as having authority to do many things on behalf of the company. He is certainly entitled to sign contracts connected with the administrative side of a company's affairs, such as employing staff, and ordering cars, and so forth. All such matters now come within the ostensible authority of a company's secretary." Concurring with this opinion Salmon,L.J. held, "Whatever the position of company's secretary may have been in 1887, I am quite satisfied that it has altered a great deal from what it was then. At the end of the last century a company secretary still occupied a very humble position very little higher, if any, than that of a minor clerk. Today, not only has the status of a company secretary been much enhanced, but the state of affairs has been recognized by the statutes...I think there can be no doubt that the secretary is the Chief Administrative Officer of the company. As regards matters concerned with administration, the secretary was ostensible authority to sign contracts on behalf of the company. If a company is ordering cars so that its servants may go and meet foreign customers at airports, nothing is more natural than that the company should hire those cars through its secretary. The hiring is part of his administrative function. Whether the secretary would have any authority to sign a contract relating to the commercial management of the company, for example, a contract for the sale or purchase of goods in which the company deals, does not arise for decision in the present case, but contracts such as the present fall within the ambit of administration."
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7. PROBLEMS
1. Some member of a company executed two instruments of proxy to vote at its AGM. A shareholder challenged the validity of dating on one set of proxies, and applied for certified copy of the proxy instruments forming part of the record of civil court in some other proceeding. The Registrar ordered issue of the certified copies of the proxies. The company contended that such an order adversely affected its rights and so should be declared void. Decide [See, (1988)63 Comp. Cas. 689 (Delhi)]. 2. The executive committee of the company limited by guarantee passed certain election Rules 6(c) provided that a proxy appointed through an instrument. Other than the printed instrument duly despatched by the company, shall not be valid. Rules 7 and 8 dealt with lost proxies and revocation of proxies respectively and provided for issuance of fresh proxy forms by the company. Some of the members sought an injunction against the company restraining it from enforcing or implementing these Rules on the ground that they went beyond the stature. Discuss the validity of this contention [See (1990)69 Comp. Cas. 158 (Delhi)]. 3. The duly elected directors of a managing committee of a cooperative society sent a requisition to the joint Registrar of Cooperative Societies to summon a special meeting of the committee to consider the proposed no confidence motion against the Chairman. The Joint Registrar called a special meeting and sent a notice to all the elected members of the managing committee. This notice was challenged by a writ petition on the ground that co-opted technical members and nominees of financial institutions, who were members of the board and entitled to it and vote at the special meeting under sec. 73-ID of Maharashtra Cooperative Societies Act, 1960 or the Act had not been served with the notice. The High Court upheld the petition and directed that fresh notice should be sent to these members also. This order was further appealed against in the Supreme Court on grounds that: 1. Section 27(9) of the Act debars government or other nominees to vote at any election of the Committee of the Society; 2. Under sec. 73-ID (i) only those members who are, entitled to sit and vote at any meeting" may participate and vote at a special meeting; 3. Under bye-law 29 of the society, the nominees of financial institutions etc., not being entitled to function as Chairman or vote at election meetings, they were also not entitled to sit and vote at the special meeting. Discuss the validity of these contentions [See, (1990)69 Comp. Cas. 1 (SC)]. 4. X and Y were members of 2 rival groups of shareholders. Y was appointed as a director of the company in an extraordinary general meeting. There was no indication to show who requisitioned the convening of the EGM, how the company issued a notice, and the minutes of the meeting were recorded in a book which was not minutes book. Though the notice convening the meeting was purported to be issued by the company, there was no board meeting held for considering the requisition, and no board-decision to hold an EGM was taken. X and a few others challenged the appointment of Y on the ground that, the EGM where the articles were amended so as to provide for 3 directors on the board instead of 2 consequent to which Y was elected to the board, was illegal and hence Y's election was invalid. Keeping in mind that the book in which the minutes were noted was not available to be produced before the Court discuss the validity of this plea [See, (1993)77 Comp. Cas. 324 (Mad)]. Under the articles of a company the quorum for a directors' meeting was two. In a particular meeting, two directors were present, and in the course of the meeting, one of them was appointed as managing director and co-editor of the paper run by the company. This appointment was challenged on two grounds, namely, (1) lack of quorum, and (2) invalid voting, as an interested person cannot vote in his own case. Discuss the validity of these contentions. [See, AIR 1915 Mad. 1179]. Despite a valid requisition being made the directors of a company refuse to call a meeting. The requisitionists themselves circulated a notice for the meeting to be held on 1.1.1994 at the registered office of the company. When the people convened for the meeting they found that the directors had locked the premises and prevent the meeting taking place. The requisitionists then shifted the venue of the meeting to another place, and passed some resolutions removing 2 directors. These resolutions were challenged as being invalid on the grounds that the meeting was invalid as it was not held in the specified place. Discuss [See AIR 1951 Mad 542]. In a general meeting, voting by show of hands was held on a motion relating to sale of company undertakings. Despite there being a clear indication of the majority not being in favour of the motion, the Chairman of the meeting declared the resolution 'passed'. The shareholders challenged the chairman's ruling. The chairman relying on sec. 178 says that his ruling is 'conclusive' and cannot be challenged. Decide [See AIR 1937 Cal 645]. A poll was demanded by a member after voting results were announced. The chairman ordered the poll to be conducted and subsequently announced the results of the poll. The results are challenged on the ground that the chairman had improperly rejected certain proxies which if accepted might have given a different result. The chairman claims his decision is final. Decide [See, AIR 1955 Cal 132].
5.
6.
7.
8.
1. Avtar Singh, Company Law, 9th edn., 1989, Eastern Book Company, Lucknow. 2. Acharya, B.K. and Govekar, P.B., Company Law and Secretarial Practice, 3rd edn. (rev.): 1990, Himalaya Publishing House, New Delhi. 3. Bhandari,M.C.,Guide to Company Notices, Meetings, Resolution and Minutes, 11th edn., 1990, Wadhawa and Co., Nagpur. 4. Chakraborti,A., et.al., Secretarial Practice and Company Law, 1st edn., 1988, Kalyani Publishers, New Delhi. 5. Chandratre,K.R., et.al., Bharat's Compendium on SEBI, Capital Issues and Listing, 2nd edn: 1994, Bharat Publishing House, New Delhi. 6. Kapoor,N.D., Company Law and Secretarial Practice, 2nd edn. (rev.), 1980, Sultan Chand and Sons, New Delhi. 7. Ramaiya,A., Guide to the Companies Act (Part 1) 13th edn, 1995, Wadhwa and Co., Nagpur. 8. Taggart,W.J., Horsley's Meetings, Procedure, Law and Practice, 2nd edn., 1983, Butterworths, Sydney.
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Course No: III Module No: V
Corporate Investment & Investors' Protection

Materials Prepared By : 1. Dr. N.L. Mitra 2. Mr. Sunder Rajan, FCA Materials Checked by: 1. Ms. Sudha Peri Materials Edited by : 1. Mr. Mohandas Pai, FCA 2. Dr. P.C. Bedwa
National Law School of India University Published By: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.
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INSTRUCTIONS
In Corporate Law Module - 1 you must have learned the following. a) What are the features of a company form of organisation? What makes it distinctly different and advantageous from other forms of business organisations? b) How are a private limited company and a public limited company to be formed? c) What are the documents necessary for the formation of companies? d) When can the company commence business? c) What are the various forms of the company? f) What are the contents of the Memorandum of a company? g) What is the procedure for alteration of the Memorandum? and h) What are the significant differences between the Memorandum and Articles? If you have carefully noticed the Companies Act, 1956, you must have seen that we have: covered the area between Section 1 and Section 54 of the Companies Act as well as some other sections necessary for discussing the areas covered by Part I and Part ll, of the Act. This module primarily concerns the raising of funds from various sources for the company. Therefore in this module we have to learna) b) c) d) c) f) g) h) i) j) Different types of share capital and loan capital Different types of company securities. Documents necessary for raising capital. Various ways of raising capital. Different regulatory measures for protecting Investors interests. Various types of agencies and institutions involved in transactions of stock, shares and debentures. Role of stock exchange and the importance of listing securities with the stock exchange. Various regulatory procedures relating to share transactions. Structuring and restructuring the share capital of a company. Transfer and transmission of shares and stocks.
If you open your Companies Act, you will find that Chapter III and Chapter IV of the Act provide the substantive and procedural laws relating to the subject under study. You have to appropriately take note of various Company Rules and other related regulations in order to understand the subject in its entire operation. The Capital Issue Controller used to oversee the whole operation before 1992. Presently the Security Exchange Board of India is incharge of regulating the whole capital market. You know that a company has to raise its share and loan capital from the primary market i.e. the public at large. But public limited companies require avenue for facilitating quick and easy transfer of shares and other securities. For this purpose the secondary share markets known as Stock Exchanges came into operation. You have to understand how this share market operates. In order to appreciate the regulatory system of the country you have to understand organisation and functions of the Security Exchange Board of India (SEBI) which oversees the functioning of the Stock Exchanges. Once you have the above goals of learning the subject you may ask yourself the questions raised there at the end of each subtopics and can make a self evaluation. Since this is a vast area, the reading material exceeds 100 pages. I hope. you will find the study material very informative. You have to supplement with the recent developments in the corporate sector which you will find in journals and new papers every day. N.L. Mitra Course Co-ordinator
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CORPORATE INVESTMENT AND INVESTORS' PROTECTION
TOPICS 1. 2. 3. 4. 5. 6. 7. Nature and Types of Corporate Securities .................................................................... Modes of Raising Capital .............................................................................................. Investors' Protection ...................................................................................................... Raising of Share Capital .............................................................................................. Share, Shareholder and Member .................................................................................. Transfer and Transmission ........................................................................................... Re-structure of Share Capital ....................................................................................... (a) Increase of Share Capital (b) Conversion of Shares into Stock and vice-versa (c) Alteration of Members right (d) Reduction of Share Capital 8. 9. 10. Case Law ........................................................................................................................ Problems ........................................................................................................................ Supplementary Readings .............................................................................................. 275 278 279 224 228 240 252 260 267 270
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1. NATURE AND TYPES OF CORPORATE SECURITIES

SUB TOPICS 1.1 Introduction 1.2 Kinds of Securities 1.3 Ownership instruments Nature and Type 1.4 Debt Instruments Security Nature and Type 1.5 New Financial Instruments and Regulatory Environment 1.1 INTRODUCTION What is a Corporate Security? A security is a document evidencing ownership of an asset. Blacks Law Dictionary defines the word Securities to mean stocks, bonds, notes, convertible bonds, warrants or other documents that represent a share in a company or a debt owed by a company or Government entity. Section 2 (h) of the Securities Contracts (Regulation) Act, 1956 lends an inclusive definition for the word Securities. According to the said section, securities include (i) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of alike nature in or of any incorporated company or other body corporate; (ii) government securities ; (iii) such other instruments as may be declared by the Central Government to be securities; and (iv) rights or interests in securities. Thus, the definition includes within its fold, any marketable security in the nature of share, scrips, bonds, debentures, debenture stock in an incorporated company or body corporate. It also grants powers to the Central Government to declare such other instruments to be securities. 1.2 KINDS OF SECURITIES Broadly speaking securities are documents related to various sources of corporate finance. Corporate finance is primarily collected from two sources: (i) through ownership rights in a corporate body commonly known as stocks and shares or equity instruments; (ii) through debt-instruments like debentures, notes, commercial paper etc. Let us examine the nature of some of these instruments. 1.3 OWNERSHIP INSTRUMENTS NATURE AND TYPE Corporate ownership instruments are known as stocks and shares. According to Sec. 2(46) share means share in the share capital of a company and includes stock except where a distinction between stock and shares is expressed or implied. Commercially speaking a share is a unit of the share capital which may be partly or fully paid. As for example, if A holds a 224
share of Rs.100/- in ABC Ltd, A might not have paid the full money on the share on account of the company not making a call. May be he has paid Rs.75/- only which the company has asked him pay. Therefore a share has a face value and a paid value. A stock on the other hand is a smallest unit of share capital which is fully paid. The concept of stock perhaps has arisen from the idea of joint stock that used to mean total capital pooled from the members. Generally speaking for shares people express possession by number whereas in case of stock through amount. As for example, one may say A has 5 shares of ABC or stock worth Rs.10,000/- of DEF. Thus both stocks and shares relate to share capital. A company has two types of share capital viz equity share capital, and preference share capital. [See Sec. 86] 1. Equity Share Capital Section 85(2) of the Companies Act, 1956 defines equity share capital as one which is not a preference share capital. Equity share capital is the most common form of capital issued by companies to raise funds from the public, because of the following reasons: (a) it is a risk capital around which the entire investment structure is built; b) it ensures protection to creditors as it cannot be repaid easily; c) it enhances the bargaining capacity of companies; d) it does not carry any right as to a fixed rate of return; e) as a holder of a equity gets the benefit of profits earned, the stock market values it at a multiple of its earnings; f) it insulates the company from the downturn in the business because no return needs to be paid as in case of a loss. 2. Preference Share Capital Section 85 of Companies Act, 1956 defines preference share capital as to mean that part of the share capital which fulfils both the following requirements : (a) that as respects dividends, it carries or will carry a preferential right to be paid a fixed amount or an amount calculated at a fixed rate, which may be either free of or subject to income tax ; (b) that as respect capital, it carries or will carry on a winding up or repayment of capital, a preferential right to be repaid the amount of the capital paid up or deemed to have been paid up, whether or not there is a preferential right to the payment of either or both of the following amounts, namely (i) any money remaining unpaid, in respect of the amounts specified in clause (a), upto the date of winding up or repayment of capital ; or (ii) any fixed premium or premium on any fixed scale, specified in the Memorandum or Articles of Association of the Company.
Thus preference shareholders enjoy preferential rights to the payment of dividend and capital. Kinds of Preference Shares Preference shares can be classified as : (i) redeemable and irredeemable preference shares; (ii) cumulative and non-cumulative preference shares; and (iii) convertible and non-convertible preference shares. (i) Redeemable and Irredeemable Preference Shares Redeemable preference shares are those, which will be redeemed by the company at the agreed time. They have a fixed maturity period like that of debt securities. Issue of redeemable preference shares are governed by the provisions of Section 80 of the Companies Act, which are explained below: (a) the companys Articles of Association must authorise the company to issue them; (b) the shares shall not be redeemed, except out of the profits of the company which are available for payment of dividend to equity shareholders or out of the proceeds of a fresh issue of shares made for the purposes of redemption; (c) the shares are fully paid before they are redeemed; (d) the premium, if any payable on redemption shall be provided for out of the fresh issue or out of the companys share premium account; (e) if the shares are redeemed otherwise than out of the proceeds of a fresh issue, the company shall transfer a sum equal to the nominal amount of the shares redeemed, to a reserve fund called capital redemption reserve, out of the profits which are available for distribution as dividend. (f) the redemption of shares shall be effected on such terms and in such manner as may be provided by the Articles of Association of the company; (g) the redemption of shares under the provisions of this section shall not be taken as reducing the amount of share capital of the company; (h) the Capital Redemption Reserve, mentioned in (e) above, may be applied by the company in paying up unissued shares of the company to be issued to members of the company as fully paid up bonus shares; (i) no company shall issue any preference shares which are irredeemable or redeemable after the expiry of ten years from the date of its issue. Irredeemable preference shares are the ones which will be in existence with the company so long as the company is in existence. They will be outstanding for ever, till the company is wound up. They are like ordinary shares. The irredeemable preference shareholders are entitled to dividend, either as a fixed sum or a fixed percentage. The right of companies to issue irredeemable preference shares was taken away by the Companies (Amendment) Act 1988, by insertion of sub-section 5A to Section 80. Exisiting irredeemable preference shares were made redeemable by insertion of Section 80-A.
1.4 DEBT INSTRUMENTS - NATURE AND TYPE Debentures : Debenture is the most common form of debt instrument in India. Section 2(12) of the Companies Act, 1956, defines the term Debenture, to include debenture stock, bonds and other securities of the company whether constituting a charge on the assets of the company or not. This definition of debenture is an inclusive definition and one could debate which are the instruments that could be construed as debentures. In the absence of any precise definition for the term Debenture, we will try to understand it in the manner in which it is issued by companies. Hence debenture is a specie of debt securities, which is an acknowledgement of debt, carrying a promise by the Issuer to redeem the debt on maturity and, during its currency, to pay interest at an agreed rate at agreed intervals. Debenture is a prominent debt instrument in the corporate world. It is favoured because of the following unique characteristics: (a) debentures are generally secured by a charge on the assets of the issuing company; (b) it has in-built facility of redemption. This enables the issuing company to buy back its own debentures, either as an investment or for redemption. It is to be noted that a company cannot buy its own shares. (c) it supplements other sources of securing long term funds; (d) interest paid on debentures is a deductible expenditure while computing the taxable income, while the dividends paid by the company is treated as an appropriation of profits and hence not deductable. As dividend is taxable in the hands of the recipients also it suffers dual taxation. Characteristics of Debentures Debentures and other similar debt instruments have the following characteristics: (i) as a result of its issue, there arises a contractual obligation between the Issuer and the Debenture holder, for payment of interest, redemption on maturity etc; (ii) generally the debenture holders are not permitted to surrender their debenture before it matures; (iii) these instruments are generally secured by the assets of the company, but unsecured debentures are also not uncommon; (iv) it is the practice of the company to appoint an independent agency, called Debenture Trustees, to ensure the compliance of the terms and conditions of the issue by the company; and (v) they normally carry a fixed rate of interest to be paid till they are redeemed. There are also debentures carrying a variable rate of interest. Debentures without any interest obligation such as zero coupon Debenture are also in vogue.
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Kinds of Debentures Debentures could be classified as follows: (i) secured or unsecured; (ii) redeemable or irredeemable; (iii) convertible or non-convertible; and (iv) registered or unregistered; (i) Secured and Unsecured Debentures The very defintion of the term given by the Companies Act conveys a meaning that debentures need not necessarily be secured. If the debentures are backed by a charge on the assets of the issuer company, such debentures are called secured debentures. It is because of the security created by the issuer that these debentures are relatively safe. The security can be of any form, a floating charge on all the assets of the company, or a mortgage or a hypothecation of assets of the company. On the contrary, if the debentures are not backed by a charge on the assets of the issuer, such debentures are called unsecured debentures. They are also called as naked debentures, as they are not covered by any assets of the issuer. The holders of unsecured debentures are nothing but unsecured creditors of the company. Since they are not backed by any security, these debentures command less value in the market. Previously, under the guidelines for issue of debentures by Public Limited Companies, only secured debentures were allowed to be offered to the public. But now, the SEBIs Guideline of Disclosure and Investor Protection provides room for issue of unsecured debenture also. (ii) Redeemable and Irredeemable Debentures If the debentures are issued for a definite period, such debentures are called redeemable debentures. These debentures will be paid off on maturity. These debentures have a definite life determined by the issuer. But it is also not uncommon to issue another class of debentures called irredeemable debentures or perpetual debentures. These debentures are perpetual, so long as the company is a going concern. (iii) Convertible and Non-convertible Debentures A convertible debenture is one, which will be converted into another instrument having different rights and privileges. The convertible debentures are generally converted into equity shares. Once they are converted, they loose the character of debentures and the converted shares cannot be reconverted into debentures. Companies issue convertible debentures for the following reasons: (a) dilution of ownership could be delayed by the conversion period; (b) since the debentures are to be converted into shares, the company can offer a lower interest rate, than it would offer if the debentures were not convertible; and (c) in India, due to the lack of an active secondary market for debt instruments, investors commonly do not favour such instruments. The conversion clause in the debenture makes it attractive for investors as it offers the chances of a capital gain. 226
Debentures which are not so convertible are called nonconvertible debentures. Due to the lack of support from ordinary investors the nonconvertible debentures are often issued to institutional investors by private placement. (iv) Registered and Unregistered This is a very peculiar classification. Once the debentures are issued by a company, the names, address etc., are entered in a register called Register of Debenture holders. These debentures are called Registered Debentures. On the contrary, if the debentures are not entered in that register, such debentures are called unregistered debentures. This generally arise when the borrower company issues debentures to its bankers, as a security against the loans and advances granted by it. Issue Price Debenture could be issued either at its nominal value, or at premium or at a discount. The companies Act contains elaborate provisions regarding issue of equity shares but there are no such provisions regarding debentures. Hence there are no formalities to be complied with to issue debentures at a premium or at a discount. Likewise, companies are free to redeem the debentures either at its nominal value, or at premium or at a discount. 1.5 NEW FINANCIAL INSTRUMENTS & REGULATORY ENVIRONMENT Historically, the range of instruments was limited due to a regulated market, issues opted for pure equity or pure debt with some hybrids known for variety. As the markets widened, investors need also expanded and new instruments were needed to meet their liquidity, risk and yield expectation. Pure equity issues were subject to market risks, pure debt to interest rate risks. The convertible Debenture offered a solution in the form of convertibility and capital appreciation for the investor and a lower interst to the issuer. The innovation spawned by this lead to the creation of more innovative instruments like Naked Warrants, Debentures, convertible and non-convertible with warrants, optionally convertible Debentures with warrants, Secured Premium Notes, Deep discount bonds, Floating rate bonds and so on. These instruments allowed the investors to hedge their risks. With anticipated arrival of the options and future markets, innovation is expected to increase and new instruments to proliferate. Regulatory Environment for Issue of New Instruments Issue of new Instruments are governed by the Guidelines for Disclosure and Investor Protection issued by SEBI. Section G of these Guidelines read as under : Issuer of capital shall make adequate disclosures regarding the terms and conditions, redemption, security, conversion and any other relevant features of the instruments such as deep discount
bonds, debentures with warrants, secured premium notes etc., so that an investor can make reasonable determination of the risks, returns, safety and liquidity of the instruments. These disclosures shall be vetted by SEBI. Thus a company may issue any new financial instrument, to the public if: (a) the issuer makes adequate disclosure of the following: (i) all terms and conditions of Issue; (ii) redemption of these instruments, if applicable; (iii) security of these instruments, if applicable; and (iv) all other relevant features of these instruments. The disclosures to be made as aforesaid should be adequate so that an investor can make reasonable determination of the risks,
returns, safety and liquidity of the instrument. The disclosures so made shall be vetted by SEBI. It is also to be noted that Section 86 of the Companies Act provides that companies shall issue only two classes of share capital : (i) Equity share capital, and (ii) Preference share capital. But there is no express prohibition or provision in the Act as to the nature of debt instruments or derivatives that could be issued by a company. Complying with these two provisions, the guidelines of SEBI and the Companies Act, companies are free to issue any new instruments or cluster the instruments which are already known to the market, with additional features.
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2. MODES OF RAISING OF CAPITAL

SUB TOPICS 2.1 Introduction 2.2 Private Placement 2.3 Public Issue 2.4 Right Issue 2.5 Cost of Raising Capital 2.6 Share Issued at a Premium 2.7 Share Issued at a Discount 2.8 Raising of Loan Capital (a) Debentures (b) Public Deposit 2.1 INTRODUCTION A public limited company can raise capital in the following manner (i) by issue of securities on private placement basis ; (ii) by issue of securities to the public ; and (iii) by issue of securities to the existing shareholders of the company on rights basis. 2.2 PRIVATE PLACEMENT What is a Private Placement? Private placement of securities means offering the securities of the company directly to a select group of persons. This is an issue of securities that excludes the public and is a privileged offer made to a select group of persons. Though there is a limited prohibition for issuing securities privately, the term private placement is not defined anywhere. But the provisions of Section 67 of the Companies Act, 1956 are worth quoting here. This Section reads as under (1) Any reference in this Act or in the articles of a company to offering shares or debentures to the public shall, subject to any provision to the contrary contained in this Act and subject also to the provisions of sub-sections (3) and (4), be construed as including a reference to offering them to any section of the public, whether selected as members or debenture-holders of the company concerned or as clients of the person issuing the prospectus or in any other manner. (2) Any reference in this Act or in the articles of a company to invitations to the public to subscribe for shares or debentures shall, subject as aforesaid, be construed as including a reference to invitations to subscribe for them extended to any section of the public, whether selected as members or debenture-holders of the company concerned or as clients of the person issuing the prospectus or any other manner. (3) No offer or invitation shall be made to the public by virtue of sub-section (1) or sub-section (2) as the case may be, if 228
the offer or invitation can properly be regarded, in all circumstances: (a) as not being calculated to result, directly or indirectly, in the shares or debentures becoming available for subscription or purchase by persons other than those receiving the offer or invitation; or (b) otherwise as being a domestic concern of the persons making and receiving the offer of invitation. (4) Without prejudice to the generality of sub-section (3), a provision in a companys articles prohibiting invitations to the public to subscribe for shares or debentures shall not be taken as prohibiting the making to members or debentureholders of an invitation which can properly be regarded in the manner set forth in that section. (5) The provisions of this Act relating to private companies shall be construed in accordance with the provisions contained in sub-sections (1) to (4). The effects of the section could be summed up as follows 1. Offers made to any section of the public even if selected as members or debenture-holders, would be construed as a public offer. 2. The offer so made to any section of the public, even if selected as members or debenture-holders will not be construed as a public offer if the shares or debentures are not made available for subscription or purchase by persons other than those specifically receiving the offer or invitation. Is Private Placement Prohibited? Many investors would have received handouts, pamphlets and other literature from companies and brokers inviting them to subscribe for the shares and debentures of companies and assuring them of firm allotment. Some issues are offered at a premium also. This practice became more popular, with the increase in stock market activities. Since these securities were not subject to any statutory formalities, the information made available to the prospective investors were minimal. As adequate and proper information was not available many investors were misled into investing, sometimes with disasterous consequences. Since such malpractices were found to be an impediment to the steady growth of the securities market, there was an obvious need to keep such practices under check. Securities and Exchange Board of India in its first circular on 'Guidelines for Disclosure and Investor Protection' came out with a directive as follows: In the case of first issues of new companies, no private placement of the Promoters shall be made by solicitation of share contribution from unrelated investors through any kind of market intermediaries. Thus this guideline prohibits private placement of securities by the first Issue of new companies by solicitation of contributions from unrelated investors through any kind of market intermediaries.
Subsequent to this guideline, Department of Company Affairs, Ministry of Law, Justice & Company Affairs released a Press Note on 6th July, 1992 (Press Note No.7/92; File No. 17-61992 CLV dated 6th July, 1992), which states It has come to the notice of the Government that some companies utilise the services of brokers and other intermediaries for private placement of equity shares, out of Promotors quota or otherwise, insert advertisements in the print media and also mass mail literature/material/brochures superscribed by the caption Confidential/For private circulation only. It is also noticed that the rights of renunciation are floated in the market by the companies themselves, charging unofficial premium from the investing public. Then the press note referred to the provisions of Sections 67 (3) (a) & (b) and statedIn the context of the above provisions of law, such offers cannot be treated as private placement and provisions relating to prospectus under the Companies Act 1956 are applicable. The companies concerned, their promoters and their intermediaries are hereby warned that making of such so called private placement of shares or collecting unofficial premia without recording the same in the books of accounts of the company, are serious contraventions of the Companies Act 1956 and will invite penal action under the Act by the Government. It may be noted that marketing of rights of renunciation by a private company is prohibited under Section 3(1) (iii)(c) of the Act, as it cannot make any invitation to the public to subscribe for its shares. The crux of the press note was to prohibit the private placement of securities by sending literature/material/brochures etc., and charging unofficial premia without accounting for the same in the books of accounts of the company. Thus private placement in certain forms and by certain companies are prohibited and regulated, but there is no absolute prohibition. Advantages of Private Placements (a) A quicker way to raise capital Since it is not required to adhere to the statutory and procedural formalities, the time for raising capital is remarkably low. It is an efficient way of procuring long term funds. (b) Ownership and control of the company will be intact Since the offer is made to a select group of persons, generally known, the ownership and control of the company will be intact and the company will not be vulnerable to take-over bids. (c) Issue cost is less: A company that issues securities through a public offer would need to expend around 10% of the issue by way of issue managers fees, underwriting commission, brokers commission, printing of application forms and prospectus, bankers collection charges, campaign expenses to sell the issue, listing fees etc. On the contrary, in the private placement process, since the
target investors are already identified in advance, the likelihood of non-subscription is minimal and there is no need to incur expenses as in the case of public offer of securities. (d) Restrictions on issue size As per SEBI guidelines and listing requirements of stock exchanges, there is fixed minimum issue to be made and maximum percentage of stock that could be held by the promoters, ceiling on maximum allotment, minimum number of shareholders etc. Private placement is not subject to these restrictions. (e) Minimum service cost In public offers, due to the compulsion of wide spread shareholding, the servicing cost is high, which is not so in the case of private placements. (f) Absolute freedom and flexibility Since the issues are made on a case to case basis, there exists a great extent of freedom and flexibility both for the investor as well as for the issuer as to the terms of issue. It is to be noted that in the case of deals involving huge amounts, the terms can be tailor made. Subscribers to Private Placement Market (i) financial institutions; (ii) mutual funds; (iii) investment and finance companies; and (iv) individual investors. When Private Placement is advantageous (i) Raising funds by private placement looks meaningful to closely held companies and that too not involving substantial sums. It is suitable for debt instruments rather than for equity instruments and for investments by institutions like insurance funds, mutual funds, unit trusts and investment companies, where the placement could be structured according to the needs of these investors. (ii) Since the process of public offering takes considerable time, involves statutory and other procedures, co-ordination of agencies and involves considerable expenditure, private placement is advantageous. (iii) When the project is a greenfield project and undertaken by unknown entrepreneurs it is considered more risky by the public and if at the initial stage an issue is made, the success of the issue may be in doubt. In such circumstances, it is advisable to raise funds through the private placement route. 2.3 PUBLIC ISSUE The increasing demand for capital by companies have made them rearch out for investors throughout the country and even to countries abroad. Unlike private placement of securities, wherein the deals are concluded by face-to-face negotiation, the same is not possible if the persons involved are large and where the instruments offered are homogenous in all respects. There should be some communication between the issuer and 229
the prospective investors, which should carry the details about the issue. This communication is not permitted to be oral, but has to be written. Such written communication is called Offer Document. Since this document is of concern for investors, great importance is attached to the informations to be disclosed therein to protect investor's interest. This part deals, inter alia, with drafting of documents and liabilities involved. Types of Offer Documents Offer documents can be classified into the following: (a) Prospectus, (b) Letter of Offer. (a) Prospectus Module I has discussed in detail about the drafting of prospectus, its issue to the public and registration. The contents of the prospectus are also stipulated therein. Prospectus is not only important as an offer document but has wider ramifications as it concerns the investors interest. Some of the important issues in connection with the protection of the investors interest relate to disclosure of all material facts that are necessary for the interested investors to apply for the shares. The standard of disclosure as prescribed in Schedule II of the Companies Act has already been stated. Some of the important issues relating to prospectus require further explanations which are given below: (i) Expert's Statement included in the Prospectus A Prospectus cannot include a statement made by an expert who is involved in promoting a company or its management [See Sec.57]. An expert is supposed to be a person who has acquired special skill in any branch of knowledge. [See Sec.45 of the Indian Evidence Act] A statement of an expert as per Sec.58 of the Companies Act is only to be made when he has given his written consent and has not withdrawn his consent before the prospectus is delivered for registration and the statement must appear in the prospectus. Generally speaking prospectus contains the following matters where the experts statement could be given. (1) The project report which has to include a report about the nature of the project, locational advantages, infrastructural facilities, technology process, implementation schedule and marketing arrangements. (2) Statement of accounts, assets and liabilities all these are required to be certified by an auditor who is considered as an expert in the area. (3) Any study of marketing prospects and arrangements. (4) An evaluation of environmental impacts. A prospectus may likewise contain expert's statement on many other issues. Expert's statements are extremely important because a Director and a signatory to the prospectus may escape his civil liability if he can prove that any statement found untrue has been made bonafide relying on the statement of an expert. The signatory may even escape criminal liability by way of suggesting a 230
reasonable ground to believe what was certified by an expert though it afterwards turns to be a mis-statement. (ii) Underwriting The prospectus contains names and addresses of the underwriters and the amount underwritten by them. Underwriters are intermediaries assuring the sale upto the underwritten amount or number of shares shown against them for a commission. Failure to sell the underwritten amount would make the underwriter himself liable to subscribe up to those number of shares. A company may pay a commission to any person in consideration of his subscribing or agreeing to subscribe or procuring or agreeing to procure subscriptions for any shares or debentures or on fulfilment of the conditions that : (i) the commission is authorised by the Articles ; (ii) the commission does not exceed 5% of the price at which shares are issued and 2 1/2% of the price at which debentures are issued; (iii) the rate of the commission payable on the shares or debentures offered to the public for subscription is disclosed in the prospectus; (iv) the number of shares or debentures agreed to be provided or subscribed for is disclosed in the prospectus ; and (v) a copy of the contract is delivered to the Registrar. The advantages of underwriting is that the company is assured about its subscription. The underwriters are efficient marketers of corporate securities. (iii) Listing A company which is not listed earlier has to state in the prospectus that an application has been made for permission for the shares or debentures offered to be dealt with in one or more of the recognised Stock Exchanges. The names of these Stock Exchanges are also to be mentioned. Listing is important for the investors because it ensures liquidity of the investment. In case the permission has been refused before the expiry of 10 weeks from the date of the closing of the subscription list, any allotment made becomes void [See Sec.73(1A) of the Companies Act]. Of course if an appeal is made under Sec.22 of Securities Contract (Regulation) Act of 1956 against such refusal such allotment shall not be void until the dismissal of the appeal. (iv) Special Provision for NRI Investment In case of applications by overseas companies, and other corporate bodies owned predominantly by non-resident individuals of Indian nationality/origin, a certificate in the prescribed form OAC/OAC1 from an overseas Auditor/ Chartered Accountant/Certified Public Accountant should be submitted along with the application. Application forms from non-resident investors, properly completed together with cheques/bank drafts/stockinvest for the amount payable on application at the rate of Indian Rs.10/- or equivalent remitted through normal banking channels or funds held in Non-Resident
External (NRE) Accounts/Foreign Currency Non Resident External (FCNR) accounts maintained with banks authorised to deal in foreign exchange in India along with documentary evidence in support of the remittance, must be delivered before the close of the subscription list to such of the branch(es) of the Bankers to the issue at places mentioned against their names in the aplication form. All cheques drafts/stockinvest should be made payable to the Bankers to the issue with whom the application forms are lodged. All cheques or bank drafts should be crossed A/c Payee only. All cheques/ bank drafts /stock invest should be marked ....... Public Issue - NRI. A separate cheque/bank draft/stock invest must accompany each application form. Reserve Bank of India - vide their letter No. EC AH/101/ 06.04.1689/93 dated 23-1-93 - has given its approval for issue of shares to non-resident Indians, and NRI investors are not required to make separate applications for seeking permission from the Reserve Bank of India. Under the existing Foreign Exchange Control Regulations, such investment in shares by non-resident investors will be allowed to be repatriated along with the income earned thereon, subject to deduction of Indian taxes provided the investment is made by inward remittance from abroad through normal banking channels or out of funds held in Non-Resident (External)/FCNR Accounts. NRI applicants who have purchased Rupee drafts by debit to their NRE/FCNR accounts maintained in India must enclose the necessary certificate from the Banks to the effect that drafts have been purchased out of funds held in NRE/FCNR account on repatriation basis along with the application; otherwise such application will be considered incomplete and will be liable for rejection. Allotment of shares to non-resident investors shall be subject to the company obtaining such permission from the Reserve Bank of India or any other requisite authority as may be necessary. Refunds, interest, dividends and other distributions, if any, will be payable in Indian rupees only. In case of applicants who remit their application money from funds held in NRE/FCNR accounts, details should be furnished in the space provided for this purpose. In case of applicants who remit their money through Indian Rupee drafts from abroad, such payments in Indian rupees will be converted in US dollars or into any other currency as may be permitted by RBI at the rate of exchange prevailing at the time of remittance and will be despatched through post at the applicants sole risk, or at the request of the applicants, will be credited to their NRE accounts, details of which should be furnished in the space provided for this purpose in the application form. Applications made with Power of Attorney. If an application is made by a person who holds a power of attorney to act on behalf of another person who is the actual investor, such applications have to be accompanied by the Power of Attorney granted in favour of the former. Likewise if the application is made in the name of a body corporate, the application has to be accompanied by a Board resolution. Such
applications are liable for rejection, if they do not comply with the above provision. (v) Procedure for Obtaining Stockinvest The prospective investor, at the time of request for issue of Stockinvest to the issuing bank may have to : (a) indicate that he agrees to abide by the terms of issue and encashment of the Stockinvest. (b) give irrevocable authority to his bank to mark a lien for the value of the Stockinvest against the balance held in his savings/current/other deposit account. (c) agree for lifting of the bankers lien on expiry of the currency of the Stockinvest or in case of intimation of partial/nonallotment of shares/debentures/bonds ; and (d) agree that the issuing bank will not be liable for any damage or consequences arising out of the loss of these instruments. The Stockinvest alongwith the application forms will remain with the Registrar to the Issue and will be lodged in the bank after the allotment in case of allottees and in case of non-allottees, such Stockinvests will be returned to them. The Registrar to the Issue would be authorised through resolution of the Board to sign on behalf of the company to realise the proceeds of the Stockinvest from the issuing bank or affix non-allotment advice on the instrument, or cancel the Stockinvest of the non-allottees or partially successful allottees who have enclosed more than one Stockinvest. Such cancelled Stockinvests will be sent by the Registrar directly to the investors. (vi) Statement regarding Litigations All outstanding litigations against the company which are likely to affect the operation and finances of the company including disputed tax liabilities are to be disclosed. Such litigations could be in the nature of : (i) trade disputes between the company and its customers; (ii) trade disputes between the company and its collaborators for breach of collaboration agreements; (iii) labour disputes like workmen compensations, higher bonus and amenities; and (iv) disputed tax liabilities of any nature. (b) Letter of Offer A letter of offer is issued by a company when the securities are issued on rights basis. Therefore it is discussed in detail in connection with right issue. 2.4 RIGHT ISSUE Where at any time after the expiry of two years from the formation of the company or at any time after the expiry of one year from the allotment of shares of the company made for the first time, whichever is earlier, the company proposes to issue further shares, then such shares are to be offered to the existing holders of equity shares of the company. These issues are known
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as right issue. The company makes the offer by notice specifying a period of not less than 15 days from the date of communicating the offer for conveying acceptance. If it is not accepted within time the offer is deemed to have been declined. [See Sec.81] Letter of Offer The document issued by a company offering its securities on right basis is called a Letter of Offer. According to sub-section (5) of Section 56 of the Companies Act, 1956, the provisions of Section 56 relating to the matters to be stated and reports to be set out in a prospectus are not applicable to a right issue. Nevertheless, a company that offers its securities to its shareholders or debenture holders should make fair and adequate disclosures. Schedule II to the Companies Act, 1956 does not provide for matters to be stated in an offer document for rights issue. A government notification provides details of the information to be given in a letter of offer. Hence companies were adopting their own formats and there was no uniformity in disclosure. In order to streamline the format in which the offer document is to be sent, SEBI has directed that the Letter of Offer should conform to the disclosure requirements prescribed in Form 2A - Memorandum containing salient features of the Prospectus. Also the contents shall be in the same order as prescribed for the Memorandum. In respect of financial results of the company, the Letter of Offer should also contain the undermentioned information: 1. Working results of the company under the following heads (i) (a) sales/turnover. (b) other income. (ii) estimated net profit/loss. (iii) (a) provision for depreciation. (b) provision for taxes. (iv) estimated net profit/loss. These informations are to be made up to a date not earlier than two months from the date of the letter of offer. 2. Material changes and commitments, if any, affecting financial position of the company. These informations are to be furnished for the period between the last date of the balance sheet and profit and loss account sent to the shareholders and the date preceding by a fortnight the date of offer. Finally the undermentioned stock market data are also to be furnished in respect of the shares of the company: (a) week-end prices for the last four weeks; (b) current market prices; and (c) highest and lowest prices. This information needs to be provided relating to the period mentioned above. 3. Disclaimer clause The offer documents and the abridged prospectus should contain the following Disclaimer clause.
It is to be distinctly understood that the vetting of the draft offer document (Prospectus or the Letter of Offer as the case may be) by SEBI should not in any way be deemed/construed as approval from SEBI for the proposed issue. SEBI does not take any responsibility for the financial soundness of the document. SEBI merely ensures on the basis of information furnished to it, that adequate disclosures have been made in the offer documents to enable the investor to take informed investment decisions. 4. Memorandum containing salient features of the prospectus (Abridged Prospectus) According to Section 56(3) of the Companies Act, 1956, no one shall issue any form of application for shares in or debentures of a company, unless the form is accompanied by a Memorandum containing such salient features of a Prospectus, as may be prescribed, which complies with the requirements of this section. The memorandum containing salient features of a Prospectus is nothing but an abridged Prospectus and the same extent of care and diligence is required for drafting this also. It should be in the form prescribed. The memorandum should accompany each and every application form. Right issue of Shares One of the rights that is enjoyed by the equity shareholders of a company is right of pre-emption conferred under Section 81 of the Companies Act, 1956. The procedure relating to rights offering differs greatly from that involved in a public offering. This part intends to provide insights into the various aspects involved in such rights offerings, in an elaborate manner, with commentary notes on each and every piece of activity involved. A common manner of financing of an existing listed company is by issue of further securities by way of rights to the existing share-holders. This offer on rights basis is governed by Section 81 of the Companies Act, 1956 and the Stock Exchange listing agreement. Right of Pre Emption According to Section 81 of the Companies Act, if a company, at any time after the expiry of two years from the date of formation or at any time after the expiry of one year from the date of allotment of shares in that company made for the first time after its formation, whichever is earlier, proposes to increase the subscribed share capital of the company, by allotment of further shares of the company, then the company has to adopt the following procedure: (a) such further shares shall be offered to the persons who, at the date of the offer are holders of the equity shares of the company, in proportion to the paid up capital at that date. (b) the offer aforesaid shall be made by a notice specifying the number of shares offered and limiting a time not being less than fifteen days from the date of offer within which the offer, if not accepted, will be deemed to have been declined. (c) unless the articles of the company otherwise provide, the offer aforesaid shall be deemed to include a right exercisable
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by the person concerned to renounce the shares offered to him or any of them in favour of any other person and the notice referred to in clause (b) above, shall contain a statement of this right. (d) after the expiry of the time specified in the notice aforesaid, or on receipt of earlier intimation from the person to whom such notice is given that he declines to accept the shares offered, the Board of Directors of the company may dispose them of in such manner as they think most beneficial to the company. This right of the equity share-holders is called right of preemption. However Section 81(1A) of the Act provides that further issue of capital could be made to any persons other than the existing equity share-holders, if a special resolution is passed by the company in a general meeting, or if no such special resolution is passed, if the votes cast in favour of the resolution, exceed the votes cast against the resolution and the consent of the government is obtained. This right is not applicable, if the subscribed capital of the company is caused to be increased by the exercise of an option attached to debentures issued by the company or loans raised by the company, to convert such debentures or loans into shares in the company or to subscribe for shares in the company. These provisions are not applicable in the following cases also: (a) issue of shares which are forfeited by the company; (b) allotment of shares which are already issued; (c) issue of further shares made before two years from the date of formation of the company or at any time before one year from the allotment of shares in that company made for the first time after its formation; and (d) issues made by private companies. The provisions of this Section are applicable to issue of preference shares also but not to issue of debentures. Pursuant to the listing agreement entered into with Stock Exchanges, companies have to adhere to the following formalities while issuing securities on rights basis: (a) the Letters of Offer (LOO) should be issued simultaneously to all the eligible shareholders; (b) LOO should be numbered serially and printed on a good quality paper; (c) LOO should contain a provision for splitting; (d) LOO should spell out as to how the next payment of dividend shall be calculated, on the securities which are being issued; (e) the company should not charge for renounceable LOO; (f) to close the transfer books as from such date or to fix such record date for the purpose in consultation with the Exchange as may be suitable for the settlement of transactions and to so close the transfer books or fix the record date only after sanctions subject to which the issue or offer is proposed to be made have been duly obtained unless the Exchange agrees otherwise;
(g) to make such issues or offers in a form to be approved by the Exchange and unless the Exchange otherwise agrees to grant in all cases the right of renunciation to the share-holders and to forward a copy of the renunciation forms promptly to the Exchange; (h) to give the share-holders reasonable time, not being less than four weeks, within which to record their interest and exercise their rights; and (i) to issue LOO within six weeks of the record date and to issue allotment letters/certificates within six weeks of the last date fixed by the company for submission of LOO. Some fundamental issues on Right Shares 1. Is issue of a prospectus necessary? A Circular issued by the Department of Company Affairs, bearing no.8/81/56-PR, says that the issue of further shares by a company to its members with right to renounce them in favour of third parties does not require an issue or registration of a prospectus. Right issue under Sec.81 requires an offer by notice to be issued to the share holders. It does not specify any requirement of a prospectus. Under Sec.56 however, no form of application for shares or debentures can be issued unless it is accompanied by a prospectus. Of course this requirement is not applicable when the shares or debentures are not offered to the public. According to Sec.67(3), no offer or invitation shall be treated as having been made to the public unless the shares or debentures become available for subscription or purchase by persons other than those receiving the offer or invitation. This provision indicates that the right shares offered only to the members does not require issue of a prospectus because no one else other than the offeree can purchase it. But generally such an offer carries the right to renounce the shares by the member receiving the offer to any other person. This makes the offer akin to a public issue. This opinion is in consonance with Palmers [Company Law, 324] observation, where the issue is made to the existing holders of shares or debentures, much will depend on whether the letters of allotment which the company issues is renounceable or non-renounceable'. If as in most cases the offer is renounceable the issue becomes 'public. The Supreme Court held in Needle Industries (India) Ltd v. Needle Industries Newely (India) Holding Ltd [(1981)51 Comp.Cas. 743] that on offer which gives the offeree the right to renounce the shares in favour of the non-member is in truth and substance an invitation to the public to subscribe to the shares in the company. Therefore, in such cases, issue of prospectus is imperative. 2. Listing regulations regarding right issues The Stock Exchanges have laid down the following requirements regarding the right issues by listed companies : i) the company has to close its transfer books or fix the record date for the right issue in consultation with the Stock Exchange; ii) if the rights work out to a fraction of a whole share the company should either issue coupons or fractional certificates; 233
iii) the Letter of Offer to be issued to the shareholder is required to be approved by the Stock Exchange; iv) the Letter of Offer should provide that shareholders would be entitled to renounce their rights in favour of nominees; v) forms of renunciation should be made available to the shareholders; vi) shareholders must be entitled to apply for additional shares; and vii) a specimen of the offer letter should be forwarded to the stock exchange. 3. SEBI Gudielines on Rights Issue The new guidelines issued by the SEBI on 11 June, 1992 on capital issues deal with certain aspects of rights issues. Any public company making a rights issue will have to observe and comply with the relevant guidelines. It may be pointed out that the guidelines issued by SEBI do not in many cases categorically refer to rights issue while in certain case they use the expressions public issue and further issue which create confusion as to the applicability of the guidelines to right issues. It would, therefore, be desirable to approach the SEBI either directly or through a merchant banker for a clarification on the question as to whether a particular requirement under the guidelines applies to the rights issue or not. Sub clause (h) of clause P of the new guidelines empowers the SEBI to issue necessary clarifications on these guidelines to remove any difficulty in the implementation thereof. The first and foremost question that arises is whether the new guidelines are applicable to all kinds of companies, e.g., private companies, deemed public companies, listed public companies, unlisted public companies, government companies, etc. The guidelines are completely silent on this point. On 17 June, 1992 the SEBI issued clarifications on certain aspects of the guidelines. An analytical study of the guidelines read with the clarifications reveals that these guidelines shall apply in the case of a rights issue of equity shares to the extent and in the manner discussed below :Clause A The guidelines prescribed under this clause are not applicable to the rights equity issue because they apply to the first issue of new companies. Clause B This clause has limited application in the case of first issue by existing private/closely-held companies. The words first issue are ambiguous, because where a private company proposes to make an issue for the purpose of getting its shares listed on a recognised Stock Exchange as per this clause, such an issue cannot be said to be first issue. It would obviously be its further issue. This clause has however, no application in any other issue of equity. Clause C The title of this clause, namely, Public issue by existing listed companies indicates that it applies only to Public Issue and not to "rights issues". But this is not free from doubt owing to ambiguous language occuring in its subclauses (a) and (c)(ii). In the former there occur the words further issues (which seem to cover rights issue), and in the 234
latter there are words offer documents (which may cover letters of offer in the case of rights issue). Clause D This clause deals with two things : underwriting and minimum subscription. Prima facie the whole of this clause does not apply to a rights issue in view of the words issue of capital to the public. However in its clarifications on the guidelines issued on 16 June, 1992, the SEBI has clarified that the minimum subscription clause is applicable to a rights issue with a right of renunciation. As such a company making a rights issue will have to comply with the requirement as to the minimum subscription as stipulated in this clause if the rights issue contains a term giving the right of renunciation to the shareholders. Clause E According to this clause, where a public and a rights issues are made simultaneously or even as a composite issue, the company will be free to fix different premia. Clause F This clause applies only to debenture issues, convertible or non-convertible; hence it does not apply to the rights issue of equity shares. Clause G This clause deals with new financial instruments, hence it does not apply to the rights equity issue. Clause H It appears that the reservation in an issue of securities comtemplated in sub-clauses (c), (d) and (e) of this clause can be made even in the case of a rights issue although a plain reading of these sub-clauses do not expressly so indicate. Sub-clauses (c) and (d) are ambiguous and hence confusing. They seem to apply in the case of a public issue as well as rights issue. Clause I The word deployment seems to have been used to denote utilisation. This clause is not happily worded. The intention appears to be to make the requirement of this clause applicable to all the issues, public or rights, where the total amount comprised in the application money and the allotment money together exceeds Rs.250 crores. The clause says, in such cases, the issuer will voluntarily disclose and make arrangements for the use of proceeds of the issue as per disclosure to be monitored by one of the financial institutions. Where and how this disclosure should be made is not indicated. Which financial institution should undertake the responsibility of monitoring the utilisation of proceeds of the issue is also not indicated. The financial institution doing the monitoring job seems to be required to prepare a report on the monitoring but there is no indication regarding contents of the report. Both the concerned financial institution and the company are required to send separately copies of the report to SEBI. Sub-clause (b) of this clause requires that the amount to be called up on application, allotment and on a call should not be on each occasion, be more than twenty-five percent of the total quantum of the issue. In other words, the amount payable on application, allotment and a call should not exceed on each occasion, 25% of the total amount payable on a share/debenture, that is, face value and premium, if any. It may be noted that the aforesaid condition would apply only in the case of an issue in which the total amount on application and allotment is more than Rs.250
crores. (Significantly, sub-clause(a) uses the words exceeding Rs.250 crores but sub-clause (b) uses the words In issue of the above size and beyond. The two sub-clauses are, thus, contradictory). Clause J According to sub-clause (a) of this clause a company cannot make a bonus issue within twelve months of a public or a rights issue, but the converse is not true. In other words, a public or rights issue can be made within twelve months of a bonus issue. Sub-clause (b) of this clause has no application to a rights issue. It applies only in the case of a public issue. Sub-clause (c) of this clause (which is not happily drafted and which should have been included under clause I of the guidelines) seems to be applicable also in the case of a rights issue. It enjoins a company, which has made an issue, to make the securities fully paid-up within twelve months from the date of the issue, irrespective of whether the company is in need of funds or not. In other words, the entire nominal value and premium, if any, of the securities issued should be made fully paid-up within the twelve months period. It should be noted that the companys duty is confined to taking requisite steps so as to get the securities fully paid-up within the stipulated period. If in spite of that some of the holders of the securities do not pay the call money, this cannot be said to be a violation of, or noncompliance with, the guideline. Clause K Reservation of securities for subscription by the employees of the company upto five per cent may be made in a rights issue. In such a case, the issue and allotment of securities to the employees will be subject to the conditions specified in this clause. Any percentage less than the five percent is also permitted. In any case, the reservation is voluntary and at the discretion of the board of directors of the company. If the Board decides to make the reservation, the compliance with the provisions of Section 81(1A) will be necessary. Clause L Sub-clause (a) of this clause makes it clear, by the use of the words in any issue to the public that this clause does not apply to a rights issue. In its clarifications issued on 16 June, 1992, the SEBI has stated that in respect of further issues, if there are no promoters, the promoters' contribution will mean contribution by directors, friends, relatives, associates and contribution from them shall not be less than 25 percent or 20 percent of the issue of equity capital as the case may be, with lock-in-period of five years. This clarification no doubt uses the expression further issue (which is used in Section 81 of the Companies Act); however it should be deemed to be referring to further public issue and not a rights issue because in the case of a rights issue there is no question of promoters contribution at the fixed percentage in as much as in a rights issue, the existing shareholders are offered new shares on rights basis in a certain proportion. Clause M This clause has nothing to do with the rights issue. Clause N This clause does not apply to the rights issue of equity shares.
Clause O This clause does not apply to the rights issue of equity shares. Clause P The requirement stipulated in sub-clause (b), that the rights issue should not be kept open for more than 60 days, would seem to apply in all cases of rights offers including those to non-resident shareholders. Sub-clause (c) prohibits retention of over-subscription in all cases of issue of securities, including rights issues. Sub-clause (d) seeks to enjoin the lead managers to an issue to forward to the SEBI a report together with a compliance certificate from a chartered accountant in the prescribed form. The report and the certificate are to be forwarded within 45 days of the closure of the issue. 4. Procedure for Rights Issue (i) The rights issue must be accommodated within the authorised capital. If the authorised capital is inadequate it needs to be increased by an amendment by an ordinary resolution under Sec.94(1)(a) of the Companies Act. (ii) The board has to decide on the quantum and proportion of the rights issue; at par or at a premium; appoint underwriters and managers for the issue; and approve the draft letter of offer. (iii) Open a bank account for the acceptance of applications. (iv) Forward six sets of letter of offer together with the composite application forms to the concerned Stock Exchanges. (v) Convey a general meeting to get the requisite resolutions passed, if necessary (vi) File with the Registrar of companies within 30 days of the general meeting, certified copies of the special resolutions passed at the general meeting, alongwith Form No.23 in cases where the authorised capital has been increased. (vii) In case of a listed company, notify the Stock Exchanges at which the company shares are listed. 2.5 COST OF RAISING CAPITAL A company that raises money from the public has to incur expenditure of the following nature (i) fees to the Managers, Registrars and other intermediaries engaged for the issue; (ii) underwriting commission and brokerage; (iii) meetings and conferences to market the issue; (iv) statutory and other advertisement costs; (v) printing and stationery costs; and (vi) postage and mailing costs. 2.6 SHARE ISSUED AT A PREMIUM Shares could be issued either at its nominal value, or at a premium or at a discount. While shares are commonly issued at its nominal value, companies with a good performance and
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with growth potential, issue their shares at a premium. Initial public issue of shares at a discount is not in vogue, though there is no prohibition to do so. While the Companies Act does not contain any restriction on issue of shares at a premium, SEBIs Guidelines on Disclosure and Investors Protection permits only certain class of companies to issue shares at a premium. The guidelines further require the company to give the justification for the premium in the offer documents. However Section 78 of the Companies Act, contains certain provisions relating to the treatment of the premium received by the company. These provisions are explained below: (i) If a company issues shares at a premium, whether for cash or otherwise, a sum equal to the amount of premium on those shares should be transferred to a seprate account called Share Premium Account. (ii) The provisions of the Act relating to the reduction of the share capital of a company shall apply to share premium account also, except otherwise provided in the Act. (iii) The amount standing to the credit of the share premium account should be utilised only for the following purposes: (a) in paying up unissued shares of the company to be issued to members of the company as fully paid up bonus shares ; in writing off the preliminary expenses of the company ; in writing off the expenses of or the commission paid or discount allowed on, any issue of shares or debentures of the company ; or in providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company.
(vii)every prospectus relating to the issue of shares shall contain particulars of discount allowed on the issue of shares or of so much of that discount as had not been written off on the date of issue of the prospectus. 2.8 RAISING OF LOAN CAPITAL (A) Power to issue debentures The Board of Directors of a company has power to issue debentures and/or to borrow monies otherwise than on debenture,and/or to make loans and invest the funds of the company. Such a power is to be exercised by a resolution passed at the meeting of the Board. (See Sec.292). Of course, the Boards power to borrow money is restricted by Sec.293 (d) if the monies so borrowed exceed the aggregate of the paid up capital and its free reserves. In such a case the Board of a public company or a private company which is a subsidiary of a public company would need the consent of the public company or subsidiary in its General Meeting. Bond Under Sec.2(12) of the Companies Act, Debentures include Bonds. According to Sec.2(5) of the Indian Stamp Act, a bond means (a) any instrument whereby a person obliges himself to pay money to another, on condition that the obligation shall be void if a specified act is performed or is not performed as the case may be, (b) any instrument attested by a witness and not payable to order of bearer whereby a person obliges himself to pay money to another, and; (c) any instrument so attested whereby a person obliges himself to deliver grain or other agricultural produce to another. A bond, therefore, is an instrument under seal whereby one person binds himself to another for payment of a specified sum at a future date. Debenture as a Negotiable Instrument A debenture payable to a bearer, or where registered, to a registered holder, is by usage a negotiable instrument. A bearer debenture as explaind by the Calcutta High Court is one which is payable upon presentation thereof and upon the demand made by the bearer. [Calcutta Safe Deposit Co. Ltd. v. Ranjit M. Sampath (1971)41 Comp. Cases 1063 (Cal)] Rights of a Debenture Holder A debenture holder shall have the following rights : (i) Every debenture holder is to be provided on demand with a copy of annual accounts along with the auditor's report, [See Sec. 219(2)]. (ii) A debenture holder has the right to obtain the copy of the trust deed used for securing the issue of debenture. Within 7 days of such request made by the debenture holder the company has to forward a copy of the trust deed. [See sec.118(1)].
(b) (c)
(d)
2.7 SHARE ISSUED AT A DISCOUNT According to Section 79 of the Companies Act, a company may issue its shares at a discount, subject to the following conditions: (i) the shares that are to be issued at a discount should be of a class of shares already issued; (ii) the issue at a discount is authorised by a resolution passed by the company in a general meeting; (iii) the issue is sanctioned by the Company Law Board; (iv) the maximum rate of discount allowed should not be in excess of ten percent or such other higher percentage that may be allowed in the special circumstances of the case; (v) a minimum of one year should have elapsed since the date on which the company was entitled to commence business; (vi) the shares are to be issued at a discount within two months from the date of its sanction by the Company Law Board or within such extended time as the Company Law Board may allow; and
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(iii) A debenture holder cannot have a voting right at any meeting of the company. This is provided in Sec.117 perhaps with a view to distinguish debenture holder with an equity holder. It has been rightly pointed out by the Bombay High Court in Narottam Das v. Bombay Dyeing & Manufacturing Co. Ltd. [(1989)3 Comp.L.J. 179] that the rights of the debenture holder and the corresponding obligation of the company, excepting in the above statutory provisions, essentially depend upon the terms of the agreement between the debenture holder and the company. (iv) A debenture holder can sue the company for the recovery of the amounts payable to him as the holder of the certificate provided there is a covenant to that effect. In absence of such covenant the holders of the bond were not considered as creditors but are settled as cestui que trust of a charge. Similarly unless covenanted, debenture stock holders cannot present a winding up petition as creditors for arrears in the interest accumulated. Of course Bombay High Court in Naroharis case held that in view of clear provision of Sec. 439 of the Companies Act, a debenture holder is deemed as creditor of the company for the purpose of presenting a winding up petition. Secured Debentures and the Trust Deed Though in the Companies Act there is no provision requiring that the debentures be secured, yet, it is common to secure the debenture by a mortgage or charge on the companys property. The most common practice is to secure a debenture by a trust deed, in order to ensure the payment of the debt. A debenture trust has to be created expressly by an instrument of trust. Advantages of such trust can be briefly outlined as : (a) it constitutes trustees who are responsible to look after the rights and interests of the debenture holders; (b) the trustees can enforce the security on behalf of the holder; and (c) a legal estate is sometimes vested in the trustees. The trust deed lays down the manner of appointing a receiver and the trustees are given the power of interference in the event of the interest of the debenture holders being at stake. A Debenture Secured Under Charge The debenture secured by a charge by any form of mortgage of a companys property may have ranking in charges. As for example, a property already mortgaged to another institution may be again mortgaged by creating a charge in favour of the debenture holders. Such repetitive charges shall have sequential preference based upon the agreement between the company and the charge holders and the subsequent proposed charge holders. Charge includes a mortgage according to Sec. 124 of the Companies Act. It also includes a lien and an equitable charge whether created or evidenced by an instrument in writing or by deposit of title deeds or by an agreement to deposit. Sometimes charges may be fixed or floating. Fixed charges are created on properties which are fixed in nature, as for
example, on land, building, plant and machinery, fixtures etc. Charges can also be created against assets which are floating in nature, as for example, stock. A charge created against all the assets taken together of a company is a floating charge thereby meaning that the charge is not crystallised or fixed until anyone of the following happens: (i) the debtor company ceases to carry on the business, or (ii) goes into liquidation, or (iii) the debenture holder or any creditor in whose favour the charge is created intervens by getting a receiver appointed, or (iv) the charge holder in doing some other acts affects the companys power of disposing the assets under charge. An instrument creating the right in favour of the mortgagee to recover the loan is required to be registered under Sec.17 of the Registration Act. Where a mortgage is created by a registered mortgage deed no further stamp duty is payable on the debenture, as per the provision of Art 27 of the Schedule to the Indian Stamp Act. i.e., once a duty is paid on the mortgage deed. In Chief Controlling Revenue Authority v. Manager, State Bank of Mysore [(1989)65 Comp.Cases 427 (Kar)], the Karnataka High Court dealt with the question of correct stamp duty payable on the debenture trust deed. The High Court held that the debenture trust deed is not a deed of mortgage or bond but a deed of trust and therefore the stamp duty chargeable may be under Art 54(a) of the Schedule of the Act and not under Art 27 of the Schedule which contains the stamp duty payable on debenture whether mortgage debenture or not. Registration of Charge According to Sec. 125 of the Companies Act, every charge created by a company and being a charge to which the section applies is required to be registered with the Registrar of Companies within 30 days of the creation of charge. This section applies to the following charges : (a) A charge for the purpose of securing any issue of debentures; (b) A charge on uncalled share capital of the Company; (c) A charge on any immovable property; (d) A charge on any book debt; (e) A charge on any movable property, not being a pledge; (f) A floating charge on the undertaking or any property of the company including stock-in trade; (g) A charge on calls made but not paid; (h) A charge on a ship or any share in a ship; and (i) A charge on goodwill, patent, license, trademark or a copright. Where any charge is required to be registered u/Sec.125 of the Companies Act has been so registered, any person acquiring the charged property shall be deemed to have notice of the charge from the date of such registration. [See Sec. 126] Where a company subject a property to a charge, a certified copy of 237
the instrument by which the charge was created is to be delivered to the Registrar for registration within 30 days from the day of creation. [See Sec. 127]. The Registrar shall keep with respect to each company a register in the prescribed form recording all the charges registered. The record must contain the date of creation, the amount secured, the particulars of the property charged and the parties entitled to be charged. An index to Register of charges must also be kept by the Registrar who shall give certificate of registration of charge which shall be the conclusive evidence as to the registration of charge. Whenever a modification is made of the charges the company has to send to the Registrar the particulars of modification. It shall be the duty of every company to file to the Registrar for registration of particulars of every charge created by the company and of every issue of debentures of a series requiring registration. [See for details Secs. 125 to 144 of the Companies Act]. SEBI Guidelines on issue of debentures Securities and Exchange Board of India issued the guidelines for disclosure and investors protection on June 11, 1992 which apply to those public companies whose shares or debentures are listed on recognised Stock Exchange. Sec. F of the guidelines stipulates the following requirements as regards issue by the listed companies of fully Convertible Debentures (FCD), Partly Convertible Debentures (PCD) and Non Convertible Debentures (NCD). (a) Issue of FCDs having a conversion period more than 36 months will not be permissible, unless conversion is made optional with put and call option. (b) Compulsory credit rating will be required if conversion is made for FCDs after 18 months. (c) Premium amount on conversion, time of conversion, in stages, if any, shall be predetermined and stated in the prospectus. The interest rate for above debentures will be freely determinable by the issuer. (d) Issue of debenture with maturity of 18 months or less are exempt from the requirement of appointment of Debenture Trustee or creating a Debenture Redemption Reserve (DRR). In other cases, the names of the debenture trustees must be stated in the prospectus and DRR will be created in accordance with Section N.1. The trust deed shall be executed within six months of the closure of the issue. (e) Any conversion in part or whole of the debenture will be optional at the hands of the debenture holder, if the conversion takes place at or after 18 months from the date of allotment, but before 36 months. (f) In case of NCDs/PCDs credit rating is compulsory where maturity exceeds 18 months. (g) Premium amount at the time of conversion for the PCD shall be predetermined and stated in the prospectus. Redemption amount, period of maturity, yield on redemption for the PCDs/NCDs shall be indicated in the prospectus.
(h) The discount on the non-convertible portion of the PCD in case they are traded and procedure for their purchase on spot trading basis must be disclosed in the prospectus. (i) In case, the non-convertible portions of PCD/NCD are to be rolled over with or without change in the interest rate, a compulsory option should be given to those debenture holders who want to withdraw and encash from the debenture programme. Roll over shall be done only in cases where debenture holders have sent their positive consent and not on the basis of the non-receipt of their negative reply. (j) Before roll over of any NCDs or non-convertible portion of the PCDs, fresh credit rating shall be obtained within a period of six months prior to the due date of redemption and communicated to debenture holders before roll over and fresh trust deed shall be made. (k) Letter of information regarding roll over shall be vetted by SEBI with regard to the credit rating, debenture holder resolution, option for conversion and such other items which SEBI may prescribe from time to time. (l) The disclosures relating to raising of debentures will contain, amongst other things, the existing and future equity and longterm debt ratio, servicing behaviour on existing debentures, payment of interest on due dates on term loans and debentures, certificate from a financial institution or bankers about their no objection for a second or pari passu charge being created in favour of the trustees to the proposed debenture issues. (m) SEBI may prescribe additional disclosure requirement from time to time, after due notice. SEBI guidelines also provide that in case of convertible debentures where price was to be determined by the Controller of Capital Issues, the price for conversion now is to be determined in a duly organised meeting of debenture holders and share holders or in other words wherever the power regarding price was given to the Controller of Capital Issue it is now being given to the company itself, of course with the consent of respective debenture holders Protection of Debenture Holders Interest SEBI guidelines has laid down the following measures to ensure the protection of debenture holders interest. (a) Trustees to the debentures issue shall be vested with the requisite powers for protecting the interests of debenture holders including the right to appoint a nominee director on the Board of the company in consultation with institutional debenture holders. (b) Lead institution/investment institution will monitor the progress in respect of debentures for project finance/ modernisation/expansion/diversification/normal capital expenditure. The lead bank for the company will monitor debentures raised for working capital funds. (c) Institutional debenture holders and trustees should obtain a certificate from the companys auditors in respect of
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utilisation of funds during the implementation period of projects. In the case of debentures for working capital, certificate should be obtained at the end of each accounting year. (d) Debenture issues of companies belonging to the groups for financing or acquiring shareholding in other companies will not be permitted. (e) The companies shall, along with their application, file with SEBI, certificates from their bankers that the assets on which security is to be created are free from any encumbrances and the necessary permissions to mortgage the assets have been obtained or a No Objection Certificate from the financial institutions or banks for a second or pari passu charge in cases where assets are encumbered. The security should be created within six months from the date of issue of debentures. If for any reasons the companies are not in a position to create security within 12 months from the date of issue of debentures the company shall be liable to pay 2 per cent penal interest to debenture holders. If security is not created even after 18 months, a meeting of the debenture holders should be called within 21 days to explain the reasons thereof and the date on which the security would be created. (f) The trustees to the debenture holders will supervise the implementation of the conditions regarding creation of security for the debentures and regarding the debenture redemption reserve. (B) Public Deposit Companies (Amendment) Act 1974 has inserted Sec. 58A, enabling a company to invite and accept public deposits, according to such rule as may be laid down in consultation with Reserve Bank of India. Companies of course used to accept public deposits earlier. After the Amendment Act of 1974, public deposits cannot be invited and accepted without observing the
rules as laid down. Accordingly the Companies (Acceptance of Deposits) Rules 1975 was made by the Central Govt. in consultation with the RBI. The said rules have been amended in 1982. The rule has defined in details as to what a deposit means and includes. The definition includes any deposit of money or borrowings to a company but does not include amount received from the governments; loans received from banking and other financial institutions; amount received from employees as security deposit; amount received in trust ; amount received on bonds and debentures; etc. The Rule 3 of the 1975 Rules has imposed the following negative conditions on acceptance of public deposits by a company: (a) no company shall accept public deposit which is repayable on demand or on notice or repayable after a period, except where the deposit is repayable after the expiry of 6 months but not later than 36 months from the day of acceptance; (b) the public deposit shall not exceed 25% of the aggregate of the paid up share capital and free reserves; (c) an interest rate exceeding 14% per annum cannot be offered; (d) company cannot pay brokerage beyond 1% of the deposits for a period of one year and 2% for deposits exceeding two years; and (e) deposits cannot be accepted against unsecured debenture. Every company accepting public deposit must furnish to the depositor a receipt for the amount received, signed by the duly authorised officer of the company. Every company accepting the deposits shall keep at its registered office, register of deposits containing name and address of the depositor; date and amount of its deposit; duration; rate of interest; date of payment of interest and other particulars. [See for details Companies (Acceptance of Deposits) Rules 1975].
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3. INVESTORS PROTECTION
SUB TOPICS 3.1 Introduction 3.2 Duty of disclosure 3.3 Liability for Mis-statement 3.4 Prevention of Insider Trading 3.5 Other Institutional Protection (a) Listing in a Stock Exchange (b) Credit Rating (c) Investment through Mutual Fund (d) Portfolio Management 3.6 Protection of Minority Interest 3.7 Protection against take over operations 3.1 INTRODUCTION The realm of investment and its return is a private decision specially in an open market economy. The State through a legal and institutional process must ensure (a) complete freedom to take all decisions and (b) ensure the protection of individual rights through correspondingly fixing individual duties and consequential liabilities. In a free market economy law has generally three important roles to play (i) it recognises all players of the market and prevents any one from participating without such recognition; (ii) it creates a level playing field by ensuring equality of opportunities; and (iii) it prescribes rules to be equally applicable against all players by ensuring a neutral umpiring. As such generally in a private contractual situation law does not take side with one party unless there is an unconscionable phenomenon. In Corporate Law state has a special role to play because it is the artificial creation of corporate personality which the law of the land ensures, that empowers a group of people to organise and run commercial projects and enterprises for the purpose of earning profits with the help of investments made by a large number of investors who do not have right to participate in the management though undertaking the risks of investment. On the other hand a group of entrepreneurs or promoters or business organisers manage the whole affair by supplying sometimes a very little part of the capital. These management groups, are given wide protection by law. It is, therefore, encumbent upon the state to also ensure that these vast number of investors supplying the capital are protected against all unreasonable and questionable if not unlawful activities of a few in the company known as management. Investors invest money on the expectation of best return but best return is not always the outcome of best management. An investor requires protection against several activities of the management. As for example: (i) While investing in the company either in the share capital or loan capital an investor requires all information in its exact and true form which help the investor to take decisions 240
both on qualitative as well as quantitative terms. Therefore the legal system has to ensure in a free market condition that all such informations are made available to the prospective investors so that they freely and fairly take decisions. (ii) The arena of investment by nature has unevenness in the playing conditions. As it is possible that the information dissemination process may create greater access to a few creating thereby inequality amongst the players in the investment market based upon inequality of information, the player having more access to information will command the market and derive greater gain. Therefore, the law has to ensure not only equal information dissemination but has also a role to play in neutralising excess information available to some in view of their status. Otherwise a code of equal access cannot deliver justice in an inherent by inequal situation. Here the role of law is extremely critical because the task of neutralising the effect of advance information or previleged information is not only difficult but also extremely complicated. A simple example makes the situation clear. A director of a company has access to information about the company to which an outsider or even a shareholder does not have any access. As such, in order to ensure fair play in the capital market the director is required to be disempowered by law so that his excess power derived through advance knowledge does not allow him to dominate the market. (iii) An investor is in a disadvantageous position vis-a-vis the management. As the management is in control of company funds and assets,the potential for misuse is greater. It is also possible for the majority of the investors to suppress the minority based on voting strength. Hence investors need a greater degree of protection in such an unequal relationship. The degree of protection mentioned above can be discussed in detail under the following heads: (i) duty of disclosure; (ii) protection against insider trading; and (iii) protection against mismanagement and exploitation by the majority group. 3.2 DUTY OF DISCLOSURE Secs. 56, 58A, 58B and 66 of the Companies Act require disclosure of informations to the intending share applicants, debenture applicants and depositors. According to Sec. 56(3) no one shall issue any form of application for shares in or debentures of a company unless the form itself is accompanied by a prospectus which contains the standard of information specified in Part I and Part II of Schedule II of the Companies Act. According to Sec. 58A (2)(b) a public deposit cannot be invited and accepted without a public advertisement which has to include a statement showing the financial position of the
company. These negative prescriptions emphasize that the responsibility of issuing the prospectus or giving the advertisement as the case may be is that of those who invite the public to subscribe to the share capital or debenture or make a deposit. Sec. 61 of the Companies Act affirms the importance of the terms of contract referred to in the prospectus or statement in lieu of prospectus. Though in terms of Common Law principles of Law of Contract a prospectus is only an invitation to offer' but under company law a prospectus determines the conditions of the contract. As such according to Sec. 61 a company shall not at any time vary the terms of the contract referred to in the prospectus or statement in lieu of prospectus, except subject to the approval or except on authority given by the company in General Meeting. Therefore stipulation in the prospectus is deemed to be a term of the contract. The contents of the prospectus which is specified in Schedule II has already been mentioned in Module I. If one carefully notes the contents of the prospectus, one shall come to understand that prospectus is not a mere advertisement or a statement. It contains all informations regarding : (a) management and organisation structure, (b) extracts of all important contracts made so far by the company, (c) statements certified by the auditor as regards financial position , (d) statements of assets and liabilities, (e) important historical data such as total turn over, net profit, dividend declared in the past years, (f) amount to be raised by way of public subscription and a statement of its utilisation, etc. It may be noted that all this information is relevant for taking a decision on investment. The law therefore prescribes that if Sec. 56(3) is not observed all persons acting in contravention shall be punishable with a fine extending upto Rs.5000/-. Similarly if conditions stipulated under Sec. 58A(2)(b) are not observed the company can be fined as well as the defaulting officer shall be liable to imprisonment for a term which may extend to 5 years and shall also be liable to fine. The obligation of persons issuing the prospectus was laid down in New Burnswick & Canada Railway and Land Co. v. Muggeridge [(1860)1 Dr. & Sm. 363] thus : Those who issue a prospectus holding out to the public the great advantages which will accrue to persons who will take shares in a proposed undertaking, and inviting them to take shares, on the faith of the representations therein contained, are bound to state everything with strict and scrupulous accuracy and not to abstain from stating as fact that which is not so, but omit no one fact within their knowledge, the existence of which might in any degree affect the nature or extent and quality of the privileges and advantages which the prospectus holds out as inducement to take shares. In Pramatha Nath Sanyal v. Kali Kumar Dutt [AIR 1925 Cal 914] the Calcutta High Court very rightly observed that every statement made should be an honest one, no ambiguous phraseology, unfair reservations or half truth should be allowed to be used or to creep in. SEBI Guidelines on disclosure In the SEBI guidelines relating to disclosure necessary during first issue by existing private/closely held companies and on
public issue by existing listed companies it is provided that the draft prospectus will be vetted by SEBI to ensure adequacy of disclosure. In the case of first issue by existing private/closely held companies, the pricing would be determined by the issuer and lead managers to the issue and would be subjected to specific disclosure requirements including : (i) disclosures of the net asset value of the company as per the last audited balance sheet ; and (ii) justification for the issue price. The guideline on public issue by existing listed companies stipulates that the offer documents shall contain the net asset value of the company and a justification for the price of the issue. The high and low price of the shares for the last two years are also required to be disclosed. A separate guideline has been issued by SEBI on issue of securities by Development Financial Institutions (DFI). According to it the offer document of the DFI should contain specific disclosure in respect of: (a) the present equity and equity after conversion in case of FCDs/PCDs; (b) Debt Equity ratio, not to exceed 1.2:1; (c) Debt Service Coverage ratio (DSCR) to be maintained at minimum of 1.2:1 (d) Servicing behaviour of existing debentures; (e) Outstanding principal/interest/lease rentals due from borrowing companies; and (f) assets representing loan and other assistance portfolio classified into four broad groups as standard assets; substandard assets; doubtful assets and loss assets. SEBI may stipulate additional disclosure requirements from time to time, after due notice, as may be considered necessary. Through standard fixation about disclosure, SEBI has to ensure adequate information in the primary market. 3.3 LIABILITY FOR MISSTATEMENT It has been already stated that disclosure in a prospectus is essential in order to enable the investor to make his offer. According to Common Law there is no cause of action against an invitation to offer. But a prospectus is treated as an offer document prescribing the conditionalities of the offer to the investor. These conditionalities are binding upon the company. A prospectus is not to misrepresent actual and material facts or conceal facts which may improperly influence and mislead a prospective investor. If he is deceived thereby, he is entitled to remedies. Of course a mere non disclosure of facts would not be sufficient to result in an actionalbe claim unless such nondisclosure is against a statutory responsibility to disclose or s uch non-disclosure of facts had the effect of making the disclosed facts absolutely false. [See Peek v. Gurney (1874) LR 6 (HL)]. The liability is based upon the old Roman principle Suggestio falsi, Suppressio Veri, i.e., stating falsehood about material fact or, suppressing material fact that is required to be disclosed originate the liability of the party suggesting falsehood or suppressing material facts. There are several types of remedies. 241
(a) Contractual Liability: Palmer (Company Guide, pp. 2930) stipulated the following contractual remedy for misstatement or fraud in the prospectus: (i) he may repudiate the contract (mis-statement or fraud makes a contract voidable in Common Law as well as in Indian Law under Sec. 19 of the Indian Contract Act) and require repayment of his money with interest.; (ii) he may take proceedings to enforce rescission of the contract and repayment ; and (iii) he may bring an action for damages against the company, its directors and other responsible persons. The measure of damages is the loss suffered by reason of the untrue statement, omission etc., the difference between the value which the shares would have had but for such statement or omission and the true value of the shares at the time of allotment [McCounsel v. Wright (1903)1Ch 546]. (b) Civil Liability: Section 62 of the companies Act attaches strict liability to the following persons for any untrue statement contained in the prospectus. (i) every person who is a director of the company at the time of the issue of the prospectus; (ii) every person who has authorised himself to be named and is named in the prospectus either immediately or after an interval of time; (iii) every person who is a promoter of the company; and (iv) every person who has authorised the issue of the prospectus. These above persons are liable to pay compensation to every person who subscribes for any shares or debentures on the faith of the prospectus and suffered a loss or damages on account of the untrue statement. It is not necessary to prove the frauduent character of the untrue statement. It is enough to prove that the statement was, in fact, untrue and that in relying upon them the subscriber suffered damage. The untrue statement must be a material one. A misleading statement in a prospectus is an untrue statement attracted by this provision of the Act. A fraudulent statement also entails civil liabilities besides attracting contractual liability. A fraud or misrepresentation makes a contract voidable. If a statement is untrue on account of fraud or misrepresentation, the civil remedy of seeking damages for the loss sustained shall also be available to the party defrauded or mislead. In order to make a prospectus fraudulent, it is not necessary that there should be a false representation (suggestio falsi). Even if every word is true, the suppression of material facts may render the statement fraudulent (suppressio veri). (c) Criminal Liability : According to Section 63 of the Companies Act every authorised person issuing a prospectus is liable to be punished with imprisonment upto two years and fine upto Rupees five thousand or both for any misstatement in the prospectus. An expert or a person making any report required by Part II of Schedule II are not deemed to have authorised the issue of a prospectus. A false statement made with culpable negligence or with intention shall attract 242
punishment under Sec.68 of the Companies Act, as well. According to Sec. 68, any person who, either by knowingly or recklessly making any statement, promise or forecast which is false, deceptive or misleading, or by any dishonest concealment of material facts, induces or attempts to induce another person to enter into or to offer to enter into (a) any agreement for, or with a view to, acquiring, disposing of, subscribing for, or underwriting shares or debentures; or (b) any agreement, the purpose or intended purpose of which is to secure a profit to any of the parties from the yield of shares or debentures, or by reference to fluctuations in the value of shares or debentures; shall be punishable with imprisonment for a term which may extend to five years or with fine upto Rupees ten thousand or with both. Section 68 is applicable in the case of a fraud committed in stating a fact in the prospectus either knowlingly or recklessly. In R. v. Bares [(1952)2 All ER 892] recklessly was interpreted so as to extend to a high degree of negligence without dishonesty. The distinction between the provision of punishment in Sec.63 and that of Sec. 68, is heartening to note. Whereas any misstatement in the prospectus is punishable under Sec. 63, that is not so in Sec. 68, In Sec. 68 only those misstatements are covered which are fraudulent or made with culpable negligence. Negligence become culpable only when a duty warranted either by law or in ordinary circumstances is not cared to be implemented. For Sec. 63, use of the fact that the statement is untrue is enough but for Sec. 68 the plaintiff has to prove beyond doubt the existence of culpable negligence or intention to commit fraud. Where as in the application of Sec. 63 a high standard of proof of a criminal proceedings is not necessary, in Sec. 68 the plaintiff has to establish a proof of high standard generally followed in a criminal case. Whether a person has been induced to take shares by reason of a misrepresentation in a prospectus, is a matter of fact. The Supreme Court while deciding the case Larsen & Toubro Ltd v. Haresh Jagtiani [AIR 1991SC 119] held that a prospectus which merely specifies the dates and names of the parties to contracts, does not give notice of circumstances contained in the contracts which are material to be known and the omission of such circumstances causes the prospectus to give a false impression. How to avoid liability under Sec. 62 According to Sec. 62 (2) of the Companies Act no person shall be liable to pay compensation, if he proves (a) that, having consented to become a director of the company, he withdrew his consent before the issue of the prospectus, and that it was issued without his authority or consent; (b) that the prospectus was issued without his knowledge or consent, and that on becoming aware of its issue, he forthwith gave reasonable public notice that it was issued without his knowledge or consent; (c) that, after the issue of the prospectus and before allotment thereunder, 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 reason therefor; or (d) that (i) he believed, and had reasonable ground to believe, that the statement was true, or (ii) the statement was a correct copy or extract from a report or valuation of an expert, whom he had reasonable grounds to believe and did believe was competent to make it and that the prospectus was issued with the experts consent in writing, or (iii) the statement was a correct copy or extract from an official document. As such in a civil action for obtaining compensation, a director of a company can argue (i) bonafide belief ; (2) withdrawal of consent and (3) not giving consent. The last two arguments primarily concern documentary evidences whereas the first argument depends on both evidencial and circumstantial evidences. In Akerhielm v. De Mare [(1959)3 All ER 485 (PC)] the Privy Council held that it would be a good defence that the director concerned honestly believed the statement to be true in a sense in which it might reasonably be understood even though it was erroneous. An expert like, a Chartered Accountant, a Chartered Engineer, a Solicitor or the like, who is required to give his consent to the issue of prospectus, is also liable under Sec. 62 to give compensation to a party suffering from mis-statement in the prospectus. He can escape liability if he proves: (a) that having given his consent under Sec. 58 to the issue of the prospectus, he withdrew it in writing before delivery of a copy of the prospectus for registration ; (b) that, after delivery of a copy of the prospectus for registration and before allotment thereunder, he, on becoming aware of the untrue statement, withdrew his consent in writing and gave reasonable public notice of the withdrawal and of the reason thereof; or (c) that he was competent to make the statement and that he had reasonable ground to believe, and did upto the time of the allotment of the shares or debentures, believe, that the statement was true. How to avoid liability under Sec. 63 In order to avoid criminal liability imposed under Sec. 63 for misstatement in a prospectus a person authorised to issue such prospectus is required to prove that (a) the statement was immaterial, or (b) he had reasonable ground to believe and did believe, upto the time of the issue of the prospectus that the statement was true. A statement is immaterial if it does not have any bearing on the decision to make investment. In such a case, once the misstatement is proved the burden of responsibility of proving immateriality of the statement made or bonafide belief, lies on the defence. The provision in Sec. 63 stating unless he proves
signifies the shifting of the burden of proof. Ordinarily in a criminal proceedings the prosecution has to prove beyond any doubt the charge against the accused. But under Sec. 63 the defence (accused) has to prove the grounds on which he can be excused. Any misstatement in the prospectus per se shall attract the provision of Sec. 63 against all authorised persons having authority to issue the prospectus. But an expert required to make a statement under Sec. 58 or Sec. 60 having given his expert's consent shall not be deemed under Sec. 63 to have authorised the issue of the prospectus though he is treated as such under Sec. 62. In so far as burden of proof is concerned there is a difference between Sec. 63 and Sec. 68. As has been stated under Sec. 63 the burden of proof lies on the defence but in case of Sec. 68 the burden of proof that the statement was made knowingly or recklessly, lies on the plaintiff (prosecution). It may be noted that a person responsible for making a false statement for a wrongful gain or inflicting a wrongful loss on another may also be prosecuted under the criminal law. In such a case the prosecution has to prove the charge beyond any reasonable doubt. Liability of the Company for misstatement in the prospectus A company acting through its board of directors is responsible for a misstatement in the prospectus which forms the basis of contract between the allottee of a share and the company. The liability of the company in this regard depends upon the common law development in the area of contract of agency. The general principle is that a contract to take shares is voidable if it is induced by misrepresentation, whether fraudulent or innocent. Therefore, if there is a material misstatement in a prospectus which induced a person to invest in the company, he can, if he applies within a reasonable time and before the company goes into winding up proceedings, get his contract rescinded [See Sheromain Sugar Mills Ltd v. Debi Prasad AIR 1950 All 508]. It means the investor is entitled to get his money back with interest if he rescinds the contract. He cannot keep his share yet claim damages. The relief of rescission shall be available provided (a) The statement inducing the shareholder to invest in the shares or debentures, relates to a material fact ; and (b) The statement is untrue. Sec.65 explains the untrue statement as (i) a statement misleading in the form and context in which it is included; and (ii) where the omission of a matter is calculated to mislead. (c) The statement must have been actually relied upon by the shareholder. (d) The shareholder must proceed for rescission within a reasonable time and before the company goes into liquidation. A reasonable time shall be one calculated on the basis of taking action soon after coming to know of the misstatement. Where a person relies on a statement made by an agent, he has to prove that the statement made was 243
false and made while acting within the authority before the contract was made, and that the statement in fact was a misrepresentation. The right to rescind is lost in the following circumstances : (i) if after discovering the misstatement, the shareholder adopts the contract by paying calls or receiving dividend or attending and voting in a general meeting; or (ii) rescission becomes impossible, say when the company is in the winding up proceedings or suppose the shareholder has sold the share; or (iii) there is a lapse on the part of the shareholder in not taking any action after discovering the misstatement. 3.4 PREVENTION OF INSIDER TRADING What is insider trading? The act of a director or an official or employee of the company trading in his own companys securities and stocks for personal gain taking advantage of his access to price sensitive unpublished information on account of his being an insider, is known as insider trading. This is treated as the most henious corporate offence in the twentieth century in the corporate directors or officials or employees access to confidential information or price sensitive information in advance is an essential necessity in corporate management. Using these informations to the disadvantage of the company for personal gain, is a breach of fiduciary duties to the company. The insider the concerned director or manager of the employer is bound to account for the profit and compensate the company. But unless law tries to strictly deal with it, there is no such accountability or liability of any insider for his trading on any of his own companys securities to an outsider. An insider, a market disturbance through asymetry of information. As Gower (Modern Company Law, p. 607) puts it : "This is a practice which most countries have now recognised to be objectionable". Who is an insider ? The SEBI regulation on insider trading defines an insider to be a person who during the preceeding 8 months, is connected with the company and who may reasonably be expected to have an access to unpublished price sensitive information in respect of securities of that company or any other company and includes any other person who has received or has had an access to such unpublished price sensitive information. The regulation also interprets that a person means and includes (i) a natural person; (ii) a body corporate; (iii) a HUF; (iv) a trustee and (v) a partnership firm. Officers of a company who are generally the persons having access to price sensitive unpublished informations, means and includes (a) the managing director or managing directors; (b) the whole time director or directors; (c) the manager; (d) the secretary ; (e) any person in accordance with whose directions or instructions the board of directors of the company is accustomed to act; and (f) where any company does not have any of the officers specified in clauses (a) to (e), 244
any director or directors who may be specified by the board in this behalf or where no director is so specified all the directors. What is price sensitive information? The regulation defines unpublished price sensitive information as any information which related to specific matters pertaining to, or of concern directly or indirectly to a company and is not generally known or published by such company for general information, but which would if it were so published or generally known to them, be likely to materially affect the price of securities of that company or any other company in the market. The regulation gives an illustrative list to be of such information. These are: i) financial results (both half yearly and annual); ii) declaration of dividends (both half yearly and annual); iii) issue of shares by way of public, rights or bonus; iv) any major expansion or execution of new projects; v) amalgamation, mergers and take overs; vi) disposal of the whole or substantially the whole of the undertaking; vii) policy and taxation changes of the Government prior to announcement, and viii)extraordinary events such as strikes, lock outs, fire in the company, prohibition on dealings in securities, How to prevent insider trading According to Gower (Modern Company Law, p. 608) general equitable principle is, on its own, rarely an effective deterrent. Gower also pointed out that Stock Exchange regulation is not directly binding on directors. SEBI regulation against insider trading prohibited dealings of insiders in company securities. It stipulates that no insider shall (i) deal in securities of a company either in his own name or on behalf of any other person, on the basis of any unpublished price sensitive information; or (ii) communicate such information to any other person with or without his request for such information; or (iii) counsel or procure any other person to deal in securities of any company on the basis of information. Any insider who violates the provisions of the regulation shall be guilty of insider trading. SEBI may appoint one or more competent persons as inspectors to investigate the insider trading. These inspectors shall have the power to summon any person (a) to depose on oath any information concerning the allegation of insider trading; and (b) to produce any documents or books of accounts. Failure to comply with the above requirement or giving false information shall be punishable with a fine upto Rupees ten thousand or imprisonment for a term which may extend to six months or both. Any person found to have indulged in insider trading shall be(a) liable to pay a civil penalty not exceeding three times of the
profit gained or loss avoided as a result of the dealing ; or (b) (i) punishable with rigorous imprisonment for a term not exceeding 2 years or a fine not exceeding rupees five lakhs; (ii) or with both. In restricting insider trading it is necessary for the companies to incorporate some of the provisions of the Companies Act in England. These relate to (a) disclosure of dealings by directors and their families. Directors are prohibited form buying put or call options in the listed securities of the company or any other company under the same group ; (b) disclosure by substantial shareholders ; and (c) power of the Company to ascertain share ownership. Ultimately England had to legislate the Insider Dealing Act, 1985 by virtue of which insider trading has been criminalised. In fact, the criminalisation of this act started from USA. Gower also refers to the Chinese Wall device invented in USA primarily to protect multipurpose financial firms, against liability for insider trading, by establishing arrangements designed to prevent knowledge of price sensitive information held by members of one branch of the business being passed on to members of another branch and the firm itself being deemed to have knowledge of it. 3.5 OTHER INSTITUTIONAL PROTECTION (a) Listing: Listing means admission of securities of any Company to be dealt with in a recognised Stock Exchange. The term securities has been defined under Sec. 2 of the Securities Contract (Regulation) Act, 1956. It means and includes (a) shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or any incorporated company or any other body corporate ; (b) Government securities ; (c) such other instruments as may be declared by the Central Government to be securities ; and (d) rights or interest in securities. These securities can be listed in a recognised Stock Exchange. A recognised Stock Exchange is a Stock Exchange which is for the time being recognised by Central Government under Sec.4 of the Securities Contract (Regulation) Act, 1956. Types of Listing Listing of securities is of 5 types. These are : (i) Initial Listing Initial Listing is made by companies of securities not listed earlier by following procedure applicable to initial listing. The company has to apply for listing its securities in the prescribed form, alongwith a listing agreement duly executed and stamped on a non-judicial stamp paper and an application fee. A public company while applying for listing its securities is also bound to submit alongwith the application for listing and documents stated above, its memorandum of association ; debenture trust deed, copy of prospectus or the statement in lieu of prospectus; copies of offers for sale and circulars for advertisement offering any securities during the past 5 years; copies of balance sheet for the past 5 years; a statement showing dividends and cash bounses; particulars of shares and debentures issued; and shares forfeited; a list of ten
highest shareholders of each class or kind of securities; certified copies of agreement between vendors and promoters, underwriters and sub-underwriters, brokers and sub-brokers, and selling agents, managing directors and technical directors etc; and a brief history of the company since its incorporation. (ii) Listing of public issues of shares and debentures A company whose shares are listed on a recognized Stock Exchange has to submit necessary application to Stock Exchange for listing of its securities before a public issue. However a greenfield company may have to take all the steps of initial listing. (iii) Listing of rights issue Companies whose securities are already listed have to list shares and or debentures allotted by way of rights. (iv) Listing of bonus shares Under the listing agreement necessary application is to be made for official quotation of the bonus shares. (v) Listing of shares issued on amalgamation and merger Amalgamated companies which issue shares to the shareholders of the amalgamating companies have to get their shares listed on the Stock Exchange. Conditions precedent for listing The following conditions are generally imposed on companies applying for listing of their securities. These are 1) Minimum public offer - a company desiring to have its securities listed has to offer atleast 60% of its listed securities through the prospectus for public subscription [See Rule 19(2) of Securities Contracts (Regulation) Rules, 1957]. There has been a revision by relaxation of Rule 19(2) recently for the Non-FERA companies, new companies with foreign equity participation, joint sector companies, new companies with NRI equity participation, and companies promoted by one or more listed companies. 2) Minimum capital public offer and number of shareholders the company shall have a minimum issued capital of Rs.3 crores and minimum public offer of equity of not less than the limit stated earlier. It has also prescribed minimum number of shareholders. 3) Cost of public issue the cost of public issue has been limited to 5% of the public issue upto Rs.5 crores and 2% of the issue over Rs.5 crores. 4) Restrictions on transfers of shares belonging to promoters SEBI guidelines dated 11th June 1992 imposed a condition of restrictions on transferability of shares issued in the promoters quota for a stipulated period. A certificate in this regard has to be furnished to the Stock Exchange. 5) Stock Exchange requirements relating to prospectus and public issue this has already been discussed earlier in chapter 2. Is Listing Compulsory? According to Sec.73(i) of the Companies Act, it is obligatory for public company intending to offer shares or debentures to 245
the public, to make application to one or more recognised Stock Exchanges for listing of its securities. The prospectus has to contain details about the particulars of this application. Any allotment made by a company whose application for listing has been rejected within 10 weeks from the date of closing of subscription list, is void in law & the application money has to be returned. Advantages of Listing (i) Liquidity of investment by the investors is ensured. (ii) Right entitlement can be disposed through the market. (iii) Better loan facilities on listed securities. (iv) Investors right is protected under the rules of Stock Exchange. (v) Better quality of disclosure through semi-annual financial results. (vi) Take over bids are required to be announced to the public. (vii) Company gains national & international repute. (viii) It helps the company in mobilising resources. (ix) Tax concessions are available. (b) Credit Rating: The increase in the issue of Debt securities has led to a proliferation of information. The investor does not have the time or expertise to peruse the offer documents in order to determine the safety of the offer. This gave rise to specialized companies which studied the offer documents and gave an opinion on the adequacy of the safety of the proposed debt instrument. This is called as credit rating. Specialised companies make a credit rating of a company after critically examining the financial records of the company over a period of time. This type of credit rating is based upon various criteria. There are several managerial accounting methods including ratio accounting, to ascertain financial strength of the company. This type of credit rating initially started in USA according to the desire of corporations. Presently, the credit rating is taken by most of the public companies in the advanced world specially because it shows credit worthiness and helps in building up a financial stability and goodwill. Of course the standing of the credit rating agencies help the public companies to build up a climate of faith and trust by the investors. This credit rating is done absolutely on voluntary basis and through disclosures. It must be remembered that the public put faith on this certificate given by professionals and therefore, any statement which is misleading may be acted upon by the investors. In India, this type of credit rating was started by Credit Rating Information Services of India (CRISIL), an expert credit rating agency. Besides, big investors take their help in ascertaining the credit rating of companies with which they intend to establish relations by supplying all required informations and financial statements. But this type of credit rating is only privileged communication and can not be used for public purposes unless the company whose credit rating has been made gives its consent for public disclosure of this credit rating. CRISIL employs for credit rating both qualitative and quantitative criteria. The methodology 246
includes analysis of the past performance and assessment of the future prospects. Cash flow projections, working capital growth, debt servicing obligation, chances of raising funds at the quickest time etc.- these are taken into calculation. CRISIL looks as well at the operating efficiency of the company, to sectoral advantages, power and labour situations, nearest competitiors, technology agreements and 'issues relating' to financial and operational efficiency. At present, there is no legal regime in India for dealing with problems and issues of credit rating. c) Investment through Mutual Fund Mutual Funds are institutions that collectively manage the funds obtained from thousands of small investors. In the developed countries, small investors cannot and do not indulge in investment activities specially through share market. Capital market has become famous for its notoriety in affecting the investors interests. As such, big mutual funds and portfolio managers manage the funds obtained from small investors. The difference between mutual fund and portfolio management is that, mutual funds invest in their own name in the securities of public company. In exchange it issues shares, scrips or certificate of the mutual fund to its investors. A small investor has the protection against the capital loss because of superior management and he has the assurance of return and capital accretion. Besides the mutual funds stock, scrip or certificate is also easily transferable. So, a small investor does not directly invest in public companies. On the other hand, portfolio managers represent the individual investor in designing the investment pattern of his client. Portfolio managers therefore are essentially agents. The relation between the investor and portfolio managers is governed by the principles of Law of Agency, Mutual funds have different proprietal interest on the one hand it receives the investable money from thousands of investors against its own securities and on the other hand it buys securities of public companies and public undertakings as the owner of those securities. Many of these mutual funds are organised on the basis of trust. A trust is generally created for the benefit of the investors. A mutual fund can be formed by way of forming a company as well. With a view to facilitate the development and orderly functioning of the mutual funds in India, the Government of India has issued the following guidelines: I. Relating to establishment (i) Excepting mutual funds established by statutes, all other mutual funds require the approval of SEBI. 1A. All these mutual funds are to be constituted as trusts under the Indian Trust Act, the sponsoring institution will be free to work out the details regarding the constitution of the trust. 11B. All mutual funds formed in whatever way shall be required to register themselves with SEBI. (ii) & (iii) .x x x x x x x x x iv. The sponsoring institution must contribute atleast Rs.2 crores to the corpus of the mutual fund-
II. Relating to Management (i) Mutual funds are to be managed by professionals having proper qualifications/experience of industry, capital market or other relevant fields. (ii) Atleast 40% of the trustees should be persons of eminence in suitable fields and not associated with promoters. III. Relating to investment objectives and policies (i) Mutual funds shall not encourage term lending, except in case of consortium lending in associating with other financial institutions. (ii) It is expected to invest in stocks, bonds, securities and money market instruments. (iii) Money market instruments should normally be limited to 25% of the assets of the mutual fund for short term liquidity requirement. (iv) It should not invest in immovable property or undertake any property dealings, but may subscribe to bonds and debentures issued by institutions dealing in housing finance. (v) Only foreign mutual funds located abroad may enter into agency agreement with any foreign institution for a fund activity to be carried out in India, but only with the prior approval of RBI. IV. Regarding investment limitation (i) It shall not invest more than 5% of its assets in the shares of any company. (ii) It shall not invest in more than 5% of the shares of any company under any one scheme. (iii) The scrips purchased shall be registered in the funds name. (iv) It shall not borrow money or pledge assets in the normal course. If it is compelled to do so in an emergency situation, it must be reported to the SEBI. (v) It shall not normally keep deposits with companies. (vi) It shall not normally invest in another mutual fund. V. Regarding disclosure, pricing and valuation (i) Each scheme should clearly disclose the investment objectives. (ii) The maximum spread between purchase and sale price of units/shares of the scheme shall not exceed 7%. (iii) The valuation method of investment should be announced before hand. The time lag between successive valuations should not exceed 6 months. VI. Regarding distribution policy (i) Depreciation on investment held and provision for bad and doubtful debts should be adequately provided. (ii) A dividend equilisation fund has to be created in order to avoid sharp annual variations in dividends. (iii) Mutual fund must distribute 90% or more of income earned as dividends
VII. Regarding settlement of accounts (i) Each scheme shall have separate accounts. (ii) Each scheme must have separate statement of accounts showing assets and liabilities, income and expenditure. (iii) Affairs of the mutual fund shall be audited. (iv) Accounting and disclosure requirements shall be prescribed by SEBI. (v) Disclosure guidelines issued by the government relating to institutional transactions in shares shall be applicable to mutual funds. Guidelines has also been given on development and regulation of Mutual Funds in order to develop and regulate Mutual Funds for ensuring investors interest. (d) Portfolio Management The role of portfolio management and mutual fund has already been discussed above. It has already been stated that portfolio manager performs specialized agency functions, to properly deploy the clients money maximally beneficial to him, which includes decisions on buying and selling of shares, scrips and securities at the most appropriate time in the open market. A regulation has been made by SEBI on portfolio managers. The regulation can be summarised as follows: (i) On Portfolio Management- Merchant bankers of category I & II are authorised to render portfolio management services. The contract between the portfolio manager and the client shall define the exact relationship including inter alia the investment objectives; area of investments and restrictions imposed. The portfolio management shall be in the nature of investment consultancy and management. The contract shall also deal with the procedure of settling the clients accounts. (ii) Client relationship - The relationship is fiduciary in character. As such the portfolio manager acts both as an agent and a trustee. He takes decisions as a man of prudence who take decisions in regard to his own funds. He takes instructions from his client and shall not deal on any security on the basis of price sensitive classified information. He shall observe a high standard of integrity and fair dealing. He shall keep clients fund separate from his own funds. Portfolio managers shall not pledge, or give on loan or otherwise, securities held on behalf of clients to a third person. (iii) Investment tenure The tenure shall not be less than a period of 1 year. Any renewal shall be deemed to be a fresh placement and shall again be deemed to be for a minimum period of 1 year. (iv) Investment of clients funds This shall be made in money market and capital market instruments. But the funds must not be deployed in bill discounting, badla financing or lending. Appropriate records must be maintained. The portfolio manager shall not indulge in speculative activities. Purchase and sale of securities must be kept separate for each client. He shall ensure best execution of clients deal, and avoid any conflict of interest. 247
Wherever necessary he shall take adequate steps for registration of clients securities and for claiming and receiving dividends, interest payments and other rights accruing to the investors. (v) Periodical reports The contract shall include provisions for submission of periodical reports to the clients, but not exceeding a gap of 6 months between two reports. The report shall comprise composition and value of portfolio ; transactions undertaken during the period ; beneficial interest received including bonus and rights and expenses incurred. At the end of the period the portfolio manager has to give a termination report settling the accounts. The client shall have the right to inspect the books of accounts. The books of accounts and other records shall be audited yearly by an external auditor. (vi) SEBIs regulatory power The portfolio manager shall submit to SEBI such reports, returns and documents as has been prescribed or called for SEBI may investigate the affairs and contracts of the portfolio manager, and in the event of violation of any provision suspend the portfolio manager and cancel his regulation. 3.6 PROTECTION OF MINORITY INTEREST Any memmber of a company who complains that the affairs of a company are being conducted in a manner oppressive to any member or members, may apply to the court for an order : 1. under Sec.397 for the redressal, or 2. under Sec.433 (f) for winding up of the company on just and equitable grounds. Under Sec.397 of the Companies Act, court may make such order as it thinks fit with a view to bringing the oppression to an end. Of course in order to make such an order the court has to come to an opinion that (a) there is oppression to any member(s) ; (b) that the winding up of the company would unfairly prejudice such members though on the ground of just and equitable principle, the company should be wound-up. Who can apply under Sec. 397? The right to apply is given to 100 or more members or 1/10th the total number of members or any member(s) holding not less than 1/10th of the issued capital of the company. Any member(s) having obtained in writing the consent of the requisite number of members may apply. Of course the right to apply is not confined to an oppressed minority of shareholders alone as under Sec.397, an oppressed majority may also apply. It is also not necessary that the applicant has to suffer personal prejudice. Bombay High Court in Killick Nixon Ltd v. Bank of India [1982 Tax L.R 257] held that, no personal prejudice need be caused to a member who applies for relief under this section. The only cause of action which is required to be proved is that the affairs of the company are conducted in a manner oppressive to any member or members. Where after the applicant having obtained the requisite number of consents 248
institutes the proceedings, and later on some of the members withdraw their consent, the right of the applicant to proceed with the application before the court of law cannot be affected. In Rajahmundry Electric Supply Corp. v. Nageshwara Rao [AIR 1956 SC 213] the court held that the validity of the application must be judged on the facts as they were at the time of presentation of application. Requirements for an application U/Sec.397 In Shanti Prasad Jain v. Kalinga Tubes Ltd [(1965) 35 Comp.Cas 351] the Supreme Court after reviewing the leading authorities has expressed the position thus: it is not enough to show that there is a just and equitable cause for winding up of the company, though that must be shown as a preliminary to the application of Sec.397. It must further be shown that the conduct of the majority shareholders was oppressive to the minority as members and this requires that events have to be considered not in isolation but as a part of a consecutive story. There must be continuous acts on the part of the majority shareholders continuing upto the date of petition, showing that the affairs of the company were being conducted in a manner oppressive to some part of the members. The conduct must be burdensome, harsh and wrongful, and mere lack of confidence between the majority shareholders and the minority shareholders would not be enough unless the lack of confidence springs from oppression of a minority by a majority in the management of the companys affairs and such oppression must involve atleast an element of lack of probity or fair dealing to a member in the matter of his proprietary rights as a shareholder. The position has been made very clear in this case. A conduct which lacks in probity, a conduct which is unfair to and which causes prejudice to the petitioner in the exercise of his legal and proprietary rights as a shareholder must be shown to exist. [See Needle Industries India Ltd v. Needle Industries (Newly) India Holding Ltd. [(1981) 51 Comp. Cas 743]. Meaning of the word oppression Lord Keith understood the word oppression as a lack of probity and fair dealing in the affairs of the company to the prejudice of some portion of its members. Lord Denning meant oppression in a more wider way. According to him, the affairs of a company can in my opinion be conducted oppressively by the directors doing nothing to defend its interests when they ought to do something just as they can conduct its affairs oppressively by doing something injurious to its interests when they ought not to do it. In Needle Industries India Ltds case it was held as an obiter that unwise, inefficient or careless conduct of a director in the performance of his duty cannot give rise to a claim for relief under this section. Oppression may take different forms, as for example, it may be merely vindictive [See In re H.R. Hammer Ltd. (1958) 3 All E.R. 689]; denial of rights [See In re Hindustan Cooperative insurance society AIR 1961 Cal 443]; or exercise of force to oust from power [See Ram Shankar Prasad v, Sindri Iron Foundry Pvt. Ltd (1961)1 Comp. L.J. 310]}
One single unlawful act may not necessarily by itself create oppression, but a series of illegal acts may constitute one. In Re Five Minute Car Wash Service Ltd [(1966)1 All ER 242] it was held that unwise inefficient and careless in the performance in his duties (duties of the Directors) do not make out a case of oppressive conduct within the meaning of the section and a petition limited to such allegations will be dismissed in limine. A conduct becomes oppressive if it is (i) continuous ; (ii) burdensome, harsh and wrongful, and (iii) lack of probity and fair dealing. These tests envisaged in Kalinga Tubes by the Supreme Court of India, have been referred earlier. In Re Hindustan Co-operative Insurance Society (AIR 1961 Cal 443) the directors of the company having the backing of the majority shareholders did not call any general meeting of the company, nor did they place the annual accounts before the shareholders for the year ending 31.12.1955. Besides 1/3rd of the directors required to retire by rotation did not do so and continued wrongfully. It was held that such was the situation required to be dealt with Ss.397 and 402. Similarly in Gajarabar v. Patny Transport [AIR 1966 AP 226] two of the three directors of the board withheld transfer of shares of one party to the petition due to their personal disputes and vindictiveness. It was held to be oppressive. Courts power to give order: Under Sec. 397 the court may give any order as it may think fit. Sec. 402 however has provided a list of order that the court may give in this situation. These are not exhaustive but indicative of the nature of order that the court may give. The court under the order may provide for : (a) the regulation of the conduct of the companys affairs in future ; (b) the pruchase of the shares or interests of any member of the company or by other members thereof or by the company; (c) the reduction of the companys capital where the company purchases any such shares ; (d) the termination, setting aside or modification of any agreement howsoever arrived at, between the company and its manager, managing director or any of its other directors; (e) the termination, setting aside or modification of any agreement between the company and any other person other than referred to in (d) after due notice to the concerned parties and in case of modification with the consent; (f) the setting aside of any transfer, delivery of goods, payment, execution or other act relating to property made or done by or against the company within three months before the date of application which would, if made, in an insolvency proceedings, make a fraudulent preference; (g) any other matter which, according to the court will be just and equitable. The court may also make an order altering in or adding to it. In such a case, the company in question shall not be entitled without the leave of the court, to make any further alteration in or addition to the Memorandum or the Articles, as may be concerned, which is inconsistent with the order. The alterations
or additions made thus by an order shall have the same effect as if they were duly made by a resolution of the company. A copy of the order is to be delivered by the company to the Registrar for registration within 30 days from the date of the order failing which a fine upto Rupees five thousand can be imposed on the company and its defaulting officials. Central Governments power to prevent oppression In addition to the courts power to provide remedies against oppression, the Central Government has also the power to achieve the same object through different process. According to Sec. 408 if at least 100 members or members holding 1/10th of the total voting power apply to the Central Government on the plea of oppression, or of its own motion the Central Government is satisfied after an inquiry that instances of oppression are present, it may : (i) appoint such number of persons either from its members or as it may think necessary, to hold office as directors of the company for such period not exceeding three years on any occassion; or (ii) direct the company to make fresh appointment of directors within such time as it may specify on the basis of proportional representation provided in Sec. 265; and (iii) until such appointment is made, specified persons shall hold office as additional directors of the company; Any such person appointed need not hold qualification shares and are removable only by the Central Government; and/or (iv) issue such directions to the company as it may consider necessary or appropriate in regard to its affairs; and (v) direct submission of report to it from time to time. The Central Government may also prevent a change in the board of directors under Sec. 409 if such a change is likely to affect the company prejudicially, on an application by the Managing director or any other director or the manager of the company. On such an application the Central Government shall have power to make an interim order as well. Under Sec. 388 B the Central Government has also the power to refer to the High Court if there are circumstances to show that the business of the company is or has been conducted and managed in order to defraud members (majority or minority). Sec. 388 B has specified several other grounds for referring to the High Court against managerial personnel. Based on the decision of the High Court, the Central Government shall remove the director from his office or any other person from management against whom there is a decision of the High Court. 3.7 PROTECTION AGAINST TAKE OVER Easy transferability of shares is one of the basic characteristics of public limited companies. The management and ownership of the company therefore depends upon either corporate action or shareholders transfering their shares through sale in the open market. In open market purchases a party may gain controlling shares of a company and take over its management. The word 249
take over has been used in two senses in the Companies Act, 1956. In Sec. 108A, take-over is used as bids by groups or companies to take over control and/or management and/or ownership of a company. In this sense take over is prejudicial to the interest of promotional and managerial group and also of non-controlling shareholders like public financial institutions. A recent incident that generated debate related to the take over bid of the Reliance group in Larsen & Toubro. The financial institutions took the fight to maintain the professional management structure of Larsen & Toubro. The second meaning of take over is taken from the spirit of Sec 395. According to Sec. 395 majority shareholders may in certain situation take over the shareholding from the minority shareholders. The main purpose of restricting 'take-over' through direct and open market purchase of shares was prevention of monopoly holding. But with the amendment of Monopolies and Restrictive Trade Practice Act recently, prevention or regulation of take over bids must have other objects. The previous Chairman of SEBI while arguing for RBI norms for prevention of take-over bids in private banks to be extended to the whole corporate sector under-lined the purpose of such regulation. According to him with the arrival of number of foreign institutional investors (FIIs) a number of technically strong companies would face the real threat of take over. Due protection to the management of these strong companies, is needed against hostile or predatory takeover. The fear of takeover has become a real threat to well managed and comparatively small Indian industries. Two basic questions therefore, come to terms. Firstly the efficient management may ask for protection against take over for short term gains that may destroy an efficient organisation. Secondly, the opposite question is why the law shall bring in regulation and control over the free sale and transfer of shares? Indian Companies Act, has so far, maintained mostly the anti-monopoly holding to be the main objective of regulating takeover bids. Sec. 108A which is inserted in the Companies Act by the Amendment Act of 1974 provides that no individual, group, firm body corporate or body corporates under the same management can acquire more than 25% of the paid up equity share capital of a company, unless previous approval of the Central Government is obtained. The contravention of this principle is a penal offence attracting imprisonment upto 3 years or with fine upto five thousand. Government through circulars clarified many of the issues. As for example : (1) Company or group already holding 25% or more shares before the provision is included in the Companies Act, is not required to seek permission to continue to hold the same. (2) Such a company acquiring further shares is required to take permission ; (3) Any share transfer, within the group already holding 25% shares or more, also requires approval; (4) No approval is necessary on right share issue unless the right share is renounced in favour of a person whose holding increases to the limit of 25% or more, in which case permission is to be obtained. The object of Sec. 108B is to prevent the change of management
of a company which is prejudicial to the interest of the company or to the public interest. In order to do this, Sec. 108B provides: (1) Every body corporate or body corporates under the same management singly or jointly holding 10% or more subscribed equity share of a company has to inform the Central Government before transfering any share or shares specifying shares proposed to be transfered, shareholding of the transferee and other particulars; (2) Where such transfer is prejudicial as stated earlier the Central Government may direct that no such shares shall be transferred to the proposed transferee. (3) If shares are transferred in contravention, every officer responsible may be punished with imprisonment upto 3 years and the company shall be punishable with fine upto five thousand. In England, a Panel on Take Over and Mergers was constituted at the request of the Bank of England. This panel overseas the City Code which according to Lord Denning was a guide to good commercial practice. The Code consisted of general principles and Rules, that concerned the provision of adequate and timely information to the shareholders and the general responsibilities of the boards of both the offeror and offeree companies. Shareholders must be in possession of all the facts and information so that they are in a position to evaluate merits and demerits of an offer. They must also have sufficient time to make an assessment and decision. It must be the object of both the parties to use every endeavour to prevent the creation of a false market in shares of either the offeror or the offeree company. 42 Rules in the Code are concerned about the disclosure of identity of the parties; stages of the transactions, consideration of the offer, documents and supporting instruments, dealings etc. Since in India such a detailed self regulatory prescriptions and a body overseeing the commercial practices are absent, the RBI guidelines on take overs in banking industries may need to be extended to all companies. A fair trading and competition requires take over bids to be regulated and prevented because in most of the take over bids there is asymetry of informations and unreasonable commercial advantages. Management of sound companies can be dislodged. Sec. 108D of the Companies Act empowers the Central Government to direct a company not to effect transfer where the Central Government is satisfied that as a result of the transfer of shares : (a) a change in the controlling interest of the company is likely to take place and that (b) such a change is prejudicial to the interest of the company or to the public interest. On shares already transfered and registered, the Central Government may direct the company not to permit the transferee or any nominee or proxy to exercise any vote or exercise other rights attached to such shares. The other form of take over specially provided for in Sec. 395 is the right of the majority shareholders to purchase the shares of the minority in a given situation. Whereas in the
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earlier prescription take over is meant as a coup and is prevented on special grounds, in Sec. 395 such a take over of the minority interest is specially provided for. According to Sec. 395 if under a scheme or contract a company is required to acquire shares or any class of shares which is approved by at least 90% of the shareholders of the transferor company, the transferee company may by giving a two months notice to the dissenting minority shareholders, shall be entitled and bound to acquire those shares unless the court orders otherwise. Generally speaking in amalgamation or absorbtion such a scheme is made to acquire the shares of the transferor company or companies. At this stage if at least 90% of the share holders agree to the proposal within 4 moths of proposing such scheme or contract, the transferee company gets the special right to acquire the minority interests. In amalgamation, two or more companies make resolutions to merge into one to enjoy better economy of scale. Amalgamation is merger of two or more companies, forming into a new company by dissolving the earlier companies. Based upon the agreements the shareholders of various companies receive consideration in the form of shares of the new company. In absorption one company purchases another company through an agreement of sale of the growing concern. The buying company may by acquiring shares through the Stock Exchange takeover the management of the absorbed company. Or the absorbed company may sell itself to the absorbing company through an agreement. In all such cases if a minority shareholding class holding not more than 10% shares stand in the way of this amalgamation or absorption, the majority shall have the power to buy the shares of the minority insuch terms and conditions as may be determined by the management. The same may be prevented if such an action can be successfully argued on the basis of fraud on the minority. As for example, suppose a company has three interest groups viz, groups A B & C. Suppose Group C held 10% interest. A and B can form another company and the management of the company A B & C, obviously regulated by AB may dispose the company to A & B company, compelling C to sell its shares to A & B company. This can be a fraud on the minority as C has been asked to sell the shares through a legal mechanism. In re Bugle Press Ltd. [(1960)3 All.E.R 791 (C.A)] it was held that the court will see that the scheme is not a mere device to enable the majority holders to expropriate the minority, unless the article so provided. In case where legal mechanism is applied to defraud the minority or oppress the minority may bring an action for winding up of the company on Just and equitable ground. According to Sec. 395 the power and duty to acquire shares of dissenting shareholders arises when a scheme or contract
approved by majority which the minority shareholders do not agree upon, on the following conditions : (a) a scheme or contract involving transfer of shares or any class of shares, has within four months after making of the offer by the transferee company, been approved by the holders of not less than nine-tenth in value of the shares of the transferor company ; (b) a notice has been given by the transferee company within two months after the expiry of the said four months specifying a desire to acquire the shares ; (c) terms to all holders of the shares of that class are same ; and (d) holders of the nine-tenth value of the shares or class of shares are not less than 3/4th in number of the total holders of those shares. In the above situation the transferee company shall be entitled and bound to acquire those shares. Of course a dissenting member can make an application to the court within one month from the date on which the notice is given and the court on such an application may think fit to order otherwise. Of course in calculating nine-tenth of the value of the shares, has already held by the nomince for the transferee company or by the transferee company shall not be taken into consideration. The following provisions are applicable in relation to every offer of a scheme or contract under Sec. 395: (i) the offer must contain all information as may be prescribed; (ii) a statement disclosing the steps to be taken or has been taken to raise necessary cash will be made available; (iii) acceptance to the offer must be presented to the Registrar for registration and no circular containing or recommending acceptance shall be issued until it is registered; (iv) for inadequate information the registration may be refused; and (v) an appeal shall lie to the court against such refusal. Valuation of such shares must be based upon certain principles. If the transaction appears to be unjust, or unfair or unconscionable or if the court is satisfied that the sanction of the majority has been obtained by fraud or by improper means the court will not make an order in favour of the transferee [See Viswanathan v. East India Distilleries and Sugar Factories Ltd (1957)27 Comp. Cases 175]. Since the terms must be similar to all holders, the test of responsibility and fairness shall depend upon whether it is fair to the shareholders as a whole.
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4. RAISING OF SHARE CAPITAL

SUB TOPICS 4.1 Types of Share Capital 4.2 Issue of Preference Shares 4.3 Frame-work for raising Capital: Law at a glance 4.4 Share issue, allotment, calls, forfeiture & re-issue 4.5 Commission and Brokerage 4.6 Regulation on purchase of own shares 4.1 TYPES OF SHARE CAPITAL A Company limited by Share or limited by guarantee but having a share capital is registered with a capital stipulated in the Memorandum of Association. This sets the limit of the capital that the company can raise from the public. This capital is known as Authorised Capital or Registered Capital or nominal capital. Share actually issued to the public for subscription determines the issued capital. Obviously, the issued capital cannot exceed the authorised capital. Out of the issued shares, shares actually subscribed, by the shareholders determine the subscribed capital. Subscribed capital may be either equal to the issued capital or may be less. Money actually called up and paid up for each share subscribed by the shareholders constitute the called up and paid up capital. According to Schedule VI, Part I, the Balance Sheet of a company has to divulge its various stages of share capital, viz, authorised, issued, subscribed, called up and paid up capital. Actually called up and paid up capital is the share capital of the company. Other stages of share capital are only for information. According to Sec. 148 where any notice, advertisement or official publication of a company contains authorised capital of the company, the document must also contain information about the subscribed capital of the company. Non compliance of this provision may entail a fine of Rupees One thousand for every responsible officer of the company. Thus the logic of corporate responsibility due to representative action cannot be extended. Or in other words, the law has cracked the corporate shell to fix up individual liability. In India, a public limited company having a share capital and a private limited company which is a subsidiary of a public limited company can issue only two types of shares (Sec.86). As such a company may have (a) Equity share capital, and (b) Preference share capital. According to Sec. 85(2) equity share capital means all share capital which is not preference share capital. A preference share capital means, according to Sec.85(1) capital fulfilling the following conditions: i) that in respect of dividends, carry preferential right to be paid at a fixed rate; and ii) that in respect of the return of capital, in the event of winding up of the company, a preferential right over the equity share capital. 252
Of course if a company registered before 1956 issued more than two types of shares, the arrangement shall not be affected due to the prescription of two types of shares under Sec. 86. Presently, a debate has come to surface on the rationality of restricting companies from issuing more than two types of shares. In many countries company may issue deferred ordinary shares with more voting rights. It is not understood as to why the managerial promoters may not be allowed to float such shares in order to protect themselves from the danger of over throwing from the management by various take over bids under cover. It is argued that companies must be free to issue any kind of shares with disproportionate voting rights if the companies so choose. Professional management groups can be encouraged to be associated with company promotion and management with such types of shares with disporoportionate voting rights. One of the argument against such 'disproportionate voting right shares' is that a small group may be allowed to monopolise its power through this technique and have control over a large size of public shareholders. This goes against the corporate democracy. As against this argument, the counter-argument given is that shareholders seldom, invest for participating in the democracy. They invest to get better return. So long management can give them adequate profit they are satisfed. Shares with disproportionate voting rights like defered ordinary shares ensures continuity of able management and makes take over bids under cover impossible. 4.2 ISSUE OF PREFERENCE SHARES Preference shares are, therefore, those where the holders have a preferential rights to a fixed dividend and a preferential right on the return of capital in the event of winding up against the equity shareholders (see Sec. 85). The preferential shares may be cumulative or non-cumulative. A cumulative preference shareholder has a preferential right to be paid any arrears of dividend due on shares for a number of years. As for example, a cumulative share paying a dividend of 10 percent shall have to be given 20 percent at the end of the second year if the company could not give 10% at the end of the first year. It means that the dividend cumulates over the period if it can not be paid every year. A non cumulative share is one where the preference shareholder cannot demand the arrears of dividend. In other words, if in a year dividend cannot be paid for inadequate income, the holder cannot demand the fixed rate of dividend for that year in the next year when there may be sufficient income of the company. Preference share can be participatory or non-participatory. A participatory preference share is one where the holder has a right to share in surplus profits by way of additional dividend (see Sec. 85 Explanation 1). As for example, if the preference shareholder is given the right to share on the profit initially say preferred dividend of 10% and then on profits in excess of
available after payment of 10% dividend to both preference and equity shareholders, such preference shares are known as participatory. A participatory shares has a right to share excess amount available after paying all liabilities, with the equity shareholders in the event of winding up. A non participatory share does not have such rights. These rights are specified in the constitutional documents like Memorandum and Articles. These are also stated in the offer documents. If so authorised by the articles, a company may issue redeemable preference shares which means the company can pay off this preference shareholders and take over those shares for cancellation. But it must be remembered that a preference shareholder is a shareholder and cannot claim a position of a creditor. "Preference shareholders cannot sue for the money due on the shares undertaken to be redeemed, and cannot, as a right, claim return of their share money except in winding up" (Ramaiya, p. 228). Specific issues to be noted in redeemable preference shares One of the basic principles in capital formation is that capital once formed cannot be reduced. Preference share capital is a part of the capital. Therefore, the redemption of preference share can be made possible only by repairing the deficiency in the capital structure with: (a) capitalisation of profit otherwise available for dividend by transferring the profit to the capital redemption fund; or (b) the fresh issue of shares which must take the place of the redeemed capital. (See for details Sec. 80). Profits which are otherwise available for dividend, are to be transferred to a capital redemption fund which shall form part of the capital. Such fund can be used for issue of bonus shares to the existing shareholders prorata. This is known as capitalisation of profit. As such the existing shareholders shall be receiving bonus shares instead of dividends. Preference shares may be redeemed at a premium. Premium payable in redemption is a loss which must be provided from (1) profit of the company or (2) share premium account or (3) both. If the preference shares in question were issued at a discount (under Sec. 79) the loss on the issue further rise with equal amount. The loss on issue and on redemption, is required to be written off out of the profit and/or share premium account if any. Redemption of preference shares should not be confused with purchase of own shares. This we shall discuss later with some detail. 4.3 FRAMEWORK FOR RAISING CAPITAL: LAW AT A GLANCE Sec. 60 : Registration of prospectus Sec. 72 : Application for and allotment of shares Sec. 69 : Prohibition of allotment if minimum subscription not received Sec. 71 : Effect of irregular allotment Sec. 75 : Return of allotment Sec. 76 : Power to pay Commission
Sec. 77 Sec. 78 Sec. 79 Sec. 80 Sec. 81 Sec. 85 Sec. 86 Sec. 91 Sec. 92 Sec. 94 Sec. 94A Sec. 95
Restriction to purchase of own shares Share issued at a premium Share issued at a discount Power to issue redeemable preference shares Further issue share forfeiture and reissue Kinds of share capital Only two kinds of share capital Calls Uncalled amount when acceptable Alteration of share capital Stand altered Notice to Registrar for consolidation or conversion of shares Sec. 100 : Reduction of Share Capital Cancellation of unissued share. 4.4 SHARE ISSUE, ALLOTMENT, CALLS, FORFEITURE & REISSUE (a) Share Issue Under the Companies Act, a company is not deemed to have a share capital. In case a company has a share capital either limited by share or guarantee, the company has to issue shares privately or publicly or to the existing members themselves. We have already seen that a company cannot issue shares to the public without issuing a prospectus. In case a public limited company having a share capital or a private limited company subsidiary to a public limited company, issue shares to private parties, a statement in lieu of prospectus is necessary to be issued and registered. The said company has to issue share only by issuing a prospectus or a statement in lieu of prospectus. In evey public issue the company proposes the amount of the issue through the prospectus. An issued capital is one, as already stated, which is offered to the public for subscription. (b) Allotment Allotment is acceptance of offer to purchase a share/debenture expressed formally through an application for a share/debenture. Allotment is agreement to issue a share/debenture generally communicated through a letter. Allotment is not defined in the Companies Act. In Re Calcutta Stock Exchange Association Ltd [(1957) 27 Comp. Cases 559 (Cal)], the Calcutta High Court explained allotment as "division of the share capital into definite shares of a particular value, and assignment of such shares to different persons". Some of the baisc rules of allotment are explained below: (i) No allotment without application: According to Sec. 56(2) no one shall issue any form of application for shares in or debentures of a company, unless the form is accompanied by a prospectus. It means that a formal application is needed for applying a share. Besides as per Sec. 41(2) a person becomes a member of a company if he agrees to become 253
: : : : : : : : : : : :
the member (shareholder) in writing. This means that allotment of shares/debentures cannot be made without a formal application. The view given in Sree Ayyanar Spinning & Weaving Mills Ltd v. V.V.V. Rajendran [(1973) 43 Comp. Cases 225 (Mad)] is erroneous because in this case Justice Ramanujam has expressed the view that the Companies Act 1956 nowhere provided a written application for the allotment of shares. It seems that the judge did not take Sec. 41 (2) of the Companies Act into consideration. In India, an oral offer to purchase shares/ debentures of a company does not have any value and allotment cannot be made on oral offer. (ii) No allotment unless minimum subscription raised: The prospectus contains the statement of minimum subscription that the company has to receive before it can allot shares. 'Minimum subscription' is the minimum amount that must be raised to carry on the programme for which shares are issued. If this suggested minimum subscription is not raised, shares cannot be allotted. According to Sec. 69(1) no allotment shall be made of any share capital of a company offered to the public for subscription, unless the amount stated in the prospectus as the minimum amount which, in the opinion of the Board of Directors, mus be raised by the issue of share capital in order to provide for the matters specified in clause 5 of Schedule II has been subscribed, and the sum payable on the company, whether in cash or by a cheque or other instrument which has been paid. (iii) No allotment unless statement in lieu of prospectus delivered: A public company having a share capital may not issue shares to the public. Such company may issue shares on private placement. But it cannot allot shares or debentures unless there has been delivered to the Registrar for registration a statement in lieu of prospectus (See for details Sec. 70). (iv) Minimum time to proceed with allotment: No proceedings can be taken on the application for shares or debentures in order to allot shares or debentures as the case may be, until the beginning of the fifth day after that on which the prospectus is first so issued or such later time as may be specified in the prospectus. When a prospectus is first issued, generally a public notice is given by the person responsible under Sec. 62 limiting his liability. Allotment cannot be made until beginning of the fifth day after that on which such public notice is given (See Sec. 72). This provision require four clear days to the public for responding upon the prospectus. Such minimum time is provided for in order to check close holding on a public issue. Public in general must be given sufficient opportunity to apply for the shares. Irregular allotment and consequences An allotment in contravention of any of the above requirements shall make the allotment irregular. But all irregular allotments do not follow with same consequence. It is therefore necessary to understand the nature of irregular allotments to decide about the fate of the allotment. 254
(i) Irregular allotment on account of minimum subscription being not raised before allotment of shares or where filing of a statement in lieu of prospectus is necessary but not done before allotment is made (irregular allotment under Sec. 69 and 70), the contract is voidable at the option of the shareholder within two months after the holding of the statutory meeting or where company is required to hold a statutory meeting or allotment is made after holding the statutory meeting, within two months from the date of allotment (See Sec. 71). Now suppose the company goes into winding up proceeding during this two months period the contract remains voidable even during the course of winding up. Besides, directors of the company who have knowingly or wilfully contravene the provision by irregular allotment are civilly liable to compensate the company and the allottee any loss that may have been sustained. (ii) Allotment to a person who has not applied for the shares or debentures, is ab initio void because under Sec. 41(2) of the Company's Act, a written agreement is necessary. Of course in Sree Ayyanar Spinning and Weaving Mills Ltd (cited earlier) Madras High Court has given an opposite opinion but the statutory provision is clear requiring a written application under Sec. 56(2) and a written contract under Sec. 41(2). Of course it may still be agreed that Sec.56 has not clearly indicated that application cannot be made otherwise than applying through the 'application form' as provided in Sec. 56(2). Similarly a written agreement may not necessarily involve a written offer. Sec. 41(2) only requires a written agreement. It has not mentioned about written offer. An oral offer and acceptance written thereafter into a document of agreement or memorandum of understanding 'MOU' is a written agreement. Such type of argument is unfounded because positive interpretation of communication of prospectus in the application form itself underlines that one cannot apply for shares and debentures in any manner. It has to be only processed through an application form. (iii) Where the allotment is irregular because it is made within five days after the prospectus is issued, the allotment is valid but penal. Every officer of the company working in default shall be punishable with fine upto five thousand rupees [Sec. 72(2)]. Jurisprudentially the argument seems to be a difficult proposition to accept. An act which is penal cannot prouduce a valid result. This is the fundamental basic proposition of criminalization. In response to such an observation one may argue that in so far as the agreement between the allotee and the company is concerned, the agreement is perfectly valid because there is no violation of contractual term. It is in the interest of a third party (public in general) that the prescription is made. As such, it is a statutory norm violation inside the management of the company for which a penalty is imposed on defaulting officials. (iv) Allotment to be void in case of default in listing requirement: Where a prospectus stipulated that application has been made or will be made for listing of shares in one
or more recognised stock exchanges, the prospectus must contain the name or names of such recognised Stock Exchange/s to which application has either been made or shall be made. If permission has been refused before the expiry of ten weeks from the date of the closing of the subscription list the allotment becomes void (Sec. 73). If an appeal is made under Sec. 22 of the Securities Contract (Regulation) Act, 1956 against the refusal of the provision, the allotment shall not be void until the appeal is disposed of. Where the application for permission under Sec. 73 is not made or if made, refused by the concerned Stock Exchange, the company shall forthwith repay the application money received from the public. If such money is not paid within 8 days after the company becomes liable to pay, the directors of the company shall be jointly and severally liable to pay the amount with 12% interest per annum. If permission is not granted within 10 weeks, action shall be taken on the assumption that the permission is not granted for the purpose of Sec. 73. Default under this section attracts punishment to evey officer responsible for the default. The punishment is fine extendable upto five thousand rupees. But if the default continues over a period of six months it may involve imprisonment upto one year. Sec. 73 is a complete code on the issue and the readers are advised to read this section critically. Allotment of share in case of over-subscription When total number of shares/debentures applied for is higher than the number of shares/debentures offered to the public, it is known as over-subscription. In such a case public policy demands promotion of interest of the small investors and ensuring widest possible dispersal of shareholding. That prompted the Government to issue a circular (No. F1/25/SE/78 dated 26.7.78) asking the recognised Stock exchanges to settle the matter for the listing of shares in the following manner: (a) The allotment is made predominantly in favour of the applicants in the lower categories of 50 to 200 shares of the face value of Rs. 10 each. The allotment by drawal of lots, wherever necessary, should begin with 25 shares and should be increased progressively in multiples thereof. It should be the effort to have about 200 shareholders for evey Rs. 1 Lakh. Share capital issued/offered for sale; specially in case of issues over-subscribed by more than 10 times. (b) The allotment per applicant does not in any event exceed 500 shares of the face value of Rs. 10 each. In case of excessively heavy over- subscription, say issue oversubscribed by more than 20 times, the celing can even be reduced to 250 shares per applicant. (c) If allotment of more than 500 shares per applicant is essential, prior permission from the government be taken: Two types of questions may be raised in this regared. Firstly, is such a circular instruction binding? Secondly, should the policy determination be not left with the company instead of taking it from government? The first question related to administrative
law. Whether a circular, guideline or instruction has the validity of law is to be examined in the light of whether the same act is covered by delegated legislation i.e., whether, under the statute, government is empowered to issue the same. If it is not covered by delegated legislation, the action remains as an executive instruction. The second question relates to policy issues. How far freedom is to be allowed to individuals to take a decision on public policy? Can a government absolutely abdicate itself from guiding individuals on public policy issues? Return as to allotment After making allotment of shares, the company shall within 30 days thereafter, file with the Registrar a return of the allotment stating the number and nominal amount of the shares allotted, names, addresses and occupation of the allottees and the amount paid and/or payable on each share. A share issued in discharge of a debt is considered as share issued in cash [circular No. 8/ 4/69 dated 18.11.1969; see Sec. 75 also]. The return must not include a share as allotted for cash where the cash has not been received. The return has also to include shares allotted as fully or partly paid otherwise than in cash. Number and nominal amount of the shares so allotted, the extent of which they are to be treated as paid up and the consideration for which they have been allotted are also to be stated. The company has to produce for inspection and examination of the Registrar a contract in writing constituting the title of the allottee. In case the shares are issued at a discount, the return has to accompany a copy of the resolution passed authorising the issue at a discount, a copy of the order of the Company Law Board sanctioning the issue and where the discount rate is more than 10%, a copy of the order of the Central Government authorising the rate. In case of issue of bonus shares, the return statement shall contain number and nominal value of the shares, names, addresses and occupation of the allottees and a copy of the resolution authorising the issue. The Registrar may extend the time in case he is satisfied on an application that 30 days time is inadequate. If default is made in filing the return, every officer is punishable with a fine of Rupees five hundred for every day, during which the default continues (Sec. 75). The Registrar cannot refuse to accept a return perfectly in order on the substantial question of legal validity of allotment. As for example, he cannot raise issues like share allotted to a minor or shares allotted within 5 days from the date of issue of prospectus etc. If the return is in order under Sec. 75, the obligation of the Company in so far as submission of return is discharged. In Golkonda Industries (P) Ltd v. Registrar of Companies [(1918) 1 Comp. L.J. 245] the full bench of the Delhi High Court held that where a return of allotment is made and it is otherwise in order the Registrar cannot enquire into the legal validity of the matters concerned in the return. Is share allotment a transfer of property? A company creates shares. Can it be called owner of these shares before allotment? In re Calcutta Share Exchange Association Ltd [(1957) 27 Comp. Cases 559] allotment has been understood as creation of lots of shares and then the division of 255
them into value and classes and lastly allocation of them to various persons? Understanding share in this section brings confusion. Shares are not something as a property created a priori and then selling them. It is not like a furniture that is created and then sold. Therefore, the person who creates it has a proprietary interest. A share is a certificate acknowledging that the holder whose name is inscribed in it has contributed the stated amount towards the capital of the company. Therefore, share is not something created a priori. Unless anyone subscribes towards the capital, those certificates already printed without having any specific name inscribed remain as merely scrap of papers or stationery. Only when the appropriate portion of capital is contributed by a shareholder, the certificate gets into a proprietorial document in the hand of the shareholders. In Raj Sachdeva v. Board of Revenue [AIR 1959 All 595] the matter was debated. It was held that an agreement to allot shares or an allotment of shares is not a transfer of property, as the company which allots the shares is not in any sense an owner of the shares which it creates. The agreement will therefore, cannot be liable to stamp duty as a conveyance. (c) Calls on shares Calls has not been defined in the Companies Act. Generally speaking the nominal value of the shares and the share premium if any, are collected from the shareholder in some instalments. The amount fixed to be paid at the time of application is known as application money. When the share is allotted the allotment letter asks the allottee to pay the second instalment, known as allotment money. Subsequently as and when company requires further sum, company asks its shareholders by a call to pay a part of the balance amount on the shares. These cases are known as 'Call on shares'. It is a call to pay an instalment. The final call with which share becomes completely paid, is known as final call. Calls are generally numbered. As for example, instalment called after receiving allotment money, is known as first call. The next is known as second call. The final instalment, is known as last and final call. As for example, suppose the nominal value of a share is Rs. 100. Suppose twenty rupees are asked to be deposited along with application. This application money is required to be kept in a bank. The money cannot be used until shares are allotted. Suppose, the allotment letter asks to pay another twenty rupees. This amount is known as allotment money. On each share balance due is (Rs. 100-40) Rs. 60.00. Suppose after three months company required a further sum and gives a call to pay another twenty rupees, this call is known as first call. Following call for another twenty rupees is the second call and the last twenty rupees could be asked for by the last and final call. Regulations for management of a company limited by shares provided in Table A of Schedule I contain regulation about calls in Regs. 13 to 18. These regulations provide: (a) no call shall exceed one-fourth of the nominal value of the share or (b) payable at less than one month from the date fixed for the payment of last proceeding call; 256
(c) a fourteen days notice specifying the time or times and place of payment. The Board of Directors shall authorise the call. Joint holders of a share are jointly or severally liable to pay all calls. If payment is not made in time, the shareholders shall pay the sum with interest at five percent per annum. For non payment of calls and interest, shares are liable to be forfeited. If a call is made in contravention of the regulation provided in the articles, it may become invalid. In Re Cawley & Co (42 Ch.D 209) the diretors passed a resolution fixing the amount of the call but omitted to fix the date of payment. It was held that there was no valid call. A share holder is not liable to pay against a call not valid. He can obtain an injunction restraining the directors to forfeit his shares for non payment of a call not validly given. According to Sec. 91 any calls for further share capital shall be made on a uniform basis on all shares falling under the same class. If a partly paid up share is transferred the transferor transfers his rights to future payments and liability for the future calls. But If a call is given before a share is transferred the transferor apparently remains liable in absence of a specific contract otherwise between the transferor and the transferee. Power of the Company to receive uncalled amount According to Sec. 92 a company may receive the amount uncalled if the company is so authorised by its articles. The amount is kept in a 'calls in advance account as a part of the share capital account. (d) Forfeiture of share: The power to forfeit shares is provided in the articles of a company. Regulation 29 of Table A, Schedule I of the Companies Act, stipulates that if a member fails to pay any call, or instalment of a call, the Board may serve a notice of forfeiture calling the shareholder to pay the call money and the interest thereon within a specified date failing which the share would be forfeited. If the requirements of the notice are not complied with, the Board of Directors may forfeit the shares by a resolution of the Board. Can the articles of a company provide for forfeiture of a share for any other debt? In the Calcutta Stock Exchange Association Ltd v. S.N. Nandy & Co [ILR (1950) Cal 235] the Calcutta High Court held that a company may by its articles provide for grounds of forfeiture other than non-payment of calls. While approving this decision Supreme Court of India held in Naresh Chandra v. The Calcutta Stock Exchange Association Ltd (AIR 1971 SC 422) that articles 22, 24, 26, 27 and 29 of the Articles of Association of the Calcutta Stock Exchange which expressly provided that in the event of a member failing to carry out the engagement and the conditions specified in those articles, his share would stand forfeited, were valid. Forfeiture of share in this manner is inconsistent with the philosophy of limited liability In Corporate System. Reason demands that forfeiture is allowed according to the provision of the articles only for non-payment of calls and not for any other dues. The Company court in England in Hopkinson v. Martiner Harley & Co [(1917)1 Ch 646] rightly observed that forfeiture of share for any other debt is in excess
of authority and such power is invalid as an unauthorised reduction of capital. Forfeiture of share is a very delicate issue as it may involve permanent reduction of capital. The articles must include a clear procedure and the shareholder can insist on the strict implementation of the procedure before the shares are forfeited. A procedural justice is required to be ensured failing which the forfeiture may be rendered null and void. In Re New Chilie etc, Co. [(1890)45 Ch.D 598] the Court suggested that in case of irregularities in forfeiture, the aggrieved shareholder may sue the company for damages. According to the decision of the Supreme Court in Public Passenger Service v. M.A. Khader (AIR 1966 SC 489) the Board has to exercise the power of forfeiture like a trust, for the benefit of the company. A share forfeited for a personal gain of a director is considered an abuse of power. If a share is forfeited the shareholder ceases to be a member with effect from the date of forfeiture. He cannot be asked to pay unpaid calls on the shares in future. Unless the article provide for it, the dues on unpaid calls becomes an ordinary debt [See Indian Cooperative Navigation Co v. Padamsey (36 Bom. L.R. 32). Reissue of forfeited shares: A share forfeited becomes the property of the company. The company may, if provided in the articles :(a) reissue the shares on such terms and in such manner as the Board thinks fit; or (b) cancel the forfeited share. In fact, cancellation of forfeited share reduces the share capital. In Bishhambharan v. Agra Electric Stores Ltd (AIR 1954 All 541) the Court held that the company is not bound to reissue a share forfeited for non-payment of calls. But if the articles provide for any other ground for forfeiture without providing for reissue of the same the forfeiture shall amount to reduction of capital. Since the forfeited share becomes the property of the company, the company has reissued the share in favour of the person to whom it has been resold. The company may resell the partly paid up share at any price which may be less than the amount actually paid up on such shares. But the new holder has to pay the amount due on the share because the company sells the share free from that liability. Thus the companys total receipt on the share cannot in any way be less than the original value of the share (with share premium if any). Reissue is not an allotment as per Sec. 75(5) and no return is required to be filed with registrar on such reissue of the forfeited shares. 4.5 COMMISSION AND BROKERAGE In the Corporate world many specialised financial agencies started operating during the twentieth century as intermediaries specially in securing public subscriptions and ensuring easy transferability of shares and stocks. Some of these intermediaries institutions are:
i) Underwriters, ii) brokers and iii) portfolio managers. i) Underwriters: Persons who run an agency to procure subscriptions and give an assured public subscription in the event of issue of shares or debentures of a company are called underwriters. They subscribe to the share/debenture if it fails to secure the assured quota of public subscription. In India many public institutions like LIC, GIC or UTI carry on this type of activity along with many private underwriting agencies. In Nani Gopal Lahiri v. State of U.P. [(1965) 35 Comp. Cases 30 (SC)] the Supreme Court narrated the job of an underwriter and advantages of underwriting. According to the Court "Underwriting is in the nature of an insurance against the possibility of inadequate subscription. A public company cannot proceed to allot shares offered to the public, unless the amount specified in the prospectus as the minimum subscription is raised by the issue of shares ... an underwriter is entitled to enter into subsidiary agreements with which the company is not concerned. ....... The underwriting agreement being a contract that the underwriter will either himself purchase or procure purchasers for the shares underwritten by him, it is no concern of the company as to how the underwriter procures the purchasers". As per SEBI guidelines, underwriting is mandatory for the full issue i.e., to net offer to the public. The lead manager to the issue must satisfy himself about the net worth of the underwriters and the outstanding commitments and disclose the same to SEBI. A statement to the effect that in the opinion of the lead managers, the underwriters assets are adequate to meet their obligation should be incorporated in the prospectus. Underwriting Commission According to Sec. 76(1) a company may pay a commission to any person in consideration of his : (1) subscribing or agreeing to subscribe or (2) procuring or agreeing to procure for any shares in or debentures of the company subject to the following conditions (i) the payment of commission must be authorised by the articles, (ii) commission must not exceed 5% in case of shares, 2 1/2% in case of debentures or the amount authorised by the articles, whichever is less; (iii) the rate of commission to be disclosed in the prospectus or in the statement in lieu of prospectus, as the case may be; (iv) the underwritten amount of shares or debentures must be stated in the prospectus or in the statement in lieu of prospectus, as the case may be; (v) a copy of the contract for the payment of the commission to the underwriters is delivered to the Registrar. No company can pay any commission or discount directly or indirectly save as aforesaid, on the issue of shares or debentures. Of course over and above, brokerage can be paid. In Sec. 76(4A) 257
it has been further prescribed that no commission shall be paid on shares or debentures to any person not offered to the public for subscription. The Central Government vide its letter No F/14/1/ SE/85 dated 7 May 1985 to recognise Stock Exchanges stipulated the maximum underwriting Commission as follows :
Types of Shares/debentures On share amount devolved to underwriters 2.5% On public subscription 2.5%
proposed to issue 1,20,000 shares of 1 each on the term that a bonus of 7% would be returned to the applicants and a commission of 10% would be paid to the guarantors. It was held that it was an issue of shares at a discount and illegal. As such commission payable on share issue must strictly come within the perview of Sec. 76. ii) Brokers to an issue A broker is a intermediary, who arranges for or manages a bargain between a vendor (the company or an underwriter) and a purchaser (an applicant for a share) for which he is paid a commission, known as brokerage. Both the parties to the contract pay for the brokerage. According to Sec. 76(3) the right of paying brokerage is not affected by the provision of Sec. 76(1). Names of brokers to an issue are published in the prospectus. The manager of the issues and the brokers arrange for direct dealings, as much as possible, between the general applicants for shares and the company. The present tendency in corporate management is to appoint a bank as the Banker to an issue and leading brokers of Stock Exchanges as official brokers. These brokers try to motivate their customers to buy shares of the company directly. The Stock Exchange byelaws prohibit members from acting as brokers to the issue unless: (a) the Stock Exchange to which they are members approves; and (b) the company conforms to the prescribed listing requirement, and (c) the company undertakes to have its securities listed on a recognised Stock Exchange. Of course appointment of official brokers is not obligatory. However, the conditions prescribed regarding brokerage by the Central Government vide its letter no. F.14/1/SE /85 dated 7th May, 1985 are as follows: (a) Brokerage is fixed at 1.5% on all public issues; (b) All mailing cost and other expenses are to be met by the Stock brokers; (c) Listed companies may pay brokerage on private placement at a maximum rate of 5%; (d) Brokerage will not be allowed in respect of promoters quota including the amounts taken up by the directors their friends and employees; (e) Brokerage is not payable on applications made against underwriting commitments. The rate of brokerage payable must be disclosed in the prospectus. Managers to the issue A merchant banker is generally engaged as manager to the issue to advise the promoters on the composition of the capital structure of the company and the manner in which the funds are to be raised. The manager also assists in drafting of the prospectus and in its publication, as well as taking all steps
(a) Equity Shares (b) PreferenceShares/ Convertible and non-Convertible debentures (i) amounts upto 5 lakhs (ii) exceeding 5 lakhs
2.5% 2.0%
2.5% 1.0%
No underwriting commission is payable on share-amounts taken by promoters group, employees, directors and their friends, relatives and business associates. The above rate is maximum within which negotiation may be made. The government has issued the following guidelines relating to underwriting of capital issues by members of the Stock Exchanges: (1) The Stock Exchange will satisfy themselves that the companys securities which are being underwritten would be officially quoted on a recognised Stock Exchange; (2) The members of the Stock Exchange desiring to underwrite will satisfy themselves that the company duly complied with the listing regulations; (3) The Governing body of the recognised Stock Exchanges shall have the discretion to refuse permission or impose such conditions in respect of underwriting of securities by members of Stock Exchanges as they may deem necessary in the special circumstances of any given case; (4) The underwriting of public issues should be distributed amongst the members of the Stock Exchanges as widely as possible. (5) No member should be allowed to undertake an underwriting commitment of more than 5% of the public issue; (Banks generally underwrite 10%. There is no limit for financial institution); (6) The Stock Exchange should prescribe procedures for advance action to be taken by the companies, merchant bankers, etc. for making underwriting arrangements so as to ensure that all the relevant Information is furnished in the draft prospectus which is submitted to the Stock Exchange for approval (See for details "Stock Exchange Listing", a Bombay Stock Exchange publication, p. 20). However, any attempt to issue at a discount is prevented. If the commission to a subscriber of shares is not accountable under Sec. 76, it becomes in fact 'Shares issued at a discount'. In Keatings v. Paringa Mines Ltd [(1902) W.N. 15] the Companys 1 share stood at 3s. in the market. The Company 258
necessary to raise the funds which includes, appointment of underwriters and brokers with suitable terms and arranging for listing of the shares. The manager of the issue, in fact, takes a complete charge in managing the whole affairs. The ministry of finance issued guidelines providing merchant bankers to take authorisation from SEBI. The Registrar of Companies are advised to see that merchant bankers acting in any capacity as lead managers, co-managers, advisers or consultants, are authorised by the SEBI. According to the guidelines the fees payable to lead managers are fixed at 0.5% when the issue is upto Rs.5 crores and 0.2% when it is more than Rs.5 crores. No fees are payable on financial institutions subscription or underwriting amounts promoters quota and right issues. Banker to the issue A Company raises its capital from the primary market through a Bank or Banks named in the prospectus. Therefore banker has a very important role to play in issues of shares and debentures. The banker is to be very carefully selected. Collecting branches of the Bank/s are nominated taking into consideration of the convenience of the public, distribution of the investment throughout the country and the convenience of the NRI if NRI investment is desired. So the Banker to the issue shall have facility of overseas branches. Functions of the collecting branches, inter alia are (1) collecting applications, passing daily informations about collection to the controlling branch, receiving and implementing instructions from the controlling branch; (2) collecting stationeries like share applications, prospectus and other documents from the issuing company; (3) clearing cheques and drafts promptly; (4) acknowledge the receipt of the application; (5) remit the proceeds periodically; and (6) issuing certificate testifying no application pending with it. On the other hand, regulating or controlling branch shall (1) prepare instruction to collecting branches and send them; (2) issue consent letter for acting as the manager to the issue; (3) finalising the list of names of collecting branches in consultation with the company; (4) inform all collecting branches as to opening and closing subscription list; (5) open separate bank accounts; (6) hold in trust applications; (7) liaison with the registrar etc. Registrar to the issue Another institution in a public issue is Registrar to the issue. The registrar to the issue must have many internal agency facilities that are extended to the company. The registrar to the issue receives all applications from the collecting banks; duly process the applications for allotment; issue certificate or refund orders; maintains necessary issue registers and submits returns. The registrar to the issue has number of functions starting from designing the application form to attending to enquiries of the investors. 4.6 REGULATION ON PURCHASE OF OWN SHARES The share capital of a company once planned and formed, cannot be reduced in any way other than the way of reduction of share
capital under Sec. 100. As such, according to Sec. 77 a company limited by shares or limited by guarantee and having a share capital cannot purchase its own shares because this in fact reduces the share capital. The basic philosophy of keeping the capital intact is based on the need of protection of the creditors. Besides, a company is a body corporate constituted by shareholders. If the company is allowed to purchase its own shares, the constituting element shall be lost. According to British & American Trustee & Finance Corporation v. Couper (1894 AC 399) the court underlined the reason for not allowing a company to purchase its own shares. According to the court if such purchases are allowed, it would result in 'trafficking in its own shares thereby enabling the company, in an unhealthy manner, to influence the price of its own shares or it operates as a reduction of capital. A company is also prevented to give any loan or any security or any financial assistance to anyone for purchasing its shares or shares of its holding company. According to Sec. 77(2) this type of transaction is prohibited. Whereas Sec. 77(1) is applicable to all companies, Sec. 77(2) is applicable only in case of public companies and private companies which are their subsidiaries giving financial assistance to persons purchasing their shares. Sec. 77(2) does not apply to a holding company for directly buying shares of its subsidiaries or providing financial assistance or granting loan to anybody to purchase shares of its subsidiaries. Most of the litigation on the issue centres round what is 'financial assistance. In re G.M. Holding Ltd [(1942 ch 225] it was observed that where a company makes a gift of its money, or grants a loan, or sells property to a person at a fradulent consideration, there is financial assistance. In case of default under this section, the company and all officers of the company responsible for the contravention shall be punishable with fine upto Rupees one thousand. Of course this section i.e., prohibition of (1) purchasing own shares and (2) giving loan to purchase the companys shares thereby reducing, in fact, the share capital of the company, shall not apply in the following cases: (i) a company can forfeit its shares as per the provision of its articles for the non-payment of dues on the share. If the same share is reissued the capital is repaired. But company may cancel the shares. This is, in fact, a reduction which is allowed. (ii) lending of money by a banking company in the ordinary course of business; (iii) provision of money according to a scheme for purchase of shares by trustees for the benefit of employees of the company; (iv) making by the company of loans within the prescribed limit of 6 months salary to any employee, not being a Director or Manager, to purchase or subscribe for shares of the company (v) reducing preference shares issued under Sec. 80. (vi) obtaining a share through a bequest of his share by a shareholder.
259
5. SHARE, SHAREHOLDER AND MEMBER

SUB-TOPICS 5.1 Shares and Stocks 5.2 Types of Shares 5.3 Share certificates & Share warrants 5.4 Lien of Shares 5.5 Shareholders: rights and duties 5.6 Joint Shareholding 5.7 How to become a member 5.8 Who can be a Member 5.9 Cessation of Membership 5.10 Liabilities of Members 5.11 Register and Index of Members 5.1 SHARES AND STOCKS 1. Shares and Stocks defined Sec. 2 (46) defines share as share in the share capital of a company, and includes stock except where a distinction between stock and shares is expressed or implied. In CIT v. Standard Vacuum Oil Company [(1966) 1 Comp. 'L.J. 187 (SC)], the court tried to appreciate share in the sense of property and meant by it 'not any sum of money but an interest measured by a sum of money and made up of diverse rights conferred on its holder by the articles of the company, which constitute a contract between him and the company. In Bacha Gazdar v. CIT [57 Bom. LR 617] shares are considered as right to participate in the profits of the company while it is a growing concern, and in its assets when the company is wound up. In Press Tools Corporation v. M.R. Patney [AIR 1968 AP 320] share is considered not a sum of money. Stock is not defined in the Companies Act. In fact' the definition of share both includes and excludes stock according to express provision of the Companies Act. According to the universal dictionary of the English language edited by Wyld, Stock means 'capital of a company or corporation divided into units, often of 100, entitling holders to a proportion of profit. The dictionary gave a brief historical background of the term. It started with a wooden tally representing a sum of money lent to the King. Later on money lent to the government at a certain rate of interest, divided into units of 100 came to be known as stocks. Ultimately when Joint Stock Company came into being, it used to pool the total capital from various persons for which the total capital was divided into units. Each unit was called a Stock. Several Stocks jointly used to build up the capital of the Joint Stock Company. A company may issue debenture-stock. Debenture stock is also not defined in the Companies Act though according to Sec. 2(12) debenture includes debenture-stock. Debenture-stock is itself the debt due from the company secured by a document called a debenture stock certificate. Debenture stock is 260
generally created by a trust deed. The difference between debenture and debenture stock is like difference between share and a stock. A debenture is always for a fixed sum and is transferable in its entirety and not in fraction. But debenturestock is transferable in parts. 2. Values of Shares and Stocks Shares and Stocks have face value i.e., the value shown in scrips. As for example, a share of Rs. 100 means the certificate shall show the face value of Rs. 100. This share may be sold at a premium or at a discount or at par. A share of Rs. 100 sold at Rs. 100 shall mean, share sold at par. If it is sold at a higher price than Rs. 100, it is said that shares are sold at a premium and if it is sold at a price less than Rs. 100, it is said that the share is sold, at a discount. The legal provision of share sold at a premium or discount has been explained earlier. In a subsequent sale or transfer, this valuation of the share or stock is necessary because the seller shall try to realise his capital appreciation and the buyer is required to be assured about the real worth of the share. Such a valuation can be made in different ways as follows: Valuation of Share Fair Value (X+Y) 2 Market Value (X) (Calculated on Income/yield basis) Intrinsic Value (Y) (Calculated on net worth or break up basis).
The market value of a share is not necessarily reflected in the share market price. It is expected that share or stocks having high rate of capital appreciation shall be on high demand and as such, the market price shall show higher value. But the demand on a share on which market price in the share market is determined depends on many factors, capital appreciation rate being only one of those factors. 5.2 TYPES OF SHARE It has already been explained that shares may be either preference or equity. In India a company cannot issue any other type of shares like deferred equity or ordinary shares generally issued in favour of the promotional and managerial people with discriminatory voting right. But in India, according to Sec. 88 of the Companies Act, no company shall issue any shares (not being preference shares) which carry voting rights in the company as to dividend, capital or otherwise which are disproportionate to the rights attaching to the holders of other shares. In case shares were issued with disproportionate voting rights before the Act of 1956, the company would reduce the voting right of such shareholders to the equality of voting rights of all equity holders within a year. Of course the provision is not applicable in case of a private company unless it is a subsidiary to a public company.
A scrip is the written document called share certificate. It is also designated as the preliminary certificate as for shares allotted. 5.3 SHARE CERTIFICATES AND SHARE WARRANTS 1. Share Certificate A share certificate is defined as "a declaration by the company to all the world that the person in whose name the certificate is made out and to whom it is given, is a shareholder in the company and it is given by the company with the intention that it shall be so used by the person to whom it is given, and acted upon in the sale and transfer of shares. According to this definition, the requirements of a share certificate are (i) a declaration by the company to the effect that the person named in the declaration is the shareholder of the company; (ii) Stamp duty (varied from state to state) to be affixed to make the declaration a certificate of title on the property, and (iii) giving the certificate to the person in whose name the declaration is made by the company. But the Calcutta High Court held in re. Asiatic Oxygen Ltd [(1972) 42 Comp.Cas 602] that duty of the company is to keep ready the certificate within the time prescribed in Sec. 113 and the duty does not extend to deliver the same. This is too narrow an interpretation of the words complete and keep ready specified in Sec. 113. Acccording to Sec. 113, the share/debenture certificate is to be completed and kept ready for delivery : i) within three months after the allotment, or ii) within two months after application for the registration of tranfer as the case may be. Conditions for issue of share certificate According to Rule 4 of the Companies (Issue of Share Certificate) Rules 1960 no certificate of any share shall be issued unless the following conditions are fulfilled: (i) a resolution is passed in the Board for issue of the certificate; ii) the letter of allotment or fractional coupon of requisite value [excepting in case of issue against letters of acceptance or of renunciation or bonus shares]; iii) the earlier certificate is surrendered where replacement is required to be made for consolidation, or due to worn out, torn out or where spaces in the reverse for recording transfer have been duly utilised, and iv) a resolution is passed to issue duplicate for lost or destroyed certificates. A certificate issued under the common seal of the company is prima facie evidence of the title of the member to the shares of the company. Particulars of every share certificate shall be entered in the Register of Members. Every certificate shall specify the name of the person in whose favour it is issued and the share to which it relates and the amount paid up thereon.
2. Share warrants According to Sec. 114 a public company limited by shares may issue under its common seal a share warrant stating that the bearer is entitled to the shares specified therein, if: (a) such issue is authorised by its articles; (b) prior permission from the Central Government is obtained. The Share warrant is transferable document by delivery. The bearer of the warrant is entitled to the share as well as dividends and provided with specified coupons. The warrant requires adequate stamp duty on the basis of value of the shares entitled and the rate varies from state to state. On the issue of warrant the company shall strike out the name of the member as if he has ceased to be a member. Instead the register has to now contain the date and the fact of issue of warrant and the statement of shares specified in the warrant. A share warrant though not a negotiable instrument but is transferable on delivery. The bearer of the warrant is entitled to register his name as the member of the company subject to the regulations prescribed in the articles of the company, on surrendering the warrant and cancellation thereof. If a company registers the name of a person without the warrant being surrendered and cancelled, the company shall be liable to compensate the loss incurred by any person. The bearer of the warrant may, if the articles so provide, be deemed to be a member of the company for the purposes mentioned in the articles. 5.4 LIEN ON SHARES According to Regulation 9 of the Regulations for Management of a company limited by shares provided in Table A under Schedule 1 of the Companies Act a 'first and paramount lien is provided in favour of the company on all shares for all money called and payable. It means the company has first charge on the shares for the unpaid amount on the shares. The company right of lien is paramount against all other creditors. The right of lien is not automatic. Unless the articles of the company provide for it, a company has prima facie no lien on the shares of the members. (For details See, Canara Bank Ltd. v. Tribhuvandas [AIR 1957 Trav. Co. 183]). In the same case the Court has also directed that a company may so adopt its articles as to give it a lien on fully paid shares, as regards any money due to it from the shareholders. But clause 34(a) of the Listing Agreement prohibits a lien on fully paid shares. It also does not allow the exercise of the right of lien in respect of partly paid shares except in case of moneys called or payable at a fixed time. Generally speaking 'articles of a company provide for the right of lien of the company on the unpaid calls. In Champagne V. Perrier Janet v. H.H. Finch Ltd [(1982) 3 All ER 713] the article of the company provided for first and paramount lien. The shareholder created an equitable charge on the shares against a debt to another person. It was held that the companys lien was to have priority over the equitable charge. In India against all legal charges created, the company shall have its priority on lien. Where 'articles of a company 261
have been altered to provide the right to lien for the company a shareholder can argue that he purchased the shares with the knowledge that there was no lien. The company can waive the right expressly or impliedly. After exercising the lien, the company, if authorised by the articles, may sell those shares. Regulation 10 provides some conditions for such a sale. According to Reg 10, such a sale cannot be made unless (1) a sum in respect of the concerned share is presently due and until (2) the expiration of fourteen days after a notice in writing has been given demanding the money. Unless the articles so provide there is no right of the company to sell the share after exercising lien unless specifically permitted by the court. Acording to Sec. 181, the articles may provide that no member shall exercise any voting right in respect of any shares registered in his name and on which lien has been exercised by the company. 5.5 SHAREHOLDERS: RIGHTS AND DUTIES The term 'shareholder has not been defined in the Companies Act probably because the term is self-explanatory. A person who is the holder of a share is known as shareholder of the company. A shareholder is one of many owners of the company. But in effect, he is only an investor investing towards the capital of the company. He has the following rights: (1) To be a Member: In case of a company limited by share or guarantee and having a share capital and an unlimited company having a share capital, the only shareholders are members of the company. Of course a company not having a share capital can have members but not a share holder (See Killick Nixon Ltd. v. Bank of India 1982 TaxL.R. 2547). (2) To share profit: When the company earns profit, shareholders are entitled to the dividend as and when the company declares the same. It may be pointed out that unless and until the company declares the dividend, a shareholder does not have the automatic right to demand share of profit. (3) To participate in the distribution of assets: In the event of winding up, a shareholder has a right to participate in the distribution of the companys assets in accordance with the rights given to him under the articles. (4) To further issue : A shareholder has a pre-emptory right to subscribe to further issue of capital where the company issues any further capital after the expiry of two years from the formation of the company or at any time after the expiry of one year from the allotment of shares. The existing shareholder may renounce the shares offered to him in favour of any other person unless the articles otherwise provide. (5) To vote on any special resolution: Right to vote is essentially concerned with the corporate democracy. This right is given to the members. But some special category shareholders like preference shareholders shall have a right 262
to vote on any resolution directly affecting their interests. [See Sec. 106]. (6) To transfer share: There cannot be any restriction on the transferability of shares. (7) To apply for winding up: A shareholder may also apply to the court for winding up of the company as a contributory subject to conditions laid down in Sec. 434. Shareholders have certain duties as well. As for example, a shareholder has a duty of (1) paying calls on the shares within the stipulated day; (2) specifying in writing to become member of the company; (3) attending meetings personally or through proxy and participate in voting as and when required; (4) informing the Central Government in buying and selling shares wherever required. 5.6 JOINT SHAREHOLDING Two or more persons owning a 'share are called joint-holders. It may happen in different ways, viz; (a) Through joint application: two or more persons may jointly apply for and are allotted shares in their joint name; (b) Through firm holding: a firm cannot be registered as a member. Partners are registered as joint holders. (c) Through succession: two or more persons may succeed the right of holding a share and are registered as joint holders. Joint holders can insist on having their names registered in such order as they may require their holdings to be split into several joint holdings with their names in different orders so that all of them may have a right to vote as first name holder in one or other joint holdings. According to the Company Law Department change in the order of names of joint holders does not need transfer deeds provided the request is made by all joint holders to the company. But if change in the order of names is required in respect of part of the holding, execution of a transfer deed will be required. The following positions of joint holders are to be noted: (i) For the purpose of determining number of members for different purposes like, number of members of a private limited company; requisition meeting, making application under Secs. 397 and 398 etc., all the joint holders of a share are counted as one member. (ii) Notices to be served by the Company, shall be deemed to have been served if it is served on the first name of the joint holders [See Sec. 53(4)]. (iii) For the purpose of payment of dividend under Sec. 205(5)(b), the company is to pay the amount to the first name of the joint holders unless instruction in writing is given otherwise by all joint holders. (iv) Joint holders are individually entitled to be present in the meeting. take part in the deliberation but in poll the voting right can be exercised together. For the purpose of quorum, all joint holders together shall be taken as one.
(v) For holding position like director in the company, joint holders are to be considered as sufficient qualification unless the articles otherwise provide. (vi) In the absence of any provision in the articles, the liability for paying calls on the shares are joint and several in India unlike England where it is only joint. 5.7 HOW TO BECOME A MEMBER A person may become a member of a company in any of the following ways 1) by subscribing the memorandum of association, on registration of the company; 2) by agreeing to become a member of a company in writing by subscribing to shares of the company and placed in the register of members; 3) by purchasing a share and registering the name as a member: 4) by taking a share on transfer by way of assignment or succession and registering the name; 5) by allowing name to be recorded in the register of members of a company. According to Sec. 41, the subscriber of memorandum of association, on registration becomes a member of a company. A person agreeing in writing and whose name is registered in the register of members becomes a member. In fact excepting (1) in the above list all others become members by consent and registration. In case of a company limited by shares or guarantee and having a share capital and in case of an unlimited company having a share capital, a person can become a member of a company only by being a shareholder. In the case of a company not having a share capital, a person can become a member of the company according to rules adopted by the company. The special features of the following members are required to be noted: (a) Promoter member In U.P. Oil Mills v. Jamna Prasad [AIR 1955 All 417] the Court held that those who signed the memorandum of association are deemed to have agreed to become members of the company by reason of being the signatory to the memorandum. Their names, of course, are required to be entered into the register of members. A signatory to the memorandum cannot after the incorporation of the company, withdraw by repudiating the consent on the ground of misrepresentation [See for details, In re Metal Constituents Co (1902) 1 Ch 707]. Besides, a subscriber to the memorandum is liable to pay for his shares in cash even if he has entered into an arrangement with the promoters under which he received the shares for his services as legal consultant in promotion of the Company [Kanduri Chetty v. Adoni Electric Supply Co Ltd [AIR 1944 Mad 322]. Though the signature to the memorandum can be repudiated before the incorporation of the company it cannot be revoked after incorporation.
(b) Member by application According to Sec. 41(2) a person must agree in writing to become a member of a company. Generally speaking an intending investor applies for shares through an application form supplied by the company. He offers to purchase shares in the company. The company accepts the offer by sending a notice of allotment. The applicant may of course revoke his offer before notice of allotment is communicated [Hobbs case (1867) LR 4 Eq. 6]. The company may not communicate through writing. What is necessary is communicating the acceptance of the Company to allot shares to the offeror [Gums case (1867), LR 3 Ch. App 60]. An acceptance by telex is a valid communication [Entores Ltd (1955) 2 All E.R. 493]. Shares allotted to an applicant are deemed to have been issued to the applicant on the date of allotment and not when certificates are issued [Shri Gopal Paper Mills Ltd v. CIT, AIR 1970 SC 1750]. In re. Saloon Steam Packet Co. [(1867) WN 259] the share applicant was present at the Board meeting which made the allotment to the applicant. It was held that notice of allotment was served even though formal notice was not posted. In view of the present legal development this decision is doubtful to be applicable in similar situation. Application shall become lapsed if allotment is not notified within a reasonable time [Ramsgati Victoria Hotel Co. Ltd. v. Montefiore (1866) L.R. 1 Exch 109]. Applicant may waive the notice of allotment. Generally an agreement of reconstruction or amalgamation results into such type of waiver in serving notice. It may be noted that with written consent of becoming a shareholder in the newly reconstructed company, a person does not become a member of that company. He becomes a member as per Sec. 41(2) when his name is entered in its register of members. (c) Member by transfer A person may become transferee in several occasions. As for example, he may purchase the share; share may be assigned to him against a loan or it may be gifted. According to Sec. 82 shares of a public limited company are freely transferable. It is natural that on transfer the shareholder becomes member of the company on his name being entered into the register of members. Rules regarding transfer and mode of registering the name as a member is specified in the articles of the company. (d) Member by succession Succession is one mode of transfer, and this transfer is usually known as transmission of shares; Successors, executors or administrators getting the share at the death of a shareholder are entitled to register their names as members. Similarly an official assignee is entitled to be a member in the case of a shareholder becoming insolvent. The successors are bound to pay the calls on the shares. (e) Member by estoppel A person may be deemed to be member if he allows his name to be recorded in the register of members. A minor after obtaining majority and thereafter receiving dividend may be estoppel to deny that he has become a member. 263
5.8 WHO CAN BE A MEMBER Any person who is capable to enter into a contract can become a member of a company by agreeing in writing to become a member and allowing the name to be recorded in the register of members. The Companies Act does not prescribe any disqualification. (a) Company: A company may become a member of another company if it is so authorised by its memorandum through the object clause. Of course the Companies Act has stipulated certain restrictions. As for example, a subsidiary company cannot be a member of its holding company and any allotment of share to such a subsidiary company by the holding company is void. Exceptions are of course there, such as: (i) a subsidiary company may be the legal representative of a deceased member of a holding company (ii) a subsidiary company is a trustee where the holding or subsidiary company is not a beneficiary (iii) a subsidiary used to hold shares of its holding company at the commencement of the Act of 1956 and continuing as such. (b) Minor : In India a minor is completely incompetent to enter into the contract. Hence he cannot be a member of a company. In Palaniappa v. Official Liquidator [AIR 1942 Mad 470] the father applied for shares in the name of his minor daughter and registered the shares in her name. The transaction was held to be ab initio void. If the company allot shares in the name of a minor in ignorance of the fact, the company can repudiate the contract. The minor can also repudiate the allotment at any time during minority and also within a reasonable time after becoming major. But if after attaining majority the person receives the dividend on the shares, it may be deemed that the person has accepted to become a member. But where a signatory to a memorandum is a minor and the company is already registered, the registration cannot be invalidated on the ground that one of the signatory to the memorandum is a minor even though only minimum number of persons floated the company and one of them being minor. (c) Lunatic: In Morgan v. Gray [(1953)Ch 83] it was held that as long as the name of the lunatic is in the register of members, he is a member and is entitled to vote at the meetings of the company. A lunatic or a person of unsound mind can enter into a valid contract at the lucid interval when the mind is sound. Therefore, a lunatic remains a member as long as his name is there in the register of members. But if it is proved that at the time of allotment of the shares he was insane, the company can rescind the contract. (d) Bankrupt: As long as the name of an insolvent member remains in the register of members, he is a member and he is entitled to exercise vote. The property of an insolvent is transferred to an official assignee who Is entitled to get his name registered as member. 264
(e) Benamdar: A person who takes shares in the name of a fictitious person would be liable as a member in respect of the share and his name may be entered in the register of members. He is also liable to be punished for impersonation under Sec. 68A. Under Sec. 187C a holder of a share not having beneficial interest in the share must submit a declaration to the company within the time prescribed, specifying name and other particulars of the beneficial holder. Similarly within 30 days from the commencement of the Companies (Amendment) Act 1974 all beneficial owners shall have to declare to the company the nature of their interest, particulars of the person in whose name the shares stand registered. Whenever there is a change in the beneficial interest the beneficial owner shall submit a declaration to the company regarding the date and nature of the change. On such declaration the company makes a note of such declaration and within 30 days from the date of receipt of the declaration submit a return to the Registrar with regard to such declaration. If the beneficial owner fails to give the declaration, for every days delay he shall be punished with fine upto Rupees one thousand. Besides, Sec. 189(e) declares a beneficial owner of a share or any person claiming under him from enforcing any charge, promissory note or any other collateral agreement, created, executed or entered into by the ostensible owner if the declaration is not made. As such benami has become a distinct disincentive. (f) Trustee: Where any shares in or debentures of a company are held in trust by any person, he shall make a declaration to the public trustee appointed by the Central Government under Sec. 153A, within such time and in such form as may be prescribed. A copy of such declaration is to be sent to the company by the trustee within 21 days of such declaration. Failure to submit such declaration attracts fine upto Rupees five thousand and for continuation of the offence upto Rupees one hundred for everydays delay. According to Sec. 187B the voting rights on these shares became exercisable by the public trustee or by his appointed proxy. According to Sec. 153 no notice of any trust, express or implied or constructive, shall be entered on the register or be receivable by the Registrar. It implies that if the trustees transfer shares to a person other than the one for whom they were held in trust, the company will not be liable to the latter. Another effect of Sec. 153 is that the shares may be held in the cover of a trust. Fraud can be practised in regard to the management of the company. Member and Shareholder From the above discussion it is clear that equity shareholders are ordinarily the members of the company having a share capital. In case of a company not having a share capital, the membership is determined according to the articles of the company. Though shareholders are members but there may be a situation when a shareholder is not a member or a member is not a shareholder. As for example: (a) Shareholder but not a member: A shareholder having received a share warrant is not a member though he is a
shareholder. A person purchasing a share has to apply for registering his name in the register of members under Sec. 108. Until such registration is made, the shareholder does not become a member. (b) A member but not a shareholder: A signatory to memorandum becomes a member before shares are allotted to him. Similarly, a person agreeing in writing to become a member and allowing his name to be recorded in the register of members, becomes a member though no shares were yet allotted. A shareholder whose name is registered as a member, remains a member until the new holder applies and gets his name recorded as member. Until then the old shareholder remains a member though he has actually sold his share. There may be several such situations where a shareholder is not a member or a member is not a shareholder. But generally speaking a member becomes a member of a company only through shareholding. 5.9 CESSATION OF MEMBERSHIP A person may cease to be member in the following circumstances: (a) on forfeiture of his shares due to non payment of dues; (b) by valid surrender of his shares; (c) by transferring his shares when the new holder registers his name as a member; (d) on his death; (e) in case of his insolvency, on the disclaimer by the official assignee; (f) on winding up of the company; (g) on grounds of rescision of the membership contract like misrepresentation or fraud or mistake. 5.10 LIABILITY OF MEMBERS (1) According to Sec. 36(2) all money payable by any member to the company under the memorandum and articles shall be a debt due from him to the company. Articles of a company generally provide that calls and instalments payable shall be paid when due. It may be noted here that the member whose name is entered in the register of members is only liable to make the payment. It makes no difference whether he is beneficial owner or a trustee. (2) A member of a company is liable to pay the whole nominal value of the share unless it is expressly provided otherwise. The payment is required to be made in cash. The liability is not discharged until the whole amount is paid up. (3) A member who ceased to be a member within one year prior to the winding up, is nevetheless liable to pay the unpaid amount on the shares. His name is included in B list, to pay, if necessary (a) debts incurred when he was a member, (b) debts not specified by members in A list.
5.11 REGISTER AND INDEX OF MEMBERS (a) Register of Members According to Sec. 150 every company shall keep in one or more books a register of members and keep therein the following particulars of each member; (a) the name and address, and occupation of each member; (b) in the case of a company having a share capital, shares held by each member, and the amount paid or agreed to be considered as paid on those shares; (c) the date at which each person was entered in the register as a member; and (d) the date at which any person ceased to be a member. In the event of share converted into stock, the register shall show the amount of the stock held, by each member. If default is made in keeping the records as mentioned above, every responsible official and the company are punishable with a fine upto Rupees fifty per day during which the default continues. A minor cannot enter into a contract. As such, his name cannot be entered in the register of members. The name of the guardian on behalf of the minor can be recorded. A firm cannot be taken as a member because a firm is not an incorporated body. As such, name of a firm cannot be entered as a member. Name of the partners must be entered as joint holders. The register must be kept up to date incorporating all changes in the holding of the shares due to transfer and transmission of the shares. According to Sec. 164 a register is a prima facie evidence, but not conclusive, of matters directed or authorised by the Act to be entered therein. A company having foreign members shall keep in its foreign branch a register to enroll members of that state or country outside India. The Company shall file with the Registrar within 30 days from the date of opening such a foreign register, a notice stating the situation of the office where the register is kept (See Sec. 157). In default a fine upto Rupees fifty per day may be imposed on every responsible official and also on the company for every day during which the default continues. According to Sec. 152 the company must have to keep register of debenture holders with similar particulars. (b) Indexes of members According to Sec. 151 every company having more than fifty members shall keep an index of members unless the register of members is maintained in such form that it contains an Index. With changes in the register, the index is also required to be amended within 14 days. The index has to contain sufficient indication to enable the entries relating to each member to be readily found in the register. The index is to be kept at the same place where register of members is kept. Similarly index of debenture holders is also to be prepared and kept at the place where the register of debenture holders is kept. (c) Location, inspection and closing of the register According to Sec. 163 the register of members, debenture holders and the indexes are to be kept in the registered office. 265
If these are to be kept in any other place within the city in which the registered office is located, it has to be approved by a special resolution and the Registrar is given an advance copy of the proposed special resolution. Central Government may make rules for the preservation and for disposal of the registers and Indexes. The Registers and Indexes shall remain open for inspection during the business hours excepting during the time when Registers and Indexes are closed for inspection under the provision of the Act. Such inspection can be made by any member or a debenture holder without any fees and any other person on payment of a fees of one rupee for each inspection. A member or creditor may inspect the registers and other documents by his solicitor or agent as well [Bevan v. Webb (1901) 2 Ch 59]. Any member, debenture holder or outsider may make extracts from the Register or can have a copy by paying required fees. According to Sec. 154, a company may, after giving not less than seven days notice, close the register of members or
debenture holders for any period or periods not exceeding in the aggregate in a year forty-five days but not exceeding 30 days at any one time. Such a closure is necessary at beginning of the AGM to ascertain the members for the purpose of serving notice. This is also necessay for the purpose of paying dividends. A person whose name appears in the register of members at the time of closure, remains a member until the opening of the register for revision even though he has transferred the share to another person. Register is also closed before the right or bonus shares are issued in view of ascertaining the member to whom it must be issued. In each or such cases of closure at least a 7 days notice must be served by advertising in some newspaper circulating at the city of the registered office of the company. Any violation of such norms shall attract fine upto Rupees five hundred per day during which register remains closed in violation of the law, to be imposed on every defaulting official of the company and also on the company.
266
6. TRANSFER AND TRANSMISSION

SUB-TOPICS 6.1 Introduction 6.2 Private Companies and Transfer of Shares and Debentures 6.3 Public Companies and Transfer of Shares and Debentures 6.3(A) Procedure for transfer of shares & debentures 6.3(B) Power of Central Government to direct companies 6.3(C) Refusal to Transfer Shares and Debentures 6.4 Effect of Transfer before Registration 6.5 Some forms of Transfer & Problems 6.1 INTRODUCTION The great advantages of being a joint stock company form of organisation is its perpetual life. The Members or Shareholders of the Company may get changed, but the company retains its identity, until it is wound up under the provisions of the Companies Act. The right to transfer the shares serves certain distinct advantages, which are mentioned herein below: (i) it provides liquidity for the shares and the holders of shares could sell their shares; (ii) it becomes the permanent capital for the company as the transfer of shares does not affect the share capital of the company; (iii) the capital of the economy becomes mobile, which is a very important parameter for the economic growth of a country. 6.2 PRIVATE COMPANIES AND TRANSFER OF SHARES AND DEBENTURES In order to confer Privacy", Section 3(i) (iii) (a) of the Companies Act, 1956, provides for compulsory restriction of the right to transfer its shares. But, it is to be noted that, this restriction is applicable only in respect of shares and not to other forms of securities like debentures, etc. According to Section 43 of the Act, if a private company defaults in complying with the provisions contained in Section 3(i) (iii) of the Act, then it shall cease to be entitled to the privileges and exemptions conferred on private companies under the provisions of the Act. However, a proviso to the section grants the Company Law Board the power to relieve the defaulted company from the said consequences, if it is satisfied that the failure to comply with the conditions was accidental or due to inadvertance or some other sufficient cause or if it is just and equitable to grant such relief. A private company, even on becoming public company by virtue of Section 43A of the Act, could still restrict the right to transfer its shares. 6.3 PUBLIC COMPANIES AND TRANSFER OF SHARES AND DEBENTURES Sec. 82 of the Companies Act makes property in share, movable and transferrable in the manner prescribed in the Articles. It may be noted here that 'right to transfer a share/stock is a statutory right and cannot be altered by the articles. The articles may only prescribe the manner in which by the transfer is to take place. According to the definition of goods under Sale of Goods Act, goods include stocks and shares of a company. As such, when the nature of the property as enunciated in Sec 82 to a share or stock being 'movable, it is very complementary. In Borlands Trustee v. Steel brothers Co. Ltd [(1901)] Ch 279] a share has been defined as a right to a specified amount of the share capital of a company carrying with it certain rights and liabilities, while the company is a going concern and in the winding up. Share represents the interest of the holder measured for purposes of liability and dividend by a sum of money. A share or a stock being movable can either be mortgaged or pledged. Whether a transaction is a mortgage or a pledge depends upon the intention of the parties while making it [See for details, Shahzadi Begum Saheba v. Giridharilal Sanghi AIR 1976 AP 273]. A share is freely transferrable and there cannot be any absolute restriction imposed by articles. Articles may prescribe the mode of transfer and procedural restrictions. Setions 108 to 112 of the Companies Act, 1956, govern the matters relating to transfer and transmission of shares and debentures. 6.3 (A) PROCEDURE FOR TRANSFER OF SHARES AND DEBENTURES (i) Every request for transfer of shares and debentures has to be accompanied by the following, viz (a) certificate relating to the shares and debentures; if no certificate is in existence, the letter of allotment thereof; (b) proper instrument of transfer vide Form 7B, prescribed under the Companies (Central Governments) General Rules and Forms, 1956. In case, the instrument of transfer is lost, then the Board of Directors of the company if satisfied, may proceed to transfer the underlying shares and debentures, if the parties give an indemnity. (ii) the instrument of transfer has to be duly stamped and executed, both by the transferor and by the transferee or on behalf of them. (iii) (a) in case of shares dealt in or quoted on a recognised Stock Exchange, the transfer documents are to be delivered at anytime before the date on which the register of members is closed for the first time after the date of presentation of Form 7B to the authority or within twelve months from the date of presentation of such Form 7B whichever is later; (b) in any other case, within two months from the date of such presentation. A transfer becomes effective upon its registration in the register of the company. 267
6.3 (B) POWER OF CENTRAL GOVERNMENT TO DIRECT COMPANIES NOT TO GIVE EFFECT TO TRANSFER OF SHARES Section 108D of the Companies Act, 1956 grants power to the Central Government to direct Companies not to give effect to a transfer of shares in certain circumstances. If the Central Government is satisfied that, as a result of the transfer of any share or block of shares of a company, a change in the controlling interest of the company is likely to take place and that such change would be prejudicial to the interest of the company or to the public interest, then the said Government may direct the company not to give effect to the transfer of any such share or block of shares. In case, such transfer of shares or block of shares has already been registered, then the Central Government may direct that the transferee or nominee or proxy of the transferee should not be permitted to exercise any voting or other rights attached to such shares or block of shares. Further, the section also provides that, if the transfer of shares or block of shares has not been registered, then the Central Government shall direct that the transferor or his nominee or proxy should not be permitted to exercise any voting or other rights attached to such shares or block of shares. [Section 108D(1)]. Sub-section (3) of section 108D provides that, if any direction is given by the Central Government under sub-section (1), the shares or block of shares shall stand retransferred to the person from whom it was acquired and thereupon, the amount paid by the transferee for the acquisition of such shares or block of shares shall be refunded to him by the person to whom such shares or block of shares were retransferred. If the refund of the amount paid by the transferee is not paid within thirty days from the date of the direction referred to in sub-section (1), then, on the application of the person who is entitled for the refund, the Central Government may direct the refund of the amount. Any order so passed by the Central Government may be enforced as if it were a decree made by a Civil Court. The provisions of Section 108D are not applicable to transfer of share by the undermentioned persons, viz (i) any company in which not less than fifty one percent of the share capital is held by the Central Government; (ii) any corporation, not being a company, established by or under any Central Act; or (iii) any Financial Institution. 6.3(C) REFUSAL TO TRANSFER OF SHARES AND DEBENTURES Sec 111 of the Companies Act gave a wide power to the company to refuse registration. According to this provision, nothing in Sec. 108, 109 and 111 shall prejudice any power of the company under its articles to refuse to register the transfer of, or transmission by operation of law. This unrestricted power of the company to refuse registration stands in the way of free mobility of capital and on different occasion protects managerial 268
incompetence and inefficiency. The only avenue to obtain justice against the arbitrary decision the company, under the Companies Act, is an appeal to be made to CLB thin the time mentiond below: (i) in case, notice of refusal has been sent by the company, within a period of two months from the date of receipt of such notice; ii) in case, the company did not send the notice of refusal, within a period of four months from the date of lodgement of the instrument of transfer. The above protective arrangement was amended in order to restrain the veto power of the company and for ensuring free transferability of securities public limited companies Sec. 22A has been inserted in the Securities Contract (Regulation) Act in 1985. According to this provision excepting as provided in the section, securities of companies shall be freely transferrable. A company may refuse to register the transfer only on the following ground of(a) procedural defects: that the instrument of transfer is not proper or has not been duly stamped and executed or that the certificate has not been delivered or any requirement under the law relating to registration of transfer not being complied with; or (b) contravention of law: that the transfer is in contravention of any law or rules or any administrative instructions or conditions of listing agreement laid down in pursuance of such law or rules; or (c) composition of the board to be affected: that the transfer of the security is likely to result in such change in the composition of the board of directors as would be prejudicial to the interests of the company or to the public interest; or (d) transfer prohibited by court order: that the transfer is prohibited by any order of any court, tribunal or other authority. Sec. 22A (4) of the Securities Act further provides that the company shall, before expiry of two months from the date on which instrument of transfer is lodged must either: (a) effect registration on forming opinion that registration ought not to be refused; or (b) intimate the transferor and the transferee by notice as to what is required to be done to effect registration under the law; or (c) make a reference to the CLB and forward reference to the transferor and the transferee. Where on a reference under Sec. 22A(4) of the securities (Regulation) Act is made and the CLB (a) directs the security to be registered in favour of the transferee, it must be done within 10 days of the receipt of the order; (b) opined that it need not be registered, the company shall within 10 days intimate the transferor and the transferee accordingly.
Under Sec. 111(3) there is an additional right of the transferee to appeal to the Central Government against the refusal to register a transfer. Every appeal under Sec. 111(3) shall be made by a petition in writing and shall be accompanied by such fee not exceeding fifty rupees as may be prescribed by the Central Government. Before making an order, the Central Government may require the company to disclose to it the reasons for such refusal. In Kinetic Engineering Ltd v. Sadhana Gadia [(1992) 7 CLA 8; (1992) 1 Comp. L J 62], Regulation 47A of the Articles of the company provided that the directors shall not accept an application for transfer of less than 5 equity shares ......". In exercise of the power the company refused to split the share certificate comprising of 50 shares, for the purpose of transferring 8 out of 50 shares, in favour of the transferees who were not members of the company. The CLB held, that articles of association are not only contract between the company and its members but they also constitute contract between the members to regulate their rights inter se. But that does not mean that the articles or memorandum has the force of law, If any provision of articles or memorandum is contrary to any provision of law it shall be invalid, ab initio. While deciding the case, CLB held "since there is a specific provision which seeks free transferability and registration of transfers of listed securities, any provision which puts any restriction on free transferability of shares would be in the negation of expressed provisions of law and would be self defeating. If there is any delay in filing the application, the Limitation Act is not applicable in the case of Securities (Regulation) Act since it is a special statute. In Carbon Corporation Ltd. v. Abhudaya Properties (P) Ltd [(1992) 73 Comp. Cas 572] it was held that the Company Law Board has no power to extend the time limit for filing a reference as prescribed in Sec. 22(A)(4). The most important ground of refusal to request a transfer apprehension of take over. The apprehension must be real. In Bajaj Tempo Ltd. v. Bajaj Auto Ltd. [(1991) 2 Comp LJ 393] it was found that transfer of 1% of shares in favour of BAHL and BAL two existing shareholders of Bajaj Tempo Ltd holding 22% was unlikely to change the composition of the Board. As such, one cannot refuse registration on the apprehension of take over under 22(A)(3) of the Securities (Registration) Act. But where over 31.7 percent of the shares of the company were acquired by a number of parties allegedly connected with each other and controlled by one person (M.R. Chabria), it was held that the material before the board of directors was more than enough to come to a conclusion that transfer was likely to change the complexion of the Board. The board of directors considered the shareholding pattern, the high-tech nature of jobs undertaken by the company and the track record of Chabria and bona fide decided to refuse registration which was held justified. [Gammon India Ltd v. Hongkong Bank (P) Ltd [(1992) 7 CLA 124].
6.4 EFFECT OF TRANSFER BEFORE REGISTRATION Where the transferor completes his responsibility to effect all actions necessary to register the name of the transferee as laid down in Sec. 108, the transfer is complete in so far as the transferor is concerned but it is really not complete in respect to the transferee until the transfer is registered and the tansferees name is entered in the register of members. What is the responsibility of the transferor to effect registration of the transferee? A transferor has obligation under Sec. 108 to take all steps and to follow all procedure for registration. He is not expected to go beyond. He does not undertake to secure registration. He does not have obligation to record the transfer. His obligation is to do nothing to prevent registration of the transfer. If the transferee wishes to protect himself from the consequences of a possible non-registration of the transfer of shares by the company, he has to take the shares with registration guaranteed. In the absence of such a condition the transferor is not liable and the transferee cannot recover the price of the shares from him on the ground of no consideration. 6.5 SOME FORMS OF TRANSFERS AND PROBLEMS (a) Blank transfer: Shares may be mortgaged by depositing the share ertificate with the creditor along with the Instrument of transfer signed by the transferor without mentioning the name of the transferee and the date transfer. In such a case the mortgagee is given the right to fill up the banks and get it registered. In this case the transferee gets an equitable right on the shares. He may sell the share in the event of the mortgage failing to pay for them after giving them a reasonable notice. Blank transfer for effecting sale of shares can obviously be misused for speculative purposes. In order to prevent this practice, Sec. 108(1A) stipulated that every instrument of transfer should be in the prescribed form and every such form should be presented to the prescribed authority, being a person already in the service of the government, for stamping or otherwise endorsing thereon the date of such presentation, before it is signed by the transferor and even before any entry is made therein. After the form is submitted being stamped, endorsed, executed and delivered, the registration is to be made: (i) in the case of shares dealt in or quoted on a recognised Stock Exchange at any time before the closing of the register of members or within one year from the date of presentation, whichever is later; and (ii) within two months from date of presentation in any other case. (b) Forged transfer: A share certificate is not a negotiable Instrument and as such, no defective transfer can take effect so as to give a better title to the transferee. Where a transfer was forged, and a company issued a certificate, the Court held that the title of the original holder was not defeated. [Barton v. L & N.W. Rly Co 24 BD 77]. If such a certificate is transferred to a bona fide purchaser for value, he does not get any better right to be registered, but he is entitled to claim damages. 269
7. RESTRUCTURE OF SHARE CAPITAL

SUB TOPICS 7.1 Introduction 7.2 Increase of Share Capital 7.3 Conversion and consolidation 7.4 Alteration of Members rights 7.5 Reduction of Share Capital 7.1 INTRODUCTION A company may restructure its share capital in different ways. This restructuring of capital to be noted at a glance is given below: (1) Increase its authorised capital [Sec. 94(1)(a)]: (2) Consolidate and redivide in shares of higher amount [Sec. 94(1)(b)]; (3) Convert share into stock or stock into shares [Sec. 94(1)(c)]; (4) Subdivide shares into smaller value [Sec. 94(1)(d)]; (5) Cancel unissued shares and thereby reduce share capital [Sec. 94(2)]; (6) Conversion of debentures and loans into shares [Sec. 81(3)(b) and Sec. 94A(1)]; (7) Reduction of Share Capital [Sec. 100] (8) Alteration of rights of shares [Secs. 106-107] (9) Facilitating under Sec. 391 for reconstruction and amalgamation which can be stated as external reconstruction [Sec. 394] 7.2 INCREASE OF SHARE CAPITAL According to Sec. 94(1) a limited company having a share capital may, if so authorised by the articles, alter the conditions of the memorandum by increasing its share capital by such amount as it thinks expedient by issuing new shares. Since the share capital mentioned in the memorandum is the authorised capital of the company it is therefore contemplated that the change mentioned here is a change in the authorised capital. Such an increase is to be made by issue of new shares. So in order to increase the authorised capital of a company the conditions needed to be followed are : (a) Such an alteration [increase of capital) must be authorised by the article: (b) Such an alteration can be made by the company in the general meeting [Sec. 94(2)]; (c) a notice of such alteration is to be filed with the Registrar [Sec. 97(1)] As such, authorised or nominal share capital of a company can be increased only if such an increase is authorised by the articles of the Company. If articles do not permit any such alteration, the articles are required to be altered first before any step is taken for increasing the authorised capital. In re North Cheshire Brewery Co. [(1920) W.N. 149] it was held that there is no 270
reason as to why in the same general meeting a special resolution cannot be taken at first to alter the articles and then a resolution taken to increase the authorised capital. The resolution is to be taken bona fide for the interest of the company and not for benefitting any group of interest. It may be noted that increase of authorised capital is really an alteration of memorandum. But Sec. 94(2) does not require a special resolution for this purpose. Besides, in case the capital is increased and new shares are issued, those can be issued only according to the prescription given in Sec. 81 i.e., existing shareholders will have a pre-emptory right to purchase those shares. The general body cannot give any decision against the statutory prescription. In this regard therefore, the decision of the Rajasthan High Court in Mahalakshmi Mills v. State [AIR 1968 Raj 331] holding that it is not necessary that the new shares should have been offered or allotted to the existing members is inapplicable. 7.3 CONVERSION AND CONSOLIDATION A company having a share capital may according to Sec.95(l): i) consolidate and redivide its share capital into shares of larger amount than its existing shares; ii) convert any shares into stock; iii) reconvert any stock into shares; (iv) subdivide its shares or any of them; (v) redeem any redeemable preference shares or (vi) cancel any shares otherwise than in connection with a reduction of capital under Sec. 100-104. Provided that within 30 days of doing so, the Company has to give a notice to the Registrar regarding such consolidation, division, conversion, redemption or cancellation. The last relating to conversion are specified below: (a) Shares into stock: If articles so permit a company may convert fully paid shares into stock if the company in its general meeting resolves to do so. It may be noted that a partly paid share cannot be converted into a stock because a stock is always fully paid. A stock denotes an amount which can be divided and a part sold. A share even if fully paid cannot be divided and sold in parts. (b) Stock into Shares: Stock of an amount can be converted or reconverted into a share fully paid. For such reconversion, (a) a general meeting has to pass a resolution, and (b) it must be authorised by the articles of the company. (c) Debenture into Stock: Presently, debentures are issued on terms that these shall be converted into equity shares after some time. Such conversion has three primary conditions on which the conversion is dependant: (1) A special resolution to this effect is required to be taken in a general meeting unless the debenture holder or the creditor is the Government;
(2) Such a term of conversion is approved by the Central Government or be in conformity with the rules made by the Central Government; and (3) As stated earlier, the term of issue of debenture included the option. Section F of SEBI guidelines issued on June 11, 1992 on "Disclosure and Investor Protection contains the following requirements as regards issue by the listed companies of Fully Convertible Debentures (FCD) and Partly Convertible Debentures (PCD) (a) Issue of FCDs having a conversion period more than 36 months will not be permissible, unless conversion is made optional with put and call option (b) Compulsory credit rating will be required if conversion is made for FCDs after 18 months. (c) Premium amount on conversion, time of conversion, in stages, if any, shall be predetermined and stated in the prospectus. Thus interest rates for above debentures will be freely determined by the issuer. (d) * * * * * (e) Any conversion in part or whole of the debenture will be optional at the hands of the debenture holder, if the conversion takes place at or after 18 months from the date of allotment, but before 36 months. (f) In case of ..... /PCDs credit rating is compulsory when maturity exceeds 18 months. (g) Premium amount at the time of conversion for the PCD shall be predetermined and stated in the prospectus. (h) * * * * * * (i) * * * * * * (j) * * * * * * (k) * * * * * * (l) * * * * * * (m) SEBI may prescribe additional disclosure requirement from time to time, after due notice. In clarification I dated 11-6-1992 on the guidelines....SEBI stipulated in 'L' relating to Promoters Contribution and lock-in period as follows: In the case of FCDS, the intention is that over and above the proposed issue amount of FCDS, the promoters, directors, friends, relatives and associates should bring in by way of contribution to equity, amount equivalent to one-third of the amount proposed to be issued as FCDs. Likewise in case of PCDs, one third amount of equity should be with reference to convertible portion of PCDs. In section L(e) of the clarification II dated June 17, 1992 on guidelines for disclosure it is stipulated that : Where the PCDs/FCDs are issued, the promoters may bring in their contribution either by way of additional equity or by way of subscription to FCDs/PCDs so that total contribution of the promoters is not less than 50%, 25% or 20% as the case may
be, of the equity after the conversion of FCDs/PCDs. If the contribution is by way of equity, the promoters may subscribe to such equity at par, if the first conversion of the FCDs/PCDs is to take place after 18 months from the date of allotment irrespective of the terms of conversion of debentures. In other cases, viz., if the conversion is to take place at 18 months or less. the promoters contribution towards equity shall be at the same price at which subscribers to FCDs/PCDs are entitled to conversion. The lock-in period of 5 years shall apply from the date of allotment of debentures and in respect of the shares accruing on conversion of such debentures from the date of allotment of debentures. If the contribution is brought in advance by way of equity, the lock-in period shall commence from the date of allotment or commencement of commercial production (in case of a manufacturing company), whichever is later. Section M(ii) stipulates that: No company may, pending conversion of FCDs/PCDs, issue any bonus shares by way of rights or bonus, unless similar benefit is extended to the holders of such FCDs/PCDs through reservation of shares in proportion to such convertible part of FCDs/PCDs falling due for conversion within a period of 12 months from the date of rights or bonus issue. The shares so reserved may be issued at the time of conversion of such debentures on the same terms on which the rights on bonus issue were made. Section P (ii) stipulates that: Where in terms of the consent issued by the Controller of Capital Issues, the price of conversion of PCDs/FCDs is to be determined at a later date by the Controller, it would be sufficient, if such price and timing of conversion are determined at a general meeting of the shareholders subject to(a) the consent of the holders of PCDs/FCDs for the conversion terms being obtained individually and conversion is given effect to only if the concerned debenture holders send their positive consent and not on the basis of non-receipt of their negative reply; (b) Such holders of debentures, who do not give such consent, are invariably given an option to get the convertible portion of debentures redeemed or repurchased by the company at a price, which shall not be less than the face value of the debentures; and (c) Where the consent from the Controller stipulates cap price for conversion of FCDs/PCDs, the Board of the company may determine the price at which the debentures may be converted. Besides the above classification IV; guidelines H, K & L on issue securities by development financial institutions (DFI), also include certain explanation and principles on FCDs/PCDs. 7.4 ALTERATION OF MEMBERS RIGHTS According to Sec. 106 where the share capital of a company is divided into different classes of shares, the rights attached to the shares of any class may be varied with the consent in writing 271
of the holders of not less than three-fourths of the issued shares of that class or with the sanction of a special resolution passed at a separate meeting of the holders of the issued shares of that class: (a) if provision with respect of such variation is contained in the memorandum or articles of the company, or (b) in the absence of any such provision in the memorandum or articles; If such variation is not prohibited by the terms of issue of the shares of that class. The variation referred to in this section is variation affecting the interest or right of any class of shareholders. In case the variation is to the advantage of any class it is not expected that anyone belonging to the class of shares shall have objection. As such, the presumption is that where a variation involves the curtailment of the rights of any class or classes of shareholders, the consent or sanction of such class or classes will be necessary. In re Hindustan General Electric Corporation [(1959) 29 Com.Cases 144] it was held that a variation which merely affects the enjoyment of a right without modifying the right itself does not come within the scope of Sec. 106. In re Saltdean Estate Co. Ltd [(1968) 3 All E.R. 829] it was held that repayment of preference shares in terms of conditions attached to the issue of preference shares was not a variation of rights. Similarly increasing the voting power of the equity holders by issue of right or bonus shares does not affect the rights of the preference shareholders. As such no application lies even though the importance of the preference shareholders in relation to total capital may be decreased. In case the variation is due to a scheme under Sec. 391 (arrangement with creditors) or Sec. 394 (amalgamation or absorption), Sec. 106 is not applicable. One of the defects of Sec. 106 is that it does not require any notice to be served on the shareholders of the class whose rights are affected. It only prescribes that 3/4th of the shareholders of that class in a meeting have to approve the variation. Variation in India includes cancellation and as such a company cannot cancel a class of share without following the provision prescribed in Sec. 106. Remedy available to the minority holders Sec. 107 provides for the protection of the interests of the minority shareholders of the class of shareholders the rights of whom are affected due to variation of rights by the company. The minority holders holding not less than 10% of the issued shares of that class may apply to the court to have the variation cancelled. Where an application is made under this section the variation shall not have effect unless and until it is confirmed by the Court. This application is to be made within 21 days from the date of the consent being taken or the resolution being approved for the alteration. On such application the Court shall hear all interested parties and decide as to whether the variation would unfairly prejudice the shareholders of the class represented by the applicant or not. The decision of the Court shall be final and within 30 days from the date of the order, a copy of it shall have to be forwarded to the Registrar. In re 272
Suburban and Provincial Stores [(1943)1 All ER 342] where an applicant filed an application challenging the variation, the court held that he has to show that he was authorised by the required percentage of dissenting shareholders. Variation can be effected therefore, in two ways, viz., (a) by consent given by three fourth of the class of shareholders or (b) by a resolution passed in the meeting with three fourth majority. The "Variation" is effective as soon as any of the above takes place. It can, of course, be stayed if an application is made preventing the variation within 21 days from the day of the consent or resolution passed in the meeting. In Sitaram Reddy v. Bellary Spg. & Wvg Co. Ltd. [(1984) 56 Comp. Cas 281] it was observed that a resolution, which is not passed by the three fourth majority as required under Sec. 106, cannot be acted upon by the company. 7.5 REDUCTION OF SHARE CAPITAL One of the cardinal principle of corporate finance is that capital once formed cannot be reduced because of representation to investors and creditors. Replacement of one form of capital by another is permissible but not the reduction. Under the Companys Act the following types of reduction of capita is allowed: (a) Reduction of Preference Shares : According to Sec. 80(1) a company may issue redeemable preference shares if so authorised by the articles. According to Sec. 80(3) redemption shall not result into reduction of the authorised capital. In order to replace the amount of capital in place of the preference shares redeemed, either a fresh issue of capital is necessary or a part of the undistributed profit can be transferred to a Capital Reserve in order to redeem the preference shares. The whole procedure has already been discussed earlier. It is sufficient to note here that the authorised capital of a company cannot be reduced though one form of capital may replace another. As such, either a new issue is necessary or profit has to be capitalised in order to redeem preference shares. This type of reduction does not require the procedure laid down in Ss. 100-103. (b) Cancellation of shares: A limited company having share capital, if authorised by its articles, may alter the condition of the memorandum in so far as diminishing the amount of share capital by cancellation of shares not taken or agreed to be take by any person. This is an instance of decrease of capital but according to Sec. 94(3) not a reduction of share capital within the meaning of the Act. (c) Forfeiture of Shares: If so authorsed by articles a company may forfeit shares on account of non payment of calls, as already been discussed earlier. Unless the forfeited shares are reissued the capital is reduced though according to the Act, this is not deemed as the reduction of share capital. (d) Reduction of Capital : A company can reduce its share capital according to Sec. 100 & 101 if: (i) the company is either limited by shares or guarantee; (ii) it is so authorised by the articles; (iii) a special resolution is passed to this effect;
(iv) a court order confirming the reduction is obtained; and (v) a certified copy of the court order is given to the registrar for registration. Reduction of capital may be in any of the following ways: (a) extinguish or reduce the liability on any of its shares in respect of share capital not paid up; (b) 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; (c) 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 Country. Why is Capital required to be reduced: A companys capital may be wasted on account of different reasons, say for example: 1) A capital intensive industry requiring a long gestation period may have taken a longer period than anticipated. As a result, losses continued to accumulate which is shown as an asset in the companys books of account but really stands for capital wasted. 2) A company with inadequate working capital may be compelled to not utilising the installed capacity and remain much below the break-even point resulting in sickness and wasting capital. 3) If a company continue to under-depreciate its assets thereby artificially jacking up the profit, the capital may be wasted by paying dividend not actually out of profit. 4) Inefficient management may resort to window-dressing in the accounting practice in order to cover up the inefficiency. As a result. the capital is wasted firstly by showing asset with no real worth and secondly paying dividend actually from capital; 5) Due to technological change, manufacturing assets of any company may become useless and with outdated production technique it is unable to compete with other industrial units. As a resplt, suddenly its assets may be required to be reduced resulting into wasting of capital. In many cases a sick industry before BIFR finds any or many of the above reasons making its asset-liability position highly tilted in favour of liabilities. Assets are built up some worthless; some with some worth, some doubtful and yet some nonrealisable. Similarly liabilities may be understated. The reason may be longer gestation time, inefficient management, or acute under capitalisation resulting into shortage of working capital. Over a period of time, the asset-liability equation is disturbed and the book figures become simply an eye-wash and window dressing. In such a case, the first task is to prepare a scheme of reconstruction through which (a) capital is reduced by making the size of it actually representing the real worth, and
(b) liability of secured and unsecured creditors reduced by agreement. The amount thus available is 'offset' by: i) reducing assets to real-worth: ii) writing off all fictitious, doubtful and unrealised assets; and iii) writing off all accumulated loss. The financial statement then is brought to the line of actual worth at the ground level. The scheme, thereafter, contains ways of finding capital for rejuvenating the industry and the required working capital. In fact reduction of capital is attempted to administer 'oxygen' to an acute patient as the last chance. In order to prevent wasting of capital in a systematic manner due to inefficient management, there is credit rating system available in advanced countries. Professional agencies make grading by examining the accounts of the concern. But in many cases such a position becomes inevitable and as such, reduction of capital is necessary. If a company raises more capital, it has to keep a part of the capital idle. This results in low yield on capital. This also require reduction. What is reduction According to the decision in re Panruti Industrial Co. (P) Ltd [AIR 1960 Mad 537] the expression 'reduction of share capital' applies to all cases of reduction, whether of nominal, issued or unissued and if issued, whether paid up or not. But a judgment of Patna High Court suggesting cancellation of illegal allotment is a reduction of capital under Sec. 100 is unfounded because an illegal allotment is ab initio void. (See Rupak Ltd v. Registrar of Companies (1976) 46 Comp. Cas 53]. Surrendering shares to the company by way of settlement of a dispute or for any other reason, is a reduction. But share transferred to a nominee of the company is not reduction of capital. In re Castigloane's Will Trusts [1958) 28 Comp. Cas 365] it was observed that shares bequeathed to the company will be reduction of capital. Procedure of reduction Reduction of share capital can be one in case of existence of some a priori conditions. These are as stated in Sec. 100: (a) the company must be limited by share or guarantee and (b) the articles must provide the power of reduction. In re Dexine Patent Packing & Rubber Co [1903 W.N. 82] the memorandum of the company provided the authority. The court held that it was of no consequence. The 'articles' have to provide the authority. If it does not, if has to be altered first. Once these a priori conditions exist, the company has to pass a special resolution in order to reduce the capital in any manner as mentioned earlier. Ss 101, 102 & 103 which provide the detailed procedure as: (1) A petition is to be made to the court for obtaining a confirmatory order. (2) Every creditor of the company is entitled to object to the reduction. 273
(3) A list of these creditors shall be prepared and the court may publish notices fixing a day or days to creditors not enlisted for enlistment. (4) A creditor in the list on dissenting the reduction, the court may dispense with his consent if the company secures the payment of the creditor. (5) Having regard to some special circumstances the court may direct enlistment of creditors but securing payment in case of objection shall not apply. (6) If the court is satisfied that either the consent of the creditors is taken or the debt is discharged or made secured, the court may make an order confirming the reduction on such terms and conditions as it thinks fit. (7) Where the court makes the order, the company has to add to its name as the last words thereof, the words 'and reduced' until expiration of the period for which the order is made.
(8) Where the company makes such orders the company has to give proper information to the public by publishing information as to the reduction of capital and the circumstances leading to such reduction. (9) The Registrar on production of a copy of the court order confirming the reduction and a certified copy to be delivered to him, shall register the order and minutes of the meeting as approved by the Court. (10)On such registration the memorandum of the company shall stand altered. In Scotish Insurance Corporation v. Wilsons & Clyde Co. Ltd [(1949) 1 All E.R. 1068], it was held that in the case of reduction of capital 'the task of the Court is not only to see that the procedure by which reduction is carried through is formally correct and that the creditors are not prejudiced but it has the further duty of satisfying itself that the scheme is fair and equitable between the different classes of shareholders'.
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8. CASE LAW
Canara Bank Ltd v. Tribhuvandas Jath Bhai & another [Air 1957 Trav-Co. 183] The Canara Bank Ltd are the appellants in this suit for money due from defendants 1 & 2. The bank claimed a paramount lien over some shares of a company (deft. 3) in their name. The Company also wanted to exercise its right of lien over these shares for amount due to it from defendants 1 & 2. The shares were in the possession of the defendant 3 i.e. the company. The trial court held that the 3rd defendant who was in prossession of these shares had a prior charge over that of the plaintiff. On appeal, the Court quoting from Palmer's Company Law (19th Edn. P. 134) held, "A Company has, prima facie, no lien on the shares of members; but the Articles may, and usually do provide that the company shall have a paramount lien on the shares of each member for his debts and liability to the company, whether matured or not. Such a provision is effective and its efffect cannot be destroyed either by the fact that shares are brought and sold in the open market or that they are fully paid up or because of company's failure to obtain custody of the shares. The controversy that has engaged the attention of courts has never been on the existence or validity of such a lien but its availability after notice in respect of transactions subsequent to the receipt of the notice...... we entertain no doubt that as regards the two heads of claim in respect of which priority is claimed before us the Bank is entitled to succed on the basis of Art. 36 of Articels of Association of the Bank. Appeal allowed. Shahzadi Begum Saheba v. Girdharilal Sanghi [AIR 1976 AP 273] B pledged certain shares of a company with N to whom he had to pay Rs. 54,000/-. B requested the plaintiffs to redeem these shares from N by paying him Rs. 54,000 and to keep the shares as pledge against the loan thus advanced to B. Accordingly, the plaintiffs paid the money and redeemed the shares, and B executed an instrument of pledge. As per the agreement, the plaintiffs were to lodge the shares for transfer in their names immediately. B was given the right to pay the amount including the transfer fee and take delivery of all these shares within a period of 2 years from that date. A further period of 1 year was also given to him to take back these shares after paying the entire amount plus 9% interest. If the amount was not paid even after this, the plaintiffs were given the right to dispose of the shares in open market at the risk and responsibility of B, after giving B prior information of sale. The plaintiffs were also given full voting rights on these shares. When B failed to pay the amount and redeem the shares even after several notices, the shares were sold off at public auction. After deducting the amount realised by the sale of shares, the principal amount and the interest due was sought to be recovered by the plaintiffs. Held, that the suit transaction constituted a mortgage. In bringing the shares to sale, the plaintiffs had only exercised their right under the agreement and not because they were pledgees. The main point of distinction between a pledge and a mortgage is that the right of enjoyment of the property is not given to a pledgee, but that right vests in a mortgage. ..... The transferees enjoyed cetain rights with respect to the shares which were given in their possession. Something more than mere delivery of shares with blank forms was intended by the parties, the right to enjoyment of the shares was bestowed on the plaintiff which is in consistent with an agreement of pledge; and consistent with mortgage. A mere power of sale conferred by the express terms of the agreement between the parties does not make it a pledge inasmuch as the right of enjoyment of the shares is also created under the agreement in favour of the plaintiffs. Peek v. Gurney [(1861-73) All ER rep 116] A deceitful prospectus was issued by the defendants on behalf of a company. The plaintiff received a copy of it but did not take any shares originally in the company. The allotment was completed and several months afterwards the plaintiff bought 2000 shares in the stock exchange. His action against the directors for deceit was rejected. The Court said that, "the office of a prospectus, is to invite persons to become allottees, and, the allotment having been completed, such office is exhausted and the liability to allottees does not follow the shares into the hands of subsequent transferees. Directors cannot be made liable ad infinitum for all the subsequent dealings which may take place with regard to those shares upon the stock exchange". Needle Industries India Ltd. v. Needle Industries Newely (India) Holding Limited [1981) 51 Comp. Cas 743] The articles of a private company contained a clause that when the directors decided to increase the capital of the company by the issue of new shares the same should be offered to the shareholders proportionately and, if they failed to take, they may be offered to the others in such manner as may be most beneficial to the company. The company was a wholly owned subsidiary of an English company. Government of India adopted a policy of diluting foreign holdings. The company accordingly issued new shares to its employees and relatives reducing the foreign holding to sixty percent. When Section 43-A came into operation, the company became a deemed public company because more than 25% of its share capital was held by a body corporate. The company, however, chose to remain a private company for all other purposes. The leader of the Indian 40% holding was the chief executive and the managing director of the company. The company was further required to reduce its foreign holding to 40%. At this stage in the English and Indian blocks developed a difference. The English block wanted that the 20% reduction of their holding should be allotted to one of the Indian companies in which they had substantial interest. A meeting of the company's board of directors, on the contrary, adopted the policy of issuing new rights shares to the existing members, which the English company would not be able to 275
subscribe and thereby its holding would be reduced to 40%. Under the resolution 16 days time had to be given to the members to take their proportion. The letter offering its proportion to the holding company was sent only 4 days before the last date and it received the letter after the date for exercising the option had already expired. Similarly, the notice of the meeting of directors for completing the allotment was sent to them with so short a gap of time that they received it in England only on the day on which the meeting was being held in India. Neither was it able to exercise the option of buying its block of rights shares nor was it able to attend the crucial meeting of the board. Its block of shares was allotted to Indian shareholders. The holding company complained of oppression on these facts. But the court was not convinced that there was any such thing as a continuous policy of oppression. The ultimate purpose of the scheme was Indianisation to the extent of 60%. This could be achieved either by buying the excess holding of the English company or by increasing the Indian shareholding. The latter course was adopted in the interests of the company of its opportunity of participating in the rights issue. But the facts were such that even if proper notice was given the English company could neither have subscribed for its proportion nor renounced it to any one else. There was not right in the company's articles in favour of any member enabling him to renounce his rights shares in favour of others. In the case of a private company there simply cannot be the right of renouncing rights shares in favour of nominees because that would make it impossible for the company to restrict the number of members. The real loss suffered by the holding company was the loss in terms of the market value of the shares which fell to its share. The market value of the shares was much higher than their nominal value. The allotment was at nominal value. The loss of the holding company was the "unjust enrichment" of those whom the block of rights shares was allotted which, but for the policy restriction, belonged to that company. The Supreme Court accordingly held that the Indian allottees of those shares must compensate the holding company to the extent to which the market value was in excess of the nominal value. Dealing with the argument that the illegal nature of the board meeting should itself be an indication of the repressive policy. Chandrachud, C.J., said: The question sometimes arises as to whether an action in contravention of law is per se oppressive. It is said, that, "a resolution passed by the directors may be perfectly legal and yet oppressive, and conversely a resolution which is in contravention of the law may be in the interests of the shareholders and the company". Marwari Stores Ltd. v. Gouri Shanker Goenka [AIR 1936 Cal. 327] The defendant company had a capital of Rs. 1,92,000 divided into 1,920 shares of Rs. 100 each. By a special resolution the company resolved to reduce the capital to half, that is, to Rs. 95,000 divided into 1,920 shares of Rs. 50 each. In other words, the paid-up capital was to be cancelled to the extent of Rs. 50 276
each share. The petitioner, a shareholder, opposed the reduction on the ground that there had been no loss of capital and, therefore, the reduction was unwarranted. The question was whether a scheme of reduction can be confirmed only on the proof of the fact that there has been a real loss of capital. This fact was, however, provied by the company and, therefore, the court did no hesitate in confirming the scheme but cited with approval the opinion of Lord Macnaghten, in Poole v. National Bank of China Ltd., [(1904-7) All ER Rep 138] where he said: "The condition that gives jurisdiction is not proof of loss of capital or proof that capital is unrepresented by any available assets or that capital is in excess of the wants of the company. The jurisdiction arises whenever the company seeking reduction has duly passed a special resolution to that effect", Life Insurance Corporation of India v. Escorts & Others [(1986) 59 Com. Cas 548] In this case, several principles relating to shares and their transfer have been laid down, as given below: Share is movable property, with all the attributes of such property. The rights of a shareholder are: (i) to elect directors and thus to participate in the management through them; (ii) to vote on resolutions at meetings of the company; (iii) to enjoy the profits if the company in the shape of dividends; (iv) to apply to the court for relief in the case of oppression; (v) to apply to the court for relief in the case of mismanagement; and (vi) to apply to the court for winding up of the company; (vii) to share in the surplus on winding up. A share is transferrable but while a transfer may be effective between the transferrer and transferee from the date of transfer, the transfer is truly complete and the transferee becomes a shareholder in the true and full sense of the term, with all the rights of a shareholder, only when the transfer is registered in the companys register. A transfer effected between the transferror and the transferee is not effective as against the company and persons without notice of the transfer until the transfer is registered in the companys register. Until a transfer of shares is registered in the books of the company, the person whose name is found in the register alone is entitled to receive the dividends, not with standing that he has already parted with his interest in the shares. However, on the transfer of shares, the transferee becomes the owner of the beneficial interest though the legal title continues with the transferor the relationship of trustee and "cestui que trust is established and the transferor is bound to comply with all the reasonable directions that the transferee may give. He also becomes a trustee of the dividends as also of the right to vote. Where the transfer of shares is regulated by a statute, as in the case of transfer to a non-resident which is regulated by the Foreign Exchange Regulation Act, the permission, if any, prescribed by the statute must be obtained. In the absence of the permission, the transfer will not clothe the transferee with the right "to get on the register" unless and until the requisite permission is obtained. A transferee who has the right to get on
the register, where no permission is required or where permission has been obtained, may ask the company to register the transfer and the company which is so asked to register the transfer of shares may not refuse to register the transfer except for a bona fide reasons, neither arbitrarily nor for any collateral purpose. The paramount consideration is the interest of the company and the general interest of the shareholder. The only effective way the members of a company in a general meeting can exercise their control over the directorate in a democratic manner is to alter the articles of association so as to restrict the powers of the directorate and appoint other directors in their place. The holders of the majority of the stock of a corporation have the power to appoint by election, directors of their choice and the power to regulate them by resolution for their removal. An injunction cannot be granted to restrain the holding of a general meeting to remove a director and appoint another. When the State or an instrumentality of the State ventures into the corporate world and purchases the shares of a company, it assumes to itself the ordinary role of a shareholder, and dons the robes of a shareholder, with all the rights available to such a shareholder. There is no reason why the State as a shareholder should be expected to state its reasons when, like any other shareholder, it seeks to change the management by resolution of the company. Every shareholder of a company has the right, subject to statutorily prescribed procedural and numerical requirements, to call an extraordinary general meeting in accordance with the provisions of the Companies Act. He cannot be restrained from calling a meeting and he is not bound to disclose the reasons for the resolutions proposed to be moved at the meeting. The principal object of Section 29 (of FERA) is to regulate and not altogether ban the carrying on In India of the activity contemplated by clause (a) and the acquisition of an undertaking or shares in India of the character mentioned in clause (b). The ultimate object is to attract and regulate the flow of foreign exchange into India. Parliament did not intend adopting too rigid an attitude in the matter and it was, therefore, left to the Reserve Bank than whom there could be no safer authority and in whom the power may be vested, to grant permission, previous or ex post facto, conditional or unconditional. The Reserve Bank could be expected to use the discretion wisely and in the best interests of the country and in furtherance of declared Government fiscal policy in the matter of foreign exchange. Deccan Farms and Distilleries Ltd. v. Velabai Laxmidas, Bhanji [(1979) 49 Comp. Cas 321 (Bom)] The petitioner had given a loan of Rs. 2,500 to a company named D.F.D. Private Ltd., repayable on August 31, 1974, with interest at 15 per cent per annum. The said company was converted into a public limited company and certificate of change dated
November 19, 1973, was duly obtained from the Registrar of Companies. The company offered 3,00,000 equity shares of Rs. 10 each to the public and received Rs. 15,00,000 on the basis of money paid on application and on allotment in respect of the said 3,00,000 equity shares. The company was granted permission to list the shares on the Bombay Stock Exchange but the said permission was withdrawn on April 26, 1975, on account of the failure on the part of the company to fulfil the various requirements. Out of the Rs. 15,00,000 received pursuant to the issue of shares, the company utilised about Rs. 8,00,000 for making payments to M/s. T.I.C. for the purchase of machinery. The managing director of the company and his brother who was also a director of the company, were interested in the said T.I.C. The funds of the company were frozen on a complaint given by some of the directors of the company. As the amount of the loan given by the petitioner was not repaid in time. the petitioner by a letter dated September 25, 1974, demanded repayment of the loan amount with interest and also gave a statutory notice under Sec. 434 of the Companies Act, 1956. The company sent reply that it was trying its best, and it would repay as soon as funds were available. On October 28, 1974, the petitioner presented a winding-up petition under S. 433 (e) of the Act on the ground that company was unable to pay its debts. This petition was duly admitted and advertised. At the hearing of the petition, the company raised various objections. Three other petitions were also filed by other persons for winding-up of the company on the ground that it was unable to pay its debts, and one other petition No. 14 of 1975, was filed by a director of the company to wind up the company on the ground that it was just and equitable to do so. The company preferred an appeal to the High Court against the order of winding-up. The Court held that, in the present case there was no evidence at all to show that the creditors were opposing the winding-up. It is, not an absolute rule of law that the court is bound to make an order for winding-up even when the conditions required for winding-up exist. It is entirely a matter of judicial discretion.... There was no prospect of the company doing any business. There was a complete deadlock among the directors. These directors have filed a winding-up petition on the ground that it was just and equitable that the company be wound up. The majority of the directors did not have confidence and faith in the managing director and another director. Large amounts had been paid by them to a concern in which both of thern were interested. In these circumstances, it was desirable that the assets of the company should be protected. The object of winding-up by the court is to facilitate the protection and realisation of the assets of the company with a view to ensure an equitable distribution thereof among those entitled. The winding-up order was in the general interest of all the creditors. The appeal was dismissed.
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9. PROBLEMS
1. B.K. Holdings (P) Ltd of Calcutta purchased some shares of Prem Chand Jute Mills Ltd of Calcutta. Shares were not quoted or dealt with on any recognized stock exchange. This was an agreement sale with the vendor of the shares which provided that the price was to be the face value of Rs. 100 each, 50% of which was to be paid against the delivery of blank transfer deed duly signed by the vendor and the balance 50% was to be paid within nine months from the date of agreement. On the application of B.K. Holdings (P) Ltd, the Prem Chand Jute Mills Ltd refused to register the shares. B.K. Holdings files a suit against the Jute Mill. You are asked by the Prem Chand Jute Mills Ltd to prepare a brief for them arguing justification of the action by the company. 2. Raymond Synthetics Ltd issued a prospectus inviting applications for equity and preference shares both at a premium of 10%. The company did not seek permission of any recognised Stock Exchange for listing of the shares. You are the Company Secretary. The BOD wanted your opinion on (1) allotment of shares presuming the offer has been oversubscribed; (2) what would have happened if the company applied for listing before the Issue of prospectus; (3) Suppose the company proceeds to allot the shares, can the company retain the oversubscribed amount? 3. A company refuses to register the name of three companies purchasing shares equal to about 6% of its total shares on the plea that these three companies are all controlled by only one person, M and it is against the interest of the company to register these three companies as its members. About 75% of the shares of that company are held by LIC, IFC, IDBI, ICL and UTI. An application is made against the decision to CLB. Prepare a list of arguments for and against. Give your decision as well, with reasoning. 4. A HUF purchased a few shares of Vickers Systems International Ltd. But the company refused to register in the name of HUF represented by its Karta, K. The companys plea is that HUF is not a judicial body and a legal entity and the transfer deed executed by in favour of the HUF represented by it is not a valid transfer deed because a company cannot take notice of any trust on its register of members. Critically examine the arguments of the company and give proper advice to the BOD of the company. 5. (a) St. James Court Estates Ltd. wants to redeem its preference shares to the tune of Rs. 6 crores. But creditors of the company threaten to take the matter to the Court on the plea that such an act amounts to reduction of capital. Decide. (b) A shareholder holding 1000 shares in the company left a will on the death gifting all these shares to the company itself. A creditor contested the transfer on the plea that it amounts to acquiring of own shares. Decide. (c) A company raised a capital of Rupees 100 crores but found that presently the company can use only 50 crores. The company passed a resolution to refund Rupees 50 278
crores to the shareholders. Some creditors contested the decision. How can the company do the same? 6. An Indian company proposes to make a EURO issue and seeks your advice for suggesting the steps to be taken in conformity with the present legal requirement. Give your advice. 7. In a General Body Meeting of a company, a resolution was passed removing three directors of a company and electing new ones to replace them. This representation could not be given immediate effect to because of the order passed by a court. Later on the sitting directors moved for quashing the resolution on the ground that the management and control of the company will go to the hands of the opposite parties. Can the resolution be quashed on this ground - decide. 8. A petition under Ss 397 and 398 of the Companies Act was filed by a member who was not acting in his own right but at the behest of the transferee who was not yet a registered shareholder. The respondents contented that, "every member who came before the court must have a grievance, either that he has been oppressed or that the company is being conducted in a manner prejudical to the interests of the company. This grievance must be a personal grievance of a member. It cannot be a vicarious grievance, a grievance of his beneficiary". Is this contention valid? Decide. 9. Charles is a director of Panorama Development and has just received a letter from Prestown Council informing him that the company has been awarded a contract worth Rs. one million to build the new Preston Polytechnic. He carelessly leaves this letter on his desk. Florence, the office cleaner, reads the letter when she is cleaning the office that night, and informs her husband Jack of the contents of the letter. Jack decides to invest Rs.500 in the shares of Panorama Development. When the news of the contract is announced, the shares of the company increase in value by 50p. Discuss if the SEBI regulations on Insider Tradings have been violated. 10.Finlex Ltd. is a company specialising in property development and it needs to acquire new land. It is also the subject of a take-over bid by Essel Ltd. The take over is opposed by all directors of Finlex except Mr. Menon. Kanchan Ltd. wants to acquire a shareholding interest in Finlex, but lacks sufficient funds to do so. An agreement is reached whereby Finlex purchased land owned by Kanchan Rs. 10 million, and the directors of Finlex were to allocate to Kanchan 1 million shares of Rs. 10 each. Kanchan pays for these shares from the proceeds of the sale of its land. All the cheques for the transaction pass through State Bank of India, the manager of which is assured that Finlex funds are not being misapplied. Mr. Menon resigns and is paid Rs. 2,50,000 as compensation. Essel discovers that the land acquired by Finlex is really valued only at Rs. 2.5 million. Discuss the lawfulness of these actions.
[Note: Specify your Name, I.D. No. and address while sending answer papers]

1. Companies Act, 1956. 2. Gupta, B.K.S., Company Law; 2nd edn: 1990 Eastern Law House. London. 3. Gower, L.B.C., Principles of Modern Company Law, 5th edn: 1992, Sweet and Maxwell Ltd., London. 4. Kim-Lane Scheppele, Its Just Not Right: The Ethics of Insider Trading; Law and Contemporary Problems Vol. 56 (Summer 1993) p. 122. 5. Ramaiya, A., Guide to the Companies Act, 11th edn (rep.): 1991 Wadhwa & Co. Pvt. Ltd., Nagpur. 6. Sen, S.C., New Frontiers of Company Law, 1 edn (rep): 1971, Eastern Law House, Lucknow. 7. Shah, A.L. Lectures on Company Law, 19th edn: 1990. N.M. Tripathi Pvt. Ltd., Bombay.
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Course No: III Module No: VII
Monopolies & Restrictive Trade Practices

Materials Prepared by: Dr. P.C. Bedwa Mr. Sudhir Kumar Materials Checked by: Ms. Sudha Peri Materials Edited by: Prof. N. L. Mitra
National Law School of India University Published by: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.
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INSTRUCTIONS
MRTP Act has given new dimension to the economic legislation of the post-Independent era. This enactment imbibes social and economic philosophy enshrined in the Directive Principles of State Policy contained in the Indian Constitution, which lays down that the state shall strive to promote the welfare of the people by securing and protecting as effectively as it may, a social order in which justice - social, economic and political, shall inform are the institutions of the national life, and the state shall, in particular, direct the policy towards ensuring that the ownership and control of the material resources of the community are so distributed as best to subserve the common good and that the operation of the economic system does not result in the concentration of wealth and means of production to the common detriment. The state policy has to ensure economic and industrial growth consistently with reduction in concentration of wealth and economic power. While the growth factor has to be taken care of by the state, the MRTP Act is designed to take care of the second important aspects of economic growth, namely, the benefits of growth should belong to the public at large and not merely to a handful of industrial houses. The three declared objectives of the MRTP Act. 1969 as envisaged are - (1) that the operation of the economic system does not result in the concentration of economic power to the common detriment. (2) for the control of monopolies, and (3) for the prohibition of monopolies and respective trade practices and for the matters connected therewith or incidental thereto. The Act has been amended number of times keeping in view the need of the society and after the amendment of 1991 the following objects are intended to be achieved: 1. 2. 3. 4. 5. Controlling monopolistic trade practices (section 31 & 32). Controlling restrictive and unfair trade practices (section 33 to 41). Making provision for registration of agreements relating to restrictive trade practices (section 33 to 36). To regulate unfair trade practices (section 36A to 36E). Control of certain restrictive trade practices (section 37 to 41).
Now the emphasis has shifted to controlling and regulating the monopolistic, restrictive and unfair trade practices rather than making it necessary for certain undertakings to obtain prior approval of the Central Government for expansion, establishment of new undertakings, merger, amalgamation, takeover, etc. In this module you are required to study the law as it works and how the MRTP Commission and the judiciary reacts towards achieving the goals set by the Constitution in the light of the above objectives. It would be helpful if you could read a good commentary on the Act so that you can have a good analytical basis of the Act as it originally was and as it is now and the effect cause and of the repealed provisions of the Act, as also the importance of the MRTP Act in the light of liberalization and globalization.
N. L. MITRA Course Coordinator
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MONOPOLIES & RESTRICTIVE TRADE PRACTICES
TOPICS 1. 2. 3. 4. 5. 6. 7. 8. 9. Introduction .................................................................................................................. ...................................................................................................... 284 286 295 297 299 312 314 315 316
MRTP Commission
Concentration of Economic Powers ............................................................................ Monopolistic Trade Practices .....................................................................................
Restrictive Trade Practices & Unfair Trade Practices .............................................. Offences & Penalties ...................................................................................................... Case Law ......................................................................................................................... Problems ......................................................................................................................... Supplementary Readings ..............................................................................................
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1. INTRODUCTION
SUB-TOPICS 1.1 History of MRTP Legislation in India 1.2 Enactment of MRTP Act, 1969 1.1 THE HISTORY OF THE MRTP LEGISLATION IN INDIA The problem of concentration of economic and monopolistic power is an economic phenomenon, which transcends the borders of economics, and assumes significant importance in the realms of politics, and jurisprudence. The earliest writing in India on this subject was by Mahatma Gandhi himself, when writing in the newspaper Young India on 23-3-1921, he wrote that: What India needs is not the concentration of capital in a few hands, but its distribution so as to be within easy reach of the 7 1/2 lakhs of villages that make this continent 1900 miles long, and 1500 miles broad. Again he wrote in the news paper Harijan on 22-6-1938 to say that I can have no consideration for machinery which is meant to enrich the few at the expense of the many. Again on 2-11-1934 in the same paper, he wrote I hate privilege and monopoly. Whatever cannot be shared with the masses is taboo to me. On 28-71946, again in Harijan, he wrote that Nor would there be any room in his picture of Indian independence for machines that would concentrate power in a few hands. Therefore, as a political and economic thinker and philosopher, Gandhiji was influenced by the implication of machinery and large scale production on social justice. From this concern arose his theory of Trusteeship, whereby he invited the capitalist to regard himself as a trustee for those on whom he depends for the making, the retention and the increase of his capital. He was prepared to advocate the implementation of measures to make the rich to change their attitude, and to become trustees in the public interest, instead of continuing as exploiters, and to trusteeship a statutory form, and make it a legalized institution through the process of an appropriate legislation. However, the visionary that Mahatma Gandhi was, he wrote the following prophetic paragraphs in The Modern Review, October, 1935: I look upon an increase in the power of the State with the greatest fear, because, although while apparently doing good by minimizing exploitation, it does the greatest harm to mankind by destroying individuality which lies at the root of all progress. The State represents violence in a concentrated and organized form. The individual has a soul, but as the State is a soulless machine, it can never be weaned from violence to which it owes its very existence. "It is my firm conviction that if the State suppressed capitalism by violence, it will be caught in the coils of violence itself, and fail to develop non-violence at any time. What I would personally prefer, would be not a centralization of power in the hands of the State, but an extention of the sense 284
of trusteeship; as in my opinion, the violence of private ownership is less injurious than the violence of the State. However, if it is unavoidable, I would support a minimum of State-ownership. "What I disapprove of is an organization based on force, which a State is. Voluntary organization there must be. Similarly, in his later writings, Gandijis thoughts came closest to practical economics. He conceded the place of machines, electric power, large industries, individual initiative, and key industries in the economy, but he subjected his acceptance of these realities to several severe conditions, and his twin concepts of Sarvodaya and Trusteeship. He felt that machines must not deprive people of employment, they must not exploit the villages or compete with village crafts, they must help the village artisan to reduce his drudgery and improve his efficiency, but they should not tend to make atrophied the limbs of man. They must not lead to monopoly or concentration of wealth-power in a few hands, and they must not lead to exploitation, either national or international. And, when the machines involve large capital or large number of employees, they must be owned by the State, and administered wholly for the public good. With Satyagraha as the means and socialism as the objective to be achieved, Gandhiji offered an alternative to the class war and proletarian dictatorship as the means for achieving western kind of socialism. His goal was Sarvodaya, the welfare of all; and this included not only the humble, the lowly, and the lost, but also the capitalist and the landlord, if they forswear the use of capital and land for their personal ends, in excess of their basic needs. He was for a classless society based on destruction of the classes, but not on the destruction of the individuals who constitute the classes, a system of production that does not fail to make use of science and technology for creating an economy of abundance, but does not in the process either kill individual initiative or freedom for development, and a system of distribution that will ensure a reasonable minimum income for all and, while not aiming at a universal equality of an arithmetical kind, will nevertheless ensure that all private property or talent beyond the minimum will be used as a trust for the public good and not for individual aggrandizement, and a social order where all will work but there is no inequality, either in status or in opportunity for any individual. While the concepts of Monopoly and Concentration of economic power as well as Restrictive Trade Practices have been present in Western Economic Thought and jurisprudence for more than two centuries, these words and phrases started acquiring a meaning, relevance, and importance in India only in the twentieth century. After Mahatma Gandhis political and economic thoughts on this subject came to be widely discussed and debated during the period between the two World Wars, the first substantive Economic theorization on this subject was provided by Sri Ashoka Mehta in the late 1930s and early 1940s.
Immediately after India attained independence on August 15, 1947, at the political level, the then Prime Minister Sri Jawahar Lal Nehru himself chaired the Economic Programme Committee of the Indian National Congress, and its 1948 report recommended the establishment in India of an economic structure which will yield maximum production without the operation of private monopolies and the concentration of wealth. This report of the Economic Programme Committee of the political party in power then provided the basis for the first Industrial Policy Resolution of the Government of India, adopted on April 6, 1948, which laid down the major policy objectives to be pursued by the Government in the field of industry and industrialization, and propounded the theory of imposing social control on private economic activity, and promoting the desired goal of the prevention of concentration of economic power. Even at this stage, there was no clarity of thought and perception as to how to go about imposing social control on private economic activity, and as to the nature of legislative framework required for this purpose. 1.2 ENACTMENT OF MRTP ACT, 1969 The first definitive parameters of the philosophy of the Indian State were provided by the Constitution of India, which came into force on January 26, 1950. The preamble to the Constitution mentioned social and economic justice as one of its declared objectives, and two of the Directive principles, contained in Articles 38 & 39, require the State Policy to be directed towards securing the political and economic philosophical objectives earlier propounded by Mahatma Gandhi in his writings, that (i) the ownership and control of the material resources of the community are so distributed as best to subserve the common good, and that (ii) the operation of the economic system does not result in the concentration of wealth and means of production to the common detriment. Still the picture as to how and to what extent the Indian State would intervene by way of regulation of the economic processes to achieve these objectives was not clear. Even the First Five Year Plan launched on 1st April, 1951, did not lay down the nature and extent of State intervention in this field. In December, 1954, the Parliament of India adopted the socialistic pattern of society as the objective of its social and economic planning. This was followed soon by the Second Industrial Policy Resolution of the Government of India, adopted on 30th April, 1956, replacing the first (1948) resolution. This Second Industrial Policy Resolution specifically emphasized the policy of prevention of private monopolies and concentration of economic power in different fields in the hands of a small number of individuals, but stopped short of suggesting the modalities for such policy interventions. The industrial progress achieved by the end of Second Five Year Plan (1956 - 61) showed that in the time period of the two five year plans, the national income had increased by around
42 percent, and the per-capita income had increased by a lower percentage of only 20 percent. Around the same time, the Industrial Licensing Policy Inquiry Committee (widely known as the Hazari Committee), chaired by professor R. K. Hazari of the Bombay University, submitted its report in July 1960, and came to the conclusion that the benefit of the industrial licensing procedure had gone only to a few business houses, and this had resulted in their disproportionate growth. As a result, when the Prime Minister Sri Jawahar Lal Nehru presented on August 22, 1960, the draft outline of the Third Five Year Plan, he volunteered to get an enquiry conducted about who had benefitted from the additional income generated in the country as a result of the first 9-10 years of planned economic development, and to appoint an expert committee for this purpose. As a follow up action on the commitment given by the Prime Minister, in October 1960, the Planning Commission appointed an expert committee under the Chairmanship of Prof. P. C. Mahalanobis, which was known as the Committee on Distribution of Income and Levels of Living, which submitted its report in February, 1964. In pursuance of the report of Mahalanobis Committee, in April, 1964, the Government of India appointed a five member Monopolies Enquiry Commission under the Chairmanship of Justice D. C. Das Gupta, a sitting Supreme Court Judge. This commission gave its report in October, 1965. Consequently, the Monopolies and Restrictive Trade Practices Act was passed by both the houses of parliament on May 28, 1969 and it was notified later on 30th May, 1970 to come into force from June 1, 1970. The Monopolies and Restrictive Trade Practices Commission (MRTP Commission), which was envisaged to be established under the Act, was later constituted by a Government notification dated August 1, 1970, on which date the first Chairman of the Commission was administered the oath of office and secrecy by the President of India, the other two members being sworn in later on August 6, 1970. In the first 6-7 years of implementation of the MRTP Act, certain difficulties were encountered, and several suggestions for making amendments in the Act were made, including some by the MRTP Commission itself. In June, 1977, the Government appointed a High-powered Expert Committee to examine the changes necessary in the MRTP Act and Companies Act, 1956, which committee was headed by Mr. Justice Rajinder Sachar, and submitted its report in August, 1978. Recommendations of the Sachar Committee led to the first amendments of the Act in 1980. The MRTP Act has since been amended five more times, in 1982, 1984, 1985, 1988 and 1991, the last amendment being the most significant, which has retracted the position to such an extent that the very wisdom of continuation of the rest of the legislation now appears to be questionable and in doubt.
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2. MONOPOLIES & RESTRICTIVE TRADE PRACTICES COMMISSIONS

SUB TOPICS 2.1 Establishment & constitution 2.2 Powers & functions 2.3 Orders 2.4 Enforcement of orders 2.5 Procedure 2.6 Officials, duties & functions 2.1 ESTABLISHMENT & CONSTITUTION Sec. 5(1) of the Act enjoins upon the Central Government to establish by notification a quasi judicial tribunal known as the Monopolies and Restrictive Trade Practices Commission comprising of a Chairman and not less than two and not more than eight members. Qualifications The Chairman is to be a person who is or has been or is qualified to be a judge of the Supreme Court or of a High Court and the members of the Commission must be persons of ability, integrity and standing who have adequate knowledge or experience of or have exhibited capacity in dealing with the problems relating to economics, law, commerce, accountancy, industry, public affairs or administration [S 5(2)]. It is incumbent upon the Central Government to ascertain before appointing the members that none of members has financial or other interests which may prejudice his functioning as a member of the Commission. So to say a member must not be a person whose interests may come in conflict with his duties as a member of the Commission [S 5(3)]. Terms and conditions of appointment The term of appointment of every member of the Commission is five years at a time, not exceeding a total period of ten years or till he attains the age of 65 years, whichever is earlier [S.6(1)]. The Chairman & every member of the Commission before entering upon his office, make and subscribe to an oath of office and of secrecy in such manner and before such authority as provided. When a Chairman or any other member ceases to hold his office, he is debarred for a period of five years from holding any appointment or connection with any industry or undertaking to which this Act applies [Sec. 6(7) & (8)]. A member may resign his office at anytime by written notice, served on the Central Government and for that matter no period of notice is required. Similarly the Central Government may also remove a member on grounds of insolvency, conviction, involving moral turpitude and physical or mental incapability. A member may also be removed on grounds of acquiring financial or other interests which prejudicially affect his functioning as a member of the Commission or for having abused his position which renders his continuance in office 286
prejudicial to the public interest, but he cannot be removed by the Central Government after a reference to the Supreme Court is made and the Supreme Court after holding due enquiry reports that the member should be removed on the grounds alleged against him [S.7(1) & (2)]. The casual vacancy so caused on resignation or removal is filled by the Central Government by fresh appointment [S.6(3)]. When a vacancy occurs in the office of the Chairman, the senior-most member is to discharge the functions of the Chairman till a person is appointed and assumes the charge of the office of the Chairman of the Commission. Similarly when the Chairman is unable to attend to his work owing to absence, illness or any other reason, the senior-most member is to act as the Chairman, if he is so authorized by the Chairman in writing and he will continue to work as such till the Chairman resumes his duties [S.6(3-A) & (3-B)]. The acts of the Commission cannot be brought in to question only by reason of any vacancy or any defect in its Constitution [S.6(4)]. In re Bengal Potteries Ltd., & Allied Distributors & Co., V MRTP Commission, [(1975) 45 Comp Cas 697] where the issue raised was that the Commission was not validly constituted as it had less than three members including the Chairman at the relevant time, the court held that under Sec. 6(4) of the Act no act or proceeding of the Commission shall be invalid by reason only of the existence of any vacancy among the members of the Commission and further that Sec. 16(2) provides that powers or functions of the Commission may be exercised or discharged by the Benches formed by the Chairman of the Commission from among the members. Provision has been made in the Act itself for contingencies when the Chairman or some of the members may not be available, either because one of them resigned or retired or because some members are on leave or busy else where [DGIR v. Cement Mfrs. Assn. (1991 71 Comp Cas 46 (MRTPC)]. There is specific provision u/s 16(2) that the functions of the Commission are to be discharged by the Benches constituted by the Chairman from among the members. At the same time we can refer to Sec. 18 (1) which empowers the Commission to regulate the procedure and the conduct of its business, procedure of Benches and delegation of powers or functions to the members of the Commission. MRTP (Amendment) Act, 1984 specifically classifies that any order by a member of the Commission, under delegation, shall be deemed to be the order of the Commission. Remuneration The remuneration and other allowances of the Chairman of the Commission and other members shall be governed by such rules and conditions of services which have been prescribed in the MRTP Commission (Conditions of Service of Chairman and Members) Rules, 1970. The remuneration and allowances of the Chairman or any members of the Commission cannot be reduced or varied to his disadvantage after their appointments [S.6(5)].
Sittings of the Commission The Central office of the Commission is in Delhi. But the commission can hold its sittings at any place in India and at such time as may be most convenient to the Commission in exercise of its functions. Its powers and functions may be exercised by Benches which can be formed by the Chairman among the members [S.16]. Hearing before Commission Generally the proceedings before the Commission are held in public. But where for some reason, like the confidential nature of the offence under enquiry, it is necessary to maintain secrecy, the Commission is competent to (a) order that the proceedings, or any part of it, shall be in camera; (b) give necessary directions to the persons present there; (c) prohibit or restrict the publication of evidences given before the Commission (whether in public or private) or of matters contained in documents filed before the Commission [S.17]. Members, etc., to be public servants Every member of the Commission, the Director General and every member of the staff of the Commission, and of the Director General, shall be deemed, while acting or purporting to act in pursuance of any of the provisions of the Act, to be public servant within the meaning of Sec. 21 of the India Penal Code, 1860. Protection of action taken in good faith No suit, prosecution or other legal proceedings shall be against the Commission or any member, officer or servants of the Commission, the Director General, or any member of the staff of Director General in respect of anything which is in good faith done or intended to be done [S.64 (1)]. 2.2 POWERS & FUNCTIONS (1) Power of Inquiry The Commission has been vested with powers of a Civil Court under the Code of Civil procedure, 1908. These powers shall be in respect of the following matters: (a) the summoning and enforcing the attendance of any witness and examining him on oath; (b) the discovery and production of any document or other material object producible as evidence; (c) the reception of evidence on affidavit; (d) the requisitioning of any public record from any court or office; (e) the initiating of any Commission for the examination of witnesses. These powers of the Commission as aforesaid are the same as those of a Civil Court, and through any regulation or otherwise the Commission cannot enlarge those powers over those of the Code of Civil Procedure, 1908 [In re Atul Products, RTPE No.24A of 1974; PRTA V. Escorts Ltd., RTPE No.87 of 1975].
Above mentioned powers u/s 12(1) have been conferred on the Commission for the purpose of any inquiry under the Act and the provisions of the Civil Procedure Code in relation to the matters referred to in this Sec. are (a) Summoning & examination of witnesses: Sec. 31 & Orders 16 & 18 (b) Discovery & production of documents : Orders 11 & 13 (c) Proof of Affidavits (d) Summoning records from Courts & Public Offices (e) Issuing Commission for examination of witnesses : Order 19 : Orders 13 & 16 : Order 26
Though the Commission has the powers of a Civil Court, but it is not strictly bound by the rules of evidence provided in the Indian Evidence Act. Under Sec. 18(1) Commission is vested with the power to regulate the procedure and conduct of its business. Therefore opinion evidence may be produced, particularly in the case of expert witnesses and exchange of evidence by way of affidavits between parties may be permitted by the Commission so that at the hearing proof need be adduced on the contested facts alone. Likewise, the Commission may frame issues after endeavouring to arrive at the agreed or proved facts. The procedure that may be followed by the Commission in conducting inquires under the Act, is regulated by the MRTP Regulations framed by the Commission under Sec. 66 of the Act (empowers the Commission to make regulations for the efficient conduct of its functions under the Act) and the provisions of the Civil Procedure Code, would apply to the extent provided in the regulations. Sec. 12(1) refers to the powers as are vested in a Civil Court under the Civil Procedure Code and Sec. 12(2) provides that any proceeding before the Commission shall be deemed to be a judicial proceeding for purposes of punishment in case of false evidence or contempt committed by way of insult or interruption of its proceedings within the meaning of Sec. 193 and 228 of the Indian Penal Code and that the Commission shall be deemed to be Civil Courts for the purposes of Sec. 195 and chapter 35 of the Criminal Procedure Code, 1973. It means that the proceedings before the Commission shall be judicial proceedings for the limited purpose of empowering the Commission to award punishment as provided in Sec. 193 of the Indian Penal Code. Sec. 12(3) confers special powers which are not available to Civil Court. The powers, however circumscribed in as much as it has been related to trade practice. A trade practice becomes subject matter of examination only when it is in the nature of monopolistic, restrictive or unfair trade practice. Hence the provisions of Sec. 12(3) are applicable only for inquiries under the Act pertaining to the above matters. The power of examination of trade practice is exercisable by the Commission for investigation also, before formal enquiry is instituted [In re Nylon Filament Yarn Case, (l975) 45 Comp Cas 646 (MRTPC); In re Indian & Eastern News Papers Society, (l976) 46 Comp Cas 165 (MRTPC)]. 287
The authority of the Commission u/s 12(3) is confined to require any person: (a) to produce such books, accounts or other documents in the custody or under the control of the person so required as may be specified or described in the requisition. The documents required to be produced shall relate to any trade practice, the examination of which may be required for the purposes of the MRTP Act. The books or documents are required to be produced before an officer of the Commission in this behalf. The officer may examine and keep these books or documents. (b) to furnish such officer with such information as may be specified by the Commission in respect of the alleged trade practice or such other information as may be in his possession in relation to the trade carried on by any other person. Commission has been empowered u/s 12(4) to enforce the attendance of witnesses and for this purpose the jurisdiction of the Commission extends to the whole of India including Jammu & Kashmir though the other provisions of the Act are not applicable to this State since there is no exclusion to such effect Sec. 16(4) Codes: For the purpose of enforcing the attendance of the witnesses the local limits of the Commissions jurisdiction shall be the limits of the territory of India During the enquiry under the Act, if the Commission has grounds to believe that the owner of the undertaking in respect of which enquiry is being made if required to produce certain books, orders etc., may destroy, mutilate, alter, falsify or secrets, Commission by written order may authorize any officer of the Commission to exercise the powers of entry, search and seizure of the books or papers [S.12(5)]. (2) Power to grant temporary injunction Sec. 12-A of the Act empowers the Commission to grant temporary injunction during the course of inquiry relating to any monopolistic, restrictive, or unfair trade practice. Such an order granting temporary injunction can be passed by the Commission only after an enquiry has been instituted under the Act. The object of the injunction is to prevent any resort to monopolistic, restrictive or unfair trade practices. Such an injunction was issued in Director General of Investigations & Registration v. Truck Union [(1988) 63 Comp Cas 340 (MRTPC)] against operators who were trying to impose higher freight rates in their operation in mines. The Commission can pass the injunction order, if it is proved, by way of an affidavit or otherwise, that the person or undertaking or any person is carrying on, or is about to carry on, any monopolistic or any restrictive or unfair trade practice which is likely to effect prejudicially the public interest or the interest of any trader, class of traders or traders generally or of any consumer or consumers generally [See A.K.K.Nambiar v. Union of India, AIR 1970 SC 652; DGIR v. Cement Manufacturers Association, (1991) 71 Comp Cas 46]. For the purposes of this 288
function the Commission has been vested with the same powers as are enjoyed by a Civil Court under Rules-2-A to 5, Order XXXIX of the first Schedule of the Code of Civil Procedure. The Commission has been empowered u/s 12A(2) to grant temporary injunction so as to prevent injuiry to public interest or to any party. This certainly helps the cause of justice. In this regard we can refer to the case Indo-Japan Photo Films v.Indian Newspaper Society [(1990) 67 Comp Cas 573 MRTPC] where the Commission issued an ad interim injunction to save the complainant from an irreparable loss. In this case the complainant developed a dispute with his advertising agency over poor quality service. The complainant offered a compromise payment by means of a cheque and demanded the return of its material if the cheque was to be accepted. The agency did not return materials and consequently the payment of the cheque was stopped. The agency retaliated by exercising its power under a clause of the agreement by advising media members not to accept any advertisement of the complainant released directly or through any other source. The Commission while granting ad interim injunction observed; The rule is prima facie violative of Sec. 33(1) (d) of the Act and is prima facie a restrictive trade practices. If an ex parte injunction is not issued immediately, it may result in irreparable loss to complainant as his total advertisement and publicity would come to a stand still. The operation of Rule 56 of the rules and regulations framed by the Indian News Paper Society enabling it to impose embargo on advertisements of the complainants was stayed [see Indo-Japan Films Co.Ltd. v. Indian News Paper Society Ltd., (1990) 68 Comp Cas 134 MRTPC; DGIR v. Nalli Silk Traders, (1988) 63 Comp Cas 44 MRTPC; DGIR v. Kamlesh Thapar, (1988) 84 Camp Cas 109 MRTPC; Avtar Singh, , pp 31-32]. (3) Power to award compensation Sec. 12 B (1) says that where any monopolistic, restrictive or unfair trade practice had caused damage to any government, or trader or class of traders or any consumer, application may be made to the Commission asking for compensation from the undertaking or owner there of or the person causing the loss or damage without prejudice to their rights to institute a suit for the recovery of any compensation for the loss or damage so caused. The amount of compensation for the loss or damage so caused is to be determined by the Commission : It is significant to note that Central or State government is not empowered to apply for grant of a temporary injunction as per the reading of S 12 A(1) but they can still apply for award of compensation under Sec. 12(B)(1). It therefore appears that before the Commission awards such compensation after due inquiry, the existence of monopolistic trade practice must be established by the Commissions findings, as communicated by the Commission to the Central Government. While the Central Government may pass orders for prohibition of a monopolistic trade practice, the Commission may after due enquiry and hearing, award compensation for loss or damage already s uffered as a result of such monopolistic trade practice. It is significant that while the Central Government may pass orders
prohibiting a monopolistic trade practice, it has to apply the Commission for compensation for any loss or damage suffered by it owing to such monopolistic trade practice. Representative or class action By Sec. 12 B (2) where numerous persons are affected by loss or damage as referred to in Sec. 12 B (1), one or more persons having the same interest may make a representative application, with the permission of the Commission, on behalf of and for the benefit of the persons so interested. For this purpose the provision of Rule 8 of Order I of the First Schedule of the Civil Procedure Code, 1908, would become applicable. One aspect of the matter is worth noting that under Sec. 12 A any person entitled to make application may apply for injunction, but u/s 12 B (1) any person who can establish loss or damage caused to him by the resort to monopolistic, restrictive or unfair trade practices by the defendant can file an application for damages. But such a person is also competant to make an application u/s 12 A, for grant of an injunction for the benefit of others in public interest. Consideration for Compensation In Bandana Chadha V. Sheri-Louise Slimming Centre, [(1991) 70 Comp Cas 712 MRTPC] where a claim for compensation arose out of slimming services which proved injurious to the client, the Commission adopted the following view as to the concept of compensation: Compensation in Sec. 12 B is used in the sense for reparation for the loss or damage caused. Compensation is thus a monetary equivalent of any loss or damage and may include(i) the actual pecuniary loss sustained which can be quantified with precision; (ii) the indirect loss which nevertheless is consequential to the alleged indulging in of an unfair trade practice, i.e., loss of profit, loss of reputation, loss of business or loss of credit; (iii) the mental suffering like anxiety, worry, tension; (iv) bodily suffering like pain, illness, loss of limb etc., In this case the slimming service was so incompetent that a number of ailments was caused to the client producing mental pain, physical suffering and unfitness for work. Nobody appeared for the side of the slimming centre to controvert the claim. The Commission accordingly allowed Rs.4,07,110 by way of compensation on the basis of the claim submitted by the complainant. The Court noted that the Act nowhere provides any suitable yardstick to measure compensation for loss or damage envisaged under Sec. 12B. It is well settled law that all losses or damages are not capable of being compensated. Only those which have a causal connection with the unfair trade practice or which are the proximate (and not remote) consequences of an unfair trade practice are compensable [Avtar Singh p 35; see also India Book House Re. (1989) 65 Comp Cas 36 MRTPC]. (4) Power to find out defiance Sec. 13-A empowers the Commission to find out by means of investigation by Director General or by any Officer of the
Commission if any order made by it under the Act has not been complied with. For the purpose of investigation when so authorized by the Commission, the Director General or any other Officer of the Commission to undertake such investigation shall be entitled to exercise all or any of the powers conferred on the Director General under Sec. 11 of the Act, i.e., the powers of a Inspector under Sec. 44(2) and any order or requisition made by a person making an investigation, shall be enforced in the same manner as if it were an order or acquisition made by an Inspector appointed under Sec. 240, or Sec. 240-A of the Companies Act, 1956. Sec. 240 of the Companies Act makes it a duty of the officer of the Company, its employees or agents to preserve and produce books and papers relating to the affairs of the Company to the Inspector and Sec. 240-A provides for seizure of documents by the Inspector. On the completion of the investigations entrusted by the Commission the Director General or any other officer of the Commission as the case may be shall submit his report to the Commission for such action by the Commission as it thinks fit. At the same time it is worth noting that no provision has been made in the Act for any time limit within which the investigating officer is to submit his report (Sec. 13-A(1) and (2)]. (5) Power to punish for Contempt Sec. 13-B vests the Commission with the same power, jurisdiction and authority in respect of contempt of itself as a High Court has and for this purpose the provisions of the Contempt of Courts Act, 1971 have been made applicable subject to the modification that reference in that Act to a High Court is to be construed as a reference to the Commission and references to the AdvocateGeneral in Sec. 15 of that Act are to be construed as a reference to such law officer as the Central Government may specify by a notification in Official Gazette [Avtar Singh, pp.40-41]. (6) Power to constitute Benches and regulate Procedure Sec. 16(2) empowers the Chairman of the Commission to form Benches from among the members. The powers or functions of the Commission may be exercised or discharged by these Benches. There is no statutory bar for conducting a proceeding or hearing a matter by a Bench formed by the Commission with one member of the Commission [Bengal Potteries Ltd. v. MRTP Commission, (1975)45 Comp. Cas 697 (cal.)]. The Commission in its order in Avery India Ltd. [MTP Enquiry No.01/75] took the view that one member can constitute a Bench provided he is so appointed by the Chairman under Sec. 16(2) and the Commission has assigned this position to him under Sec. 18(1)(c). According to Sec. 18 which empowers the Commission to regulate its procedure, the Commission shall have the power, to - (a) lay down regulations, for the procedure and conduct of its business for carrying out its function, (b) the procedure to be followed by the Benches constituted by the Commission, and (c) to delegate its powers or functions to member subject to any general or special direction. Sec. 18(c) states that such member shall perform or discharge those functions in the same 289
manner and with the same effect as if such powers or functions, have been directly conferred on such member, directly under the Act itself, and not as delegation of authority to such member, and orders made by such member shall be deemed as orders made by the Commission. Thus, such powers conferred by the Commission under Sec. 18 and the functions which such members or member is required and empowered to perform is not a case of delegated responsibility or exercise of delegated responsibility [Mitra, p.164]. Sec. 18(2) empowers the Commission to decide about the participation of person or persons in the proceedings before it [Sivakasi Chamber of Match Industries v. Western India Match Co. Ltd., (1979) 49 Comp Cas 836 MRTPC]. The Commission has the entire discretion to determine the extent to which any person claiming to be interested in the subject matter of any proceeding before it would be allowed to be present, or to be heard either by themselves or by their representatives or to cross-examine witnesses or otherwise take part in the proceedings. Thus Sec. 18(2) provides the complainant with full rights of participation in the proceedings [See In re Ballarpur Industries Ltd. v. DGIR, Civil Writ Petition No.707 of 1986 (Delhi High Court]. (7) Power to make Regulations Sec. 66 of the Act empowers the Commission to make regulations for the efficient conduct of its functions under the Act. Regulation making power may relate to matters relating a) the conditions of service, as approved by the Central Government, of persons appointed by the Commission; b) the issue of the process to the Government and to other persons and the manner in which they may be served; c) the manner in which the special Sec. of the register kept by the Director General under Sec. 36 shall be maintained and the particulars to be entered or filled therein; d) deleted by the Amendment Act of 1984; e) the payment of costs of any proceedings before the Commission by the parties concerned and the general procedure and conduct of the business of the Commission; and f) any other matters for which regulations are required to be or may be, made under the Act. Under Sec. 66(3) the Central Government shall cause every regulation made under this Sec. to be laid, as soon as may be after it is made, before each house of Parliament, while it is in session, for a total period of thirty days which may be comprised in one session or in two or more successive sessions, and if before the expiry of session immediately following the session or the successive sessions aforesaid, both houses agree in making any modification in the regulation, or both houses agree that the regulation should not be made, the regulation shall thereafter have effect only in such modified form or be of no effect, as the case may be; so however, that any such modification or annulment shall be without prejudice to the validity of anything previously done under that regulation. 290
(8) Power to Compound Offences The power is conferred on the Commission by Sec. 53-A in the following words: 53-A. Power to compound offence - The Commission may, for reasons to be recorded in writing either before or after the institution of proceedings, compound any offence under Sec. 48-C or Sec. 50 relating to contravention of any order made by it. Sec. 48-C deals with penalty for contravention of the orders of the Commission relating to unfair trade practices. Thus, the Commission has the power to accept compounding of unfair trade practices. This may be done either before or after the institution of proceedings. Reasons for compounding have to be recorded in writing. Sec. 50 deals with the punishment for disobedience of the orders of the Commission under Sec. 13, and punishment for contravention of orders relating to monopolistic and restrictive trade practices. Thus all offences relating to monopolistic, restrictive and unfair trade practices have been made compoundable [Avtar Sing, p.203]. 2.3 ORDERS Orders may be conditional, particular or general Sec. 13(1) empowers the Commission to provide in the order made by it under the provisions of the Act that it may stipulate such condition, which are not inconsistent with the provisions of the Act, as it may deem necessary, for the proper execution of the order. The Commission should however, make such stipulation or provision consistent with observance of natural justice. The failure to comply with the obligations or stipulations imposed on any person by the Commission shall be deemed to be guilty of an offence under the Act punishable with imprisonment for a term which may extend to three years, or with fine which may extend to 50,000/- rupees, or with both, and where the offence is continuing one, with a further fine which may extend to 5,000/- rupees for every day, after the first day, during which such contravention continues [S 50 (1)]. The Commissions orders may be general in its application or may be limited to any particular class of traders or a particular class of trade practice or a particular trade practice or a particular locality. Thus under this provision an order of the Commission may prima facie appear to be discriminatory but is within its statutory powers and such orders would not be discriminatory of the order be in personam [Mitra p 152; S 13 (3)]. Amendment or Revocation of Orders The Commission is empowered u/s.13 (2) to amend or vary any order made by it in the same manner in which it was made. This includes the scope for the Commission to make suo motu amendment or variation or revocation of such an order already passed by it. Such amendment or revocation etc. may also be ordered by the Commission on an application made u/s. 13 (2) of the Act read with Regulation 78 and the provisions of Sec.
114 and order XLVII of the Code of Civil Procedure referred to in the said regulation. An order made by the Commission can be amended or revoked in appropriate circumstances, i.e., when there is any material change in the situation which was the basic foundation of the Commissions decision [Delhi Pipe Dealers Association v. India Tube Co.Ltd. (1975) Tax LR 2034 MRTPC] or when there has been some mistake or error of fact apparent on record, or if there is discovery of new matter or evidence of substantial importance which despite due diligence the applicant could not be produced by him at the hearing. Also in the event an ex parte order is passed by the Commission on the failure of a person to attend the hearing, if the person is able to show that he was prevented by sufficient cause from being present, e.g., his council was grossly negligent and/or he failed to inform the respondent about the date of hearing whereby he was precluded from submitting this case before the Commission, the Commission may, in view of Regulation 15 of MRTPC Regulations read with Order IX, rule 13 of Code of Civil Procedure, revoke its ex parte order [In re Ramgopal Maheshwari & Sons, (1979) 49 Camp Cas 202 MRTPC] Though the power of the Commission to redress the grievance of any of the parties affected by any of the orders of the Commission is very wide but it could not be construed to be so wide as to, permit a de novo hearing on the same material without anything more, with a view to showing that order was wrong on facts. This is the only limitation that could be read in Sec. 13(2), apart from the consideration that the Commission has to exercise its discretion judicially or quasi-judicially in exercise of its powers, and not in an arbitrary manner. Further the Commission must be guided by relevant considerations as may be applicable in individual cases on merits. The fact that an appeal which lies under Sec. 55 against the order has not been preferred, would be no ground for refusing to exercise power under Sec. 13(2), nor will failure to prefer an appeal be construed as acquiescence on its part [Mahendra and Mahendra Ltd. v. Union of India, AIR 1979 SC 798]. Also any contention of the respondent that the direction given or obligation imposed by the Commission in its order has or would have caused difficulties in carrying on the business by him would not warrant for revision of the order, in as much as such difficulties, could have been visualized when the order has been passed [Telco Ltd. v. PRTA, (1977) 47 Comp Cas 520 (SC)]. Where, however, an order passed by the Commission runs contrary to a view taken in any other case by the Supreme Court (to which appeal lies from the orders of the Commission), the Commission may revoke its orders. On the mere fact that the order passed by the Commission was a consent order would not, however, deprive the respondent of his remedy of to seek a revision of the order under Sec. 13(2) but then he would have to justify the circumstances warranting such a course of action by the Commission [In re Anil Hard Boards Ltd., (1979)49 Comp Cas 278 MRTPC] . Order awarding compensation The Commission u/s.12 B (3) has to make an enquiry as provided in the Act in to the allegations made in the application
u/s.12 B (1), before making an order on the undertaking or owner thereof to pay the applicant the amount determined by it as realisable as damages or compensation for the loss or damages caused to the applicant by reason of the monopolistic, restrictive or unfair trade practice resorted to. 2.4 ENFORCEMENT OF ORDERS Under s. 12 C every order made by the Commission u/s.12 A (granting a temporary injunction) or u/s.12 B (directing the owner of an undertaking or other person to make payment of any amount) may be enforced by the Commission in the same manner as if it were a decree or order made by a Civil Court. In case the decree on order passed by the Commission could not be executed by the Commission, the same can be sent by the Commission to the Civil Court having jurisdiction overr the Registered office of the Company or the place where the person concerned resides or carries on its business, as the case may be, for execution. There upon the Court to which the order is so sent shall execute the orders as if it were a decree or oder sent to it for execution. Under S 38 of Civil Procedure Code, a decree may be executed by the Court which passed it, or by the Court to which it is sent for execution. Sec. 39 of the Code provides for transfer of a decree to another Court for execution(a) if the person against whom the decree is passed actually and voluntarily resides or carries on business, or personally works for gain, within the local limits of the jurisdiction of such other court, or (b) if such person has no property within the local limits of the jurisdiction of the Court which passed the decree sufficient to satisfy such decree and has property within the local limits of the jurisdiction of such other court, or (c) if the decree directs the sale or delivery of immovable property situated outside the local limits of the jurisdiction of the court which passed it, or (d) if the court which passed the decree considers for any other reason, which it shall record in writing, that the decree should be executed by such other court. 2.5 PROCEDURE As envisaged under regulation 84 B of the MRTPC Regulation, 1974 every application u/s 12 A of the Act must be supported by an affidavit of the person making the application stating specifically the facts which constitute such trade practices and the circumstances whereby the intention is to prove that the said trade practice is likely to affect the public interest, or the interest of any trader, class of traders, or traders generally, or any consumer or consumers generally. Under regulation 84 D, the Commission may, before making any order u/s. 12 A, direct the Director General to make investigation into such allegations and submit a report there on. It is worth noticing that by virtue of regulation 13(2) of the MRTPC Regulations, 1991 an ex parte injunction can be issued only if the delay in issuing the same would defeat the purpose for which the application is made u/s 12 A of the Act. Where adulterated butter being supplied to the inmates of the hospital, it was considered to be fit case for an 291
immediate interim preventive order because no one can be permitted for a day larger to make a fun of peoples health particularly those who are suffering and are at the mercy of trust of the hospital authorities [DGIR V. N.Shanta Kumari, (1987) 62 Camp Cas 157 MRTPC; DGIR V. Manjog Builders, (1987) 62 Camp Cas 845; DGIR V. Universal Luggage Mfg., Co.Ltd., (1987) 62 Camp Cas 275]. At the same time concerning the grant of ex parte injunction the Gauhati High Court in Aparjita Mukherjee V. Anil Kumar Mukherjee [AIR 1990 Gau 73], by way of caution observes Injunction by court not be a matter of course. Although an ex parte injunction operates for a short period, that is, until the other side appears and contests the matter, if the ex parte injunction is vacated afterwards, by that time irreparable damage might have been caused. There is real risk of causing injustice while granting or refusing injunction at the interlocutory stage. Therefore, at the stage of granting injunction court should not act casually i.e., the court should pass an order only after considering all the facts and circumstances of the case. Set off of amount of compensation awarded by Commission against any decree In case a decree is passed by any court also for the recovery of compensation in favour of any person or persons who have approached the Commission, the amount recovered by the person or persons concerned pursuant to the Commissions order shall be set off against the amount recovered under the decree. The decree shall, notwithstanding anything contained in the Civil Procedure Code, 1908, or any other law for the time they in force, be executable for the balance, left after such set off [S 12 B (4)]. This is a safe guard against unjust enrichment, and is a provision for fair play and to avoid double jeopardy. Procedure for application for review, amount, or revocation of Commissions order: Regulation 78 deals with an application made u/s 13(2) of the Act for amendment or revocation of an order of the Commission. But Regulation 78 does not say that an application made u/s 13(2) shall be entertained only on certain specific grounds. That regulation only provides that the new developments that make the order irrelevant must be stated in the application and the Commission should serve notice on all the parties who appeared at the previous proceedings and all of them must be given an opportunity to be heard, and that the provision of Sec. 114 of the Code of Civil Procedure, Order XLVII, Rule 1 shall apply insofar as they are applicable. Sec. 114 provides for review of a decree or order from which no appeal is allowed under the Code. Similarly Order XLVII, makes provision for any person considering himself aggrieved may make any application for review on ground of a clerical or arithmetical mistake or error or where new and important matter or evidence, which offer the exercise of due diligence was not within his knowledge or could not be produced at the time when decree or order was passed; Rule 1 also speaks to this effect. This does not have the effect of saying that an application under Sec. 13(2) can be maintained only on the grounds mentioned in Sec. 114. Even if a case is not covered by Sec. 114, the Commission would 292
have the power to grant relief under Sec. 13(2). Regarding the grant of review application the Supreme Court observed in Sow Chandra Kanta v. Sheik Habib [AIR 1975 SC 100] thus A review of judgment is serious step and reluctant resort to it is proper only where a glaring omission or patent mistake or like grave error has crept in earlier judicial fallibility. Provision for appeal As already stated, an order under Sec. 13(2) of the Act, may be appealed against, Under Sec. 55 of the Act with Supreme Court on any ground specified in Sec. 100 of the Code of Civil Procedure 1908. Under Sec. 55 any person aggrieved by any decision can appeal to Supreme Court on a) any question referred to Sec. 2-A (which deals with power of the Central Government to decide certain matters), or b) any order made by the Central Government under Chapter III (which deals with Division of Undertaking, Severance of Inter-connection), or Chapter IV (dealing with monopolistic trade practices). Within 60 days from the date of the order on one or more of the grounds specified in Sec. 100 of the Code of Civil Procedure 1908. The MRTP Commission can also prefer an appeal to the Supreme Court undera) Sec. 13 (according to which order of the MRTPC may be subject to condition, etc.), or b) Sec. 36-D (which deals with powers of the MRTP Commission to enquire into an unfair trade practice), or c) Sec. 37 (which deals with investigation into restrictive trade practices by the MRTP Commission). 2.6 APPOINTMENT OF DIRECTOR GENERAL AND STAFF Director General Sec. 8(1) provides for the appointment of Director General by a notification by the Central Government and as many Additional, joint, Deputy or Asstt Directors General of Investigation and Registration as the Central Government may think fit for carrying out investigations for the purposes of the Act and including maintenance of Register of agreements which are registerable under the Act [Sec. 33 and 35] and perform such other functions as are or may be, provided by, or under the Act [Sec. 8(1)]. Registrar of Agreements Under Sec. 8(2) Director General is empowered to authorize by written order one of the additional, joint, deputy or assistant director generals to carry out the functions as the Registrar of agreements subject to registration under Sec. 33 and 35 of the Act. Powers and functions of officers The Registrar of agreements and every Additional, Joint, Deputy or Assistant Director will exercise his powers and discharge
his functions, subject to the general control, supervision and directions of the Director General [sec 8(3)]. Staff of the Commission The Central Government may provide for the staff of the Commission. It may, in addition, make provisions for the conditions of service of the Director General, Additional, Joint, Deputy, or Assistant Director General and of the members of the staff of the Commission [Sec.s 8(4) 8(5)]. These conditions of service shall not be varied to their disadvantage. This is very extraordinary protection which is generally reserved for constitutional, judicial or similar high posts where it is desirable that the holder of such posts should not be vulnerable to pressures from the executive by way of adverse revision of their emoluments. This protection is also available to Chairman and the members of the Commission u/s 6(5). Salaries, allowances etc. Though statutorily constituted, the MRTP Commission is an organ of the Central Government. All its expenses including salaries, allowances and pensions of the members of Commission and its staff are met out of the consolidated fund of India, in conformity with Article 266 of the Constitution [sec 9]. Duties and functions of Director General 1. To represent the Commission: In the event of an appeal u/ s 55, or application for grant of special leave to appeal under Article 136 of the constitution, or a writ petition under article 226 or 32 of the Constitution, the Director General is to represent the Commission before the Supreme Court or the High Court, as the case may be, except in those cases where he himself has filed an appeal or special leave to appeal against the order of the Commission. 2. Filing application with Director General: The application filed before the Director General u/s 36(3) of the Act must be accompanied with five additional copies thereof, besides as many additional copies as is the number of respondents. 3. Filing application by Director General: Where Director General files an application for seeking any directions of the Commission for disposing of any application under sec 36(C), he shall make an application along with four extra copies there of to that effect and such an application shall contain information and be accompanied by the following documents: (a) a copy of the application of the party concerned; (b) a copy of agreement in (quadruplicate); and (c) comments of Director General on the application. 4. Disposal of application: On the receipt of the application, the Commission may, if it considers necessary, give the applicant an opportunity of being heard in such proceedings and for this purpose intimation about the date of hearing shall be sent to him. 5. To undertake primary investigation: Sec. 11(2) provides that director General may upon his own knowledge and information or on a complaint received by him undertake a
preliminary investigation to satisfy himself whether or not an application should be made by him to the Commission. 6. Order of investigation: Commission may in the matter of restrictive or unfair trade practice u/s 10(a)(i) or u/s 36-C order a preliminary investigation to be conducted by the Director General in case of a complaint of an association. this investigation is to be made by the Director General. 7. Submission of Preliminary report: Director General will be required to submit report with in such time as fixed by the Commission. 8. Further investigation: Where the Commission on perusal of report of Director General is of the view that a further investigation is necessary, it may order the Director General to make such further investigation, as the Commission may think necessary, and submit a further report. Powers concerning preliminary investigation The power of the Director General or any other person authorized by him to undertake preliminary investigation are those as provided in Sec. 240 and 240A of the Companies Act, 1956. Power to obtain information: If the Director General has reasons to believe that a person is a party to an agreement concerning a restrictive trade practice which is registrable u/s 35, he may give a notice to that person requiring him to furnish to the Director General such particulars of the agreement as may be specified in the requisition if he is a party to such an agreement with in a period of not less than 30 days [sec 42(1)]. At the same time such a person or any other person who is also a party to the agreement containing restrictive trade practice can be required to furnish to the Director General further documents or information in his possession or control which the Director General considers expedient in connection with the registration of agreement [sec 42(2)]. Where the party is a trade association, notice is to be served upon the secretary, manager, or other similar officer of the association and any such association will be treated as a party to the agreement to which the members are parties as such [sec 42(3)]. In case the particulars called for are not furnished, the Director General would apply to the Commission and the Commission may (a) order the person or the association to furnish these particulars within such time as may be specified in the order; or (b) authorize the Director General to treat the particulars or information in his possession as the particulars relating to agreement; or (c) restrain wholly or partly the parties to the agreement and from making an other agreement to that effect, if the Commission is satisfied that the failure to furnish particulars is wilful [sec 42(4)]. Thus sec 42, specifically empowers the Director General to obtain information in connection with, and for the purpose of, registration of an agreement. 293
Function Sec. 36 requires the maintenance of a register of agreements by the Director General, which are subject to registration u/s 33 and in respect whereof particulars have been furnished to him u/s 35. The Director General has to maintain a special Sec. or part of the register for the purpose of filing such particulars as the Commission may direct. Such particulars may contain information about which the Commission is of opinion that its publication would be contrary to the public interest, or their publication would substantially damage the legitimate business interests of any person. Where a party to an agreement which requires registration feels that the agreement or part of it should be excluded from registration because it is of no substantial economic significance or that an agreement should be included in a special part of the Sec. of the register, he may make a request to the Director General accordingly. The Director General has to dispose of the matter in conformity with any general or special direction issued by the Commission for that purpose. In this regard the case RRTA v. Baroda Rayon Corpn Ltd [(1976) 46 Comp Cas 192], is worth noticing. An inquiry was started in this case upon an application by the Registrar [Now Director General since 1984]. The company wanted to inspect the documents on the basis of which the inquiry was held. Registrar claimed privilege to disclosure. The Commission allowed the privilege in respect of documents which contained secret information and which were submitted in confidence, such as the information submitted by the actual users of the goods and by the Ministry of Foreign Trade. Explaining the position of the Registrar [now Director General] the Commission said: The Director General is a public servant appointed under the Act for maintaining a register of agreements and for performing the other functions imposed upon him by the Act. One of the
functions imposed upon him by Sec. 10 of the Act is to make applications to the Commission about restrictive trade practices. The Director General has, therefore, to perform certain statutory functions. If the information given to him about restrictive trade practices was liable to be disclosed, it might be withheld and the Director General would thereby be hampered in the discharge of the duty imposed on him by the statute to make applications to the Commission in respect of restrictive trade practices. There are acute shortage of consumer goods and raw materials in the country and any person furnishing information to the Director General is liable to be victimized by the producers and suppliers by withholding supplies from him. In our opinion, public interest requires that the complaints made by such informants should not be produced for inspection if the Director General does not rely upon such communications as evidence in the hearing. If he produces the complaint in evidence, the respondents will certainly be entitled to inspection of it. Appointment of Inspectors Sec. 44 empowers the Central Government to appoint one or more inspectors for making an investigation into the affairs of any undertaking, if there are circumstances suggesting that the undertaking is indulging in monopolistic, restrictive, or unfair trade practice or trying to acquire control over any dominant or interconnected undertaking. For purposes of investigation the powers and privileges of the Inspector would be same as are enjoyed by the Inspector under Sec. 240 and 240-A of the Companies Act, 1956 i.e., he will have all the powers of investigation including production of documents, examination on oath and search and seizure of documents.
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3. CONCENTRATION OF ECONOMIC POWERS

SUB-TOPICS 3.1. Introduction 3.2. Division of Undertakings 3.3. Severance of Inter-connection 3.4. Manner of Carrying out Orders 3.1 INTRODUCTION Big businesses by its very highness sometimes succeeds in keeping out competitors. It can do so by reason of its financial strength and that the very presence of big business in an industry is likely to have a deterrent effect on the entry of small units, even in industries without any special scope of economies of scale. Hence the provisions of Chapter III of the Act are meant to regulate concentration of economic power. Ss 27, 27-B and 27-C empower the Central Government to order the sub-division or delinking of inter-connections of enterprises whose working is prejudicial to public interest or which are indulging in monopolistic or restrictive trade practices. The purpose of the provision is not to frown upon big business per se It only attempts to regulate the working of large size business in public interest. 3.2 DIVISION OF UNDERTAKINGS When the MRTP Commission is of opinion that the working of any undertaking is prejudicial to the public interests, or has led, or is leading, or is likely to lead, to the adoption of any monopolistic or restrictive trade practices, it may inquire as to whether it is expedient in the interests to make an order. a) for the division of any trade of the undertaking for the sale of any part of the undertaking or assets thereof; or b) for the division of any undertaking or interconnected undertakings into such number of undertakings as the circumstances of the case may justify. When to enquire The Commission may proceed to enquire with the matter i) upon receiving a complaint of facts from any trade association or from any consumer or registered consumers association, whether such consumer is a member of that consumers association or not; or ii) upon a reference made to it by the Central Government or the State Governments; or iii) upon its own knowledge or information. The Commission after such hearing as it deems fit may report to Central Government or his opinion in regard to the division. Where it is of the opinion that the division is imperative, he may specify the manner of division and compensation, if payable for such division [Sec. 27(1)]. For purposes of enquiry and forming an opinion, all activities carried on by way of trade by an undertaking or two or more inter-connected undertakings are to be treated as a single trade [Jiyajee Rao Cotton Mills v. Deputy Secretary, (1989) 65 Comp Cas 525 (Delhi)]. If the Commission recommends division, the Central Government may by an order in writing, direct the division of any trade of the undertaking or of the interconnected undertakings [Sec. 27(2)]. Matters to be provided in the order [Sec. 27(3)] An order for the division of any trade of the undertaking may provide for all matters necessary for the purpose including: a) The transfer or vesting of property, rights, liabilities or obligations. b) The adjustment or discharge of the contracts of the undertaking. c) The creation, allotment, surrender or cancellation of any shares, stock or securities. d) The payment of compensation. e) The formation or winding up of an undertaking or an amendment of its foundation documents such as the memorandum or articles. f) The extent to which the provisions of the order can be altered by the undertaking. g) The continuation of any pending proceedings with such changes as may be necessary. Where such an order is in the contemplation of the Government and the Government is afraid that the implementation of the order may be obstructed and, therefore, to assure that the purpose or the order shall be satisfactorily achieved, the Government may prohibit the doing of anything which may impede the operation of the order. For this purpose also the Government may impose any obligation on a person for the purpose of carrying on any activity or safeguarding of any assets. The Government may even appoint a person to look after the activities or safeguarding of the assets [Avtar Singh, p.75]. If any officer is undertaking ceases to hold office by reason of its division, he shall not be entitled to any compensation [See Sec. 27(4) and (5)]. Penalty for contravention If any person contravenes the provision of Sec. 27 he is punishable with a fine extending upto one lakh of rupees or with imprisonment extending to 5 years or both, and in case of continuing default, the fine will be Rs.1,000/- for every day of default under Sec. 46 of the Act. 3.3 SEVERANCE OF INTERCONNECTION Sometimes MRTP Commission may be of opinion that the continuance of inter-connection of an undertaking (called the principal undertaking) with any other undertaking is detrimental to a) the interest of the principal undertaking; or b) the future development of the principal undertaking; or 295
c) the steady growth of the industry to cover the principal undertaking pertains; or d) the public interest. In such a case the MRTP Commission may enquire as to whether it is expedient in the public interest to make an order for the severance of such inter-connection on one or more of the aforesaid grounds. The Commission may proceed to inquire into the matter i) upon receiving a complaint of facts from any trade association or from any consumer or a registered consumers association, whether such consumer is a member of that consumer association or not; or ii) upon a reference made by the Central Government or a State Government; or iii) upon its own knowledge or information. Commission may after such hearing as it thinks fit, report to the Central Government its opinion regarding severance of interconnection. Where it is of opinion that the severance of the inter-connection of the principal undertaking with an undertaking ought to be made, it shall include in its report a scheme with respect to such severance providing for the matters specified in Sec. 27-A(2) [Sec. 27-A(1)]. Matters to be provided for in the scheme of the MRTP Commission The scheme of the Commission with reference to the severance of inter-connection shall provide for the following matters 1. The manner and period of severance, 2. The appropriation and transfer of the interest of the owner of the principal undertaking in the other undertaking and the termination of any office or employment held by the owner in that concern; 3. Compensation which ought to be paid; 4. incidental, consequential and supplemental matters. The Government may then order severance in accordance with the report and recommendation of the Commission. The Government may, for the purpose of the implementation of the
scheme, prohibit or restrict the doing of anything that might impede the operation of the order, or may require a person to carry out an activity or safeguard any assets or may appoint a person to some position for any of the purposes of the scheme. Any officer who ceases to hold office by reason of severance will not be entitled to compensation for loss of office [Kapoor, p.29-30, Avtar Singh, p.76; Sec. 27-A(4) and (5)]. 3.4 MANNER OF CARRYING OUT ORDERS Sec. 27-B extends the scope of the power exercisable by the Central Government under Sec. 27 or 27-A. It provides that if the Commission in its report under Sec. 27 or 27-A recommends division of any undertaking or severance of inter-connection by disinvestment or sale of undertaking, the whole or in part, or any part of the assets of such undertaking, then the Central Government is empowered to pass an order to give effect to such recommendation within the time prescribed, inter alia, in one or more of the following modes: a) by making a public offer for sale of shares held by the person in the company, owning the undertaking. b) by making further issue of equity capital to members of public by the company, owning the undertaking; c) by public auction of assets of the undertaking; d) by any other method specified by the Central Government. In case of any need the prescribed time may be extended by an other order by the Commission on its own motion or on the application of the person concerned. The order of the Government will be effective even if there is some contrary provision elsewhere in the Act or in any other Law for the time being in force or in the memorandum or articles of the body corporate owning the undertaking. If the person concerned omits or fails to disinvest his shareholding, the company concerned may be ordered not to permit him to exercise any voting right or other rights attached to those shares. Penalty for Contravention Varying degrees of punishment have been provided for violation of the provision under Sec. 27-B vide Sec. 48-A and 48-B which have been discussed under Offences and Penalties.
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4. MONOPOLISTIC TRADE PRACTICES

SUB-TOPICS 4.1 Definition 4.2 Investigation 4.3 Power of Government 4.4 Penalty 4.5 When MTP not prejudicial to public interest 4.1 DEFINITION The expression monopolistic trade practice is defined in sec 2(i) of the Act. It means a trade practice which has or is likely to have the following effects: (1) A practice which has the effect of maintaining prices at an unreasonable level. This may be attained by any method, for example, by limiting, reducing or controlling the production of goods or services. (2) A practice which has the effect of unreasonably preventing competition in the production, supply or distribution of goods or services. (3) A practice which has the effect of limiting technical development or capital investment or causing deterioration in the quality of goods or services and all this to the common detriment. (4) A practice which has the effect of increasing unreasonably the cost of production of any goods or charges for the provision or maintenance of any service. (5) A practice which has the effect of increasing unreasonably the prices at which goods may be sold or resold or the charges at which services may be rendered, or the profits which may be derived by the production, supply or distribution of any goods or the rendering of any services. (6) A practice which will prevent or lessen competition in the production, supply or distribution of goods or the provision or maintenance of services by the adoption of unfair methods or unfair or deceptive practices [Avtarsingh pp.79-80]. The definition would apply to the practices of the kind described whether they be resorted by a monopolistic or non-monopolisitc undertakings. But it is difficult to think of an undertaking being able to influence a market without possessing some sizeable market power. It is difficult to concieve of a monopolistic trade practice indulged in by an undertaking, having a small or marginal share in market, to the exclusion of a monopolist or oligopolist with substantial market power [Duggar, 53]. The goal of this law is to ensure that the competitive economic system works and achieves its goals of lower prices, product innovation and equitable diffusion of real income among consumers and the factors of production. In other words, antitrust laws (anti-monopoly laws) are designed to ensure a system of workable competition [Corley, p252]. 4.2 INVESTIGATIONS According to sec 31(1) of the Act, where the Central Government is of the view that the owners of one or more undertakings are indulging in any trade practice which is, or, which may be, a monopolistic trade practice, as defined in sec 2(i) of the Act, or, that monopolistic trade practice was already prevailing in respect of any goods or services, then the Central Government may refer such matter to the Commission for inquiry. The Commission after such hearing as it may deem fit, shall report to the Central Government its findings thereon. The Commission may also, on an application from the Director General of Investigation and Registration or on its own motion, and not withstanding that no reference has been made to it by the Central Government u/s 31(1) make an inquiry into the matter [Proviso to sec 31(1)]. Thus the power of the Commission to conduct an inquiry can be exercised suo motu, an application from DGIR, or on reference by the Central Government. The Commission after inquiry and holding of a public hearing and having given reasonable opportunity of hearing to the parties has to take into account the economic conditions prevailing in the country, a trade practice operating or likely to operate which is against public interest, and to all other matters which appear in the particular circumstances and then to submit its findings to the Central Government. The Government can pass any order which may be necessary to prevent the mischief. The Government may order the owners to discontinue the practice [sec 31(2A)] and the owners in turn would be required to inform within 30 days of the order of their compliance thereto. [sec 31(4)(a)]. The Government may have the fact of compliance investigated by the Director General and may then take suitable action on the report [sec 31(4)(b)]. 4.3 POWER OF GOVERNMENT The power of the Central Government is of general nature but it is provided in sec 31(3) that without prejudice to the generality of the power Central Government may order concerning the following matters: (a) Regulating the production, shortage, supply, distribution or control of any goods by the undertaking or the control or supply of any service by it and fixing the terms of sale (including prices) or supply thereof. (b) Prohibiting the undertaking from resorting to any act or practice or from pursuing any commercial policy which prevents or lessens or is likely to prevent or lessen, competition in production, storage, supply or distribution of any goods or provision of any services. (c) Fixing standards for the goods produced or used by the undertaking. (d) Declaring unlawful, except to such extent and in such circumstances as may be provided by or under the order,
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the making or carrying out of any such agreement as may be specified or described in the order. (e) A party to any such agreement may be ordered to put an end to the agreement within the time as may be specified in the order. (f) Regulating the profits which may be derived from the production, storage, supply, distribution or control of goods or from the rendering of services. (g) Regulating the quality of any goods or services in such a way that there is no deterioration in standards. 4.4 PENALTY If any person contravenes, without any reasonable excuses any order of the Central Government under sec 31 for prevention of monopolistic trade practices then he shall be punishable with imprisonment which shall be 6 months and not more than 3 years for the first offence and 2 years and not more than 7 years for second or subsequent offences. Where the contravention is of continuing nature, a further fine of Rs.5000/- for every day would be imposed during which the contravention continues [sec. 50(2)].
Where a person carries any trade practice which is prohibited by the Act, the punishment is imprisonment for a term which may extend to six months or fine which may extend to Rs.5000/ - or both and where the offence continues, a further fine of Rs.500/- for every day, after the first, during which the offence continues [sec. 50(3)]. 4.5 LAWFUL MTP - WHEN The provision contained in sec 32 of the Act is that every monopolistic trade practice is prejudice per se to the public interest excepting cases mentioned under the Sec.. Thus a monopolistic trade practice will not be prejudicial to the public interest in the following cases: (1) where it is specifically authorized by any law; (2) where it is permitted by the Central Government by written orders for: (a) meeting the requirement of the defence of India or any part there of, or for the security of State; or (b) ensuring the maintenance of supply of goods and services essential to the community; or (c) giving effect to terms of agreement to which the central Government is a party.
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5. RESTRICTIVE & UNFAIR TRADE PRACTICES SUB-TOPICS

5.1 Meaning: restrictive trade practices 5.1.1 Trade practices 5.1.2 Application to services 5.1.3 Exempted agreements 5.2 Meaning: unfair trade practices 5.2.1 Enquiry commission 5.2.2 Powers of commission 5.3 5.4 5.5 Control of restrictive trade practices Protection of public interest Resale price maintenance Restrictive Trade Practice and by law have become statutory illustrations of restrictive trade practice. The trade practices enumerated in amended S.33(1) and per se restrictive trade practices and the law laid down by the Supreme Court in Telcos case has because infructuous. The definition of restrictive practices in S.2(o) is now of little use as the definition only seeks to be referred to for testing the trade practices, other than those enumerated in Sec. 33(1) [Duggar, p.70]. 5.1.1 TRADE PRACTICES
5.1 RESTRICTIVE TRADE PRACTICES Meaning The restrictive trade practice, means a trade practice which has or may have the effect of prevailing, distorting or restricting competition. Any practice which tends to obstruct the flow of capital or resources in production of goods and services is construed as restrictive trade practice. Likewise, manipulation of prices, conditions of delivery or flow of supplies in the market, which may have the effect of imposing on the consumers unjustified costs or restriction is also regarded as restrictive trade practice [S2(o)]. Thus any agreement which is restrictive of competition, whatever may be the manner of restriction, it is a restrictive trade practice. The special feature of the MRTP Act is that enquiry into restrictive nature of the trade practice is related to the effect on competition. The whole thurst of S.2(o) is on the effect of the trade practice on the relevant competitive situation. Thus, effect on competition is the touch stone under the Sec. [RRTA v. Usha Sales P. Ltd., (1977) 47 Comp Cas 480 MRTPC]. Therefore, before any trade practice can be regarded as restrictive in nature, some damage, however slight, must be indicated in the context of the relevant competitive situation. In Telco Ltd v. PRTA [AIR 1977 S.C. 973], the MRTP Commission held that the trade practices referred to in S.33(1) which require registration of agreement in respect thereof, are ipso facto restrictive trade practices and they need not be tested on the touch stone of S.2(o) before they are so held. But the Supreme Court did not agree with this view and laid down that every trade practice in restraint of trade is not necessarily a restrictive trade practice. The definition of restrictive trade practice is exhaustive and not an inclusive one. The decision whether a trade practice is restrictive or nor has to be arrived at by applying the rule of reason and not on the doctrine that any restriction as to area or price will per se be a restrictive trade practice. Now after the Amending Act of 1984, trade practices enumerated in S.33 do not require to be examined with reference to the definition in S.2(o). They have all ingredients of
Trade practices set out in Sec. 33(1) of the Act are restrictive trade practices and the agreements relating to these matters are required to the registered under the Act, and following are these practices. (1) Any agreement which restricts, or is likely to restrict by any method the persons or classes of persons to whom goods are sold or from whom goods are bought [clause (a)] Under this sub-clause cases are covered where attempt is made to require a person by employing any method to buy and sell goods to given persons or classes of persons. Thus where stockists could be appointed area wise only with the consent of the district or the state associations and they could sell only within the allotted area, it was held that it amounted to restricting the persons to whom the goods could be sold and was a restrictive trade practice within the meaning of sec 33(1)(a) [DGIR v. All India Organisation of Chemists and Druggists, (1992) 73 Comp.Cas 668 MRTPC]. (2) Any agreement requiring a purchaser of goods, as a condition of such purchase, to purchase some other goods [clause (b)]. This type of agreement is called a tying arrangement, i.e. where the purchaser of a product is coerced by his supplier to buy the complete range of his products, though he does not desire to do so. Such practices though widespread in trade are prima facie reprehensible, as they force the buyers to forgo their choice among products which compete with the tied product. They also deny competitors free access to the market for the tied product. Requiring the buyers of cars to pay towards the servicing of the cars with the sale price is a case of such tie up [In re Hindustan Motors Ltd and another, RTP Enquiry No 17(1983)] In re Asu Agency [RTPE 76 of 1985] a complaint was received from a person that Asu Agency, Bombay is indulging in restrictive trade practice of forcing the former to purchase a gas stove from the latter for getting a gas connection. It was held that the respondant shall not repeat the practice of tie up of gas stoves with the installation of gas connections because such tie up is a restrictive trade practice within the meaning of sec 2(0)(ii) of the MRTP Act. It means changing the conditions of delivery in a such a manner as to impose unjustified costs on the consumer [Hindustan Lever Ltd v. MRTPC, AIR 1977 SC 285]. 299
However a case can be made out for some justifiable tying up arrangements such as providing for after sales service to ensure efficient maintenance and repair and provision of genuine spares, thereby also protecting the goodwill of the manufacturer as well as for achieving economics of scale for such other allied products or accessories or ancillaries. But such justification have to be established under the provisions of gateway u/s 38 of the Act [Mitra, p.441] The essence of the Sec. is that when it is found by the Commission that the restrictions imposed by an agreement are justified, they would be allowed. The balancing clause after clause (h) in Sec. 38 indicates when the restriction is not unreasonable having regard to the balance between the circumstances mentioned in the Sec. and the detriment to the public interest resulting from the operation of the restriction [Tata Engg and Locomotive Co v. Registrar (1977) SCC 55 at 59]. (3) An agreement restricting in any manner the purchaser in the course of his trade from acquiring or otherwise dealing in any goods other than those of the seller or any other person [clause (c)] The clause refers to exclusive dealings. Exclusive dealings is a contract where the buyer agrees to purchase all his business needs of a products supplied by a seller during a certain period of time, or where by a buyer agrees not to purchase an item or items of merchandise from the competitors of the seller. Such a contract might take the form of a franchise, in which a dealer agrees to sell only the product manufactured or distributed by a seller. Exclusive dealing agreements originate principally to cater to the manufacturers need to promote his brand products at all stages of distribution, down to the consumer. Where a manufacturer indulges in the practice of exclusive dealing, his competitors are prevented access to that market and the dealers are denied the freedom to handle competing products. In this process, the consumer is also restricted in his choice among the number of competing products. This type of arrangements, which are bilateral and are linked up with territorial restriction, are mostly prevalent in India. [Duggar, p 523]. In RTA v. Usha Sales Pvt Ltd [RTPE, No 8/1974], the commission while holding that the stipulation regarding exclusive dealing in agreements with its dealers amounted to restrictive trade practice, allowed gateways under clause (b) and (h) of Sec. 38(1), in respect of sewing machines and diseal engines in view of nature of products, and the need for after sale service. The same was the view of Commission in RRTA v. Swadeshi Mills Co. Ltd and others [RTPE No 19/1974] and PRTA v. Standard Mills Co. Ltd and others [RTPE No 5/1976]. (4) Any agreement to purchase or sell goods or to tender the sale or purchase of goods only at prices or on terms or conditions agreed on between the sellers or purchasers [clause (d)] Such arrangements could be in terms of bilateral agreements between an individual buyer and an individual seller in respect of goods or services which are for sale. But this may not affect or prevent competition unless such agreement is between parties who have significant control over a substantial portion of the 300
market or supply of goods. It is more significant of collective agreement between one dominating buyer with a number of sellers, or, one dominating seller with a number of buyers or between a group of buyers and a group of sellers. This may then give rise to price cartels or discriminatory or favourable prices, or terms and conditions of sale or purchase between members of such associations, which would not be available to others or which would thus prevent, distort or restrict competition and be prejudicial to public interest. In RRTA v. In Check Tyers and Others [RTPE 1 of 1971] the Commission had for consideration the general code of conduct among companies manufacturing tyres. The salient features, as noted by the Commission, were that the respondents could maintain at a reasonable level the prices of and profits derived from production, supply and distribution of goods, or from performance of any service. It also provided for joint action wherever any respondent was threatened with or suffered from boycott. The agreement also provided for collectively fixing prices, for limiting output and production range of and arranging the pattern of production of tyres in a mutually agreed manner, as well as, provision of joint action in case of any move of boycott against any of its members. The Commission held that the above provisions of the general code of conduct constituted restrictive trade practice and were void and the respondents were restrained from indulging, in such restrictive trade practices in the future [Mitra, p.454]. (5) Any agreement to grant or allow concessions or benefits, including allowances, discount, rebates or credit in connection with, or by reason of dealings [clause (e)] This restrictive trade practice involves an agreement or agreement at the instance of the manufacturer or a distributor providing for differentiation or discrimination in granting or entitlement of rebates, concessions, discounts, allowances or credit to customers in view of part dealings, business relations or transactions. Such rebates, discounts, etc., are distinct from any quantity or turnover or discount on a graduated scale, according to different slabs of turnover, (provided that such differentials of discounts were small and would not materially affect competition), or discounts for payment made in cash or rebates, as incentive for payments made within a stipulated period of time, or credit allowed at the discretion of the supplier, in view of the quantum of turnover or incentive, bonus or commission for promoting sale of new product. It is clear that any concession or benefit, to be construed a restrictive trade practice, must satisfy the following two tests: (i) that differential concessions or benefits must have been allowed or granted in connection with, or by reason of, dealings. Dealings suggest regular course of transaction of sale or purchase, or the provision of service. An individual or isolated transaction does not fall within the scope of restrictive trade practice; and (ii) that they are injurious to the competition. In Registrar v. Carona Sahu Ltd., [(1976)46 Comp.Cas 431, MRTPC], Commission held that allowing discriminatory or
differential incentives bonuses by a manufacturer to dealers on the basis of turnover is a restrictive trade practice as it may have the effect of preventing smaller dealers from being able to compete with bigger ones. Likewise in Nylon Filament Yarn, Re., [(1976)46 Comp.Cas 357] where four major spinners of nylon yarn entered into an agreement with 18 weavers associations which contained a number of clauses, some were considered as restrictive trade practice and were declared void. But in Registrar v. Tata Oil Mills Co. [(1977)47 Comp.Cas 287] it was held that where differential Commission paid is so negligible that it would have no material effect on competition, it would non offend the Act.[In re Poona Beverages Pvt Ltd, [RTPE No 24/1981] (6) Any agreement to sell goods on condition that the prices to be charged on resale by the purchaser shall be the prices stipulated by the seller unless it is clearly stated that prices lower than these prices may be charged [clause (f)] A price list which does not permit the seller by means of a specific stipulation in the list itself to sell at a price lower than those mentioned is violative under clause (f) of Sec. 33 (1) [DGIR v. Drill Co., Metal Carbides Ltd, (1990) 3 Comp.LJ 173]. In Registrar v. Bata India Ltd, [(1976)46 Comp.Cas 441 MRTPC] the following practices were regarded as unreasonable : (1) A clause fixing resale prices for the whole country without indicating that the seller was entitled to sell below the price fixed; (2) A clause requiring the buyer to purchase up to a certain gross value if he wanted a variety; (3) Clause prohibiting the dealers from purchasing raw materials from unapproved persons, enlarging production without approval; changing machinery for production, or increasing production and in case their production increased, requiring then to sell to the company only; (4) Clauses restricting use, number, selection and disposal of moulds. The Commission has also held in Registrar v. Steel Age Industries, [(1976)46 Comp.Cas 607 MRTPC] that where distributors are merely required to stock and display goods of certain minimum value, but without any restriction as to what kind of goods shall be stocked, does not amount to a full line forcing or a tie up. The practice does not offend the Act [Avtar Singh, P.123]. This sub clause is based on the concept of Resale Price Maintenance (RPM) which has been explained thus: Whenever a manufacturer sets the price at which the retail shop which he does not own must resell his products to the public, or at which the wholesale business he does not own must resell that product to a retailer, the practice is known as resale price maintenance. [Andrew & Franse 1960]. The Commission while dealing with the resale price maintenance in RRTA v. Amar Dye Chem. Ltd, [RTPE 51 of
1975] by its order inter alia, restrained resale price maintainence and stipulated that in all price lists issued by the respondent it must be clearly stated that the prices relating to the consumers are maximum prices and the distributor was free to charge lower prices [See also RRTA v. Bajaj Electricals, (RTPE 6 of 1975); RRTA v. Bata India Ltd; (1976)46 Comp.Cas 441] (7) Any agreement to limit, restrict or withhold the output or supply of any goods or allocate any area or market for the disposal of the goods [clause (g)] Clause (g) sets out two categories of restrictions, the first relating to production or supply of goods, and the second relating to area or market for the disposal of goods. The underlying object of such agreements is to regulate the flow of supply of goods or services of a particular kind in the market, so that the producers engaged in that line of activity may benefit equally in times of prosperity or may face the set back uniformly in adverse market conditions. Various measures may be adopted for the purpose i.e, size of capital investment, installed capacity, quality or value of existing production or sale. Proper appreciation of the scope of this provision can be had from of the case Hindustan Pilkington Glass Works Ltd and Windows Glass Ltd [RTPE 2 of 1972] which entered into an agreement with Surat Cotton (Proprietors of Navin Glass Products), by which Surat Cotton agreed not to make or sell certain glass products except existing stocks and it shall keep its plant idle in consideration of payment of an agreed compensation by Pilkinigton Glass Works. Also, Pilkington and Window Glass entered into a common marketing arrangement through Associated Patterned and Wired Glass (APWG) a company promoted by them for the purpose of procuring orders and distribute the products on uniform basis. On an application by RRTA, the Commission held that the agreements were meant to restrict output and supply of glass products and eliminate competition. The Commission passed cease and desist orders. The territorial or market restrictions imposed by the manufacturer may result in imperfect competition, and thereby reduces the consumers choice. Often it might be used by the manufacturer to enhance the monopoly power of his dealers so that the manufacturer, in turn, could extract higher pricess from them. It may also enable the dealers to engage in price discrimination and on the other hand, this practice could be usefully employed by a manufacturer to increase the efficiency of his operations and that of his dealers by providing certain measures of product production, by increase in the range of customers to be contacted by the dealer and cost reduction for self at the dealers. In India, the practice of area allocation is widely prevalent. In DGIR v. All India Organisation of Chemists and Druggists [(1992)73 Comp.Cas 668 MRTPC], according to an agreement between manufacturers of pharmaceutical products and their distributors association only one stockist was to be appointed for each geographical district who was to confine himself to that district and a new stockist could be appointed only with the consent of the association. The agreement was held to be 301
restrictive trade practice [See also RRTA v. Usha Sales Pvt Ltd (RTPE No.8 of 1974)] (8) Any agreement not to employ or restrict the employment of any method, machinery or process in the manufacture of goods [clause (h)]. Clause (h) is consistent with restrictive trade practices as defined in the Act, and sets out an example of classical theory of monopolistic competition where there may be a small group of major producers, who are in the position to make large investments on research and development in their undertakings. There are different ways, direct and indirect, for eliminating competition. The imposition of restriction on the deployment of any machinery or the use of any manufacturing process, for production of goods is a direct way to achieve this purpose. Such restriction can be put by an enterprenuer, who has a dominant say and/or share in the market for goods of any particular description, and who either provides his technical knowledge to other, or avails of the production facilities of other similar units engaged in the some line of activity. Such arrangements are, however, too conspicious and are rarely resorted to openly. But there have been instances where under contract manufacturing arrangements the manufacturer dominates on small scale or ancillary unit which are mainly dependent on such larger undertakings for bulk of there business. In RRTA v. Bata India Ltd [(1976)46 Comp.Cas 441] the respondent had stipulated in their agreements with small scale industrial units which undertook manufacture for them that such small industrial units would neither purchase raw materials from parties other than those approved by the respondent nor manufacture, sell their footwear products, for other. The Commission prohibited such restrictive trade practices, and the clause was modified so that such small manufacturers, did not use the same moulds as provided by the respondents for manufacture and supply to others [See also, In re Sarabhai Chemicals Pvt. Ltd; (1979)49 Comp.Cas 145]. In the matter of All India X-ray and Electro Medical Trades Association [(1977)47 Comp.Cas 237] the Commission struck down an agreement which contained clauses to the effect: (a) that the purchaser would get the equipment installed by the supplier; (b) that the equipment would be guaranteed for 12 months against manufacturing defects and (c) that during the period of guarantee there would be only one routine service and that too would be confined only to oiling, cleaning and adjustment excluding attendance for repairs, breakdowns or normal wear and tear [See also Registrar v. Usha Sales Pvt Ltd (1977) 47 Comp.Cas 472; Registrar v. Tata Engineering and Locomotive Co. (1976)46 Comp.Cas 470]. (9) Any agreement for the exclusion from any trade association of any person carrying on or intending to carry on, in goodfaith, the trade in relation to which the trade association is formed [clause (i)] The object of such an agreement is to restrict the membership of the association to a few persons for mutually sharing the benefits which may arise from the membership. Trade associations enforce their discipline by boycotts, black-listing 302
or shop-listing or refusal to deal with competitors, who do not observe rules of their assocation. This practice of boycott is not widely prevalent in India. Not many cases have came up for enquiry before the Commission. In re Ghee Merchants Association [RTPE No 23/1976] it was observed that the constitution of this association, which was registered for doing the business of selling ghee on wholesale basis in Greater Bombay, inter alia, contained unduly wide powers in the matter of admission to membership. Holding it as a restrictive trade practice the Commission declared the impugned conditions void. Thus collective boycott is not available as an instrument to discipline unethical business practices. The Monopolies Commission of Enquiry (1965) had cited two cases of such practices on which clause (i) regarding instance of boycott based (1)a already manufacturer of pistons stipulated with his distributors that he may maintain a list of persons called shoplist and the distributors shall not sell to any person in that shop list any of the products covered by the agreement; (2) a similar list was prepared by one oil company prohibiting the supply of oil to persons on the list. At the same time it is worth mentioning that the individual traders choice to deal with a certain person or not, is something different. (10) An agreement to sell goods at such prices as would have the effect of eliminating competition or a competitor [(clause (j)] This clause covers predatory pricing agreements to eliminate competition or to destroy a competitor. Predatory pricing means selling at a lower price than customary profits - maximising consideration would dictate, for purpose of driving a competitor out of business or crippling his competitive power [Dugger., p.281]. However predatory pricing arrangements are strategies adopted by undertakings in a position of strength to increase their share of the market. This is similar to loss lenders [In re Johnson & Johnson Ltd & another, (1989)64 Comp.Cas 394 where the Commission did not agree with the complianants and held that both clause (h) and the balancing clause of Sec. 38 would apply even if the charges of predatory pricing could be proved]. (11)Any agreement restricting in any manner, the class or number of wholesellers, producers or suppliers from whom any good may be bought [clause (ja)]. What is mentioned in this clause is also covered by clause (a) of Sec. 31(1) i.e., as an agreement which restricts or is likely to restrict, by any method, the persons or classes of persons to whom goods are sold or from whom goods are bought. In Barnala Truck Union and others [CompanyLaw Digest Vol XVII, Vol.II] where the trade practice of fixing of uniform and exorbitant freight rates and not allowing non-members to load/ unload goods in and around Barnala prevented, distorted and restricted competition in rendering transportation services to the consumers and imposed unjustified cost on the consumers it was held of the Commission that there is a prima facie case against the respondents for having indulged in the restrictive trade practices.
(12)Any agreement as to the bids which any of the parties thereto may offer at an auction for the sale of goods or any agreement where any party thereto agrees to abstain from bidding at any auction for the sale of goods [clause(jb)] By virtue of this clause such collusive agreements can be held to be void unless they are necessary in public interest within the meaning of Sec. 38. The clause is wide enough to cover cases of search agreements as to participation in an auction according to pre-planned terms. Though collusive tendering has not been specifically included in the clause, it is likely to be covered by the wide ambit of the clause because it is often difficult to distinguish an auction from a tender where secrets bids are invited in the shape of tenders. For example, in Perfect Circle Victor Ltd. case [RTPE, 120 of 1984] the Commission issued cease and desist orders against three respondents manufacturing gaskets who were acting in concert by quoting the same or identical prices against tender orders floated by the Director General of Supplies and Disposals [Avtar Singh, p.150] (13)Any agreement not herein before referred to in this Sec. which the Central Government may, by notifications, specify for the time being as being one relating to a restrictive trade practice within the meaning of this subSec. pursuant to any recommendation made by the Commission in this behalf. [clause (k)]. This is a residuary clause. It enables the Central Government, on the recommendation, of the Commission, to include by a notification in the Official Gazette, any other restrictive trade practice not already listed u/s 33(1). (14) Any agreement to enforce the carrying out of any such agreement as is referred to this sub-Sec. [clause(l)]. This clause requires the registration of even an agreement which, though by itself does not relate to restrictive trade practice, but which seeks to enforce any agreement relating to any of the restrictive trade practices enumerated in clauses (a) to (jb). 5.1.2 APPLICATION TO SERVICES
5.2 UNFAIR TRADE PRACTICES Meaning Protection of the people in their capacity of consumers is a manifestation of progressive social and economic policy aimed at enhancing the quality of life and thereby to promote the higher standards of living...... and conditions of economic and social progress and development [UN Charter, Articles 55 and 1(3)]. This is the same object of the MRTP Act, which aims to protect the consumer from the business community by providing modes to deal with the unfair practices perpetuated by the business community. Sec. 36-A of the Act elaborates what unfair practices means for the purposes of the Act. Hence under the Act anything which is an unfair method or a deceptive practice for the purpose of promoting sale etc., of goods or provision of services may amount to an unfair trade practice whether it falls in the list of categories(1) to (5) detailed u/s 36A or not. These listed categories are merely illustrations of the unfair practice under the MRTP Act. The unfair practices mentioned in Sec. 36-A can be grouped under five headings, viz.: 1. Misleading advertisements and false representations. 2. False offer of bargain price. 3. Offering of gifts or prices with the intention of not, providing them and promotional contests. 4. Non-compliance of product safety standards. 5. Hoarding or destruction of goods. (1) Misleading advertisements and false representations The practice of making any statement, whether orally or by writing or by visible representation which: (i) Falsely suggests that the goods are of a particular standard, quality, grade, composition, style or model; False representations connotes that which is untrue, whether the person making the representation is aware of the untruthfulness or not. Where a tape recorder is sold under a representation that it is of Japanese make it would be a false representation of standard, if it is not in fact of Japanese make. Where cotton garments are sold as made of Eygptian cotton, it would be a false representation as to grade. Where readymade garments are sold with a representation that they are currently in style in U.S, it would be false representation if they are infact out of style in U.S at the material part of time. The description as port what was infact Tarrangona wine and the description as non brewed vinegar what in fact was a solution of acetic acid and caramel were held to be false description [Akai v. Dumet, (1951) 1 KB 34], Sandeman v. Gold, (1924)1K 107]. A placard advertised a computer with a software package including a number of games. This package was incomplete and it was held to be false representation as to composition [Denard v. Smith 1991 Crim LR 63 DC]. (ii) Falsely represents that the services are of a particular standard or grade; Where a Health Club advertises that it can help achieve slimming in a month and thereby indicates that the services are of a particular quality and standard, it would be a false 303
The provision of Sec. 33 shall apply in relation to agreements making provision for services as they apply in relation to agreements connected with the production, storage, supply, distribution or control of goods [Sec. 33(2)]. Thus an agreement under which a buyer has a voice in the manufacturing programme would fall under Sec. 33(2) [See Registrar RTA v. Allied Distributors & Co , 1976 Tax LR 1280] 5.1.3 EXEMPTED AGREEMENTS
Any agreement falling within Sec. 33 of the Act shall not be subject to registration if (a) it is expressly authorised by or under any law for the time being in force; or (b) it has the approval of the Central Government; or (c) the Government is a party to such agreement [Sec. 33(3)].
representation if in fact, slimming cannot be rendered possible in a month's time by the advertiser. Likewise a false representation regarding excellent facilities at a hotel which in fact are not there; false representation as to ones professional qualification which he in fact has not got [R v. Breeze, (1973)2 All ER 1141]. (iii) Falsely represents any re-built, second-hand, renovated, reconditioned, or old goods as new one; Where a motor car is sold as new, when in fact it is second hand, or accidented and repaired or repainted one, or where a house is sold as having been newly constructed a year back, when it is in fact more than a year old it is unfair trade practice u/s 36-A(i)(iii). Similarly when repaired, reconditioned and renovated furniture is sold as a new furniture, or when retreaded tyres are sold as new tyres, this sub clause stands attracted. (iv) Represents that the goods or services have sponsorship, approval, performance, characteristics, accessories, uses or benefits which such goods or services do not have ; Where a seller or supplier of shock absorbers represents that they have been certified by the I.S.I, when in fact the certification is under consideration, it is a false representation as to approval and characteristics which such certification normally carries. Where a dealer in scooters or motorcycles represents that complete accessories for the vehicle would be supplied alongwith the vehicle, but he charges for them separately or does not supply the entire range, Sec. 36-A(i)(iv) would be applicable. (v) Represents that the seller or the supplier has the sponsorship or approval or affiliation which such seller or supplier does not have; Where a correspondence school advertises that it is affiliated to the London University and its LL.M. courses are therefore recognised, it would be a false representation, if no such affiliation is with the school at the material point of time. Likewise where a supplier advertises as: Mafatlal, Binny, OCM Mill approved show-room it could be a false representation as to approval where no such approval has been granted by these mills. (vi) Makes a false or misleading representation concerning the need for or usefulness of any goods or services ; A representation which gives rise to two meanings or interpretation one of which is not true, is misleading representation. Where a dealer in motor vehicles represents that the fixing in of a particular device would save petrol, it could be a false representation as to the need for the use thereof, if there is no saving of petrol infact. Similarly, where an institute advertises that its special computer course fetches employment, carrying fabulous salary, it could be a false or misleading representation where the course is very truly like the one offered by other institutes. Likewise where a tyre manufacturer advertises that the steel belting of the tyres increases the longitivity of tyers by 200%, averts skidding of the vehicle on 304
application of brakes, it would be a false representation as to the need for the tyre, if the claimed properties of the tyre are absent. (vii)Gives a warranty or guarantee as to the durability, performance or efficacy of the goods which is not based upon adequate or proper tests; the burden of proof will be upon him to show that the goods were adequately or properly tested. What is adequate or proper tests would depend upon the facts and circumstances of each case. The opinion expressed by any laboratory established for such testing and certification of by or at the instance of the Government may be taken as authentic in case the questions arises whether a particular test is adequate or proper. (viii) Materially misleading warranty or guarantee of a product or goods or services as well as promises to replace, maintain, or repair an article or any part thereof or to repeat or continue a service until a specified result has been achieved; Where a representation is not materially misleading, as opposed to misleading simpliciter the case cannot be brought under this clause. Warranty has to be understood in the sense in which it is understood under the Sale of Goods Act, namely, breach of a particular term of sale which gives rise to a claim for damages, and not avoidance of the contract as a whole. The guarantee would be materially misleading if it does not disclose - (i) what products or part of the product is guaranteed? (ii) what parts are excluded from the guarantee? (iii) what is the duration of the guarantee? (iv) what any person claiming under the guarantee should do? (v) what manner would guarantor fulfil the guarantee (vi) identity of the guarantor - whether manufacturer, wholesaler, or retailer. For instance where a particulr device is advertised as Satisfaction or your money back or "one week free trial the advertisement would be misleading materially unless the terms and conditions of the guarantee are also disclosed simultaneously. Where the representation purports to be a promise to replace, maintain or repair an article or any part thereof or to repeat or continue a service until it has achieved a specific result, this clause (viii) of Sec. 36-A(1) shall be attracted, if such caluse is (a) materially misleading, or (b) there is no reasonable prospect of the promise they carried out. Where the dealer in tyres represents that he would replace a particular brand of tyres found defected within one year of purchase, he would be hit by the clause if he does not have a long term continuing arrangements with the manufacturer for carrying out the promise [Duggar, p.306-7]. (ix) Materially misleads the public about the prices at which such goods or services are available at the market; This sub-clause is aimed at prohibiting misleading representation of prices. For example, there is a seller/retailer who gets his supply of flasks at Rs.30/- in which his normal margin is 20%, and he offers for sale the flask at Rs.45/-. fully realising that he would not be able to sell the flask in competition
with others at this price. After a few days he announces Terrific cut in flask prices previously sold at Rs.45, and now they are only for Rs.36/-. This is materially misleading as to the price at which flasks have been sold previously, and this method may mislead the consumers in believing that the price reduction is quite substantial and a good bargain. However this prescription is rebuttable if the seller/retailer shows that he had earlier sold number of flasks at Rs.45. [Duggar, p.308] (x) Gives false or misleading facts disparaging the goods, services or trade of another person [S.36.A(1)]. False representation may also be by way of giving false or misleading statements as facts which are intended to be disaparaging by representing that the goods or services provided by other in the same trade to be of inferior quality, characteristic or performance or after sales service warranties. For example: This is Insta spark plug; it is always troublesome. This statement by a competing brand of spark plug manufacturer or dealer is disparaging if the fact is otherwise. The explanation to sub-sec.(1) classifies as to under what circumstances a statement may be said to be made to the public. The explanation is not exhaustive of the various forms in which the statement may be expressed but provides that the statements in the manner said there in, or advertisements by means of banners, placards, cinema slides, handouts, broadcasts on the T.V and radios etc., would very much amount to statements made to public. If such advertisements influence significantly the buyer behaviour by their exalted appeals, metaphorical phraseology, and animated visuals, various such clauses of subsec. (1) would be applicable to all such advertisments. All false or misleading advertisements intended to deceive the consumers would be attracted by this clause, and hence it would be appropriate to refer to some cases. In DGIR v. M.S. Resorts Ltd [(1987) 61 Comp.Cas 592, MRTPC] an advertisement for sale of holiday resorts held out promises as to appreciation box in terms of value and snet and offered free holiday for ever comparing then with commissioned complexes like those in Connought place, the promises and comparisons were found to be false, the Commission prohibited any further portrayal of the advertisement [See also DGIR v. Manjog Builders, (1987)62 Comp.Cas 823 where false claims as to sites were restrained] In Bandana Chodha v. Sherie Louise Slimming Centre [(1991)70 Comp.Cas 712 MRTPC] the slimming service was so incompetent that a number of ailments were caused to the client producing mental pain, typical suffering and unfitness for work, the Commission put similar restraint on the slimming centre and also allowed compensation of Rs.4,07,110 to the complainant. These provisions are applicable to educational institutions also which advertise with their guaranteed success and high sounding promises [Bhartiya Veterinary College, Bangalore, (1988) 63 Comp.Cas 3]. 2. False offer of bargain price Caluse (2) of Sec. 36-A deals with advertisements by publication in newspapers or otherwise, by which the sale or supply of the goods or services are offered at bargian price. As defence in
explanation to caluse (2) compared to the usual prices for such goods or services offered for sale by the manufacturer, which is not acutally true, that is, what is being represented, as a bargain price or reduction sale is not actually so, would be an unfair practice. A common method is to display as the usual price that which is crossed out (though these are not the actual prices but an inflated price), and along side the bargain price or reduction sale price is shown and thus, the unwary customers is enticed into buying such goods or services, such as clothes, shoes etc., in the false belief of having bought some goods or services at a bargain. Such display of a purported reduction in price would be unfair trade practice. It is worth noting that such purportedly bargain prices became possible because of imperfect knowledge or ignorance of the prevailing prices at which such goods or services are already available, which is a characteristic of imperfect competition. In Bharati Devi, re [(1987)61 Comp.Cas 734 (MRTPC)] it was held by the MRTP Commission an announcement for sale of textiles at a throwaway prices, which were not verifiable because neither the quality of goods was mentioned nor their prices, to be unfair trade practice. Similarly an advertisement was restrained by the Commission because it purported to offer 50% discount whereas it was offered only on a few items, no indications of original prices and quality was mentioned [Inter Shoppage, re, (1988)63 Comp.Cas 286 (MRTPC)]. Similalry, it would be an unfair trade practice to publicise by publictions of an advertisement in a newspaper or by pamphlets, or leaflets sent by mail or personally delivered which states that such reduction or bargain price will be valid for a limited period and that such stock are limited, and then inducing the public to buy such goods in a hurry so as not to lose such opportunity. By such sale promotion tactics the seller seeks to induce and influence the public to make such purchases in haste without deciding on the merits of the products vis-a-vis, other competitive or substitute products available in the market ignoring the other needs [Mitra p.525]. (3) Schemes offering gifts, prizes, etc. (a) Clause 3(a) of Sec. 36A covers cases were gifts, prizes or other items are offered with an intention of not providing them or creating an impression that something is being offered free of charge when it is fully or partly covered by the amount charged in the transaction as a whole. In such cases Commission enquires whether the prizes or gifts were reasonable from the standpoint of the cost to the consumer, and actually given, as set out in the advertisement and that there were no false or misleading representation as compared to what was actually given. [In re Kochar Mills Ltd, (UTPE 53/1985]. In some cases the Commission has also taken into consideration as to whether the cost of prizes which were awarded, if passed on among all consumers would result in any significant reduction in prices of the goods to all or larger interests of consumers could be better served [In re Avon Cycles Ltd, (1986) 60 Comp.Cas 1036]. In Khetan Electricals Ltd., [UTPE, No.15 of 1986] gift scheme against increased prices was restrained and in 305
Oswal Agro Mills Ltd, Re [UTPE, No.25 of 1985] participation housing gifts scheme against purchasing two washing soap cakes restrained. It would be better to understand the meaning of Bait and Switch selling which is being used relating to clause 2 of the Sec.. Bait advertisement is an alluring but insincere offer to sell a product or service which the advertiser in truth does not intend or want to sell. The purpose is to switch consumers from buying the advertised merchandise, in order to sell something else, usually at a higher price as a basis more advantageous with advertiser. The primary object of a bait advertisement is to obtain leads as to persons interested in buying merchandise of the type so advertised. Advertising includes any form of public notice however disseminated or utilized. The MRTPC Commission restrained a prize scheme which was desired to boost the sale of cycles during the rainy season when sales would otherwise be sluggish. The Commission required the producer that instead of biating customers like that he should have given the benefits of price reduction. The Commission was of the view that although the intention was to confer benefits upon some consumers who would be selected by chance, it was not in the interest of all in as much as it would deprive them of the benefits of competition offered by an affluent market [Avon Cycles Pvt. Ltd., Re, (1986)60 Comp.Cas 1036 MRTPC]. (b) Clause 3(b) of Sec. 36 A covers the conduct of contest, lottery, game of chance or skill for purpose of promoting directly or indirectly - (a) the sale, use or supply of any product ; or (b) the business interest. The sponsored quiz programmes in televison and radio, monthly lottery at the showroom or shop, publication of cross-word puzzles and the like in the newspapers, a scheme whereunder the customer is required to affix certain labels normally to be found in the product under sale, would come under this sub clause. The schemes may either be used to promote the sale of any product or to promote the business of a particular person, firm or company as has been said above. [Avon Cycles P Ltd., Re (1986)60 Comp.Cas 1036 MRTPC; In re Kochar Oill Mills, 4PTE No.53 of 1985 MRTPC]. A restraint order was issued under the provisions of Bombay Lotteries (Control and Tax) and Prize Competition (Tax) Act, 1958, by the Gujrat High Court in Wimco Ltd., v. Liberty Match Co., [(1991)70 Comp.Cas 620] where a manufacture of match boxes having factories at various parts of India prayed for an injunction, ad interim as well as permanent, against another manufacturer of match boxes who had introduced a scheme effective in the city of Ahmedabad for purpose of attracting wholesalers, retailers and consumers. A person purchasing a container of sixty dozen match boxes was to get according to his luck a gift or prize, coupon of denomination between Re 1 to Rs.25. The complainant, Wimco, showed that there had been a substantial decrease in its sales in Ahmedabad after the introduction of the scheme. The Court held that the scheme was a lottery and therfore,
unlawful. Under the Bombay Lotteris (Control and Tax) and Prize Competition (Tax) Acts, 1958. The appellant company had locus standi to pray as such . Soceity Foot Civic Rights v. Colgate Palmolive Jute Ltd [(1991)72 Comp.Cas 80 MRTPC], in a scheme induced the contestants to buy a minimum of two trigaurd toothbrushes to enable him to participate in the contest. If he wanted to send more than one entry, he had naturally to purchase greater number of tooth brushes. The early bird prizes were to be awarded for entries received first. Early had nothing to do with skill. It was a matter of chance as to whose entry reached earlier. This was purely in the nature of lottery. The fact that a large number of persons were persuaded to part with their money in the hope of getting some prices was not in public interest and the commission restrained the scheme [See Achal Kumar Galhotra v. Byford Motors Ltd, (1991) 72 Comp.Cas 702 MRTPC]. But the question for consideration, at the same time, is whether in certain situations promotional contest (prizes schemes) can be regarded in the public interest, the answer is in the affirmative in view of the following cases. In British Airways Board v. Taylor [(1975)3 All ER 307] an announcement was made that students traveling to USA by British Airways before 15.9.86 would have the opportunity to win one of the free tickets valid for travel from India to USA till 31.3.1988. The contestant was required to write a paragraph of not more than 50 words on how he believed his studies in the USA will help. The scheme was held to be beneficial to consumers. Similar views were expressed in Mid Day Publications (P) Ltd., Re [(UTPE)No 50 of 1925]; Competition Success Review (P) Ltd, Re [UTPE No 7 of 1985]; Santosh Kalro v. India Book House (P) Ltd, [(198889) MRTP 477]. (4) Non-compliance of product safety standards Clause (4) of Sec. 36-A would rope in cases where certain goods are knowingly being allowed to be sold as complying with standards prescribed by a competent authority. Even where a person does not know, it is sufficient if he has reasons to know that sales are being so made. For example, unauthorised use of I.S.I mark on the goods or any other mark not permitted by the State Govenment, would be hit by this clause. Clause(4) reads: The practice of making any statement, whether orally or in writing or by visible representation which permits the sale or supply of goods intended to be used, or are of a kind likely to be used, by consumers, knowing or having reason to believe that the goods do not comply with the standards prescribed by competent authority relating to performance, composition, contents, design, construction, furnishing or packaging as are necessary to prevent or reduce the risk of inquiry to the person using the goods In DGIR v. Ford Specialities Ltd, [(1987) 62 Comp.Cas 122 MRTPC] the respondent company manufactured and marketed Tomato Ketchup in packages of 400 gms. The Director General contended that this was in contravention of the Standard of Weights and Measures Act, 1976/Packaged Commodity Rules,
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1977, which did not earlier allow such packages of 400 gms, and likely to mislead the public into thinking of the package to be of 500 gms and therefore it was an unfair trade practice under Sec. 36-A(4). The Commission held that in packages of 400 gms could not be assured to be necessated to prevent or reduce the risk of injury to the customer. Therefore the provisions of Sec. 36-A(4) of the Act were not attracted [See also similar case In re ; Messrs Kissan Products Limited, [IA 79/86 In UTPE 73 of 1986]. The Commission had adopted the view that there was no risk of injury when the contents was less in wieght or quantity than that mentioned in the packing. (5) Hoarding or destruction of goods The last categoy of unfair trade practice includes cases of hoarding or destruction of goods or refusal to sell the goods, or to make them available for sale, if such hoarding or distruction or refusal raises or tends to raise or is intended to raise the cost of those or other similar goods or service [S.36.AC5)] [S.36-A (5)]. 5.2.1 ENQUIRY BY COMMISSION Sec. 36-B empowers the Commission to enquire into any alleged unfair trade practice in the following situations : 1. Upon receiving, a complaint of facts which constitutes such practice from any trade association or from any consumer or a registered consumers association, whether such consumer is a member of their consumers association or not ; 2. Upon a reference made to it by the Central Government or a State Government ; 3. Upon an application made to it by the Director General; or 4. Upon its own knowledge or information. Where a complaint is made u/s 36-B by consumers or consumers association, the Commission before proceedings against anybody, will require the Director General u/s 36-C to hold preliminary investigation in to the truth of the complaint so made to it. The object of preliminary inquiry is to satisfy itself that the complaint is genuine and deserves to be probed into deeply. 5.2.2 POWERS OF THE COMMISSION The Commission may inquire into any unfair trade practice which may come before it for enquiry. If upon enquiry Commission finds that the unfair practice in question is prejudicial to the public interest or the interest of any consumer or consumers generally, the Commission can pass final orders of the following nature under Sec. 36-D (i) : (a) that the practice shall be discontinued or shall not be repeated; (b) that any agreement relating to such trade practice shall be void or shall stand nullified in respect thereof in the manner specified in the order ; and (c) that any information, statement or advertisement relating to such unfair trade practice shall be disclosed, issued or
published as the case may be, in such manner as may be specified in the order. The Commission may, instead of making any order u/s 36-D, permit any party to carry on any trade practice, if it applies to the Commission. The Commission will grant the permission if the party takes such steps within the time specified by the Commission as may be necessary to ensure that the trade practice is no longer prejudicial to the public interests or the interests of any consumer or consumers generally. If the Commission is satisfied that necessary steps have been taken within the time specified, it may decide not to make any order under Sec. 36-D in respect of that practice [S.36-D(2)]. Where any trade practice is expressly authorised by any law for the time being in force, no order will be made by the Commission in respect of such trade practice [S.36-D(3)]. Subject to this exception, however, the Commission and Director General have the same powers in reference to an unfair trade practice as they have in respect of restrictive trade practice [S.36-E]. Exclusive Jurisdiction The power of enquiry into unfair trade practices is exclusively vested in the Commission [ITC v. Shri Krishna Moktan, AIR 1992 Sikkim; See also ITC v. Phusba Lama AIR 1992 Sikkim 34]. The Court opined : The aforesaid Act (MRTP) empowers the Commission to inquire into any unfair trade practice and to make necessary orders. Rights and obligations relating to unfair trade practices have been created by the MRTP (Amendment) Act, 1984, and , therefore, one who feels aggrieved has to pursue the remedy provided [by] the Acts, with the result that the Civil Court does not have the jurisdiction to deal with the matters brought before it by virtue of Sec. 36-A of the Act. Among various allegations against the ITC, one was that by using the WD & HO Wills mark on their brands the company was erecting the false impression that their production belongs to the Wills family, and that use of foreign brand names was against Government guidelines and that thereby they had increased smoking habit which is against public health, and therefore, it was an unfair trade practice. It was held that the use of that mark was there even before the Government guidelines were notified and, therefore, it was not affected by it. Furthermore, the guidelines had already been revised and exclusive foreign marks had been allowed and the damage to health by smoking was a general feature and not the contribution of any particular brand [Avtar Singh, p.179]. 5.3 CONTROL OF RESTRICTIVE TRADE PRACTICES Investigation by Commission The Commission has jurisdiction u/s 37 to enquire into all restrictive trade practices whether or not a practice emanates from an agreement or not. Thus the termination or expiry or lapse of an agreement containing a restrictive trade agreement 307
would not mean that enquiry proceeding cannot be held. Likewise registration of an agreement u/s 35 is not a condition precedent for an enquiry u/s 37 by the Commission. A trade practice devoid of an agreement, could be as much a subject of inquiry by the Commission, as one flowing from an agreement. The Commission, in an inquiry u/s 37, is not at all concerned with the question of registrability of an agreement [J K Synthetic Ltd v. Director of Investigation (1977) 47 Comp cas 323 (All)]. The inquiry of the Commission is into a restrictive trade practice, and not of the agreement relating to the restrictive trade practice. The agreement, if any, comes up for scrutiny incidentally for ascertaining the true nature, scope and impact of the practice. Also it serves as evidence in the course of inquiry. Where a restrictive trade practice flows from an agreement, it of course, becomes necessary for the Commission to order modifications of the agreement or to declare it void. The scope of inquiry by the Commission goes beyond an agreement, and even if the impugned agreement did not fall under any of the categories of Sec. 33(1) it could still amount to a restrictive trade practice under Sec. 2(0) and , hence liable for inquiry [General Electric Company of India v. MRTP Commission (per Calcutta High Court), RTPS in India, Vol. III; p.351]. In essence, an inquiry u/s 37 is in the nature of disciplinary proceeding against a business undertaking alleged to be indulging in anti social practice and the consequence of the enquiry is an injunction restraining the continuation of the anti social act [All India Motor Transport Congress v. Goodyear India Ltd, (1976) 46 Comp Cas 315]. Alternatively an opportunity could be granted by the Commission to the delinquent party if it is ready to take steps that the trade practice is no longer a restrictive trade practice prejudicial to public interest [37(2)]. The requisite permission could be granted only to a party to a restrictive trade practice [Bengal Potteries Ltd v. MRTPC, (1975) 45 Comp Cas 697 (Cal)]. The stage for considering application u/s 37(2) arises only after an inquiry into the existence of a restrictive trade practice has been made and the restrictive trade practice has been established and is considered prejudicial to the public interest. It is at this stage, that the Commission instead of making an order u/s 37(1) may act u/s 37(2). The expression S37(2) is not limited to an order under S.37(1). The Commission can, however, entertain an application u/s S37(2), instead of making an order under this Sec., without first holding an inquiry u/s 37(1), on the assumption implicit in the application in this regard that a restrictive trade practice in existence is prejudicial to public interest; and instead of making an order under Sec. 37(1), a scheme, which would eliminate the restrictive trade practice or make the trade practice no longer prejudicial to the public interest, could be offered by the Commission [Delhi Pipe Dealers Assn. v. Indian Tube Co Ltd, (1977) Tax LR 2159 MRTPC]. The Commission has absolute discretion whether it should, instead of passing an order under sub-Sec. (1), allow the delinquent party to take recourse to sub-Sec. (2). Even if an inquiry u/s 37 has been started on a complaint u/s 10(a)(i) or on a reference or application by the Government or the Director
General u/s 10(a)(ii) or (iii), the Commission, if it so chooses, may dispose of the case under sub-Sec. (2) [Duggar p.351]. In this way, case can be disposed of by the Commission only when the respondent party applies to the Commission to remedy the restrictive practice, so that it is no longer prejudicial to public interest. No order can be made by Commission in respect of an agreement for sale of goods which are bought, not for resale, but for selfconsumption and also irnespective of a practice which is expressly authorised by any law for the time being in force [s 37(3)]. This would imply that on repeal or modification of such law or the relevant provision of it, such trade practice shall be open to inquiry from the date of such repeal or modification. But this will not affect any such trade practice already existing. Under Sec. 37(4) Commission has been vested with the powers to inquire into any monopolistic trade practice being indulged in by the owner of the undertaking which comes to his notice during the inquiry u/sub-Sec. (1) or (2). The Commission after passing orders under sub-Sec.s (1) and (2), in respect of restrictive trade practice may submit the case to the Central Government in respect of such monopolistic trade practice along with his findings for such action as the Government may take u/ s 31 of the Act. It is worth mentioning that under proviso to S 31(1), on receiving information that owner of an undertaking or owner of two or more undertakings, are indulging in monopolistic trade practice, the Commission may on its own motion and not withstanding that no reference has been made by the Central Government under this sub-Sec., make an inquiry into the matter. At the same time sub-sec. (2A) of Sec. 31 provides for the Central Government, on receiving a report from the Commission to take steps to remedy or prevent the mischief which has resulted, or may result from such monopolistic trade practice. Thus the authority of the Commission to inquire into a monopolistic trade practice under sub-sec. (4) of Sec. 37 and for the Central Government to act upon such findings of the Commission is consistent with the proviso to subSec. (1) and sub-sec. (2A) of Sec. 31, and does not attract any of the exceptions specified in Sec. 32 of the Act [Mitra, p. 594]. 5.4 PROTECTION OF PUBLIC INTEREST Gateways Though Sec. 38(1) provides that a restrictive trade practice shall be deemed to be prejudicial to public interest for the purposes of an inquiry before the Commission u/s 37, but any agreement is not per se treated as against public interest even if it contains any number of restrictive trade practices. Reasonable restrictions considered to be a balance between circumstances are permitted. This is called the rule of reason, as against rule of per se circumstances. Where reasonable restrictive agreements would be allowed are called GATEWAYS and are given hereunder [sec 38(1)]: (a) Protection of public interest against injury: Where restriction is reasonably necessary having regard to the character of goods and the need to protect public injury, whether to persons or premises, in connection with the consumption, installation or
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use of those goods. (b) Denial of benefit to public: Where the removal of restriction would deprive the public or the users of such goods which they are enjoying as a result of the restriction or arrangement. (c) Counter measures against competitive activities of another: Where the restriction is reasonably necessary to counteract measures taken by any one person not party to the agreement to prevent or restrict or compete in the particular trade or business. (d) Countervailing force: Where the restriction is reasonably necessary to enable the parties to the agreement to deal on fair terms with a person who is not a party, but alone or in continuation with other controls a preponderant part of the trade to which the agreement relates. (e) Adverse effect on employment: Where the removal of the restriction would be likely to have a serious and persistent adverse effect on the general level of unemployment to any area or areas in which a substantial proportion of the trade, or industry to which the agreement relates, is situated. (f) Reduction in exports: Where the removal of restriction would be likely to cause a reduction in the volume or earnings of the export business substantially. (g) Secondary restriction: Where the restriction is reasonably required for maintaining any other restriction accepted by the parties, whether under the same agreement or under any other agreement between them which the Commission feels or has found in a previous proceeding is not contrary to public interest. (h) Harmless restriction: Where the restriction does not directly or indirectly restrict or discourages competition to any material degree in any relevant trade or industry and is not likely to do so. (i) Restriction authorized by Government: Where restriction has been expressly authorized and approved by the Central Government. (j) Restriction for Defence of India: Where restriction is necessary to meet the requirement of the defence of India or any part thereof, or for the security of state. (k) Restriction for maintenance of supply of essential goods and services: Where the restriction is necessary to ensure the maintenance of supply of goods and services essential to the community. It is therefore for the purposes of any proceedings before the MRTP Commission under Sec. 37, a restrictive trade practice shall not be deemed to be prejudicial to the public interest if the Commission is satisfied of any one or more of the circumstances referred to above. In addition to the satisfaction of the MRTP Commission on the points referred to in Sec. 38(1), the Commission should be further satisfied that the restriction is not unreasonable having regard to the balance between circumstances and any detriment to the public or to persons not parties to the agreement (being purchasers, consumers or users of goods etc.) resulting or likely to result from the operation of
the restriction. Thus balancing process means whether on the whole the restriction will advance public interest or be detrimental to it. In Telco Ltd v. Registrar of Restrictive Trade Agreement [AIR 1977 SC 973], Telco had an agreement with its dealers, of which some of the clauses were: (17 A) dealer will not directly or indirectly sell the Tata trucks outside the territory assigned to him. (2) He will maintain organization for sales and services within his territory to the satisfaction of Telco. (3) He will not sell, directly or indirectly, trucks of other manufacturers. The Supreme Court stated that any trade which restrain and binds persons or places or prices would be per se bad if it destroys competition and (a) facts peculiar to business, (b) condition before and after restraint, and (c) porbable affects of restraint, will have to be considered (This is a rule of reason). Telco stated that they had to ensure equitable distribution of trucks so that the trucks reach even remote places like Nagaland, Tripura etc. Otherwise, these trucks will be concentrated in large metrocentres only, where demand is heavy. Prompt and efficient aftersale service is vital for the truck user. The dealer has to maintain stock of spares and good service facilities with adequate equipment and trained mechanics. The dealer would not be able to maintain these facilities if it is not sure of business from the area. Consumer interest demands that he gets after-sale service. After-sale service needs specialization which would not be possible if the dealer deals in trucks of other makes. Thus, ultimately consumers will suffer. The Supreme Court accepted the above contention and declared that restrictions imposed by TELCO do not amount to restrictive trade practice. The Court further observed that the Registrar [now DGIR] should explain while applying to the MRTP Commission, the facts or features which make the trade practice restrictive and he should not just repeat bald paragraphs from agreement. The above view was confirmed in Mahindra & Mahindra Ltd v. Union of India [AIR 1979 SC 798]. Role of public interest is well illustrated by the case of Indian Ferro Alloy Producers Assn. Re [(1987) 62 Comp Cas 522 MRTPC] thus: The producers of ferro manganese were facing the problem that they were not able to stand competition in the export market and in India the only bulk purchaser was the Steel Authority of India Ltd (SAIL). Consequently, when this authority invited tenders for its requirements for 1981, the association of ferro producers, in order to assure that none of them would be thrown out of business, resolved to allocate supplies to members and fixed the price. The authority, on the other hand, invited individual producers for negotiations. The question of the validity of the associations attempt to regulate the business arose. It was held by the Commission that the regulation adopted by the association was of restrictive nature because it restricted competition as to quantity and price, but it was not against public interest because it was necessary for the survival of the trade. Sec 38 is so presented as to indicate the type of business practices which can be lawfully adopted. Its categories are open to 309
practices which not being prejudicial, are available for use. That is why these are called Gateways [Avtarsingh, p.184]. 5.5 AVOIDANCE OF STIPULATIONS OF RE-SALE PRICE MAINTENANCE (1) Stipulations for maintaining resale prices Sec. 39(1) renders any term or condition of a contract for the sale of goods in India which provides for minimum resale price, void and the contravention of the provisions of Sec. has been made punishable u/s 51 of the Act. Thus, establishment of minimum resale prices, a specie of restrictive trade practices, through any contract for sale of goods has been made per se illegal under the MRTP Act. This Sec. deals with avoidance of condition or stipulations for maintaining resale price. Sec. 33 which deals with categories of restrictive trade agreements as laid down in subSec. (1) of that Sec. which includes resale price maintenance as a restrictive trade practice under clause (f) of that subSec. and as such was registerable u/s 33(1). Under Sec. 33(1)(f) resale price maintenance was a trade practice contented in any agreement to sell goods on condition that the prices to be charged on resale by the purchaser shall be the prices stipulated to have been fixed by the seller, unless it is clearly stated that prices lower than those prices may be charged. In RRTA v. Amar Dye Chem. Ltd, [RTPE of 1975], the Commission by its order inter alia restrained resale price maintenance and stipulated that in all price lists issued by the respondent it must be clearly stated that the prices relating to the consumers are maximum prices and the distributor was free to charge lower prices. In RRTA v. Bata India Ltd, [(1976) 46 Comp Cas 441] the complainant included inter alia allegations of resale price maintenance in the price list calculated by the manufactures stipulated the whole sale and retail price lists, and retail price was also stamped on the footwear. The Commission directed the respondents to conspicuously mention in the price lists that dealers are free to charge prices lower than these prices and the prices embrossed on the footwear should read price not to exceed . The position would be more clear if we dictomize the provisions of Sec. 39 vis-a-vis Sec. 33(1)(f). Sec. 39 gives special treatment to contracts which seek to establish minimum resale price [in contra distinction to resale price as understood with reference to provisions of Sec. 33(1)(f)]. Such arrangements are void ab initio and illegal per se. On the other hand, any agreement to sell goods on the condition that the prices to be charged on resale by the purchaser shall be the prices stipulated by the seller though restrictive in nature, is not per se illegal. The distinction appears to be that in the type of agreements covered by Sec. 33(1)(f), no minimum price, as such, is prescribed for resale of the goods to buyer. In other words, the arrangements falling under Sec. 33(1)(f), inter alia, would be those where under a fixed or maximum resale price or recommended retail price is prescribed; such arrangements, though deemed to be in the nature of restrictive trade practice, would still be permissible till they are subjected to a cease and desist order of the 310
Commission. In the course of the inquiry by the Commission, before cease and desist order is passed, the respondent may even plead any of the gateways specified in Sec. 38(1). An arrangement, through fixing a fixed or maximum resale price or recommended retail price, would not be treated as relating to restrictive trade practice within the meaning of Sec. 33(1) and/ or Sec. 2(0), provided it is clearly stipulated that prices lower then those prices may be charged [Duggar, p.376]. (2) No supplier to notify to dealers or public, the minimum prices to be charged While Sec. 39(1) deals with resale prices maintenance as a restrictive trade practice adopted by an individual person including single manufacturer or wholesaler to be void, Sec. 32(2) deals with stipulation of minimum resale price maintenance by supplier directly or through an association or group of persons acting on his behalf as agents and collectively adopt a resale maintenance, by way of minimum price which may be charged on the resale of the goods in India at the instance of the supplier (i.e., which according to Explanation to Sec. 39 refers to a person who supplies goods to any person for the ultimate purpose of resale and includes a wholesaler) and the term dealer includes a supplier or retailer. Sec. 39(2) mandatorily provides that after the commencement of the Act, no supplier of goods, (as defined in the explanation) shall notify, or otherwise publish, any price stated or calculated or understood to be a minimum resale price to be charged within India for such goods. The clause does not make any provision for the dealer or retailer to charge lower prices, but provision of Sec. 40(1) provides for prohibition of with holding supplies to a dealer or retailer on ground of having sold such goods below the minimum resale price. For example, in DGIR v. Warisi Sales Corpn, [(1988) 63 Comp Cas 878 MRTPC] verbal directions to dealers not to sell the product of milk marketing federation below the maximum recommended price and to withhold supplies if they did so was held to be violative of the Act. (3) Resale price maintenance allowed for patented articles Sec. 39 shall also apply to patented articles (including articles made by a patented process and articles made under any trade mark) as it applies to other goods. However, nothing in sec 39 shall affect the validity of any terms or conditions of a licence granted by the proprietor of a patent or trade mark, so far as it regulates the price at which articles produced or processed by the licensee or the assignee may be sold by him. Thus the dealer is free to sell product at any price he likes even though he had notice of any terms or conditions as regards the price of patented articles. However, the validity of any term or condition of a licencee granted by the proprietor or licensee or assignee of a patent, in so far as it regulates the prices of any patented articles as between themselves, is not effected by this provision. In Dunlop Rubber Co Ltd v. Longlife battery Depot [(1958) LR IRP 65] it was held that ever since the decision in Incandescent Gas Light Co Ltd v. Bragden there has been no question that a purchaser who buys with knowledge of the conditions under which the vendor is authorized to deal in a
patented article is bound by such conditions, not because such conditions are contractual, but because they are incident to and a limitation upon the grant of the licence to deal in the patented article, so that if the conditions are not complied with, there is no grant at all. In Dunlop v. Longlife Battery, Dunlops made the tyres under patent and sold them subject to a licence which prohibited resale below Dunlops current price list. Longlife Battery, who had notice of the condition, resold below Dunlops price. An injunction was granted against Longlife Battery [Duggar, p.380]. (4) Prohibiting a supplier from withholding supplies In order to make the provision u/s 39 really effective, Sec. 40(1) provides that a supplier shall not withhold supplies to a seller only on the ground that he has resold goods below resale price or is likely to do so if the goods are supplied to him. A refusal to supply on any other ground will not be regarded as refusal [sec 40(4)]. Explaining as to when it can be said that supplies have been withheld, Sec. 40(3) says that supplies shall be deemed to be withheld from the dealer if the supplier: (a) refuses or fails to supply those goods to the order of the dealer; or (b) refuses to supply those goods to the dealer except at price, or on terms or conditions as to credit, discount or other matter which are less favourable than those at or on which he normally supplies those goods to other dealers carrying on business in similar circumstances; or (c) treats a dealer, inspite of a contract with such dealer for the supply of goods, in a manner less favourable than that in which he normally treats other dealers in respect of time or methods or delivery or other matters arising in the performance of the contract. Under Sec. 40(1) expression resale price means any price notified to the dealer or otherwise published as the price or minimum price which is to be charged or which is recommended or prescribed as appropriate for resale of goods. Sec. 40(2) uses the expression loss leaders and makes an exception. Sec. 40(2) allows the supplier to take measures to protect himself against his goods being used as loss leaders and such measures are not actionable under sub-Sec. (1). This is an exemption under which supplies can be with held with impurity. Explanation II to Sec. 40 defines loss leaders, as goods deliberately offered for sale at a price which shows a loss to the seller in order to attract customers to buy other goods of the seller and thereby make overall profit. Loss leaders is the name frequently applied to an article sold at a price cut drastically below the established retail price. It is used as a form of advertisement to approch customers into a shop in the hope that they will at the same time, purchase articles showing a high rate of profits, or that the increase in turnover articles showing a normal rate of profit will outweigh the losses sustained on sales of the leading goods. Very often well known proprietary articles appear to be used for this purpose; their established price provides a standard against which the public
may immediately appreciate the extent of the price reduction. In J J B (Sports) Ltd v. Millero Sport Ltd [(1975) ICR 73 (CA)], the plaintiff was a retailer operating largely by mail orders and a substantial part of the business consisted of the sale of fishing tackle and accessories. Manufacturers sold their fishing tackles including Mitchell reels with a recommended minimum resale relief price involving approximately a 50 per cent makeup on the wholesale price. The plaintiff retailed the reels at a markup which was considerably less than the recommended price. The defendants, encouraged by the manufacturers, refused to supply Mitchell reels to the plaintiff. In an action against both the defendants, the plaintiff alleged that they had unlawfully witheld the supply of goods contrary to Sec. 2(1) of the English resale Prices Act, 1964. The defendants, had cause to believe that for a period of 12 months previous to their withholding the plaintiff had been using the goods as loss leaders. No relief was allowed [Avtarsingh, p.193]. (5) Exemption from the Operation of Sec. 39 AND 40 Sec. 41 of the Act empowerss the Commission on a reference made by the Director General or any other person interested, (who may be so interested as a manufacturer, supplier or a trade associate of such persons, or a consumer or user or a consumers or users association) to make an order that goods of any class, as specified in such order shall be exempt from the operation of Sec's 39 and 40, if the Commission is satisfied that, if such minimum resale price maintenance is not allowed, public or consumer interest of the class of goods in question would be affected because: (1) the quality of the goods or their variety would be substantially reduced to the detriment of the public as consumers or users; (2) the retail prices would generally and in long run go up to the public or consumer detriment; (3) the necessary services actually provided with sale of goods by retail would cease or be reduced to the public or consumer detriment. In Registrar v. Bennet Colman & Co Ltd [RTPE 30/1979] the MRTP Commission held that news papers are exempted from the operation of sec 39 and 40 in public interest by way of surveying of public news and news of current affairs. Thus they (news papers) can prescribe minimum price. This is because speed is the essence of publishing a newspaper. Allowing retailer or vendor to bargain the price would delay the process of reaching consumers fast. This will reduce circulation, which will lead to reduction in quality and also increase in costs. This will not be long term interests of public. Onus of proof: It is to be noted that the onus of proof or of satisfying the Commission would lie on the interested person or the Director General or such other person or persons interested making such application to prove and establish that exemption of such minimum resale price maintenance was in the interest of consumers in terms of clauses (a), (b) and (c) of sec 41(1). Where goods of any class have been the subject of
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proceedings before the Commission under Sec. 31 of the Act, the Commission may treat as conclusive any evidence of fact made in those proceedings [sec 42(2)].
6. OFFENCES AND PENALTIES

SUB-TOPICS 6.1 Offences and penalties 6.2 Jurisdiction of courts to try offences 6.3 Cognizance of offences 6.1 OFFENCES AND PENALTIES Chapter III of MRTP Act deals with the provisions relating to offences under the Act and penalties prescribed for such offences. In case of several of the offences, penalty for a continuing offence has been provided. It may be noted that a continuing offence may be viewed as one, the continuance of which continues to hamper public interest and public policy. In continuing offences limitation under the Criminal Procedure Code does not apply. Usually where continuing offence is provided for, it is so stated in the section prescribing the penalty for such continuance of the offence. Hereunder we may study the various offences and consequences thereof entailing penalty under various Sec.s of the Act: (1) Contravention of Sec. 27 [Sec 46]: Any contravention of the provisions relating to division of undertakings [sec 27], is punishable u/s 46 of the Act with a fine extending up to one lakh rupees or with imprisonment extending to 5 years or both and in case of a continuing default, the fine will be Rs. 1000/for everyday, after the first day, during which the contravention continues. (2) Contravention of Sec.s 33 & 35 [Sec 48]: Sec. 48 provides punishment for failure on the part of a person to register an agreement which includes restrictive trade practices and is thus subject to registration under Sec.s 33 and 35 of the Act, if such failure is one without any reasonable excuse. The punishment is fine extending upto Rs.5000/- or imprisonment upto 3 years or both and, where the default is continuing one, Rs.500/- for every day, after the first day of default. (3) Contravention of orders under Sec. 27-B [Sec 48]: Sec. 27B is designed to break concentration on monopoly by requiring a person to disinvest or transfer his holdings. Non compliance may consist of failure to give effect to the order or concealing, or obstructing the transfer of property, etc. The punishment is imprisonment upto 2 years and or with fine upto Rs.10000/(4) Non compliance of orders under Sec.s 42 & 43 [Sec 49]: If a person fails, without reasonable excuse to submit any information required by the Central Government u/s 43 or required by the Director General u/s 42, he is punishable with imprisonment upto three months or with fine upto Rs.2000/- or both, and Rs.100/- for every day of default, where the offence is of continuing nature. If a person makes false statement or furnishes false document, 312
withholds any material fact, or alters, suppresses or destroys any document he is punishable with imprisonment up to six months or with fine which may tend to Rs 4000/-, or both. (5) Non compliance of orders u/s 13 [Sec 50]: A failure to comply with the orders of the Commission issued u/s 13, is punishable with imprisonment for a term which may extend to three years, or with fine which may extend to Rs.50000/- or with both, and where the offence is continuing one, with a further fine which may extend to Rs.5000/- for everyday after the first, during which such contravention continues. N.B. Earlier we have mentioned about the penalties for the offences committed under Sec.s 31 and 37. (6) Violation of provisions of Sec.s 39 and 40 [Sec 51]: Sec. 51 provides penalty for contravention of the provisions of Sec.s 39 and 40 of the Act relating to minimum resale price maintenance. The punishment for violation is imprisonment upto three moths or fine upto Rs.1000/- or with both. (7) Contravention of restriction under Sec. 60 [Sec 52]: Sec. 60 seeks to ensure that the information obtained by the Commission in respect of any undertaking is not to be unauthorisedly disclosed to others except for the purposes of the Act or with the consent in writing of the owner of the undertaking. Any other disclosure would be wrongful and is punishable with fine up to Rs.5000/- or imprisonment upto 6 months or both. (8) Penalty for contravention of conditions etc [Sec 52A]: Where alongwith any approval, sanction, direction or exemption in relation to any matter, any restrictions or conditions have been imposed, the penalty for contravention is fine upto Rs.1000/ - and where the offence is of continuing nature, Rs.100/- for every day after the first, during which such contravention continues. (9) Penalty for false statement [Sec 52B]: If in any application, return, report, certificate, balance-sheet, prospectus, statement or other document made, submitted, furnished or produced for the purpose of any provision of the Act, any person makes a statement, (a) which is false in any material particular, knowing it to be false, or (b) which omits to state any material fact, knowing it to be material, he shall be punished with imprisonment for a term which may extend to 2 years and shall also be liable to fine. (10) Offences by Companies [Sec 53]: Sec. 53 states that where an offence is committed by a company, (by an explanation to the Sec. a company also means a firm, or an association of individuals), every person who at the time when the offence was committed was incharge of, and was responsible to the company, for the conduct of its business shall be deemed to be guilty of the offence and shall be liable to be proceeded against and punished accordingly, unless as stated in the proviso, any such person concerned proves that the offence was committed without his knowledge, or that he had exercised due diligence to prevent the occurrence of the offence [sec 53(1)].
Where it is proved that the offence was committed due to negligence or connivance on the part of any director (by the explanation to this Sec. director includes a parner of a firm), manager or secretary or other officer of the company, then any such officers of the company shall be liable to be proceeded against and punished accordingly [sec 53(2)]. It will be necessary for the prosecution to identify and establish the person or officer due to whose negligence or with whose connivance that is willful or deliberate such act or consent, the offence has been committed and it will be for such officer in his defence to prove that such offence was committed without his knowledge, or despite due diligence exercised by him, to prevent the commission of such offence. The trial court will have to be satisfied that the officer whose negligence or connivance or consent is established after considering the defence that such officer has exercised due diligence against the offence being committed or that it was committed without his knowledge.
However sec 630 of the Companies Act, 1956 provides for relief and protection to be sought by any officer of the company from the court against any charge of negligence, default, breach of duty, if the court is satisfied that such breach or default occurred in good faith and honestly and reasonably and not due to wilful neglect or from any malafide purpose [Mitra, p.669]. 6.2 JURISDICTION OF COURTS TO TRY OFFENCES No Court inferior to a Court of Session shall try any offence under this Act [sec 56]. 6.3 COGNIZANCE OF OFFENCES Under Sec. 57 no court shall take cognizance of a complaint under the Act unless it is made in writing by a public servant as defined in Sec. 21 of the Indian Penal Code. Under Sec. 63 of the MRTP Act, every member of the Commission, Director General and every member of the staff of the Commission and of the Director General shall be deemed to be public servants,
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while acting or purporting to act, under the provisions or in pursuance of any of its provisions. It is implied that such complaint should be made in the form and in accordance with the Code of Civil Procedure [Mitra, p.675].
7. CASE LAW
(1) Achalkumar Galhotra v. Byford Motors Ltd, [(1991) 72 Comp Cas 702 MRTPC]. The advertisement which was restrained by the Commission was that the dealer was offering Premier Padmini at Rs.28,000 less than Maruti. There was no indication of the market price of Maruti. The offer of a free stereo was also false because the cost was recovered by inflating the registration charges. The scheme of replacing the car of a lucky purchases with a new car every year by drawing lottery was held to be untenable by virtue of the provisions of Sec. 36(3). (2) Hindustan Lever Ltd. v. Monopolies and Restictive Trade Practices Commission, [AIR 1977 Sc 1285] Hindustan Lever is the manufacturer of a variety of consumer goods from toiletteries to toothpaste. Their agreement with redistribution stockists contained a number of clauses in a standard form, two of which were questioned before the Commission. One of them required the stockists to purchase and accept from them such stocks as they might, at their discretion, send to the stockists for fulfilling their obligations under the agreement. The other clause required the stockists not to make the stocks outside their towns except with the written consent of Levers. The clause also required the stockists to return from the stock purchased by them such parts as levers may direct them to do for purposes of resale. Both these conditions were held to be void as restrictive trade practices. The first clause empowered the manafacturer to thrust upon the dealer any stock of their choice and the dealer was bound to accept it if he wanted to remain on their list. This violated Sec. 33(1)(b) which provides that an agreement requiring a purchaser of goods, as a condition of such purchase, to purchase some other goods, would be a restrictive trade practice. The clause in question "clearly makes it necessary for the stockist to purchase such goods and in such combination as the company may decides. Hence it would be struck by Sec. 33(1)(b) of the Act: (3) In re: Gripp System Ltd., (UTPE 214 of 1987). It was complained that the respondnt company was selling Pyramid Brand TV sets using advertisments that these were manufactured in technical association with Toshiba of Japan and that the respondent company had also advertised that it was a member of the Lalbhai group. It was found on the Director General's investigation that the Department of Electronics, Government of India, had not approved of any foreign collaboration of the respondent company with Toshiba nor did the respondent company belong to the Lalbhai group. The Commission held that the respondent company was indulging in unfair trade practice which was hit by clauses (i), (iv) of Sec. 36A(1) of the MRTP Act and cease and desist orders were passed. 314
(4) In Re: Kaleen Furnishers & Decorators, [UTPE 208 of 1986] The respondent dealt in carpets. For sales promotion he advertised a festival discount upto 40% in Diwali. No reason was given for allowing discount. Preliminary investigations were held to the points (i) written 40% discount was offered as advertised, (ii) whether the rate of discount was related to the conditions of goods, demand of them, etc. The investigation showed that discount actually allowed was within the range of 25-40% and there was no change in prices two month prior or during the sale period. The criterion for discount was that the discount was higher on smaller sizes and lower on large sizes. Range of discont was not determined by the quality or age of carpets. The commission stated that the descriptions of the discount sale period as till Diwali was quite specific. The Commission held that the discount range was not specifically indicated in the advertisement or criterion given but no element of deception was noticed in the course of investigations. The range of discounts 25% to 40% was not so wide and was commensurate with the sizes of the carpets and the quality of carpets was not inferior to the usual qualities sold at other times. Hence, the enquiry proceedings were dropped. (5) In re : India Tobacco Co. Ltd., [UTPE 50/86] Twenty seven consumers had made a complaint to the Commission under Sec. 36B(a) of the MRTP Act that the respondent had practised deception on them, as well as, a large number of other smokers of cigarettes by a massive misleading campaign launching and promoting the sale of cigaragees with the brand name NOW, which is infact an international renowned and favourite brand of cigarettes manufactured by R.J. Reynold Tobacco Co. of USA (RJR), and had sought an interim injunction against use of this brand name. The respondent claimed that it had not made any misleading or false representation of any affiliation or sponsorship of their brand of cigarettes by RJR, and had independantly conceived of the brand name after intensive market research and analysis. The brand name was printed in a style and lay-out of colour scheme etc. and was quite distinct from the brand name manufactured by RJR and had distinctly advertised this brand of cigarettes as its own product, as opposed to several other cigarattes being marketed by other manufactures with foreign brand names under license arrangements with the foreign manufacturers, in the same style and with the same lay-out colour scheme etc. It is significant that the respondent pointed out that 22 out of 27 complaints were directly or indirectly connected with Golden Tobacco Co. Ltd., a competitor of the respondent. The Commission was required to weigh in whose favour the balance of convenience went, and generally, it had been seen that after consideration of balance of convenience it was in favour of the complainant. The interim injunction was granted restraining the respondent from indulging in such restrictive or
unfair trade practice. In this case Commission found that the respondent had come out with a new advertisement showing that ITC Logo more prominently and an undertaking was given that the old advertisements will not be repeated. Hence no interim injuction was granted.
8. PROBLEMS
1. X, a respondent Company was making and supplyng graphite electrodes, anodes and carbon plates. A notice was issued to them that they were indulging in certain restrictive trade practices in respect of graphite electrodes. Later it was sought to amend the reference by including anodes and plates also. This was challenged by respondent(X) company with the contention that the Commission was incompetent in as such as the Chairman having retired, the Commission was left with only two members whereas the Act required that there shall be three members. Is the contention valid? [See Graphite India Ltd, Re, (1979)49 Comp.Cas 212 MRTPC]. 2. Commission passed an ex parte order against the proprietor of an undertaking because of his failure to attend on the successive dates fixed for hearing. He applied for revocation of the order on the ground that his advocate had not communicated to him any orders and that he came to know
of the order only from a news item. Is the contention sustainable under the MRTP Act ? [See Maheshwari & Sons Re, (1979)49 Comp.Cas 212 MRTPC]. 3. A school is charging an interview fee of Rs.50/- in addition to registration fee of Rs.10/- and there is no evidence to show that the sum so charged is being spent on interviewing the applicants or that the school is incurring any expenditure for the purpopse of admitting students to KG class. Is the manipulations of prices of the services justified cost of education? [See DGIR v. St. Francis De-Sales Senior Secondary School, (1992) 73 Comp.Cas 117 MRTPC] 4. X undertaking were producers of tomato ketchup. They were marketing the same in bottles of 400 grams. Under the provisions of standards of Weights and Measures (Packed Commodities) Rules, 1977 it was not permissible to sell tomato ketchup in bottles of 400 grams. It could be sold only in bottles of 500 grams. Is the action of X undertaking in the purview of unfair trade practice ? [See DGIR v. Food Specialists Ltd (1987)62 Comp.Cas 122 MRTPC]. 5. A pumpset was sold with one year warranty for satisfactory performance and assurance of repair or replacement in case
of defects arising during the period. The pump failed within a few months. Manufacturer did not honour the waranty. Does the action tantamount to unfair trade practice? [See Jamila Knatoon v. Jaymco Engineering Co., (1992)75 Comp.Cas 648 MRTPC].
9 SUPPLEMENTARY READINGS
1. Avtar Singh, Law of Monopolies, Restrictive and Unfair Trade Practices, (1993), Eastern Book Company, Lucknow. 2. Duggar, S.M., MRTP Law & Practice, (1984) Taxation Publishers, Pvt. Ltd, New Delhi. 3. Mitra, K.K., Commentaries on the MRTP Act 1969, (1990) Book-N-Trade, Calcutta. 4. Kapoor, N.D., Business and Economic Laws, (1995), Sultan Chand & Sons, New Delhi.
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Course No: III Module No: VIII
Corporate Accounts and Audit

Materials Prepared By :
1. 2. Mr. Mohandas Pai, F.C.A. Dr. N.L. Mitra
Materials Checked By :
1. 2. 3. Prof. V. Vijayakumar Prof. T. Devidas Mr. S. Dasgupta
Materials Edited By:

1. 2. Mr. Krishnaswami, F.C.A. Mr. Sundarajan, A.C.A.
Published By Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.
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INSTRUCTIONS
Basic Readings The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics included in the course. Experts in the area have collected the basic information and thoroughly analysed the same in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative provisions are also included. Care has been taken to communicate basic information required for decision making in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading information provided are to be selected by making marginal notes using markers. The first reading, therefore, necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the implications of those informations. In the second reading the reader has to critically analyse the material supplied and jot down in a separate note book points stated in the material as well as the critical comments on the same. A third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at every stage.) Supplementary Reading Several supplementary readings are suggested in the materials. It is suggested that the reader should register with a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National Library, any University Library where externals are registered for the purpose of library reading, any commercial library or any other public library run by Government or any private institution. Readers in Metropolitan and other big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept in the course file. Supplementary readings are also required to be read more than once and marginal notes, marking notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her place may request the Course Coordinator to photocopy the material and send it by post for which charges at the rate of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in advance. The Course Coordinator shall take prompt action on receiving the request and the payment. Case Law The course material includes some case materials generally based upon decided cases. These cases are to be studied several times for, (a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence. Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the experts comment to the students. Through these exercises one can build up an effective dialogue with the experts of the Distance Education Department (DED). Problems and Responses After reading the whole module which is divided into several topics and sub-topics the reader has to solve the problems specified at the end of the module. The module is designed in such a manner that a reader can take about a weeks time for completing one module in each of the four courses. It is expected that after finishing the module over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving the problem - which may be half an hour per problem - and maintain self discipline. While solving the problems the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already prepared. After completing the exercise the student is directed to send the same to Course Coordinator for evaluation. Though there is no time stipulation for sending these responses a student is required to complete these exercises before he/ she can be given the certificate of completion to appear for final examination. N.L. Mitra Course Co-ordinator
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CORPORATE ACCOUNTS AND AUDIT

TOPICS 1 2 3 4 5 6 7 8 9 Concept of Corporate Accounts ................................................................................. 321 346 348 350 354 356 361 365 366
Corporate Accounts and Boards Responsibility ........................................................ Dividend .......................................................................................................................... Audit and Auditor .......................................................................................................... Auditors Rights and Duties .......................................................................................... Auditor's Liabilities ....................................................................................................... Case Law ......................................................................................................................... Supplementary Readings ............................................................................................... Problems .........................................................................................................................
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1. CONCEPT OF CORPORATE ACCOUNTS

SUB-TOPICS 1.1 Introductory Note 1.2 Books of Accounts 1.3 System of Accounting 1.4 Responsibility for keeping Accounts 1.5 Inspection of Accounts 1.6 Authentication of Accounts 1.7 Submission of Accounts for Audit 1.8 Preparation of Annual Accounts 1.9 Right of Members for the Annual Accounts 1.10 Submission of Annual Accounts to the Shareholders 1.11 Standards of Accounts and Proposed Amendment to the Law 1.12 Annexures 1.1 INTRODUCTION A joint stock company by its very nature ensures separation of management from ownership. The management is vested with the Directors acting collectively as a Board. The commercial decisions taken by the Board get reflected in the accounts. An account is a summary of business transactions and reflects the result of a business decision. As the Directors of a company act in their fiduciary capacity to the company, they are enjoined upon to maintain proper books of accounts of all transactions and to present the same to the shareholders. The Directors shall annually present the accounts to the shareholders in the form of the Balance Sheet and Profit and Loss Account at the Annual General Meeting. A Balance Sheet is a statement showing the assets and liabilities of a company as on a particular date. It enables an assessment of the credit- worthiness of a company. But it is also a historical document and shows the value of the assets, liabilities and net worth on a historical cost basis. Entries in the Balance Sheet have been held by courts to be an acknowledgement of debt. A Profit and Loss Account is a statement showing the revenues earned, expenditure incurred, profits made and appropriated to payment of a return on the capital called as dividend or transferred to Reserves. Since the accounts are the main mode of reporting to the shareholders, it is essential that they are reliable, credible and consistent. This can only be done by ensuring that they are prepared on the basis of generally accepted accounting principles. These principles should be consistently followed and should reflect the transactions in their entirety. Certain fundamental accounting assumptions underlie their preparation and presentation the assumption of a going concern, that is as continuing in operation for the forseeable future; consistency, which leads to reliability and certainty, and accrual by which costs are matched with revenues.These are to be followed to give a proper perspective to the accounts. In order to ensure the reliability and credibility of the accounts of companies, the company Law provides for the appointment of an independent person,an outside agency, namely the Auditor, to verify the accounts and give a report on the same to the shareholders. The Auditor is appointed by the shareholders and is responsible to them. The duties, rights, powers and responsibilities of the Directors and Auditors have been laid down in the Companies Act. 1.2 BOOKS OF ACCOUNTS According to sec. 209(1) of the Companies Act, 1956 every company shall keep at its Registered Office proper books of account containing records of: (a) all sums of money received and expended by the company and the matters in respect of which the receipts and expenditure take place (i.e., Cash book including petty Cash book); (b) all sales and purchases of goods by the company (ie.,Sales and Purchase day book); (c) all assets and liabilities of the company (i.e., ledgers); and (d) in the case of a company pertaining to any class of companies engaged in production, processing, manufacturing or mining activities, such particulars relating to utilising material or labour or other items of costs as prescribed, if such class of companies is required by the Central Government to include such particulars in the books of accounts (i.e., Cost Accounts, Cost Account Sheets). Proper books of accounts are necessary to record evidences of all transactions so that the books of accounts may reflect or provide a true and fair view of the state of affair of the company. Further, such books have to be kept on accrual basis and according to the double entry system of accounting. Such books are to be kept normally at the registered office of the company. The books may also be kept at any other place in India as the Board may decide. This decision of the Board should however be communicated to the Registrar of companies. In the case of the winding up of a company, an officer of the company may be punished in case proper books of accounts have not been kept. Proper books in such a case means such books as are necessary to exhibit and explain the transactions and financial position of the business including books containing day to day entries in sufficient detail of all cash received and paid. In case of a trading company proper books means statements of the annual stock-taking and particulars of all goods sold and purchased showing the name of the buyer and seller thereof in sufficient detail so that these persons can be identified. The books of accounts should be prepared and maintained in indelible ink. Adequate safeguards have been built into the 321
law to prevent abuses, irregularities and mal-practices by the law insisting on maintaining of proper books of accounts, making adequate disclosures, a system of audit, establishment of internal control procedures and prescribing liability and punishment for transgression of the above. Besides the proper books of accounts the company is required to keep the following statutory registers : (i) Register of investment in order to maintain various particulars about investments made by the company (refer to sec. 49 of the Companies Act,1956); (ii) Register of Members - A register of members of the company is to record various particulars of its members (refer to sec. 150 of the Companies Act, 1956); (iii) Index of Members - Every Public Limited company is required to keep an index of its members (refer to sec. 151 of the Companies Act, 1956); (iv) Foreign Register of Members or debenture holders (refer to secs. 157 & 158 of the Companies Act, 1956); (v) Register of Charges - A register of charges is to be kept for recording particulars of all charges (refer to sec. 143 of Companies Act, 1956); (vi) Register of Contracts - Particulars of all the contracts entered into by the company and the companies in which Directors are interested must be kept in a separate register (refer to sec. 301 of the Companies Act, 1956); (vii) Register of Directors (refer to sec. 303 of the Companies Act, 1956); (viii) Register of Share Holdings of the Directors (refer to sec. 307 of Companies Act, 1956); (ix) Register of all investments of the company in shares (refer to sec. 372(6) of the Companies Act, 1956); (x) Register of Loans (refer to sec. 370(i)(c) of the Companies Act, 1956); and (xi) Register of Public Deposits (refer to sec. 58(a) of the Companies Act, 1956). 1.3 SYSTEM OF ACCOUNTING Books of accounts are to be kept ; (a) according to the doubleentry system of accounting and (b) on approval basis (refer to sec. 209 of the Companies Act, 1956) The principle of the doubleentry system of book- keeping is based upon the philosophy that every transaction has two impacts inversely affecting two accounts. Keeping the complete record of these two impacts in two accounts is known as doubleentry. These two impacts in the accounting language is known as Debit and Credit. Therefore in the doubleentry system of accounting the total debit is always equal to the total credit. The accrual system is based upon the concept of keeping records not merely of cash transactions (as is done in the mercantile system) but also of transactions primarily based upon the concept of expenses incured, but not paid for and of amounts 322
receivable but not received. Therefore these are Credit transactions. 1.4 RESPONSIBILITY OF KEEPING ACCOUNTS The following categories of persons are responsible for maintenance of proper books of account of a company. 1. Where the company has a Managing Director or Manager such Mangaing Director or Manager and all other officers and employees and agents. 2. Where the company has neither a Managing Director nor Manger, every Director of the company. It should be noted that the Auditors, Legal advisers and Bankers are excluded from the above list. (refer to sec. 209(6) of the Companies Act, 1956) 1.5 INSPECTION OF ACCOUNTS Every Director has a right of inspection of the accounts as also the Registrar of Companies or such officers of the government as may be authorised by the central government. However the shareholder has no such right of inspection. (refer to sec. 209(a)of the Companies Act,1956) 1.6 Authentication of accounts The Balance sheet and Profit and Loss Account are prepared and considered by the Board of Directors before the same is submitted to the Auditor for his report. The responsibility for the preparation is that of the Board and not of the Auditor. Every Balance Sheet and Profit and Loss Account should be authenticated by the Board. It does not mean that the Board certifies the accounts to be true, but only that the accounts are genuine and have been placed before the Board. The authentication is done by signing the Balance sheet and Profit and Loss account on behalf of the Board of Directors. In the case of a company other than a Banking company, the Manager or Secretary and not less than two Directors of the company, one of whom shall be a Managing Director if there is one, should authenticate the accounts. In the case of Banking company the authentication should be done as provided in the Banking Regulations Act, 1949. The Balance Sheet and the Profit and Loss account shall be approved by the Board of Directors before they are signed as mentioned above. 1.7 SUBMISSION OF ACCOUNTS FOR AUDIT The authenticated Balance Sheet is then submitted to the Auditor for discharging his audit function and preparing his report. In case there is any qualification by the Auditor, an explanation needs to be given by the Board as an addendum to the Directors Report. In practice, the accounts are usually authenticated by the Board with the same date as the date of the report by the Auditor. Where any company has a subsidiary, the holding companys Balance sheet shall be attached with the following documents of its subsidiary:
1. Balance Sheet and Profit and Loss Account of the subsidiary; 2. Report of the Board of Directors of the subsidiary; 3. Auditors report on the subsidiary; and 4. A statement of the holding companys interest in the subsidiary. 1.8 PREPARATION OF ANNUAL ACCOUNTS The Annual Accounts are to be prepared to indicate the profit and loss of the company in the form specified in Annexure- I (which relates to Part II of Sch. VI of the Companies Act, 1956). This Profit and Loss Account is prepared in two parts. The first part is known as the Trading Account and the latter, the Profit and Loss Account. Of course a Manufacturing Account is also prepared. In the Trading Account all direct expenses and direct receipts are posted to show gross profit. All other revenue expenses stand reflected in the Profit and Loss Account and a transfer posting is made of the gross profit as well. That shows the net profit. The Profit and Loss Account shall give a true and fair view of the profit or loss of the company for the period in view. The balance of all assets and liabilities of the company are then placed in the Balance Sheet which shall give a true and fair view of the state of affairs of the company at the end of the period of report. (refer to sec. 211 of the Companies Act, 1956). The Balance Sheet is to be prepared in the form given in Annexure- II (which relates to Part I of Sch. VI of the Companies Act, 1956) Every Balance Sheet and every Profit and Loss Account of the company shall be signed for the Board of Directors of the company by its Manager or Secretary, if any, and by not less than two Directors of the company, one of whom shall be the Managing Director, if any. The Balance Sheet and Profit and Loss Account shall be approved by the Board of Directors before they are signed. (refer to sec. 215 of the Companies Act, 1956) 1.9 RIGHT OF MEMBERS TO THE ANNUAL ACCOUNTS Every Member is entitled to be given a copy of Balance Sheet, Profit and Loss Account and all documents required to be annexed or attached to the Balance Sheet and the same should be sent to him at least 21 days before the Annual General Meeting. (refer to sec. 219 of the Companies Act, 1956) In the case of a listed company, an abridged version of the account in Form 23B which contains the salient features may be sent to the members. Even though such an exemption is granted, a member can ask for and should be provided with a full set of accounts in case he so demands. Since the documents of a public company are open to inspection by the members of the public, a copy of the Balance Sheet and Profit and Loss Account, the Auditors Report, and the Directors Report need to be filed in the office of the Registrar
of Companies. In the case of a private company Balance Sheet and Profit and Loss Account shall be filed separately as the Profit and Loss Account is not open for inspection by the public. (refer to sec. 220 of the Companies Act, 1956) 1.10 SUBMISSION OF ANNUAL ACCOUNTS TO SHAREHOLDERS For the purpose of presenting the Annual Accounts to the shareholders, the Board of Directors shall place before them every year at the Annual General Meeting the Balance Sheet and Profit and Loss Account. In the case of a company not carrying on business for profit, an Income and Expenditure Account shall instead be laid before the company. It is the task of the Directors to get the Balance Sheet and Profit and Loss Account prepared and presented to the shareholders along with the report of the Auditors. But these accounts have to be considered by the shareholders and approved by them before they can be deemed final. A dividend recommended by the Board becomes final, and a debt thereon due, only after the approval by the shareholders. The Profit and Loss Account should be annexed to the Balance Sheet and the Auditor's Report attached thereto. The difference lies in the fact that the Auditor needs to examine and report on every document annexed to the Balance Sheet. The Balance Sheet can be prepared either in the Horizontal form or the Vertical form. The Balance Sheet and Profit and Loss Account should give comparative figures for each head of account for the previous year also. The Balance Sheet is always prepared as on a particular day whereas the Profit and Loss Account is prepared for a period or year ending on that date. All the disclosure requirements of Schedule VI should be strictly followed as this information is mandatorily to be given. In case the information required to be given in the Balance Sheet cannot be conveniently included in the Balance Sheet it can be furnished in a separate schedule to be annexed to and forming part of the Balance Sheet. The Profit and Loss Account should be clearly made out to disclose the result of the working of the company during that period. It should disclose every material feature and also exceptional items. The various items of revenue and expenditure should be arranged under the most convenient heads. Unlike the Balance Sheet the format of the Profit and Loss Account has not been stated in Part II of Schedule VI which only states the information to be disclosed. Information required to be disclosed can also be given by way of a note attached thereto. The Act also provides that in case companies do not disclose information as required by Schedule VI due to any exemption granted by the government or are exempted from disclosure of certain information due to any special Act they come under, the Balance Sheet shall nevertheless be deemed to be true and fair. What is true and fair has not been fully defined in the Act except negatively. The Auditor is also called upon to report on the true and fair views of the accounts. So we could 323
say generally, that the accounts would reflect a true and fair view and disclose the information mandatorily required to be disclosed in case they are prepared as per the requirements of the Act and generally accepted accounting principles. However in the case of companies which are governed by separate Acts like the Banking Regulation Act, Insurance Act or Indian Electricity Act, the format and contents of the Balance Sheet and Profit and Loss Account are to be as laid down in these Acts . 1.11 THE COMPANIES BILL, 1993
amount of sales in respect of each class of goods dealt with by the company, and indicating the quantities of such sales for each class separately; (b) (c) (d) Commission paid to sole selling agents within the meaning of section 294 of the Act; Commission paid to other selling agents; and Brokerage and discount on sales, other than the usual trade discount. The value of the raw mateirals consumed, giving itemwise break-up and indicating the quantities thereof. In this break-up, as far as possible, all important basic raw materials shall be shown as separate items. The intermediates or components procured from other manufacturers may, if their list is too large to be included in the break-up, be grouped under suitable headings without mentioning the quantities, provided all those items which in value individually account for 10% or more of the total value of the raw material consumed shall be shown as separate and distinct items with quantities thereof in the break-up. The opening and closing stocks of goods produced, giving break-up in respect of each class of goods and indicating the quantities thereof; In the case of trading companies, the purchases made and the opening and closing stocks, giving break-up in respect of each class of goods traded in by the company and indicating the quantities thereof; In the case of companies rendering or supplying services, the gross income derived from services rendered or supplied; In the case of a company, which falls under more than one of the categories mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the requirements herein if the total amounts are shown in respect of the opening and closing stocks, purchases, sales and consumption of raw material with value and quantitative break, up and the gross income from services rendered is shown; and In the case of other companies, the gross income derived under different heads.
(ii) (a) In the case of manufacturing companies (i)
The Companies Bill, 1993 has been introduced in Parliament in order to recodify the company Law. Certain changes are proposed in the Bill as regards Corporate Accounts. 1. The formating of the Balance Sheet and the disclosure requirements of the Profit and Loss Account have been revised as stated in Schedule XII. A set of accounting policies to be followed by companies is set out in Part I of Schedule XII.(See Annexure III)
2. Accounting standards issued by the Institute of Chartered Accountants of India are sought to be given statutory recognition. Uniformity in accounting policies would now be possible. 1.12 ANNEXURES
(ii)
(b)
ANNEXURE I (Schedule VI Part II) REQUIREMENTS AS TO PROFIT AND LOSS ACCOUNT 1. The provisions of this Part shall apply to the income and expenditure account referred to in sub-section (2) of section 210 of the Act, in like manner as they apply to a Profit and Loss Account, but subject to the modification of references as specified in that sub-section. 2. The Profit and Loss Account (a) shall be so made out as clearly to disclose the result of the working of the company during the period covered by the account ; and shall disclose every mateiral feature, including credits or receipts and debits or expenses in respect of nonrecurring transactions or transactions of an exceptional nature. (c)
(d)
(e)
(b)
Note 1 : The quantities of raw materials, purchases, stocks and the turnover, shall be expressed in quantitative denominations in which these are normally purchased or sold in the market. Note 2 : For the purpose of items (ii)(a), (ii)(b) and (ii)(d), the items for which the company is holding separate industrial licences, shall be treated as separate classes of goods , but where a compnay has more than one industrial licence for production of the same item at different places or for expansion of the licensed capacity, the item covered by all such licences shall be treated as one class. In the case of trading companies, the
3. The Profit and Loss Account shall set out the various items relating to the income and expenditure of the company arranged under the most convenient heads ; and in particular, shall disclose the following information in respect of the period covered by the account : (i) (a) 324
The turnover, that is, the aggregate amount for which sales are effected by the company, giving the
imported items shall be classified in accordance with the classification adopted by the Chief Controller of Imports and Exports in granting the import licences. Note 3 : In giving the break-up of purchases, stocks and turnover, items like spare parts and accessories, the list of which is too large to be included in the break-up, may be grouped under suitable headings without quantities, provided all those items, which in value individually account for 10% or more of the total value of the purchases, stocks, or turnover, as the case may be, are shown as separate and distinct items with quantities thereof in the break-up. (iii) In the case of all concerns having works in progress,the amounts for which [such works have been completed] at the commencement and at the end of the accounting period. (iv) The amount provided for depreciation, renewals or diminition in value of fixed assets. If such provision is not made by means of a depreciation charge, the method adopted for making such provision. If no provision is made for depreciation, the fact that no provision has been made shall be stated and the quantum of arrears of depreciation computed in accordance with section 205(2) of the Act shall be disclosed by way of a note. (v) The amount of interest on the companys debentures and other fixed loans that is to say, loans for fixed periods, stating separately the amount of interest, if any (paid or payable) to the Managing Director,the Managing Agent, the Secretaries and Treasurers and the manger, if any. (vi) The amount of charge for Indian income-tax and other Indian taxation on profits, including, where practicable, with Indian income-tax any taxation imposed elsewhere to the extent of the relief, if any, form Indian income tax and distinguishing, where practicable, between income-tax and other taxation. (vii)The amounts reserved for (a) repayment of share capital ; and (b) repayment of loans (viii) (a) The aggregate, if material, of any amounts set aside or proposed to be set aside, to reserves, but not including provisions made to meet any speicific liability, contingency or commitment known to exist at the date as on which the Balance Sheet is made up. (b) The aggregate, if material, of any amounts withdrawn from such reserves. (ix) (a) The aggregate, if material, of any amounts set aside to provisions made for meeting specific liabilities, contingencies or commitements. (b) The aggregate, if material, of the amounts withdrawn from such provisions, as no longer required. (x) Expenditure incurred on each of the following items, separately for each item :(a) Consumption of stores and spare parts; (b) Power and fuel;
(c) Rent; (d) Repairs to buildings; (e) Repairs to machinery; (f) (1) Salaries, wages and bonus (2) Contribution to provident and other funds (3) Workmen and staff welfare expenses to the extent not adjusted from any previous provision or reserve Note : Information in respect of this item should also be given in the Balance Sheet under the relevant provision or reserve account. (g) (h) (i) Insurance; Rates and taxes, excluding taxes on income; and Miscellaneous expenses.
Provided that any item under which the expenses exceed one percent of the total revenue of the company or Rs.5,000 whichever is higher shall be shown as a separate and distinct item against an appropriate account head in the Profit and Loss Account and shall be combined with any other item to be shown under miscellaneous expenses. (xi) (a) The amount of income from investments, distinguishing between trade investments and other investments. (b) Other income by way of interest, specifying the nature of the income (c) The amount of income-tax deducted if the gross income is stated under sub-praragraphs (a) & (b) above. (xii) (a) Profits or losses on investments showing distinctly the extent of the profits or losses earned or incurred on account of membership of a partnership firm to the extent not adjusted from any previous provision or reserve. Note : Information in respect of this item should also be given in the Balance Sheet under the relevant provision or reserve account. (b) Profits or losses in respect of transactions of a kind, nor usually undertaken by the company or undertaken in circumstances of an exceptional or non-recurring nature, if material in amount. Miscellaneous income Provisions for losses of subsidiary companies
(c) (b
(xiii)(a) Dividends from subsidiary companies (xiv)(a) The aggregate amount of the dividends paid, and proposed, and stating whether such amounts are subject to deduction of income-tax or not. (xv)Amount, if material, by which any items shown in the Profit and Loss Account are affected by any change in the basis of accounting. 325
4. The Profit and Loss Account shall also contain or give by way of a note detailed information, showing separately the following payments provided or made during the financial year to the directors (including Managing Directors) of the company, the subsidaries of the company and any other person : (i) managerial remuneration under section 198 of the Act paid or payable during the financial year to the directors (including managing directors the Managing Agent, Secretaries and Treasurers) or Manager, if any; expenses reimbursed to the Managing Agent under section 354 ;
(a) (b)
as Auditor; as adviser, or in any other capacity, in respect of; (i) (ii) (iii) taxation matters ; company law matters ; management services ; and
(c)
in any other manner
(ii)
4C In the case of manufacturing companies, the Profit and Loss Account shall also contain, by way of a note in respect of each class of goods manufactured, detailed quantitative information in regard to the following namely :(a) (b) (c) the licensed capacity (where licence in force) ; the installed capacity; and the actual production.
(iii) commission or other remuneration payable separately to ta Managing Agent or his associate under sections 356, 357 & 358 ; (iv) commissin received or receivable under section 359 of the Act by the Managing Agent or his associate as selling or buying agent of other concerns in respect of contracts entered into by such concerns with the company ; (v) the money value of the contracts for the sale or purchase of goods and materials or supply of services, entered into by the company with the Managing Agent or his associate under section 360 during the financial year ;
Note 1 : The licensed capacity and installed capacity of the company as on the last date of the year to which the Profit and Loss Account relates, shall be mentioned against items (a) and (b) above, respectively. Note 2 : Against item (c), the actual production in respect of the finished products meant for sale shall be mentioned. In cases where semi-processed products are also sold by the company, separate details thereof shall be given. Note 3 : For the purposes of this paragraph, the items for which the company is holding separate industrial licences shall be treated as separate classes of goods but where a company has more than one industrial licence for production of the same item at different places or for expansion of the licensed capacity, the item covered by all such licences shall be treated as one class. 4D The Profit and Loss Account shall also contain by way of a note the following information namely :(a) value of imports calculated on C.I.F. basis by way the company during the financial year in respect of: (i) (ii) (iii) (b) raw materials components and spare parts capital goods ;
(vi) other allowances and commission including guaranteee commission (details to be given); (vii) any other perquisites or benefits in cash or in kind (stating approximate money value where practicable); and (viii) pensions, etc :(a) (b) pensions, gratuities,
(c) payments from provident fund, in excess of ones own subscriptions and interest thereon, (d) (e) from compensation for loss of office, consideration in connection with retirement office
expenditure in foreign currency during the financial year on account of royalty, know-how professional consultation fees, interest, and other matters; value of all imported raw materials, spare parts and components consumed during the financial year and the value of all indigenous raw materials, spare parts and components similarly consumed and the percentage of each to the total consumption; the amount remitted during the year in foreign currencies on account of dividends with a specific mention of the number of non-resident shareholders, the number of shares held by them on which the dividends were due and the year to which the dividends related; and
4A The Profit and Loss Account shall contain or give by way of a note a statement showing the computation of net profits in accordance with section 349 of the Act with relevant details of the calculation of the commissions payable by way of percentage of such profits to the directors (including Managing Directors), (the Managing Agents, Secretaries and Treasurers) or Manager (if any). 4B The Profit and Loss Account shall further contain or give by way of a note detailed information in regard to amounts paid to the Auditor, (whether as fees, expenses or otherwise for services rendered) 326
(c)
(d)
(e)
earnings in foreign exchange classified under the following heads, namely:(i) export of goods calculated on F.O. B. basis (ii) royalty, known how professional and consultation fees (iii) interest and dividend (iv) other income, indicating the nature thereof
The Central Government may direct that a company shall not be obliged to show the amount set aside to provisions other than those relating to depreciation, renewal or dimunition in value of assets, if the Central Government is satisfied that the information should not be disclosed in the public interest and
would prejudice the company, but subject to the condition that in any heading stating an amount arrived at after taking into account the amount set aside as such, the provision shall be so framed or marked as to indicate that fact. (1) Except in the case of the first Profit and Loss Account laid before the company after the commencement of the Act, the corresponding amounts for the immediately preceding financial year for all items shown in the Profit and Loss Account shall also be given in the Profit and Loss Account. (2) The requirement in sub-clause (1) shall, in the case of companies preparing quarterly or half-yearly accounts, relate to the Profit and Loss Account for the period which ended on the corresponding date of the previous year.
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ANNEXURE II
SCHEDULE VI [PART I-FORM OF BALANCE SHEET] Balance Sheet of ...............................................(Here enter the name of the company) As at .......................(Here enter the date as at which the balance-sheet is made out). Liabilities Instructions in accord ance with which liabilities should be made out Figures for the previous year Rs. (b)
*Terms of redemption or conversion (if any) of any Redeemable Preference Capital to stated, together with earliest date of redemption or conversion.
Assets Figures for the current year Rs. (b) Figures for the previous year Rs. (b)
*FIXED ASSETS : Distinguishing as far as possible between expenditure (a)goodwill, (b)land, (c)buildings, (d)lease-holds,(e)railway sidings, (f)plant and machinery, (g)furniture (h)development of property, (i)patents trademarks and designs, (j)live-stock and (k) Vehicles, etc.
Figures for the current year
Instructions in accor dance with which assets should be made out (b)
*Under each head the original cost, and the additions thereto and deductions therefrom during the year, and the total depreciation written off or provided up to the end of the year to be stated. Where the original cost aforesaid and additions and deductions thereto, relate to any fixed asset which has been an increase or reduction in the liability of the company, as expressed
Particulars of any option on unissued share capital to be specified Particulars of the different classes of preferences shares to be given
SHARE CAPITAL : Authorised .... shares of Rs .... each. +Issued (distinguishing between the various classes of capital and stating the particulars specified below, in respect of each class... shares of Rs.... each. +Subscribed (distinguishing between the various classes of capital and stating the particulars specified below, in respect of each class), (c)..shares of Rs ......... each Rs.... called up ... Of the above shares,... shares are allotted as fully paid-up-pursuant to a contract without payments being received in cash.
in Indian currency, for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of monies borrowed by the company from any person, directly or indirectly, in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before the date on which the change in the rate of exchange takes effect, the amount by which increased or reduced be added to, or as the case may be, deducted from the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed asset. Explanation 1: This paragraph shall apply in relation to all balance-sheets that may be made out as at the 6th day of June, 1966, or any day thereafter and where, at the date of issue of the notification of the Government of India, in the Ministry of Industrial Development and Company Affairs (Department of Company Affairs),
328
G.S.R.No.129, dated the 3rd day of January, 1968, any balance-sheet, in relation to which this paragraph applies, has already been made out and laid before the company in annual general meeting, the adjustment referred to in this paragraph may be made in the first balance-sheet made out after the issue of the said notification. Explanation 2.-In this paragraph, unless the context otherwise requires, the expressions rate of exchange, foreign currency shall have the meanings respectively assigned to them under sub-section(1) of section 43-A of the Incometax Act, 1961 (43 of 1961), and Explanation 2 and Explanation 3 of the said sub-section shall as far as may be, apply in relation to the said paragraph as they apply to the said sub-section(1). *In every case where the original cost cannot be ascertained without unreasonable expense or delay, the valuation shown by the books shall be given. For the purposes of this paragraph, such valuation shall be the net amount at which an asset stood in the companys books at the commencement of this Act after deduction of the amounts previously provided or written-off for depreciation or diminution in value, and where any such asset is sold, the amount of sales proceeds shall be shown as deduction.
Liabilities
Assets
Instructions in accord ance with which liabilities should be made out
Figures for the previous year Rs. (b)
Figures for the current year Rs. (b)
Figures for the previous year Rs. (b)
Figures for the current year Rs. (b)
Instructions in accordance with which assets should be made out (b)
*Specify the source from

which bonus shares are issued, e.g., capitalisation of Profits or Reserves or from Share Premium Account.
Of the above shares ....shares are allotted as fully paid-up by way of bonus shares Less: Calls unpaid : (i) By Managing Agents or Secretaries and treasures and where the Managing Agent or Secretaries and Treasurerrs are a firm, by the partners thereof, and where the Managing Agent or Secretaries and treasurers are a private company, by the Directors or members of that company. (ii) By Directors, (iii) By others. Where sums have been written off on a reduction of capital or revaluation of assets, every balance-sheet, (after the first balance-sheet), subsequent to the reduction or revaluation shall show the reduced figures, and with in place of the original cost. Each balance-sheet for the first five years subsequent to the date of the reduction, shall show also the amount of the reduction made.
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Any capital profit on reissue of foreited shares should be transferred to Capital Reserve.
*Add: Forfeited shares (amount originally paid-up)
Similarly, where sums have been added by writing up the assets, every balance-sheet subsequent to such writing up shall show the increased figures with the rate of in the increase in place of the original cost. Each balance-sheet for the first five years subsequent to the date of writing up shall also show the amount of increase made. Explanation Nothng contained in the preceding two paragraphs shall apply to any adjustment made in accordance with the second paragraph.
RESERVES AND SURPLUS : *Additions and deductions since last balance-sheet to be shown, under each of the specified heads.
INVESTMENTS : *Aggregate amount of companys quoted investments and also the market value thereof shall be shown. Aggregate amount of companys unquoted investments shall also be shown.
(1) Capital Reserves Showing nature of investments and mode (2) Capital Redemption Reserve. of valuation, for example, cost or market (3) Share Premium Account (cc). value and distinguishing between (4) Other Reserves specifying the nature of each reserve and the amount in respect thereof.
The word fund in Less : Debit balance in Profit & relation to any Reserve Loss Account (if any) (h). should be used only where (5) Surplus, i.e., balance in such Reserve is specifiProfit & Loss Account after cally represented by providing for proposed allocaearmarked investments. tions, namely : classes of shares and showing also in Dividend, Bonus or Reserves. (6) Proposed additions to Reserves. (7) Sinking Funds. Loans from Directors, the Managing Agents, Secretaries and Treasurers. Manager should be shown separately. Interest accrued and due on Secured Loans should be included under the appropriate sub-heads under the head Secured Loans
*(1) Investments in Government or Trust Securities. *(2) Investments in shares, debentures or bonds showing separately shares, fully paid-up and partly paid up and also distinguishing the different similar details investments in shares, debentures or bonds of subsidiary companies. *(3) Immovable proparties.
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Liabilities
Assets
Instructions in accord ance with which liabilities should be made out
Figures for the previous year
Figures for the previous year
Instructions in accor dance with which assets should be made out
Rs.
The nature of the security to be specified in each case. Where loans have been guaranteed by Managing Agents, Secretaries and Treasurers, Managers and/or Directors, a mention thereof shall also be made and also the aggregate amount of such laons under each head. Terms of redemption or conversion (if any) of debentures issued to be stated together with earliest date redemption or of conversion
Rs.
Rs.
Rs.
SECURED LOANS : *(1) Debentures *(2) Loans and Advances from Banks *(3) Loans and Advances from subsidiaries *(4) Other Loans and Advances
CURRENT ASSETS, LOANS AND ADVANCES : (A) Current Assets. (1) Interest accrued on Investments (2) Stores and Spare Parts (3) Loose Tools (4) Stock-in-trade (5) Works in Progress (6) Sundry Debtors (a) Debts outstanding for a period exceeding six months. (b) Other debts Less : Provision (7-A) Cash balance on hand (7-B) Bank balnces (a) with Scheduled Banks and (b) with others (G.S.R. No.78, dated 4-1-1963) Mode of valuation of stock shall be stated and the amount in respect of raw materials shall also be stated separately where practicable. ** Mode of valuation of works-in-progress shall be stated. In regard to Sundry Debtor particulars to be given separately of (a) debts considered good and in respect of which the company is fully secured ; and (b)
debts considered good for which the company holds no security other than the debtors personal security; and (c) debts considered doubtful or bad. debts due by Directors or otehr officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member to be separately stated. Debts due from other companies under the same management with in the meaning of sub-section (1-B) of Section 370 to be disclosed with the names of the companies. The maximum amount due by Directors or other officers of the company at any time during the year to be shown by way of a note. The provision to be shown under this head should not exceed the amount of debts stated to be considered doubtful or bad and any surplus of such provisions, if already created, should be shown at every closing under Reserves and Surplus (in the Liabilities side) under s separate sub-head `Reserve for Doubtful or Bad Debts.
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Liabilities Instructions in accord ance with which liabilities should be made out Figures for the previous year Rs. Figures for the current year Rs.
Assets Figures for the previous year Rs. Figures for the current year out Rs. Instructions in accor dance with which assets should be made
Loans from Directors, the Managing Agents, Secretaries and Treasurers. Manager should be shown separately. Interest accrued and due on unsecured Loans should be included under the appropriate sub-heads under the head Unsecured Loans
Out In regard to bank balances, particulars to be given separately on (a) the balance lying with Scheduled Banks on current accounts, call accounts and deposit accounts ; (b) the names of the bankers other than
Scheduled Banks and the balances lying with each such banker on current accounts, call accounts and deposit accounts and the maximum amount outstanding at any time during the year from each such banker ; and (c) the nature of the interest, if any, of any director or his relative or the Managing Agent, or Secretaries and Treasurers any associate of the latter in each of the bankers (other than scheduled Banks) referred to in (b) above. (G.S.R. No.78 dated 4th Jan 1963). Where loans have been guaranteed by managing agents, Secretaries and Treasurers, Managers, and/or Directors, a mention thereof shall also be made and also the aggregate amount of such loans under each head *See note (d) at foot of Form. UNSECURED LOANS (1) Fixed Deposits (2) Loans and Advances from subsidiaries. (3) Short Term Loans and Advances : (a) From Banks, (b) From others. (4) Other Loans and Advances : (a) From Banks (b) From others CURRENT LIABILITIES & PROVISIONS : A. Current Liabilities (B) Loans and Advances. (1) Acceptances (8) Advances and Loans to subsidiaires. (2) Sundry Creditors. (9) Bils of Exchange (3) Subsidiary Companies (10) Advances recoverable in cash or in (4) Advance payments and kind or for value to be received, unexpired discounts for the e.g., Rates, Taxes, Insurance, etc the portion for which value has (11) Balances on current account with still to be given e.g., in the Managing Agents or Secretaries and case of the following classes of Treasurers. companies : (Newspaper, Fire Insurance, Theatres, Clubs, Banking, Steamship Companies, etc.) (12) Balances with Customs, Port Trust etc., (where payable on demand) The above insturctions regarding Sundry Debtors apply to Loans Advances also.
(5) Unclaimed Divisdends. (6) Other Liabilities (if any) (7) Interest accrued but not on loans.
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Liabilities Instructions in accord ance with which liabilities should be made out Figures for the previous year Rs. Figures for the current year Rs.
Assets Figures for the previous year Rs. Figures for the current year Rs. Instructions in accor dance with which assets should be made out
B. Provisions : (8) Provisions for Taxation. (9) Proposed dividends (10) For contingencies (11) For Provident Fund Scheme. (12) For insurance, pension and similar staff benefits schemes. The period for which the dividends are in arrear or if there is more than one class of the dividends on each such class are in arrear, shall be stated (13) Other provisions. A foot-note to the Balance Sheet may be added to show separately : (1) Claims against the company not acknowledged as debts. (2) Uncalled liability on shares partly paid (3) Arrears of fixed cumulative dividends. (4) Estimated amount of contracts remaining to be executed on capital account and not provided for. (5) Other money for which the company is contigently liable.
The amount shall be stated before deduction of income tax, except that in the case of tax-free dividends for the amount shall be shown-free of income-tax and the fact that it if so shown shall be stated. The amount of any guarantee given by the company on behalf of Directors or other officers of the company shall be stated and where practicable, the general nature and amount of each such contingent, liability, if material, shall also be specified.
MISCELLANEOUS EXPENDITURE (to the extent not written off or or adjusted) (1) Preliminary expenses. (2) Expenses including commission or brokerage on under-writing or subscription of shares or debentures. (3) Discount allowed on the issue of shares or debentures. (4) Interest paid out of capital during construction (also stating the rate of interest). (5) Development expenditure noT Show here the debit adjusted. balance of profit (6) Other items (specifying nature) & loss account carried forward PROFIT AND LOSS ACCOUNT. after deduction of the uncommitted reserves, if any.
General Instructions for preparation of Balance Sheet (a) The information required to be given under any of the items or sub-items in this Form, if it cannot be conveniently included in the Balance Sheet itself, shall be furnished in a separate Schedule or Schedules to be annexed to and to form part of the balance-sheet. This is recommended when items are numerous. (b) Paise can also be given in addition to rupees, if desired. (c) In the case of (subsidiary companies) the number of shares held by the holding company as well as by ultimate holding company and its subsidiaries must be separately stated.
The auditor is not required to certify the correctness of such share holdings as certified by the management. (cc) [The item Share Premium Account shall include details of its utilisation in the manner provided in section 78 in the year of utilisation]. (d) Short Term Loans will include those which are due for not more than one year as at the date of the Balance Sheet. (e) Depreciation written off or provided shall be allocated under the different heads and deducted in arriving at the value of Fixed Assets. 333
(f) Dividends declared by subsidiary companies after the date of the Balance Sheet (should not be included) unless they are in respect of period which closed on or before the date of the balance-sheet. (g) Any reference to benefits expected from contracts to the extent not executed shall not be made in the Balance Sheet but shall be made in the Boards report. (h) The debit balance in the Profit and Loss Account shall be shown as a deduct on from the uncommitted reserves if any) (i) As regards Loans and Advances amounts due by the Managing Agents or Secretaries and Treasurers, either severally or jointly with any other persons, to be separately stated : the amounts due from other companies under the same management within the meaning of sub-section (1-B) of Section 370. G.S.R. 7 should also be given with the names of the companies the maximum amount due from every one of these at any time during the year must be shown. (j) Particulars of any redeemed debenture which the company has power to issue should be given. (k) Where any of the companys debentures are held by a nominee or a trustee for the company, the nominal amount of the debentures and the amount at which they are stated in the books of the company shall be stated. (l) A statement of investments (whehter shown under investments or under Current Asset as stock-in-trade) separately classifying *trade investments and other investments should be annexed to the Balance Sheet showing the names of the bodies corporate, indicating separately the names of the bodies corporate in the same group (with the name of the Managing Agent or Secretaries and Treasurers, if any, of every body corporate) in whose shares or debentures investments have been made (including all investments whether existing or not, made subsequent to the date as at which the previous Balance Sheet was made out) and the nature and extent of the investments so made in each such body corporate; provided that in the case of an investment company that is to say, a company whose
principle business is the acquisition of shares, stock, debentures or other securities, it shall be sufficient if the statement shows only the investments existing on the date as at which the Balance Sheet has been made out; provided further that it shall not be necessary to give any particulars in respect of investments made by a managing agency or Secretaries and Treasurers company in the managed companies shares or debentures. (m) If, inthe opinion of the Board, and of (the current assets loans and advances) have not a vaue on realisation in the ordinary course of business at least equal to the amount at which they are stated, the fact that the Board is of that opinion shall be stated. (n) Except in the case of the first balance-sheet laid before the company after the commencement of the Act, the corresponding amounts for the immediately preceding financial year for all items shown in the balance-sheet shall be also given in the Balance Sheet. The requirement in this behalf shall in the case of companies preparing quarterly or half-yearly accounts, etc., relate to the Balance Sheet for the corresponding date in the previous year. (o) The amounts to be shown under Sundry Debtors shall include the amounts due in respect of goods sold or services rendered or in respect of other contractual obligations but shall not include the amounts which are in the nature of loans or advances. (p) Current accounts with Directors, Managing Agents, Secretaries and Treasurers and Manager whether they are in credit or debit shall be shown separately. Substituted by G.S.R. 414, dated 21st March 1961. Trade Investment means an investment by a company in the shares or debentures of another company, not being its subsidiary, for the purpose of promoting the trade or business of the first company.
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PART II - A VERTICAL FORM OF BALANCE-SHEET

Items Instructions in accordance with which assets and liabilities should be made out 1. Under each head the original cost, and additions thereto and deductions therefrom during the year, and the total depreciation written off or provided up to the end of the year shall be stated 2. (a) The cost of a fixed asset shall be determined by adding to the purchase price any attributable costs of bringing it to its working condition for its intended use. (b) The cost of construction of a fixed asset shall be determined by adding to the purchase price of the materials and consumables used, the costs incurred by the company which are directly attributable to the construction of that asset. In addition, there may be included in the cost of construction of a fixed asset a reasonable proportion of the costs incurred by the company which are indirectly attributable to the construction of that asset, but only to the extent that they relate to the period of construction. (c) Financing costs relating to deffered credits or borrowed funds attributable to construction or acquisition of fixed assets up to the period such assets are ready to be put to use should also be included in the cost of the asset to which they are related. The fact of inclusion of interest in determining the cost of the asset to which they relate and the amount of the interest shall be disclosed in a note to the Balance Sheet in the year in which it is so included. 3. Where the original cost and the additions thereto and deductions therefrom relate to any fixed asset which has been acquired from a country outside India, and in consequence of a change in the rate of exchange at any time after the acquisition of such asset there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of moneys borrowed by the company from any person, directly or indirectly. In any foreign currency specifically for the purpose of acquiring the asset, the amount by which the liability is so increased or reduced during the year, shall be added to, or, as the case may be, deducted from, the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of fixed asset. Explanations : (a) Foreign currency, for the purpose of this Schedule, means any currency other than the Indian currency. (b) Rate of exchange, for the purposes of this Schedule, means the rate quoted by a bank or other authorised dealer in foreign exchange at which the rupee may be exchanged for a unit of a foreign currency or a foreign currency may be exchanged for a unit of the rupee. 4. In every case where the original cost cannot be ascertained without unreasonable expense or delay, the valuation shown by the books shall be given. For the purpose of this paragraph, such valuation shall be the net amount at which an asset stood in the Companys books at the commencement of this Act after deduction of the amounts previously provided or written off for depreciation or diminution in value, and where any such asset is sold, the amount of sale proceeds shall be shown as deduction.
FUNDS EMPLOYED A. Fixed assets I. Tangible assets 1. Land 2. Buildings 3. Plant and machinery 4. Furniture and Fittings 5. Vehicles 6. Livestock 7. Others (specify nature) II. Intangible Assets 1. Goodwill 2. Patents, Trade marks, Designs and similar rights 3. Others (specify nature) III. Capital work-in-progress
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5. Where sums have been written off on a reduction of capital or a revaluation of assets, every Balance Sheet (after the first Balance Sheet) subsequent to the reduction or revaluation shall show the reduced figures with the date of the reduction in place of the original cost. Similarly, where sums have been added by writing up the assets, every Balance Sheet subsequent to such writing up shall show the increased figures with the date of the increase in place of the original cost. 6. Each Balance Sheet for the first five years subsequent to the date of the reduction/ increase shall also show the amount of the reduction/increase made. Explanation : Nothing contained in paragraphs Nos.5 and 6 shall apply to any adjustment made in accordance with parargraph No.3 above. 7. Depreciation written off or provided shall be allocated under the different asset heads and deducted in arriving at the value of fixed assets. 8. Provisions of diminution in value shall be made in respect of any fixed asset which has diminised in value if the reduction in its value is expected to the permanent (whether its useful life is limited or not) and the amount to be included in respect of it shall be reduced accordingly. 9. Land or buildings acquired on leasehold basis shall be shown separately under the respective heads. 10. Goodwill shall be shown only when some consideration in money or moneys worth has been paid for it and shall be written off over a period which shall not exceed its useful life. 11. If any of the fixed assets acquired by the company under a finance lease are not included under the appropriate sub-heads, disclosure shall be made by way of a note to the balance-sheet of the type of assets (e.g., plant and machinery), the total value of the assets and the future obligations of the company as per the lease agreement. 12. Capital expenditure on incomplete construction work shall be shown under the heading Capital work in Progress. Advance payments to contracts shall not be classified under the specific fixed assets but disclosed in the balance-sheet as a separate item. B. Long term investments 1. Investments in Government or Trust Securities 2. Investments in shares, debentures or bonds 3. Immovable properties 4. Investment in the capital of associations of persons 5. Loans to subsidiaries 6. Others (specify nature) 1. Long term investment for the purpose of this Schedule, means an investment other than a current investment. Current investment, for the purposes of this Schedule means an investment that is by its nature readily realisable and is intended to be held for not more than one year. 2. Long term investments shall be shown at cost or revalued amounts. The book value of long term investments shall be reduced to recognise a decline, other than temporary, in their value. Such reduction shall be determined and made for each investment individually. 3. Aggregate amount of Companys quoted investments and also the market value thereof shall be shown. Aggregate amount of Companys unquoted investments shall also be shown. Quoted investment, for the purposes of this Schedule, means an investment in respect of which a quotation or permission to deal on a recognised stock exchange has been granted, and the expression unquoted investment shall be construed accordingly. 4. In the case of subsidiary companies, the number of shares held by the holding company as well as by the ultimate holding company and its subsidiaries shall be separately stated. In the latter case, the Auditor shall not be required to certify the correctness of such shareholdings as certified by the management. 5. A statement of long-term investments shall be annexed to the balance-sheet showing the names of the bodies corporate (indicating separately the names of the bodies corporate under the same management) in whose shares or debentures investments have been made (including all investments, whether existing on the date of the balancesheet or not, made subsequent to the date as at which the previous Balance Sheet was made out) and the nature and extent of the investment so made in each
336
such body corporate ; provided that in the case of an investment company, that is to say, a company whose principal business is the acquisition of shares, stock, debentures or other securities, it shall be sufficient if the statement shows only the investments existing on the date as at which the Balance Sheet has been made out. 6. Loans due from Directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any director is a partner or a director or a member shall be separately stated. 7. The maximum amount of loans due to directos or other officers of the company at any time during the year shall be shown by the way of a note. 8. Loans due from other companies under the same management within the meaning of subsection (3) of section 387, shall be disclosed separately with the names of the companies. 9. The nature of security, if any, shall be specified in respect of loans. 10. Provision made for bad and doubtful loans if any, shall be shown under respective sub-heads.
C. Net current assets Current assets 1. If the net realisable value of any current asset is lower than its cost, the amount to be included in respect of that asset shall be the net realisable value.
I. Investories 1. Raw materials and components 2. Stores, spares loose tools & other consumables 3. Work-in-process 4. Finished goods II. Debtors 1. Trade debtors 2. Other debtors 2.Trade debtor, for the purposes of this Schedule, means a person from whom amounts are due for goods sold or services rendered. 3. Instructions Nos. 6,7,8,9 and 10 regarding Long-term investments apply to Debtors also. 4. Debts outstanding for more than one year shall be shown separately under the respective heads. III. Short term loans and advances 1. To subsidiaries 2. To such other entities in which the company or any of its subsidiaries is a member 3. Advances recoverable in cash or in kind or for value to be received 4. Others (specify nature) 1. Short term loans and advances, for the purposes of this Schedule, mean deposits and other advances which fall due for payment, in a relatively short period, normally not more than 12 months from the date on which such loans, deposits or other advances are made. 2. Instructions Nos. 6,7,8,9 and 10 regarding Long-term investments apply to Short-term Loans and Advances also. 3. Current accounts with Directors and Manager shall be shown separately. 1. Debts shall not include amounts which are in the nature of loans or advances.
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IV. Current investments 1. Investments in shares, debentures and bonds 2. Other investments (specify nature)
1. Current investment, for the purposes of this Schedule, means an investment that is by its nature readily realisable and is intended to be held for not more than one year. 2. A statement of current investments existing on the date of the balance sheet shall be annexed to the balance sheet showing the names of the bodies corporate (indicating separately the names of the bodies corporate under the same management) in whose shares or debentures, investments have been made and the nature and extent of the investment so made in each such body corporate.
V. Bills of exchange VI. (a) Cash in hand (b) Cheques in hand (c) Balance at bank
In regard to bank balances, particulars shall be separately given of balances lying in current accounts, call accounts and deposit accounts. The maximum amount outstanding at any time during the year from non-scheduled banks shall be separately disclosed. Dividends declared by subsidiary companies after the date of the balance-sheet shall not be included unless they are in respect of a period which closed on or before the date of the balance-sheet.
VII. Other current assets (specify nature)
Less current liabilities provisions and short-term loans and advances I. Current liabilities 1. Acceptances 2. Sundry creditors 3. Advance payments and unexpired discounts for the portions for which value has still to be given 4. Unclaimed dividends 5. Interest accrued but not due on loans 6. Others (specify nature) II. Provisions 1. 2. 3. 4. For taxation Proposed dividends For Contingencies For pension, gratuity and similar staff benefit schemes 5. Others (specify nature) III. Short-term loans and advances 1. From banks and other financial institutions 2. From subsidiary companies 3. Others (speicfy nature) deposits or other advances are obtained. Provisions, for the purposes of this Schedule, means any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability the amount of which cannot be determined with substantial accuracy. 1. Short-term loans and advances, for the purposes of this Schedule, mean loans, deposits and other advances which fall due for payment in a relatively short period, normally not more than 12 months from the date on which such loans, 2. Current accounts with Directors and Manager shall be show separately. 3. The nature of security, if any, shall be specified in respect of short-term loans and advances. 4. Interest accrued and due on short-term loans and advances shall be included under the appropriate sub- heads under the head short-term loansand advances.
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Net current assets D. Miscellaneous expenditure to the extent not written off or adjusted. 1. Preliminary expenses 2. Expenses including commission or brokerage on underwriting or subscription of shares or debentures 3. Discount allowed on the issues of shares, debentures and other securites 4. Other items (specify nature) E. Loss as per the profit and loss account FINANCED BY A. Shareholders funds I. Share capital 1. Authorised capital 2. Subscribed capital 3. Called-up capital Less : Calls unpaid Add : Forfeited shares 2. The number of shares alloted as fully paid-up pursuit to a contract without payments being received in shall be separately disclosed. 3. The number of shares allotted as fully paid-up by way of bonus shares shall be separately disclosed. Also, the source from which bonus shares are issued, e.g., capitalisation of profits or reserves or from share premium account, shall be specified. 4. Terms of redemption or conversion (if any), of any redeemable preference capital shall be stated, together with the earliest date of redemption or conversion. 5. Particulars of the different classes of preference shares shall be given. 6. Particulars of any option on unissued share capital shall be specified. 7. Where the company has, by special resolution, determined that any portion of its share capital which has not already been called up shall not be capable of being called up, extent in the event and for the purposes of the company being wound up, the fact shall be suitably disclosed by way of a note to the Balance Sheet specifying the amount that shall not be so capable of being called up. II. Reserves and surplus 1. (a) Capital reserve (b) Capital redemption reserve (c) Share premium 2. Debenture redemption reserve 8. Any profit on reissue of forfeited shares shall be transferred to the capital reserve. 1.(i) Unless the context otherwise requires (a) the expression reserve shall not include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability ; (b) the expression capital reserve shall mean a reserve which is not available for distribution as dividend ; and in sub-clause(a) above, the expression liability shall include all liabilities in respect of expenditure contracted for and all disputed or contingent liability shall include all liabilities in respect of expenditure contracted for and all disputed or contingent liabilities The debit balance of the profit account carried forward after deduction of the uncommitted reserves, if any, shall be shown here. 1. In respect of each class of shares, the number of shares and the face value per share shall be disclosed in respect of authorised, subscribed and called-up capital.
3. Other reserves (specify nature) Less : debit balance in the Profit and Loss Account (if any) 4. Revaluation reserve 5. Surplus i.e. balance in the Profit and Loss Account after providing for proposed allocations, e.g., dividend, reserves
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2. Where (a) any amount written off or retained by way of providing for depreciation, renewals or dimunition in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act; or (b) any amount retained by way of providing for any known liability; is in excess of the amount which in the opinion of the Directors is reasonably necessary for the purpose, the excess shall be treated for the purposes of this Schedule as a reserve and not as a provision. 3. Additions and deductions since last balance-sheet shall be shown under each of the specified heads 4. The word fund in relation to any Reserve shall be used only where such Reserve is specifically represented by earmarked investments. 5. In respect of share premium, details of its utilisation in the manner provided in section 101 shall also be given in the year of utilisation. B. Long term loans I. Secured 1. Debentures 2. Loans from financial institutions 3. Loans from banks 4. Loans from subsidiaries 5. Others (specify nature) II. Unsecured 1. Fixed deposits 2. Loans from subsidiaries 3. Loans from banks 4. Others (specify nature) 1. Long-term loans, for the purposes of this Schedule, mean loans which fall due for payment in a relatively long period, normally more then 12 months from the date on which they are obtained. 2. The nature of the security in the case of all secured loans, whether short-term or long-term, shall be specified in each case. Secured loan, for the purposes of this Schedule, means a loan secured wholly or partly against an asset. 3. Where loans have been guaranted by Directors and/or Manager, a mention thereof shall be made and the aggregate amount of such loans under each head shall be shown. 4. Interest accrued and due on long-term loans shall be included under the appropriate sub-heads under the head secured loans or unsecured loans. 5. Terms of redemption or conversion (if any) of debentures issued shall be stated, together with the earliest date of redemption or conversion. 6. Loans from Directors and Manager shall be shown separately. 7. Particulars of any redeemed debentures which the company has power to issue shall be given. 8. Where any of the Companys debentures are held by a nominal amount of the debentures and the amount at which they are stated in the books of the company shall be stated. 9. The aggregate amount of long-term loan due for repayment within a period of 12 months from the date of the balance-sheet shall be indicated. 1. The period for which the dividends on preference shares are in arrears or if there is more than one class of shares, the dividends one each class are in arreas shall be stated. The amount shall be stated before deduction of income-tax. 2. The amount of any guarantees given by the company on behalf of Directors or other officers of the company on behalf of Directors or other officers of the company shall be stated, and where practicable, the general nature and amount of each such contingent liability, if material, shall also be specified.
Contingent liabilities A foot-note to the Balance Sheet may be added to show separately 1. Claims against the company not acknowledged debts 2. Uncalled liability on shares partly paid 3. Arrears of fixed cumulative dividends 4. Other moneys for which the is contigently liable (specify)
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ANNEXURE III
General instructions and accounting principles according to Companies Bill 1993 1. 2. The company shall be presumed to be carrying on business as an on-going concern. Where there is prima facie evidence to the contrary, suitable disclosure shall be made. Accounting policies shall be applied consistently from one financial year to the next. Any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in later periods shall be disclosed. In the case of a change in accounting policies which has a material effect in the current period, such change shall also be disclosed to the extent ascertainable. Where such extent is not ascertainable, wholly or in part, the fact shall be indicated. Provision shall be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information. Revenue shall not be recognised unless (i) it is realised (either in cash, receivables or other consideration); (ii) no significant uncertainty exists regarding the amount of the consideration ; and (iii) it is not unreasonable to expect ultimate collection. The accounting treatment and presentation in the Balance-Sheet and Profit and Loss Account of transactions and events shall be governed by their substance and not merely by the legal form. In determining the accounting treatment and manner of disclosure in the Balance-Sheet and Profit and Loss Account, due consideration shall be given to the materiality of the relevant items. An inappropriate treatment of an item in the Balance-Sheet or Profit and Loss Account is not rectified either by disclosure of accounting policies used or by notes thereto. Notes to the Balance-Sheet and the Profit and Loss Account shall contain only the explanatory material pertaining to the items in the Balance Sheet and the Profit and Loss Account. All significant accounting policies adopted in the preparation and presentation of financial statements shall be disclosed at one place. Where they are not in conformity with accounting standards, particulars of any material departures from those standards and the reasons therefore shall be given. The information required to be given under any of the items or sub-items in this Form, if it cannot be conveniently included in the Balance-Sheet or the Profit and Loss Account itself, as the case may be, can be furnished in a separate Schedule or Schedules to be annexed to and forming part of the Balance-Sheet or Profit and Loss Account. This is recommended where items are numerous. The Schedules referred to above, accounting policies and explanatory notes that may be attached shall form an integral part of the Balance-Sheet. The corresponding amounts for the immediately preceding financial year for all items shown in the Balance-Sheet and Profit and Loss Account shall also be given in the Balance Sheet or Profit and Loss Account, as the case may be. The requirement in this behalf shall, in the case of companies preparing quarterly or half-yearly accounts, etc., relate to the Balance Sheet/Profit and Loss Account for the corresponding date/period in the previous year. Amounts in respect if items representing assets or income shall not be set off against amounts in respect of items representing liabilities or expenditure, as the case may be, or vice versa. Assets and liabilities shall be adjusted for those events occuring between the end of the financial year of the company to which the balance-sheet relates and the date on which the Balance-Sheet and Profit and Loss Account are approved by the Board of Directors which provide additional evidence to assist the estimation of amounts relating to conditions existing at the date of the Balance-Sheet. The figures in the balance sheet and profit and loss account may be rounded off appropriately, e.g., to the nearest .000 or .00. A statement of sources and application of funds shall be annexed to the Balance-Sheet. Such a statement shall be prepared and presented for the period covered by the Profit and Loss Account and for the corresponding previous period. Funds provided from or used in the operations of a company shall be shown separately in the statement of sources and applications of funds. Unusual movement of funds, if material, should be separately disclosed. Each company shall adopt the form of presentation for the statement and changes in financial position which is most informative in the circumstances. 341
3.
4. 5. 6. 7. 8.
9.
10. 11.
12. 13.
14. 15.
ANNEXURE
IV
SCHEDULE XIV
(See Sections 205 and 350)
RATES OF DEPRECIATION
Nature of Assets Single Shift W.D.V. S.L.M. 1
I. (a) Buildings (other than factory buildings[NESD] (b) Factory Buildings (c) Purely temporary erections such as wooden structures II. Plant and Machinery (i) General rate applicable to plant and machinery (not being a ship) for which no special rate has been prescribed under below (ii) Special rates A. 1. Cinematography films -Machinery used in the production and exhibition of cinematograph of cinematograph films [N.E.S.D] (a) Recording equipment, reproducting equipment, developing machines. printing machines, editing machines, synchronisers and studio lights except bulbs. (b) Projecting equipment of film exhibiting concerns. 2. 3. Cycles [N.E.S.D] Electrical Machinery Batteries; X-Ray and electrotherapeutic apparatus and accessories thereto [N.S.E.D.] Juice boiling pans (karhais)[N.E.S.D.] Motor-cars, motor cycles, scooters and other mopeds [N.E.S.D.] Electrically operated vehicles including battery powered or fuel call powered vehicles [N.E.S.D.] Sugarcane crushers (indigenous kolhus and belans) [N.E.S.D] Glass manufacturing concerns except direct fire glass melting furnaces Recuperative and regenerative glass melting furnaces
Double Shift W.D.V. S.L.M. 4 5
Triple Shift W.D.V. S.L.M. 6 7
2
5 percent 10 percent 100 percent
3
1.63 percent 3.34 percent 100 percent
15 percent 20 percent
5.15 percent 7.07 percent
22.5 percent
8.90 percent
30 percent
11.31 percent
20 percent
7.07 percent
4. 5. 6.
7. 8.
20 percent
7.07 percent
30 percent
11.31 percent
40 percent
16.21 percent
342
1
9. B. 1. 2. 3. 4. Aeroplanes - Aircraft, aerial photographic apparatus (N.E.S.D.) Concrete pipes manufacture-Moulds (N.E.S.D.) Drum container manufacture-Dies (N.E.S.D.) Earth-moving machinery employed in heavy construction works. such as dams, tunnels, canals, etc. (N.E.S.D.) Glass manufacturing concerns except direct fireglass melting furnaces - Moulds (N.E.S.D.) Moulds in iron foundaries (N.E.S.D.) Mineral oil concerns - Field operations (above ground) - Portable boilers drilling tools, wellhead tanks, rigs, etc. (N.E.S.D.) Mines and quarries - Portable underground machinery and earthmoving machinery used in open cast mining (N.E.S.D.) Motor tractors, harvesting combines (N.E.S.D.) Patterns, dies and templets (N.E.S.D.) Ropeway structures - Ropeways. ropes and trestle sheaves and connected parts. (N.E.S.D.) Shoes and other leather goods factories-Wooden lasts used in the manufacture of shoes Machinery used in the manufacture of electronic goods or components.
30 percent
11.31 percent
5.
6. 7.
8.
9A. 10. 11.
12.
30 percent
11.31 percent
45 percent
18.96 percent
60 percent
29.05 percent
C. 1. 2. Aeroplanes-Aero-engines (N.E.S.D.) Motor buses, motors, lorries and motor taxies used in a business or running them on hire (N.E.S.D.) Rubber and plastic goods factories Moulds (N.E.S.D.) Data processing machines including computers (N.E.S.D.) Gas cylinders including valves and regulators (N.E.S.D.) Artificial silk manufacturing machinery wooden parts Cinematograph films - Bulbs of studio lights Floor mills-Rollers Glass manufacturing concerns-Direct fire glass melting furnaces 40 percent 16.21 percent
3. 4. 5. D. 1. 2. 3. 4.
343 32
1
5. 6. 7. Iron and Steel industries Rolling mill rolls Match factories-Wooden match frames Mineral oil concerns (a) Plant used in field operations (below ground) Distribution returnable package (b) Plant used in field operations (below ground) but not including assets used in field operations (distribution)-Kerbside pumps including underground tanks and fittings Mines and quarries - (a) Tubs, winding ropes, haulage ropes and sand stowing pipes (b) Safety lamps Salt works-Salt pans, reservoirs and condensers, etc., made of earthy, sandy or clay material or any other similar material Sugar works - Rollers Furniture and Fittings General rates (N.E.S.D.) Rate for furniture and fittings used in hotels, restaurants and boarding houses; schools, colleges and other educational institutions, libraries; welfare centres, meeting halls, cinema houses; theatres and circuses; and for furniture and fittings let out on hire for use on the occassion of marriages and similar functions (N.E.S.D.) Ships Ocean-going ships (i) Fishing vessels with wooden hull (N.E.S.D.) (ii) Dredgers, tugs, barges, survey launches and other similar ships used mainly for dredging purposes (N.E.S.D.) (iii) Other ships (N.E.S.D.) 2. Vessels ordinarily operating on inland waters (i) Speed boats (N.E.S.D.) (ii) Other vessels (N.E.S.D.) W.D.V. : Written Down Value S.L.M. : Straight Line Method. NOTES 1. 2.
8.
9.
10. III. 1. 2.
10 percent
3.34 percent
15 percent
5.15 percent
IV. 1.
27.05 percent
10 percent
19.8 percent 14.6 percent 20 percent 10 percent
7 percent 5 percent 7.07 percent 3.34 percent
"Buildings" include roads, bridges, culverts, wells and tube-wells. "Factory buildings" does not include offices, godowns, offices and bridges, culverts, wells and tube-wells.
344
3. 4.
"Speed boat" means a motor boat driven by a high speed internal combustion engine capable of propelling the boat at a speed exceeding 24 kilometres per hour in still water and so designed that when running at a speed it will plane, i.e., its bow will rise from the water. Where, during any financial year, any addition has been made to any asset, or where any asset has been sold, discarded, demolished or destroyed, the depreciation on such assets shall be calculated on a pro rata basis from the date of such addition or, as the case may be, upto the date on which such asset has been sold, discarded, demolished or destroyed. The following information should also be disclosed in the accounts : (i) depreciation methods used ; and (ii) depreciation rates or the useful lives of the assets, if they are different from the principal rates specified in the Schedule.
5.
6.
The calculations of the extra depreciation for double shift working and for triple shift working shall be made separately in the proportion which the number of days for which the concern worked double shift or triple shift, as the case may be, bears to the normal number of working days during the year. For this purpose, the normal number of working days during the year shall be deemed to be (a)in the case of seasonal factory or concern, the number of days on which the factory or concern actually worked during the year or 180 days, whichever is greater ; (b) whichever is greater. in any other case, the number of days on which the factory or concern actually worked during the year or 240 days,
The extra shift depreciation shall not be charged in respect of any item of machinery or plant which has been specifically, exempted by inscription of the letters N.E.S.D. (meaning No Extra Shift Depreciation) against it in sub-items above and also in respect of the following items of machinery and plant to which the general rate of depreciation of 15 per cent applies (1) Accounting machines. (2) Air-conditioning machinery including room air-conditioners (3) Building contractors machinery (4) Calculating machines. (5) Electrical machinery-switchgear and instruments, transformers and other stationary plant and wiring and fitting of electric light and fan installations. (6) Hydraulic works, pipelines and sluices. (7) Locomotives, rolling stocks, tramways and railways used by concerns, excluding railway concerns. (8) Mineral oil concerns - field operations: (a) Boilers. (b) Prime movers. (c) Process plant. (d) Storage tanks (above ground). (e) Pipelines (above ground). (f) Jetties and dry docks. (9) Mineral Oil concerns - field operations (distribution)- kerbside pumps, including underground tanks and fittings. (10) Mineral oil concerns - refineries: (a) Boilers. (b) Prime movers. (c) Process plant. (11) Mines and quarries: (a) Surface and underground machinery (other than electrical machinery and portable underground machinery). (b) Head-gears. (c) Rails. (d) Boilers. (e) Shafts and inclines. (f) Tramways on the surface. (12) Neo-post franking machines (13) Office machinery. (14) Overhead cables and wires. (15) Railway sidings. (16) Refrigeration plant containers, etc. (other than racks). (17) Ropeway structures : (a) Trestle and station steel work. (b) Driving and tension gearing. (18) Salt works-Reservoirs, condensers, salt pans, delivery channels and piers if constructed of masonry, concrete, cement, asphalt or similar materials, barges and floating plant, piers, quays and jetties; and pipelines for conveying brine if constructed of masonry, concrete, cement, asphalt or similar materials. (19) Surgical instruments. (20) Tramways electric and tramways run by internal combustion enginespermanent way : cars - car trucks, car bodies, electrical equipment and motors; tram cars including engines and gears. (21) Typewriters. (22) Weighing machines (23) Wireless apparatus and gear, wireless appliances and accessories. Notes: Refer to Notes under sections 205 and 350.
345
2. CORPORATE ACCOUNTS AND BOARDS RESPONSIBILITY

SUB-TOPICS 2.1 Introductory Note 2.2 Responsibility of Directors for Proper Upkeep of Accounts 2.3 Fiduciary Relation 2.4 Directors Liabilities 2.1 INTRODUCTORY NOTE The Board of Directors of a company is in charge of the affairs of the company. It acts for and on behalf of the company. Lord Selbourne, L.C. explained the position of Directors thus: "The Directors are the mere trustees or agents of the company - trustees of the companys money and property; agents in the transactions which they enter into on behalf of the company. [G.E.Railway Company v. Turner (1872)LR 8 Ch App 149]. According to sec. 291 of the Companies Act in India, the Board of Directors shall be entitled to exercise and draft and prepare, subject to the provisions of the Companies Act, Memorandum of Association and Articles of Association of the company. Every company should preserve the Books of Accounts together with the relevant vouchers for a period of not less than 8 years in good order. Directors are liable to be punished in case proper Books of Accounts are not kept. In the following passages an attempt is made to explain the responsibilities of the Directors in so far as keeping of accounts is concerned. 2.2 RESPONSIBILITY OF DIRECTORS FOR PROPER UPKEEP OF ACCOUNTS The Managing Director or the Manager and every Director of a company and every officer or other agent of the company appointed for that purpose are responsible to keep proper Books of Accounts according to the provisions laid down in sec. 209 of the Companies Act, 1956. 'Proper Books of Accounts' shall mean keeping of all those books necessary to give a true and fair view of the state of affairs of the company including all its branch offices. Directors are, therefore, liable to be punished if default is made in keeping proper Books of Accounts. According to sec. 209(5) such an act is punishable with imprisonment for a term which may extend to 6 months or with fine which may extend to Rs.1000 or with both. A person is liable to be proceeded against in respect of an offence under sec. 209 for failure to take reasonable efforts to secure compliance by the company with the requirements of the section. Of course it has been provided that no person shall be sentenced to imprisonment except when the offence is committed wilfully. Directors are also responsible to propose dividends out of the profits of the company after taking into consideration the detailed provision laid down in sec. 205 of the Companies Act. Every Director is responsible, therefore, not only on the recommendation but also on all consequential steps. For example, according to sec. 207, every Director is punishable with simple imprisonment for a term which may extend to 7 346
days and shall also be liable to fine if a default is made knowingly in not posting the dividend warrant within 42 days from the date of declaration of the dividend. According to sec. 210 the Board of Directors shall present before the company in a Annual General Meeting: (a) A Balance Sheet; and (b) A Profit and Loss Account for the same period. A Director who fails to take all reasonable steps to comply with the provisions of this section shall be punishable with imprisonment which may extend to six months or with fine up to Rs.1000 or with both. Of course the imprisonment is not to be given unless the offence is committed wilfully. The Directors may take a defence by proving that a competent and reliable person was put in charge to discharge the duties and responsibilites. Similar provisions of responsibilites to be undertaken by the members of the Board of Directors are provided in sec. 211 which specifies a Balance Sheet and Profit & Loss Account to be prepared in the forms indicated in Part I & Sch VI. sec. 212 provides for procuring information from the subsidiaries and putting it in the Balance Sheet of the holding company. sec..215 requires authentication of Balance Sheet and Profit and Loss Account by the Managing Director and another member of the Board. Boards Report : The Balance Sheet must accompany the report of the Board of Directors which shall inter alia include : (a) The state of the companys affairs (The state of affairs of the company); (b) The amount if any which the Board proposes to carry to any reserves ; (c) The amount if any which the Board recommends to be paid as a dividend ; and (d) Material changes affecting the financial position of the company which occured during that period. The report also includes all materials relating to the affairs of company which according to the Board is harmful to the company and its subsidiaries. It also includes list of employees drawing more than Rs.36,000 annually and also showing relation of such an employee with the Director or Manager. All the annexures to the companys accounts are not required to be included in the Boards report. But the report must give the fullest information and explanations. (Refer to sec. 217). In all the above provisions as indicated in secs. 210, 211, 212, 217 and 218 noncomplaince of the duty imposed has been made an offence punishable with imprisonment and fine. Of course unless the offence is wilful a person canot be sentenced to imprisonment. A member of the Board may however take a defence that a person having special knowledge in accounts had been appointed to look after the Books of Accounts and system of accounts. The Act also imposes certain restrictions on the powers of the Board of Directors. It provides that the Board of a Public Ltd
company or that of a Private company which is a subsidiary of a Public Ltd company will not do the following business except with the consent of the members obtained in the General Meeting : (i) Sale, lease or otherwise dispose off the whole or substantially the whole of the companys undertaking ; (ii) Remit or give time for the payment of any debt due by a Director, except renewal or continuance of an advance made by a Banking company to its Director in the ordinary course of business ; (iii) Invest otherwise than in trust securities, the sale proceeds resulting from the disposal of the undertaking (refer to clause(i) above); (iv) Borrow money exceeding the aggregate of the paid up capital of the company and its free reserves ; and (v) Contribute to charitable or other funds not relating to business of the company or Welfare of its employees, any account which will in any year not exceed Rs.25,000/- or 5% of the net average profit during the three preceeding years whichever is greater. (refer to sec. 293 of the Companies Act, 1956) 2.3 DIRECTORS FIDUCIARY RELATIONS Jessel, M.R. has very appropriately described the role of the Directors in Re Forest of Dean Coal Company [(1878)10 ch. D 415]. According to him they are commercial men managing a trade concern for the benefit of themselves and of all the share holders in it. They stand in a fiduciary position towards the compay in respect of their powers and capital under their control. According to Romer, J., In discharging his duties a Director must act honestly and must exercise such degrees of skill and diligence as would amount to the reasonable care which an ordinary man is expected to take in the circumstances in his own behalf. [Re City Equitable Insurance Company (1925) Ch.407] In other words a Director has to use fair and reasonable diligences in the management of the companys affairs and act honestly. So long as he is fulfilling these conditions he is not liable for error of judgement. Though he has the right of inspection of accounts he is not bound to inspect individual entries. So long as he ensures that maintenance of Books of Accounts is in the hands of competent persons he can be said to be not negligent. According to sec. 71(3) of the Companies Act of 1956 any Director who knowingly contravenes or wilfully authorises or permits the contravention of the statutory restrictions with respect to allotment of shares, remains for two years after the allotment
under a statutory liability to compensate the company for any loss or damage or costs incurred. In Eastern Shipping Company v. Bangkee [(1924) AC 177] it was held that apart from statutory liability the Directors as trustees are liable for breach of their fiduciary duties to their company. The failure of Directors to act within powers (ultra vires acts) will render them liable, and thus shall have to indemnify the company for any loss or damage. If a Director acts malafide, i.e., acts otherwise than honestly for the benefit of the company he is bound to compensate the company. It is on this ground that the Directors are required to account for and surrender secret profits of the company. The Director has to exercise the powers for the benefit of the company. He will be guilty of dereliction of duties, if his negligence, as such, enable frauds to be committed and losses are thereby incurred by the company. Improper maintenance of Books of Accounts, falsification of books or frauds will obviously make the Director liable for punishment. 2.4 DIRECTORS LIABILITES For several financial and accounting improprieties, the Companies Act attaches personal liabilities to the Directors. Some of the accounting improprieties and Directors liabilities thereon have already been stipulated. Some of the financial improprities and personal liabilities of the Directors are as follows : (i) Directors have civil and criminal liability for misstatement in the prospectus ; (refer to secs. 62 and 63) (ii) If public deposits are invited without issuing an advertisement and in violation of the provision of sec. 58A., a Director is personally liable. He is even punishable with imprisonment for a term which may extend to 5 years ; (iii) A Director is personally liable if the application money is not returned within 120 days unless the shares are allotted; (iv) A Director is liable for irregular allotment and his liability can be unlimited under secs. 322 and 323; (v) A Director is liable personally for fraudulent trading on the part of the company in its winding up proceedings ; and (vi) There are various statutory penalties for non complaince that can be imposed on a Director. He can be prosecuted under the Indian Penal Code for offences like fraud, perjury, misappropriation, embezzlement or conspiracy to default.
347
3. DIVIDEND
SUB-TOPICS 3.1 Introductory note 3.2 Legal Position of Corporate Profit and Dividend 3.3 Declaration and Payment of Dividend 3.4 Dividend to be paid out of Reserve 3.5 Issues Relating to Reserves and Funds 3.6 Suggested Changes in Companies Bill 1993 3.7 Annexure 3.1 INTRODUCTORY NOTE The Profit earned by a company belongs to the company and not to the shareholders. A member, being a shareholder, has a right to his share only and has no right on the assets of the company. Dividend is the payment made to him as return, for his investment in the share capital. Dividend can only be paid out of profits and not out of capital. It is the prerogative of the Board to appropriate the profits of a company for any year. The appropriation of profits to reserves and dividends shall be stated in the Directors report. Only the Board has the right to recommend the payment of profits as dividends to the shareholders. The shareholders cannot enhance the dividend recommended but can reduce or reject it at the Annual General Meeting. Hence payment of dividend is subject to recommendation by the Board and approval of the same by the shareholders for payment. The dividends once declared to the shareholders become a debt due. 3.2 LEGAL POSITION OF CORPORATE PROFIT AND DIVIDEND Futcher Moulton, L.J., explained Profit In Re Spanish Prospecting Company Ltd [(1911)1 Ch.D 92] thus : "profits implies a comparison between state of business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of assets at two dates ..... According to the principle of accounting this method of finding out profit by comparison of assets in two dates is not scientific. Profit according to the principle of accounting over a particular period of time is the surplus of income over expenditure. In this sense it is nearer to the dictionary meaning. According to Chambers Dictionary - Profit is the excess of selling price over the fixed cost. According to taxing statutes, profit is the excess of revenue income over revenue expenditure. The double entry system of book keeping on accrual basis takes into account the accruals and outstandings while calculating the profit. Accountants are - generally prudence driven. They provide for doubtfuls while considering the revenue income or revenue expenditure and recognise income de Cannon of Certainty. 348
Part II of Schedule VI of the Companies Act as reproduced in the Annexure I prescribes the requirements which the profit and loss account of a company should follow. Similarly, secs. 29 to 44 of the Income Tax Act, also provides the expenses which can be deducted to ascertain the Income of a concern. Where there is a difference in the provision of Income Tax Act and Companies Act the profit of a company is determined according to Companies Act for all purposes excepting in the matter of corporate tax. It has been already pointed out earlier that the profit of a company belongs to the company and not to the shareholders. As soon as dividends are declared at the AGM, a shareholder gets the right on the profit. Thus profit and dividend are two very inter-linked concepts. The expression dividend has two meanings which the Supreme Court pointed out in CIT v. Girdhari dass & Co Pvt Ltd (AIR 1967 SC 795). To a runing concern it means portion of the profit of a company which is allocated to the holders. In the company and in case of a winding up proceeding it means the division of the realised assets among the creditors and contributors according to their respective rights. Dividend for our purpose, in the section means the former, i.e., allocated profit on a share. 3.3 DECLARATION AND PAYMENT OF DIVIDEND According to sec. 205 of a Companies Act, a company cannot declare dividend or pay it for any financial year unless it has earned profit. The following are the clear provisions regarding declaration of dividends to the shareholders : (i) In order to declare dividend the profit must be found after providing for depreciation as stipulated in Schedule XIV of the Companies Act. (See Annexure IV) While providing for the depreciation, unabsorbed depreciation of the previous years or loss whichever is lower is also required to be provided for (sec. 205 and sec. 350) (ii) No dividend shall be payable except in cash. Of course capitalised profits may be used to issue bonus shares. (sec. 205) (iii) The dividend when declared becomes a debt due. In order to ensure that disbursement of the dividend amount is not delayed by the company, the law provides that in case the dividend is not paid or claimed within 42 days of the declaration thereof then within 7 days after the end of the 42 days, the total amount of dividend should be transfered to a bank account with a scheduled bank. This bank account cannot be operated except for the payment of dividend. In case the dividend is not claimed or paid within 3 years after the transfer, the amount should be transfered to the general revenue account of the government. This can be later claimed by the shareholder by making a claim on the government. (secs. 205A and 205B)
(iv) No dividend shall be paid by a company except to the registered shareholder of such share or to his order or to his banker or in case a share warrant has been issued to the bearer of the share warrant or to his banker. (sec. 206) (v) Where any instrument of shares has been delivered to any company for registration but has not yet been registered the company shall transfer the dividend amount to the special account mentioned in (iii) above, unless the shareholder in writing asks the company to pay the amount to the transferee. (vi) No dividend shall be declared or paid by a company except after transfer to the reserve of the company such percentage of profit as stipulated by the Central Government from time to time, not exceeding, 10%. 3.4 DIVIDEND TO BE PAID OUT OF REVENUE It has been already stated that a company is not bound to declare entire profit or any part thereof by way of dividend. Therefore, the profit may be held in a general reserve. According to sec. 205(2A) a company is not prohibited to voluntarily transfer higher percentage of profit than the stipulated percentage of profit that may be prescribed by Central Government to be transferred to the reserve. The Central government has made rules for the companies (transfer of profit to reserves) in 1975. According to rule 2 of the said Rules a company declaring dividend upto 12.5% has to transfer to the general fund atleast 2.5% of the current profit. If the dividend exceeds 12.5% but not 15% of the paid up capital the reserves shall not be less than 5% and if exceeds 15% but not 20% the reserve shall be not less than 7.5%. If the dividend is more than 20% the profit to be transfered to this reserve shall not be less than 10%. Where no dividend is declared the amount proposed to be transfered to its reserves shall be lower than the average amount of dividends to the shareholders declared by it over the immediately preceeding 3 years. Of course the company is not prohibited to voluntarily transfer higher percentage of profit to its reserve. According to sec. 205A(3) a company not having adequate profit in a year may propose to declare dividend out of the accumulated profits earned by the company in the previous years and transfered to its reserves. The Central government has prepared rules for this purpose in 1975. According to Rule 2 of the Companies (declaration of Dividends out of Reserves) Rules 1975 a company not having sufficient profit in year may declare dividend out of the accumulated profits transfered to its reserves subject to the following conditions : (i) The rate of dividend shall not be higher than the average of the rates of dividend declared in the immediately preceeding 5 years or 10% of its paid up capital, whichever is less;
(ii) The total amount to be declared as dividend shall not exceed 10% of the paid up capital and reserves; (iii) The amount thus drawn shall first use to set off the losses; and (iv) The amount of the reserve shall not fall below 15% of the paid-up share capital.
3.5 ISSUES RELATING TO RESERVES AND FUNDS General reserve has not been defined in the Act. A full Bench of the Madras High Court held that the General Body can only create general reserve on the advice of the Board of Directors under sec. 217(1)(6). Institute of Chartered Accountants in London defined this reserve as Amount set aside out of profits and other surplus which are not designed to meet any liability, contingency, commitment or diminition in value of assets known to exist as at the date of the Balance Sheet. However, in ITC v. Century Spining and Manufacturing Co Ltd [(1953) 23 Comp.Cas 462] it was held that mass of undistributed profits cannot automatically make it a reserve. Reserve may be either general or special which has to be clearly indicated. Fund is also not defined in the Companies Act. Fund is created for specific purpose by transfering a profit to a fund. Such a specific purpose fund is known as Sinking Fund. Fund is the capitalised version of profit. As such a general fund can also be not distributed by way of dividend. Out of the general fund and reserve, bonus shares can be issued. Sinking Funds like Specific Funds, Debentures-Redemption Reserve Fund or Depreciation Fund cannot be used for issue of bonus share until the basic purpose of the fund is fulfilled. 3.6 SUGGESTED CHANGES IN COMPANIES BILL 1993 1. Companies would henceforth need to inform members about the dividend remaining unclaimed by them, by way of a notice to be sent with every notice of an Annual General Meeting. In case unpaid dividend is not transfered to a separate bank account, the company would be liable to pay interest at 18% per annum. 2. Dividends unclaimed and transfered to the General Revenue account of the Central Government would be credited to an Investors Protection Fund to be used for purposes to be notified.
349
4. AUDIT AND AUDITOR

SUB-TOPICS 4.1 Introductory note 4.2 Role of Audit 4.3 Principles of Audit 4.4 Relation between Accounting and Auditing 4.5 Different Types of Audit 4.6 Qualification of a company Auditor and Restriction on the number of Auditors 4.7 Auditors Remuneration 4.8 Removal of an Auditor 4.9 Auditors Report 4.10 Some Proposed Changes Relating to Audit and Auditor 4.1 INTRODUCTORY NOTE In a Joint Stock company, the management carries on business with shareholders funds. There is a separation of power between management and ownership. The shareholder has no access to the Books of Accounts which would be maintained by the Directors. This necessitates the involvement of an independent person who would report on the accounts of a company to the shareholders. The Directors have cast upon them a duty of presenting to the shareholders each year, the Balance Sheet and Profit and Loss account, and the auditor has the duty of expressing his opinion on them in the form of a report on the accounts. As the law enjoins upon the management to present a true and fair view of the accounts, the auditor is expected to report whether the accounts in his opinion are true and fair. 4.2 ROLE OF AUDIT Audit is concerned with the verification of accounting data and with determining the accuracy and reliability of accounting statements and reports. It primarily involves testing the reliability, competency and adequacy of evidence in support of all transactions. The main objectives of company audit are to conduct an independent review of the financial statements and offer an opinion about their reliability in presenting the organisations financial condition and working results.The main function of the Auditor is to ascertain whether the financial statements fairly represent the actual financial position and working results of an organisation. The managements responsibilities include the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies and the safeguarding the assets of the entity. The audit of financial statements does not relieve the management of its responsibilities. 4.3 PRINCIPLES OF AUDIT The Institute of Chartered Accountants of India, in its statement on Standard Auditing Practices, identified the basic principles 350
governing an Audit has listed certain principles for independent audit of financial information. These principles are as follows : a) Integrity and independence : The auditor is appointed by the shareholders to carry out certain duties as laid down by the Companies Act, 1956. This requires that the auditor be straight forward, honest and sincere in his approach to his work. He should be free from bias and maintain an impartial attitude. He should be independent and able to withstand the pressures of management; b) Confidentiality : The auditor is expected to respect the confidentiality of information that he acquires during the course of his professional work and unless required by statute or any legal and professional demands he should not divulge any information; c) Skills and competence : The auditor requires certain specialized skills and competence to undertake an audit. This is ensured through his qualification which is acquired through a process of education, training and a qualifying examination. The Institute also adds to his skill and competence through its various pronouncements on matters of accounting and auditing and various guidance notes on ways and means to undertake audits and to handle the varied situations that arise in an audit; d) Responsibility : The auditor is personally responsible for whatever opinion that he forms and expresses on the financial information made available to him for audit. However, he can rely on work done by others provided adequate skill and care is excercised and the work so done by others has been properly supervised; e) Accounting systems and internal control : Though the management is responsible for maintaining adequate accounting systems incorporating internal controls, the companys auditor should assure himself that the system is adequate and the internal control procedures are in operation and are commensurate with the size of the company and the nature of its business; f) Planning : Based on the adequancy of internal controls, the auditor can plan his audit to cover the various facets of the companys activities and to establish a certain degree of reliance on the internal controls; and g) Evidence and documentation : Gathering evidence forms an integral part of an audit activity. Obtaining sufficient evidence enables him to draw reasonable conclusions and to base his opinion. The evidence so gathered should be documented. This is the proof of an audit having been undertaken in accordance with the basic principles and will help him in case of any legal or professional requirements.
4.4 RELATION BETWEEN ACCOUNTING AND AUDITING Auditing is an examination of accounts kept for and on behalf of an organization with a view to authenticate the periodical account with the help of Books of Accounts and the original vouchers and documents. Original vouchers and documents are known as primary evidences and the records maintained in the Books of Accounts are secondary evidence of transactions made by the organisation in course of a period of time. Audit, therefore, is the last step of function in the chains of accounting functions. The relation between accounting and auditing, therefore, is very close. Auditing procedures and principles and principles of accounting are inter-related and integrated. Of course without the proper development of accounting principles, the development of auditing procedures and principles are not possible. The main purpose of accounting is to find out the net result of the transactions over a period of time. The main object of auditing on the other hand is to authenticate that the result thus found is true and fair. The first principle of accounting is that the working result of transactions over a period of time which are revenue in nature determine the net profit or loss of the concern but transactions which are concerned with real or personal account determine the assets and liabilities of the concern at a given point of time. The audit principle closely follows this basic accounting principle for the purpose of accurately determining the profit and loss, and assets and liabilities at a given point of time. This working of the result and its authentication does in no way indicate the future course of transactions though there may be a logical expectation. In this sense this accounting systems is essentially historical in nature. It has nothing to do with projection, forecasting and management decisions for futher actions. Of course historical accounting is used as a data for future indication on the supposition that the future is modelled in the direction of the past. So auditing of historical accounting is essentially authenticating of what has happened through reivewing primary and secondary evidences. 4.5 DIFFERENT TYPES OF CORPORATE AUDIT A company has two types of audit viz. (i) Financial Audit and (ii) Cost Audit. The Financial Audit is done by the company Auditor appointed under sec.224 and he is required to submit audit report on the lines laid down in sec. 227 and issued dividend. According toManufacturing and other Companies (Audit Report) Order, 1975 the cost audit is to be done by the Cost Auditor appointed under sec.233 B. The Cost Auditor is to submit his report to the Central Government with a copy to the company. According to sec.209(1)(d), in the case of a company engaged in production, processing or mixing activities has to keep proper books of accounts with respect to such particulars relating to materials or labour or to other items of cost as may be prescribed. This particular clause has been inserted for the purpose of determining efficiency through Cost Audit. Of course there is a provision for a special audit in specified extraordinary circumstances under sec.233A which can be done at the behest of Central government by an Auditor appointed
under the section even if the audit has already been done under sec.221. The coverage of the audit shall extend to other matters as directed by the government. The report will be submitted to the government and not to the shareholders. 4.6(A) QUALIFICATIONS OF COMPANY AUDITORS Section 226 of the Companies Act, 1956 provides that only a person who is a member of the Institute of Chartered Accountants of India, holding a certificate of Practice and who is not in full time employment can be appointed as the auditor of a company. Further certain disqualifications exists as to the appointment of an auditor. He should not form a body corporate, or be an officer or employee of the company whose accounts are to be audited or a person who is a partner or in the employment, of an officer of the company, nor should he be indebted to the company for more than Rs.1000/- or have guaranteed the repayment of any such debt. A statutory auditor cannot be appointed as an internal auditor. Hence the intention of the law is that an auditor should be a truly independent person who is neither connected with the company nor with the management. A professional auditor should be constantly aware of his possible legal obligations to his clients and third parties, specially in the context of the increasing expectation of the society from his profession as is evident from the various amendments to the Companies Act and other relevant legislations as well as from various judicial pronouncements in this area. Knowledge of the Companies Act and its provisions is essential for a company auditor. Compliance with such provisions is no doubt the responsibility of the directors and other officers of the company. However, non compliance of many provisions of the Act may materially affect the financial statements and validity of transactions of a company. The auditor should therefore always keep the provisions of the Companies Act in mind. The qualification of a Cost Auditor as per sec.233B is that he shall be a Cost Accountant within the meaning of Cost and Works Accountants Act, 1959. Of course, Central Government may by notification empower a Chartered Accountant to function as a Cost Accountant until such time when sufficient numbers of Cost Accountants are available. A special Auditor appointed to conduct a special audit is required to be a Chartered Accountant under the Chartered Accountant Act of 1949. He may be the company Auditor or any other Chartered Accountant appointed under sec.233 A. 4.6(B) APPOINTMENT OF AUDITORS
a) Company Auditor : The first auditor of a company may be appointed by the Board of Directors within a period of one month from the date of registration of the company. The term of the first auditor is only upto the conclusion of the first annual general meeting. The appointment of the first auditor shall be made by the company in a general meeting in case the first auditor is not appointed by the Board. 351
The appointment of subsequent auditor must be made at each annual general meeting and such auditor holds office normally upto the conclusion of the next annual general meeting. The shareholders appoint the auditor at the annual general meeting. In case an auditor is not appointed or reappointed at the annual general meeting, he would be appointed by the Central Government. The Board of Directors are entitled to appoint the auditor in case a casual vacancy occurs due to any reason other than resignation. Where an auditor resigns, the vacancy may be filled only by the company at the annual general meeting. Where the central or state governments, nationalised banks or nationalised insurance companies, hold either singly or jointly 25% or more of subscribed capital of a company, the appointment or reappointment of an auditor shall be made by passing a special resolution at the annual general meeting. If an auditor is not appointed or reappointed before the expiry of his term, the company shall inform the central government within 7 days thereafter and in such cases, the central government may appoint auditors to fill the vacancy. b) Cost Auditor : A Cost Auditor shall be appointed by the Board of Directors of a company in accordance with the provisions of sec.224(1)(b) with the previous approval of the central government. The company Auditor appointed for financial audit shall not be appointed or re-appointed for cost audit. c) Special Auditor : The central government may at any time direct a special audit to be conducted either by the same company Auditor or by any other Chartered Accountant for the purpose of submission of report to the central government. 4.6(C) RESTRICTIONS ON THE NUMBER OF AUDIT A quantitative restriction has been placed on the number of company audits that can be accepted. The maximum number of public limited companies of which a person may hold appointment as auditor is twenty of which not more than ten may be companies each of which has a paid up share capital of Rs.25 lakhs or more. Hence, it is necessary to ascertain and obtain a certificate from the auditor that in case he is appointed or reappointed, the appointment would be within the limits and that he has not acquired any disqualification, to avoid an embarassing situation. The Act also provides that in case a firm is appointed as Auditors, the quantitative limit would be applicable taking each partner of a firm separately and where a partner is common to other firms he shall be counted only once. 4.7 AUDITORS REMUNERATION Where the auditors are appointed by the company, the remuneration must always be fixed by the company at the general meeting. The remuneration is fixed by the Board or by the central government where the appointment is made by the Board or the government. It is interesting to note that, in practice, and in most cases the shareholders while appointing the auditor at the annual general 352
meeting authorise the Board of Directors to fix the remuneration in consultation with the auditors. The remuneration paid to an auditor by whatever name called as also the expenses paid to him needs to be specifically disclosed in full in the profit and loss account. (section 224(8)). This is to enable the shareholders to have adequate and full information of the payments so made. 4.8 REMOVAL OF AN AUDITOR An auditor enjoys certain safeguards as regards his continuance in office. The previous approval of the central government is necessary to remove an auditor before the expiry of his term and that too only at the general meeting. In case a person other than the retiring auditor is to be appointed at an annual general meeting, 14 days special notice should be given to the company. The company shall forthwith send a copy of the special notice to the retiring auditor. He is entitled to make a written representation and to have such representation circulated among members, otherwise he is also entitled to have his representation read out at the meeting. Further under the Code of Ethics to which a Chartered Accountant is subject a person so appointed to fill in the existing office needs to communicate with his predecessor to find out objections, if any. An Auditor should not accept any position as auditor previously held by some other Chartered Accountant under such conditions as to constitute under cutting of fees. 4.9 AUDITORS REPORT The auditor is required to make a report on the accounts examined by him and on the balance sheet and profit and loss account of the company. The report must be signed by a qualified auditor practising in India and not by a firm. If such an auditor is a partner in a firm of auditors, which has been appointed as the auditor of the company, he must sign in his individual name as a partner of the firm. The report must be read out before the company at the general meeting and also be open to inspsection by any member of the company. The auditors report consists of two parts namely the affirmative and the opinionative. In the opinionative part, he has to express an opinion on certain matters. The affirmative part of the report consists of : (i) Whether he has obtained all the information and explanations which is to the best of his knowledge and belief were necessary for the purpose of the audit ; (ii) Whether the report on the accounts of any branch office audited under section 228 of the Companies Act by a person other than the companys auditor has been forwarded to them a report as required by section 228(3)(C) and how he has dealt with the same in preparing the auditor's report ; and (iii) Whether the companys Balance Sheet and Profit and Loss account dealt with by the report are in agreement with the books of account and return.
The opinionative part of the report consists of : (i) Whether proper books of account as required by law have been kept by the company so far as it appears from his examination of the books and proper returns adequate for the purpose of the audit have been received from branches not audited by him ; (ii) Whether the accounts give the information required by the Act in a manner so required ; and (iii) Whether the accounts give a true and fair view, in the case of the Balance Sheet, of the state of the companys affair, and in the case of the profit and loss account, for the year. The auditors report has to be made on the accounts examined by him, the Balance Sheet and Profit and Loss Account and every document declared to be a part of or annexed to such balance sheet. Documents annexed include the list of investments and particulars required by section 372(9) and any information given in a schedule where permitted to be so done. Documents attached to the Balance Sheet are excluded from the ambit of the report. Further, under section 227 (IA) the auditor has to make specific enquiries and report on the matters specified there in only if he is not satisfied on those matters. The matters are : (i) Whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interests of the company and its members; (ii) Whether transactions of the company which are represented merely by book entries are not prejudicial to the interests of the company; (iii) Where the company is not an investment company within the meaning of section 372, or a banking company, whether so much of the assets of the company as consists of shares, debentures and other securities have been sold at a price less than that at which they were purchased by the company; (iv) Whether loans and advances made by the company have been shown as deposits; (v) Whether personal expenses have been charged to revenue; and (vi) Where it is stated in the books and papers of the company that any shares have been allotted for cash, whether cash has actually been so received in respect of such allotment and if no cash has actually been so received, whether the position as stated in the account books and the Balance Sheet is correct, regular and not misleading. In addition, the central government has the power to direct, by a special or general order that in the case of specified companies, the auditors report shall include a statement, on such matters as may be specified. The central government has issued in 1975 and amended in 1988 the Manufacturing and other Companies (Auditors Report) Order by which the auditor is to report on the matters specified therein. The Auditors report can be an unqualified report, a qualified report, an adverse report, or a disclaimer. An unqualified report does not state any adverse comments either in the affirmative part or the opinionative part. Generally an audit report is an unqualified one, as the management would ensure compliance
with law and with accounting norms. A qualified report is one which has a reservation attached to it. Any failure to perform a statutory duty in the manner required under law cannot be absolved by merely giving a qualification or a reservation in the report. A qualification is necessary where disclosure is not made in accounts as per law. However, while qualifying a report, an auditor should be guided by the concept of materiality, whether the item to be qualified is so material that a qualification is required. In extreme cases, a disclaimer or an adverse report may be required. Where the auditor is unable to express an opinion due to lack of information, or otherwise, he would give a disclaimer expressing his inability to express an opinion. Where, however, the qualification is so severe so as to affect the true and fair view of the accounts itself, he would issue an adverse report. The qualification should be contained in the Auditors report proper, and should be self explanatory. It should be indicated by the correct terminology with the prefix subject to. A qualification is a serious matter and the law recognizes it and as such section 217(3) of the Companies Act enjoins the Director to give the fullest information and explanation on every qualification in the auditors report. An auditor is for certain purposes of the Act deemed to be an officer of the company. In the case of winding up of the company by the court, the auditor can be called by the court for purposes of examination on oath and for production of any books and papers in his custody relating to the company. The court may also publicly examine him as to the conduct of the business of the company, in case the official liquidator makes a report to the court that a fraud has been committed. As an officer he is liable for committing of fraud or for misfeasance in the case of winding up. .4.10 SOME PROPOSED CHANGES RELATING TO AUDIT AND AUDITOR
The Companies Bill 1993 The Companies Bill 1993 has proposed some changeswith regard to audit and auditor. They are : (i) Only qualified Audit reports need to be read out at the annual general meeting. An unqualified report could be taken as read with the permission of the members present ; (ii) A relative of a Director or Manager of a company cannot be appointed as Auditor; and (iii) In the Audit report the auditor should also express his opinion on (a) whether the accounting policies of the company are in conformity with the accounting standards laid down by the Institute of Chartered Accountants of India; (b) whether there have been any deviation from the companys accounting policies; (c) Whether the accounting treatment in the financial statements in respect of any item is inappropriate; and (d) whether it is in line with substance with the legal form. The scope of the report has been enlarged and comes closer to international norms of reporting. 353
5. AUDITORS RIGHTS AND DUTIES

SUB-TOPICS 5.1 Introductory note 5.2 Independence of an Auditor 5.3 Powers of an Auditor 5.4 Special Right of a company auditor to attend a meeting 5.5 Duties of a company Auditor 5.6 Branch Audit 5.1 INTRODUCTORY NOTE The role of a company Auditor cannot be exaggerated in the context of his rights, duties and responsibilities undertaken. Care in his Professional Ethics of Public Accounting emphasised the independence of the professional practioners on account of their responsibilites, moral or legal to the corporation and to the public in the context to which their relationship may tend to influence others judgement. The following text explains Auditor's rights and duties. 5.2 INDEPENDENCE OF AN AUDITOR A note issued by the Research Committee of the Institute of Chartered Accountants of India has stated that independence actually implies that the judgement of a person is not subordinate to the wishes or directions of another person who might have engaged him or to his own self-interest. Independence is a well accepted standard of auditing. The need for independence has been recognised in the Chartered Accountants Act wherein provisions have been made to cover areas or situations where there would be a conflict between interest and duty and the independence of the auditor could be affected. The Companies Act also recognises the independence of auditors. One specific area where the Act has made itself clear is with regard to the appointment of internal auditor as the statutory auditor of the company. The Act specifically states that an internal auditor cannot be appointed as the statutory auditor because the internal auditor is appointed by the management and is in the position of an employee and if he is appointed as the companys statutory auditor, it will not be possible for him to give an independent and objective report as required under the Act. Independence does not mean that the auditor should assume an attitude of hostility and proceed like a prosecutor. It only points to the need for his functioning in a fair and impartial manner with a sense of obligation not only to the management and those immediately concerned or interested in the companys business but also to those who would be interested to become shareholders or creditors. It would be apt in this context to quote Justice Lopes in the Kingston Cotton Mill Co, case citation wherein he observed that The auditor is a watchdog but not a blood hound. He is justified in believing tried servants 354
of the company in whom confidence is placed by the company. He is entitled to assume that they are honest and to rely upon their respresentations, provided he takes reasonable care. If there is anything calculated to excite suspicion, he should probe it to the bottom, but in the absence of anything of that kind he is only bound to be reasonably cautious and careful. The Companies Act can be read in the context of this observation in the following circumstances: Under sec.227(1A), the auditor is under an obligation to make an inquiry and report only if the provisions of the Act are not complied with and, under sec. 227(2) and (3), the auditor shall make a report stating whether, in his opinion and to the best of his information and according to the explanations given to him, the said accounts give the information required by the Act in the manner so required and give a true and fair view with regard to : (a) in the case of the balance sheet, of the state of affairs of the company ; and (b) the case of the Profit and Loss account for the financial year. Here again, the auditor only expresses an opinion on the truth and fairness of the financial statements and does not vouch for the correctness of the statements concerned. These clauses have been provided in the Act basically because it would be impracticable for an auditor to vouch for the veracity of each and every transaction and activity of the company and also because quite a number of the transactions could not be material enough to be considered for an indepth verification. An auditor can only approach his work with an inquiring mind and not with any preconceived notion that there is something wrong or that there is fraud in the accounts although the tests that he performs shall runover any fraud. In the statement on Auditing Practices published by the ICAI, it was pointed out that it is the directors of the company who are primarily responsible for the preparation of the annual accounts and for the information contained therein. The duty of safeguarding the assets of a company is primarily that of the management and the auditor is entitled to rely upon the safeguards and internal controls instituted by the management although he will, and of course, take into account any defficiencies he may note therein while drafting his audit programme. Based on the above, it can be stated that the auditor cannot be a bloodhound but only a watch dog. However, this does not absolve the auditor of his primary duty of reporting to the members on the accounts examined by him and he should be careful 'not to certify what he does not believe to be true and must take reasonable care before he believes that what he certifies is true(Lindley L.J.) 5.3 POWERS OF THE AUDITOR The auditor of a company is empowered to have a free and complete access at all times to the books, accounts and vouchers
of the company and also to require from the directors and officers, such information and explanation as may be necessary for the performance of his duties as an auditor. These powers enable him to discharge his duties effectively. This power is important as he can only express an opinion when he has adequate information at his disposal. The auditor should obtain all the necessary information and should take into account the views of directors before he finalises any qualification to the accounts. His report should be based on the books as he has to state whether the balance sheet and profit and loss account are in agreement with the books. 5.4 RIGHT TO ATTEND COMPANY MEETINGS The auditor is entitled to attend any general meeting of the company and to receive all notices and other communications relating to any general meeting which any member of the company is entitled to receive and to be heard at any general meeting or any part of the business which concerns him as an auditor. This right has been given so that the auditor is able to present his opinions/views to the shareholders if required. 5.5 DUTIES OF THE AUDITOR In completing his statutory function, the auditor is required to employ reasonable skill and care as is expected of a person having specialised knowledge.
The duty of safeguarding the assets of the company, is primarily that of the management and the auditor is entitled to rely upon the safeguards and internal control instituted by the management. He has to take into account any deficiencies he may note therein. The auditor does not conduct the audit with the objective of discovering all frauds because in the first place, it would not be possible to complete the audit within the time limit prescribed by the law for the presentation of accounts to shareholders. Further such an examination would require a detailed and minute examination of all the books, records and other documents of the company and the cost of doing this would be prohibitive and disproportionate to the benefits which may be derived by the shareholders. Finally even if such an examination is conducted, there will be no assurance that all types of fraud, omission and forgery etc., would be discovered. The auditor while conducting the audit bears in mind the possibility of existence of fraud and irregularities in the accounts of the company. His duty is to primarily report on the account to the shareholders. 5.6 BRANCH AUDIT The accounts of the branch office(s) of every company must be audited by the companys auditor, or by a person qualified for appointment as auditor. However, the compulsory audit of branch office is exempted in certain cases according to the rules made in this behalf by the Central Government.
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6. AUDITORS LIABILITIES
SUB-TOPICS 6.1 Introductory Note 6.2 Auditors Liability for Negligence 6.3 Auditors Liability for Misfeasance 6.4 Auditors Criminal Liability 6.5 Auditors Liability to Third Parties 6.6 Professional Ethics 6.7 Professional Misconduct 6.1 INTRODUCTORY NOTE An Auditors liabilities have different dimensions. As a contractual assignment he has some contractual liabilities that arise from the non-fulfilment of the terms and conditions of the agreement. The Corporate Auditor has a statutory Civil and Criminal liability also. The following chart shows Auditors liabilities at a glance. Liability of an Auditor Contractual Liability Liability Liability arising on non-fulfilment of Conditions Civil Liability Liability Due to Negligence Due to Misfeasance Criminal Liability arising on account of breach Statutory care and due diligence. Of course a Corporate Auditor in such cases is liable under the statute itself. 6.2(A) AUDITORS LIABILITY FOR NEGLIGENCE
The question of an auditors liability for negligence has been tried more in the English courts rather than in India. This question can be best illustrated by referring to various judicial decisions. The question basically is one of fact as to whether the Auditor has shown reasonable care in the discharge of his function. Members of a profession must exercise the standard of skill which is usual in the profession. The standard is ordinarily that of a skilled man exercising and professing to have that special skill and one need not possess the highest expertise or skill at the risk of being found negligent. In a suit for negligence it would be upto the plaintiff to prove that the professional had some duty to him and a breach of such duty has resulted in an injury. The earliest decision with regard to an Auditors liability for negligence was given In Re London and General Bank [(1895) 2 ch 673 (No.2)]. In that case Lord Justice Lindley said An Auditors duty is to ascertain and state the true financial position of the company at the time of audit. An auditor, however is not bound to do more than exercising reasonable care and skill in making enquiries and investigation. He is not an insurer, he does not guarantee that the books do correctly show the true position of the companys affairs. If he did, he would be responsible for error on his part, even if he were himself deceived without any want of reasonable care on his part; he must be honest i.e. he must not certify what he does not believe to be true and he must take reasonable care and skill before he believes that what he certifies is true. What is reasonable care in any particular case must depend on the cirumstances of that case. This decision then became the precedent in several other cases and was often cited with approval. In the case of In Re Kingston Cotton Mill Co. [(1896) 2 ch 279 (No 2)] Lord Justice Lindley stated that the auditors should not be suspicious but only be reasonably careful. Lord Justice Lopes, in the same case stated : In determining whether any misfeasance or breach of duty has been committed it is essential to consider what the duties of an auditor are. It is the duty of an auditor to bring to bear on the work he has to perform that skill, care and caution which a reasonably competent, careful and cautious auditor would use. What is reasonable skill, care and caution must depend on the particular circumstances of the case. An auditor is not bound to be a detective or, as was said, to approach his work with suspicion or with a foregone conclusion that there is something wrong. He is a watch dog but not a blood hound. He is justified in believing true servants of the company in whom confidence is placed by the company. If there is anything calculated to excite suspicion he should probe it to the bottom but in the absence of anything of that kind, he is only bound to be reasonably cautious and careful."
Besides these liabilities, the Auditor being a member of a professional body has a professional liability and accountability also. He has to follow the code of conduct. In other words if he does not follow the code of conduct prescribed by the Institute of Chartered Accountants, he is liable for professional misconduct and has to face this charge before the professional body. 6.2 CONTRACUTAL LIABILITY A Corporate Auditor has a Statutory Standard Form of Contract. If he fails to perform his contractual obligation he is liable to his employer, ie., his company. The complicacy arises primarily when the Auditor is also required to prepare whole or part of the accounts. In that case his contractual obligation is wider. Contractual liability arises also on account of lack of proper 356
The duties of the auditor must not be rendered too onerous. Their work is responsible and laborious and the remuneration moderate .... auditor must not be made laible for not tracing out ingenious and carefully laid schemes of fraud when there is nothing to arouse their suspicion. In the case of London Oil Storage Co., Ltd., v. Seear Hasluck & Co., ((1904) 31 Acent LRI) Lord Alverstone stated "The auditor is an officer contemplated by law to protect the interests of the company and its shareholder as such; he is there having certain duties prescribed by the Act. The auditor has got to bring to bear upon those duties reasonable and watchful care, he has got to discharge those duties remembering that the company looks to him to protect its interest. He is not, however, supposed to be a man constantly going about suspecting other people of doing wrong. In the case of City Equitable Fire Insurance Co., Ltd., [(1925) 1 ch 407], Sir Pollock M.R. wrote that it is the duty of the court to endeavour to ascertain what was the problem presented to the auditor, and what was the knowledge available to him at the time to audit. It is not fair to consider the case with hindsight and hold that the auditors were negligent in discharging their duties. The court must bear in mind the facts available at the time of alleged negligence by the auditor, and it is not fair to determine the fact of negligence by taking into consideration what has come to light after true scrutiny carried out in the special audit. However the legal standards of reasonable care have been critically examined in recent times more particularly in the decision of the House of Lords reported in Fomento Sterling Area Ltd., v. Selsdon Fountain Pen Co Ltd ((1958) 1 WLR 45), in which Lord Denning said What is the proper function of an auditor ? It is said that he is bound to verify the sum, the arithmetical calculations, by reference to the books and all necessary vouching material and oral explanations;..... I think this is too narrow a view. His vital task is to take care to see that errors are not made, be they errors of computation, or errors of omission or commission or down right untruth. I would not have it thought that the Kingston Mills case ((1896) 2 ch 279) relieved an auditor of his responsibility of making a proper check. It is part of his duty to use reasonable care to see that none have been omitted which ought to be included. If he cannot be sure, of his own knowledge he can take the advice of a lawyer ........... The reasonable care and skill expected of an auditor would obvioulsy become more stringent with the passage of time. Justice Pendse in Tri sure India Ltd., v. A.F. Ferguson & Co., and others (company case volume 6 (1981) Bomb 548), said The auditor is required to employ reasonable skill and care, but he is not required to begin with suspicion and to proceed in the manner of trying to detect a fraud or a lie unless some information has reached which excites suspicion or ought to excite suspicion in a professional man of reasonable competence.
An auditors duty is to see what the state of company affairs actually is, whether it is reflected truly in the accounts of the company, upon which the Balance Sheet and Profit and Loss accounts are based, but he is not required to perform the function of a detective. What is reasonable care and skill must depend upon the circumstances of each case. Where there is nothing to excite suspicion and there is an atmosphere of complete confidence based on the record of continued success in financial matters, less care and less severity of scrutiny may be considered reasonable. Whereas, reasonable care and skill may be regarded as not exercised when in spite of the presence of unusual features in the accounts or other prima facie reason for believing that the affairs of the company may not be in order, the examination is perfunctory and not sufficiently detailed. 6.3 AUDITORS LIABILITY FOR MISFEASANCE Auditor has civil liability for misfeasance. Several sections of the Companies Act attach such liability on the Auditor. As for example secs. 57, 58, 59, 62(3), 62(4), 70(5), 233, 477, 488, 543, 545, 621, 625, 633 provide civil liability on an Auditor. These relate to : (i) Providing for expert opinion relating to prospectus or statement in lieu of prospectus ; (ii) Submission of an Auditors report not in confirmity with secs. 227 and 229 of the Act ; (iii) Courts power of summoning in the event of liquidation for public examination; and (iv) Assessment of damages for misfeasance or breach of trust. 6.4 CRIMINAL LIABILITY Under sec.197 of the Indian Penal Code (IPC) whosoever issues or signs any certificate required by law to be given or signed or relating to any fact which such certificate by law is admissible by evidence, knowing or believing that such certificate is false in any material point shall be punishable in the same manner as if he gives a false evidence. So if a company Auditor knowingly issues or signs an Audit report which is false in any material points he is punishable for the offence under sec.197 of IPC. Besides, the company Law has criminalized the following acts: (i) When false statements are made by the Auditor either in Profit and Loss Account, Balance Sheet or any other document; (ii) When any voucher or document is destroyed intentionally by the Auditor; and (iii) When any voucher or document is mutilated with the object to deceive the others. The Companies Act provides in particular, for example the following criminal liabilities of a Corporate Auditor : (i) Authorising the issue of properties with a false statement knowingly or intentionally made, the offence being punishable with imprisonment upto 2 years or fine upto Rs.5000/- or with both (s.63(1)) ; (ii) Knowingly or recklessly certifying a false, deceptive or misleading statement, promise or forecast which is 357
punishable with imprisonment upto 5 years or fine upto Rs.10,000/- or with both; [s.68] (iii) Certifying a false particular in the report, or certificate, or balance sheet or prospectus, punishable with imprisonment for a term upto 2 years and also fine (s.628) ; and (iv) Intentional destruction, alteration or falsification of any books of accounts, papers or securities, punishable with imprisonment upto 7 years and also fine (s.539). 6.5 LIABILITY OF THIRD PARTIES The annual account of a company as certified by the Auditor is the standard disclosure required from the company under the corpoate law. The position of the Auditor vis-a-vis the company is based upon the contract between the parties but at the same time it is statutorily regulated also. More and more people are putting reliance on Auditors report and take the position of the company as certified by the Auditor. It is true that an Auditor doesnt have any privity with the third party but his status of independant profession and his specialised knowledge makes him a trusthworthy person to the outside world. As such investors, creditors, bankers, tax authorities and all other parties having any relation with the company take a decision on the basis of Auditors certificate. An author takes the analogy of a physician's relation with the clients with the Auditors position in so far as relation between him and third parties are concerned based on his certificate. (Basu Dr. B.K., An Insight to Auditing (1982), Books Syndicate Pvt. Ltd, p. 9.42). The physician is primarily responsible to his client and secondarily to other members of the family for the injury arising from the negligence of his duty of care and issue of certificate. Auditors position is perhaps more intricate than a physician. It is for this reason that the issue gets its importance in many litigations in several countries. The age old principle in the law of Tort as enunciated in 1893 in Le livre & Dennes v. Gould [(1922) IK.B. 688] is that the question of liability for negligence cannot arise at all until it is established that the man who has been negligent owe some duty to the person who seeks to make him liable for his negligence". In 1889 it was held in Deery v. Peek [(1889) 14 App. Cas 337] that to make an Auditor liable to third parties the following four grounds must be satisfied: (a) the statement made by the Auditor was untrue in fact ; (b) the Auditor making it knew that it is untrue or he was ... negligent to find out the truth ; (c) the statement was made with an intent that the identified third party should act on it with sound belief ; and (d) the identified third party suffered loss by placing reliance on it. Following these two cases for long it was argued that Auditors are not liable for the certificate in the absence of fraud. In fact in a dissenting judgement Lord Denning first tried to make a very big shift from this proposition in Candler v. Crane Christmans & Co [(1951) 2KB 164] as he observed that the
circumstances in which the duty to use care in making a statement can exist apart from a contract. According to him (i)... those persons, such as accountants, surveyors, valuers and analysts, whose profession and occupation is to examine books and accounts and other things and to make reports on which other people, other than their clients rely in the ordinary course of business. Their duty is not merely a duty to use care in their reports; and (ii) They also owe the duty to any third person to whom they know their employer is going to show the accounts so as to induce them to invest money .... In Hadley Byrne & Co Ltd v. Haller & Partners Ltd [(1964)AC 465] Lord Morris observed that It should now be settled that if someone possessed of a special skill undertaken, quite irrespective of contracts, to apply that skill for the assistance of another person who relies on such skill, duty of care will arise .... Furthermore if, in a sphere in which a person is so placed that others could reasonably rely on his judgement or his skill or on his ability to make careful enquiry, a person takes it on himself to give information or advice to, allows his information or advice to be passed on to another person who, as he knows or should know, will place reliance on it, then a duty of care will arise. In India the issue came before the court in CIT v. GM Dandekar [(1952) 22 Comp.Cas 256] where the issue was brought by the Income Tax officer holding the Auditor for negligence and therefore liable to compensate. The court held that the Auditor did not owe a duty of care to third parties. This decision is perhaps against the strong arguments of making an Auditor responsible for his functions. The Institute of Chartered Accountancts in England and Wales has advised its members to use a disclaimer in the certificate restricting their responsibilites. For example, the certificate is prepared for the private use of the company and no responsibilities to any third party is accepted. Guide to Companies Act, 1988 According to Ramaiya "an Auditor also owes a legal responsibility to third parties who might have been misled by his audit certificate and acted in reliance thereof. Under sec.28 of the Securities Exchange Act of USA, an Auditor is made liable to third parties not only for fruad but also for negligent misrepresentation even if it be innocent. In State Strict Trust Co. v. Ernest [(15 N & 41)] it was held that A representation certified as true to the knowledge of an accountant where there is knowledge or a reckless mistatement or an opinion based on grounds so flimsy as to lead to the conclusion that there was no genuine belief to its truth, are all sufficient upon which to base liability. A refusal to see the obvious, a failure to investigate the doubtful, if sufficiently gross, may furnish evidence leading to an inference of fraud so as to impose liability for losses suffered by those who rely on the balance sheet. In Utra Meyers Corporation v. Touche [(225 N.Y. 170)] the Court had to give a caution by holding that it would be quite wrong to expose the Auditor to all possible and potential liabilities in an indeterminate account for our indefinite time to an indeterminate class.
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It is therefore necessary to have a balanced approach towards Auditors liability towards the third party. It would be wrong to make the institution fail under heavy responsibilities. Standard Auditing Practices (Mandatory) Standards on Auditing are now issued by professional bodies (most of whom are members of the International Federation of Accountants which issues through its International Auditing Practices, Standards on Auditing Practice) on various aspects of Audit with a view to furnish a theoretical consistency as a basis for Audit which is rooted in practice. The Institute of Chartered Accountants has made the following Auditing Practices, which it has issued, as mandatory :Statement on Standard Auditing Practices a) SAP-1 Basic Principles Governing an audit. b) SAP-2 Objective & Scope of Audit of Final Statement. c) SAP-3 Documentation. d) SAP-4 Fraud and Error. e) SAP-5 Audit Evidence. f) SAP-6 Study and Evaluation of Accounting System. g) SAP-7 Relying on work of Internal Auditor. h) SAP-8 Audit planning. 6.6 PROFESSIONAL ETHICS John L. Carey [Professional Ethics of certified Public Accountants, American Institute of Accountants, (1956), p.3] defines professional ethics as voluntary assumption of the obligation of self discipline above and beyond the requirement of law. Every profession builds up a code of professional conduct which its members undertake to observe. According to Carey no self-respecting professional man will reverse or modify his professional judgement to satisfy a client or anyone else. If the clients do not agree with the advice he may atleast regret it, but his ethical standards would never condone any change in his opinion to retain his client or to secure his fee. The code of professional conduct is based upon the principle of morality and ethics. It distinguishes the professional men from others and ensures public confidence. Though the corporate law does not prescribe a clear code of conduct for the auditors, the corporate auditors are covered by the code of conduct legislated by the Institute of Chartered Accountants of India. The code of conduct prepared by the Institute of Chartered Accountants of India suggested that for the success of the profession, it is essential that it should be able to command the respect and confidence of the general public because quite often a professional man is placed in a position varrying his ablities to acquire knowledge of the affairs of his client. A client, before engaging the services of a professional man, require to be assured : (i) that he has the required competency; and (ii) that he is a man of character and integrity. For this reason, the Institute has made a code of professsional conduct which is euphemistically called professional ethics based on moral principles and quality of practice.
6.7 PROFESSIONAL MISCONDUCT The code of conduct has been negatively identified as professional misconduct. The definition of professional misconduct is given in sec. 22 of Chartered Accountants Act of 1949 as deemed to include any act or omission specified in any of the schedules but nothing in the section shall be construed to limit or abridge in any way the power conferred or duty cast on the council under sub-sec(1) of sec.21 to enquire into the conduct of any member of the Institute under any other circumstances. Thus the definition is inclusive and therefore not exhaustive. The Council of the Institute has been given the power to enquire into the other misconduct. The Chartered Accountants Act of 1949 has two schedules. The first schedule contains those misconducts which are to be dealt with by the council on the report of the disciplinary committee. The first schedule contains three parts : First Part : A Chartered Accountant shall face the charge of professional misconduct if: (i) he allows any person to practice in his name as a chartered accountant unless such person is also a chartered accountant in practice and he is in partnership with or is employed by himself; (ii) if he pays or allows or agrees to pay or allow directly or indirectly any share, commission or brokerage in the fees or profits of his professional business to any person other than a member of the institute or a partner or a retired partner or the legal representative of a diseased partner; (iii) he accepts or agrees to accept any part of the profits of the professional work of a lawyer, auctioner, broker or other agent who is not a member of the institute; (iv) he enters into a partnership with any person other than a chartered accountant; (v) he secures, either through the services of a person not qualified to be his partner or by means which are not opened to a chartered accountant any professional business; (vi) he solicits clients or professional work either directly or indirectly by circular, advertisement, personal communication or by interview or by any other means; (vii)he advertises his professional attainments or services or uses his designation or expression other than chartered accountants, on professional documents like visiting cards etc., unless it be a degree of any university; (viii)he accepts a position as auditor previously held by another chartered accountant without first communicating with him in writing; (ix) he accepts an appointment as Auditor of a company without ascertaining it whether the requirements of secs.224 & 225 of the Companies Act, 1956 have been complied with ; (x) he charges fees based on percentage of profit of clients unless permitted under any of the regulations made under the Chartered Accountant Act, 1949; 359
(xi)he engages in any other business or occupation unless permitted by the council; (xii)he accepts a position as Auditor previously held by some other Chartered Accoutant by under-cutting the fees ; and (xiii)he allows a person not being a Chartered Accountant and a partner to sign on his behalf or behalf of his firm any financial statement. Second Part: The second type of misconduct is mentioned in part II of first schedule which can be said to be committed if a Chartered Accountant: (i) pays or allows or agrees to pay any share in the emoluments undertaken by him; (ii) accepts or agrees to accept any part of fees, any profit or gain from a lawyer, chartered accountant, or broker by way of commission or gratification ; and (iii) discloses confidential information of the client without the clients permission. Third Part: The misconduct under part III of the first schedule is committed if a Chartered Accountant: (i) includes in any statement return or a form to be submitted to the council any particulars knowing them to be false; (ii) style himself as a Fellow without being a Fellow; and (iii) does not comply with the requirements asked for by the council or of its committee Misconduct under Part I is meant for chartered accountants in practice where as under part II those are meant for Chartered Accountantants not in practice. Misconduct under part III are applicable to both whether in practice or not. The misconduct mentioned in schedule II are to be decided by the High Court. This schedule has two parts. First Part: Misconducts contained in this part are committed: (i) if the Chartered Accountant discloses the information acquired in the course of his professional engagement to anyone without the consent of the client;
(ii) if he certifies a report of an examination of financial statement without personally examining the same or by a partner or an employee of his firm; (iii) if he permits his name or name of his firm to be used in connection with an estimate of earnings contingent upon future transactions as if he is vouching the accuracy of the forecast; (iv) if he expresses opinion on a financial statement of any business in which he, his firm or a partner of his firm is involved without disclosing the same; (v) if he fails to disclose material fact known to him though the disclosure is necessary to make in the financial statement to make it not misleading; (vi) if he fails to report a material misstatement known to him in his professional capacity; (vii) if he is grossly negligent in the conduct of his professional duties; (viii) if he fails to obtain sufficient information to warrant expression of an opinion or his exceptions are suffienctly material to negate the expression of an opinion; (xi) if he fails to invite attention to any material departure from the generally accepted procedure of audit; and (x) if he fails to keep money of his client in a separate banking account or to use such money for purposes for which they are intenteded. Second Part : Misconduct under Part II are the following : (i) if a Chartered Accountant contravenes any of the provisions of the Chartered Accountants Act of 1949 or the regulations made thereunder; and (ii) if he is guilty of such other act or omission as may be specified by the council. It may be noted that misconducts under Part I are for the Chartered Accountants in practice whereas misconducts under Part II are meant for all chartered accountants whether in practice or not.
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7. CASE LAW
Wilde & Ors v. Cape & Dalgleish [(1897) Acct L.R. 81] The plaintiff M/s Wilde Butchell & Butchell a firm of solicitors claimed damages from the defendant Mr. Dalgleish who used to carry on the profession of accounting and auditing the title Cape, Dalgleish & Co., for negligence and breach of duty in auditing the Books of Accounts. The Auditor did not examine the pass books and failed to discover some of the fraudulent transactions made by the plaintiffs cashier who defrauded a sum of 1756 s4 pI. It was held by Lord Russell that the Auditor was liable for losses occasioned by his not fulfilling the contract with due care. Arantage v. Brewer & Knott [(1932)77 Acct L.R. 28] The plaintiff filed a suit against his Chartered Acountant firm M/s Brewer & Knott, for negligence claiming a compensation of 1400 for not being able to detect defalcation of the said amount. The Auditor could not detect the duplicate entries and manipulations in the Wage Sheets. They had also accepted unstamped receipts, i.e., invoices and vouchers. The defalcation was made through duplicate entries and manipulation in the Wage Sheets. Some of the expenditures were shown in unstamped receipts. In defence the Auditor argued that their responsibility under the contract was to balance the books and prepare the final accounts for Income Tax purposes. So though they have certified the accounts they are not required to go for the audit work. Talbot, J in his judgement remarked that an Auditor was required to be suspicious and he had to examine the Books of Accounts diligently before giving the certificate, even if it is for Income Tax purposes. Therefore, he was found guilty of negligence and was asked to pay a compensation of 1259 to the plaintiff. Pendleburys Ltd v. Allis Green & Co [(1936)80 The Acct LR 39] The company brought an action against the Auditor of the company claiming damages for alleged negligence and breach of duties. It was alleged by the plaintiffs that a sum of 1552 was lost by them on account of negligence by the Auditor because of : (a) failure to properly add the total of the Cash receipt book ; (b) failure to check and/or reconcile the daily Cash receipt book with the general cash book; (c) failure to check the counter foil Cash slips against the daily Cash receipt book; (d) failure to count at one audit the cash in hand at or about the date of making up the books; (e) failure to compare cash & cheque receipts as shown in the Cash receipt book with the entries in the general Cash Book; (f) failure to check the addition of the Wage book and to vouch the Wage book with the general Cash book ; and (g) failure to take any proper checks to vouch the accuracy of the recorded cash sales. The Auditor brought to the notice of the Directors that there was no proper internal check with regard to the cash receipts. It was argued on behalf of the Auditor that the Auditor was not the accountant and therefore, not responsible for accounting lapses. It was further argued that the Auditor was not negligent because they had no knowledge in particular of the existence of the cash receipt book and also they had no means of knowing, at any time, the existence of such book. Similarly, they did not also know the existence of the Wage book and the plaintiff had not lost the alleged money at all. The plaintiff company was composed of three shareholders all of whom happened to be the sole Directors and sole Debenture-holders. In this case Swif, J., found the Auditor not negligent because on several ocassions the Auditors brought to the notice of the Directors the absence of internal checks on cash receipts. While delivering his judgment Swif.J., distinguished the position of an Auditor in a company of three shareholders all of whom were Directors and a company with many shareholders, say six or seven hundred. According to him the position of an Auditor must be different when his duty is to vouch the information which he gives to a large body of shareholders, as against his position when he is criticising the affairs of the company confined to three men who alone are interested in the company and who hold its very primary interest. In case of the company with a large body of shareholders, he has the responsibility of watching the Directors in order that those outside people may be properly informed, for they rely upon him to keep watch on their behalf; but where the interests of a small company are confined to a very few persons, and there are no outside people because all the interests in the company are held by the Directors themselves, if the Auditor has infact, reported to the Directors, what more could he be expected to do? In Re The Kingston Cotton Mills Co Ltd [(1896)1 Ch.6] The facts of the case were that the company went into liquidation after 15 years from the date of the commencement in 1879. A action for misfeasance was taken by the liquidator against the Auditor of the company to recover the amounts for dividends which, it was alleged, were paid by the company out of inflated profits arising from more valuation of closing stock and nonallowance for depriciation on the value of the site machinery. The Auditor relied upon the stock sheet prepared by the manager who for number of years deliberately exaggerated the quantities of cotton and Yarn in the stock of the company and thus overvalued the stock with the motive of getting higher commission on the inflated profit. The Manager used to give every year a certificate verifying the value of the stock. The Auditor used to accept the certificate and indicate in the report that the stock was as per the managers certificate. This was an appeal against the decision of Williams.J. asking the Auditor to pay to the 361
liquidator a sum of money equal to the amount of dividend improperly declared and paid out of assets of the company. Lord Lopes, J. accepting the appeal held that It is the duty of an Auditor or bring to bear on the work he has to perform, that skill, care and caution which a reasonably competent, careful and cautious Auditor would use. What is reasonable skill, care and caution must depend on the particular circumstances of each case. An Auditor is not bound to be a detective, or as was said, to approach his work with suspicion or with forgone conclusion that there is something wrong. He is a watch-dog, but not a blood-hound. He is justified in believing tried servants of the company in whom confidence is placed by the company. He is entitled to assume that they are honest and to rely upon their representation, provided he takes reasonable care. If there is anything calculated to excite suspicion he should probe into the bottom, but in the absence of anything of that kind, he is only bound to be reasonably cautious and careful. [Critically review the case in the light of the present legal position] In Re London General Bank Ltd[(1895)2Ch.166] This is an appeal made by one of the Auditors of a company, Mr Theobalt, against the judgment of William.J. holding Mr. Theobalt and all other Directors of the company jointly and severally liable to pay a sum of 14,433 with interest being the amount of dividend declared and paid for two consecutive years. The audit report certified by Mr. Theobalt stated inter-alia that "the value of assets as shown by the Balance Sheet is depended upon realisation. On this point we have reported specifically to the Board. In a separate report to the Directors the Auditor suggested that In view of the present financial state of the company no dividend should be paid at the present moment. Disregarding this separate report of the Auditor to the Directors, the Directors declared dividend out of unrealised profits. The Auditors serious doubt about the realisation of part of book debts was also brought to the notice of Directors. While delivering the judgment Lord Lindley,J. held that It is no part of a Auditors duty to give advice either to Directors or to Shareholders as to what they ought to do. An Auditor has nothing to do with prudence or imprudence of making loans with or without security ... He is not an insurer, he does not guarantee that the books do correctly show the true position of the companys affairs .... He must be honest ....ie., he must not certify what he does not believe it to be true, and he must take reasonable care and skill before he believes that what he certifies is true. ..... An Auditor who gives shareholders means of information instead of information in respect of a companys financial position, does so at his peril, and runs the very serious risk of being held, liable judicially for failure to discharge his duties. The duty of an Auditor is to convey information, not to arise inquiry ...... Therefore, it was held that the Auditor did not perform his duty properly and was guilty of negligence. 362
In Re City Equitable Fire Insurance Co. Ltd [(1925)68, The Acct L.R.53] The liquidator of a company brought an action against the Directors and Auditors of the company. The Directors were charged under fraud and the Auditors for misfeasance of negligence for failure to verify the securities of the company. The company under consideration carried re-insurance business. Mr.Beran, the Chairman of the company, was also a senior partner in Ellis & Co, the companys stock brokers. The Auditors audited the Balance Sheet of the company for three consecutive years ending February 1919, 1920 and 1921. The Auditor did not verify the companys securities kept in the custody of Ellis & Co. The following were the charges for negligence and breach of duties: (i) that in the Balance Sheet the debts due to the company from Ellis & Co and Mr.Mansell, the general Manager of the company, were misdescribed as loans at call or short notice and the part of Ellis & Cos debt was shown under the heading Cash at bank and in hand; (ii) that the sum of money due from Ellis & Co, was, in fact, larger, at the date of each Balance Sheet, than was included; and (iii) that the Auditors failed to detect and report to the shareholders that a large number of companys Securities kept in the custody of Ellis & Co for long was in fact pledged by the firm to some of its customers. In the Trial Court, Romer,J., acquitting the Auditors on all the charges remarked, that it is no part of the duty of the Auditor to bring to the notice of the Directors and shareholders as to the misdescription of the debt ... that any such misdescription does not, in any way, involve damage to the company. Moreover there was nothing to raise in the Auditors mind any doubt as to goodness of the debt. While dismissing the appeal Lord Warrington,J. M.R., remarked that this case is important in the sense that it has arisen in the course of liquidation of a notable insurance company with many and considerable liabilities. The company was at one time prosperous, and in short time it was brought to a tragic end by the fraud of the Chairman .... It is true that if you take the three Balance Sheets together and cast them in the form of a chart you can see that an increasing amount of window dressing was going on, and on the chart you will find that there is a rise of figures which are manipulated for the purpose of window dressing .... No such chart was available to Mr.Lepine and we have to take the books singly which were before him .... [N.B. Make a critique on the decision looking to Indian legal position in view of the following questions: (a) Should the Auditor of the company take a Certificate from the brokers that securities were in custody of them without physical verification? (b) Can the Auditor be excused on the ground of misdescription of an asset which has not been disclosed?
(c) What is the Auditors liability for not being able to understand and report the window dressing in the Balance Sheet?] S. Ganesan v. A.K. Joscesyne [(1957)27 Comp.Cas 114] A shareholder of Deccan Sugar Co. Ltd addressed a complaint to the Institute of Chartered Accountants against the Auditor of the company. The Shareholder's plea was that in the relevant Profit and Loss Account of the company the amount shown as paid to the Managing Agent for the remuneration included only the sum paid to him on a monthly basis and the sum due to him as a percentage of profit. According to the agreement between him and the company he was also entitled to a commission on sales which amounted to Rs.35,400/-. But the item was not shown as the item of expenditure in Profit and Loss Account either separately or by including it in the selling expenses. The selling commission paid to the managing agents was deducted out of the gross receipts and the net amount so arrived at was only shown as part of the gross profit. The contract with the managing agents stipulated as follows: by way of remuneration for their services, (i) (ii) an allowance of Rs. 5000/- per month; and a commission of 10% on the annual accounts of the company .... commission ... on account of sales of the companys products elsewhere than in Madras city at or through their branches or their agencies." The auditors failed to report to the shareholders the misstatement in the Profit and Loss Account; The Auditors failed to disclose the total of the amounts paid to the managing agents;
though the disciplinary committee found the Auditor offending against clauses (o) and (p) of the Schedule, as well. Caparo Industries Ltd., v. Dickman & Others [(1990) BBC 164] Affirming the decision of the Court of Appeal, reported at (1989) 5 BCC 823, it was held that auditors owe a duty of care to existing members of the company but not to potential investors in the company. They owe a duty of care to the members because they are under a statutory obligation to report to them and because the members have a corresponding statutory entitlement to receive their reports. Auditors of a public companys accounts owe no duty of care to members of the public at large who rely upon the accounts in deciding to buy shares in the company. Al. Saudi Banque v. Clark [(1989) 5 BCC 823] Approved by the House of Lords in Caparo Industries case . the question for decision was whether, in examining the accounts of a company and reporting thereon to its members, the companys auditors owe a duty of care to lending banks, whether known and existing or unknown and potential creditors of the company, which they know or ought to foresee may rely on those accounts and their reports when considering whether to continue, renew or increase existing facilities or to grant new facilities to the company. Millet, J. held that the auditors did make their reports to the plaintiff banks or to the company with the intention or in the knowledge that they would be supplied to the banks. The banks had no close or direct relationship with the auditors, the element of proximity was lacking, and no duty of care was owed to them. James McNaughton Paper Group Ltd., v. Hicks Anderson & Co., [(1190) BCC 891 (CA)] The Court of Appeal applied the Caparo principle and held that the existence of a duty of care had not been made out. One of the three learned judges said: At the time of the hearing before His Honour Judge Lipfriend the hearing by the House of Lords of the appeal in Caparo Industries Ltd. v. Dickman [ (1990) BCC 164] had not taken place and the speeches had not been delivered, let alone reported. If the judge had the advantage of reading the speeches of the Law Lords in the case, I think it is highly improbable that he would have reached the conclusion that a duty of care extended on the facts of the present case. The case decided that in general there was no reason in policy or principle why the auditors of a company should be deemed to have a special relationship (giving rise to a duty of care) with non-shareholders contemplating investment in the company in reliance of the published accounts. It also decided that such a duty of care did not even extend to the shareholders in the company when they relied on the accounts, not so as to exercise their class rights in general meeting, but to make decisions as to future investment in the company.
The charges against the company were : (i) (ii)
(iii) The Auditor misled the shareholders by not reporting to them the non-disclosure of the total remuneration of the managing agents; and (iv) The Auditor was negligent and had the desire to accomodate the managing agents to conceal the payment of the commission. The fourth charge was subsequently withdrawn. It was held that the professional misconduct on the part of a person exercising one of the technical professions cannot fairly or reasonably be found, merely on the finding of a mere nonperformance of a duty or some default in performing it. The test must always be whether in addition to the failure to do the duty, partial or entire, which had happened, there had also been failure to act honestly and reasonably. In this case though it was found that the Auditor did not act with reasonable care but the judge was unable to hold the Auditor liable for gross negligence because he was charged under the item (q) of the Schedule I of the Chartered Accountants Act of 1949. Since the charge of acting with a desire to accomodate the managing agent was withdrawn, the Court could not go into the question
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Lloyd Cheyham & Co., [(1987) BCLC 303] This case proceeded on a different track, in that the court held that the auditors did owe the plaintiffs a duty of care as the defendants (auditors) knew that the accounts were going to be relied on by the plaintiffs; however, on the facts there had been no breach of that duty. This was a case of take over which was based on the companys audited accounts which the auditors of the company knew. Al-Nakib Investments (Jersey) Ltd., v. Longcoff [(1990) BCC 517 (Ch D)] On the question whether auditors owe a duty of care to an investor who purchases a companys shares in the market but bases his purchases on a prospectus which had been issued earlier, the court held that the defendant did because there was not the necessary proximity, in that the prospectus having been
addressed to the first plaintiff for a particular purpose, considering the rights issue, was used by the plaintiffs for another purpose namely buying shares in the market. Morgan Crucible Co., Ltd. v. Hill Samuel & C., Ltd., [(1990) BCC 686] The takeover bidder lost the claim for damages, inter alia, against the auditors alleging that certain pre-bid financial statements and a profit forecast were misleading. Dismissing the plaintiffs claim, the court held that the purpose of the documents was to advise the shareholders as to whether or not to accept the bid and there was nothing to suggest that they were meant for the guidance of the bidder and no justification for extending a duty of care to a person relying on them for another purpose. The fact that in a contested bid, the interest of the bidder and of the shareholders were in conflict was a strong reason for denying a duty of care.
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1. Companies Act, 1956, secs. 205-208; 209-223; 224-233B, Schedule VI; XIV. 2. A. Ramaiya, Guide to the Companies Act, Wadhwa and company, Nagpur, (respective sections and Schedules as mentioned in the text) 3. N.D. Kapoor, Company Law, Sultan Chand & Co. 4. Publication of the Institute of Chartered Accountants of India. 5. Kamal Gupta, Contemporary Auditing, Tata McGraw-Hill Publishing Co Ltd, (Ch.13,14) 6. S.V. Ghatalia (ed), Spicer and Peglers Practical Auditing, Allied Publishers Pvt. Ltd (Ch.XIII) (a) Compendium of Guidance notes (b) Compendium of Opinion (c) Accounting and Auditing Standards (d) Standard Auditing Practices (e) Code of Conduct (f) Professional Ethics 7. S.M. Shah, Lectures on Company Law, Tripathi (Ch.XIV)
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9. PROBLEMS
Solve the following problems and send the answers to the Course Coordinator 1. Mr. Dasgupta FCA was appointed as an Auditor by Aryan Bank Ltd to audit for the years 1990, 1991, 1992. The Bank subsequently went into liquidation. The Audit report had been in the usual form with some special notes contained therein. The Auditor did not personally verify the cash in hand. One of the audit reports contained some information of omission, e.g., in the 1991 audit report it was mentioned on the remark that all the loans and overdrafts of branches are shown in the Balance Sheet as fully secured." But a note was specified in the description of the asset 'Loan or Overdraft specifying that these have been granted to eight parties against the fixed deposit receipts of debtors. The Auditor did not enquire about the identity of these debtors. A few criminal proceedings have been brought against the Managing Director and other Directors for falsification of the Books of Accounts of the Bank. Mr. Dasgupta was produced as one of the prosecution witnesses where he observed against some of the enquires on those audit reports that he had doubts about some of the loans and overdrafts. He did not examine the identity of the parties to whom the loans were granted and he did not know that some of those parties were non-existent. Due to the enormity of cash in hand as shown, he did not verify the same. The Deputy Secretary of the Department of Economic Affairs, Government of India filed a formal complaint to the Institute of Chartered Accountant of India against the Auditor. The disciplinary committee examined the whole affair and found that: (i) the Auditor failed to verify the cash in hand ; (ii) though according to him some loans and overdrafts were doubtful about recovery, he did not specifically mention then ; and (iii) he did not examine the identity of the parties to whom loans were granted and adequacies of the security there on. The Institute referred the matter to the High Court. Give your decision as the Presiding Judge. 2. Mrs. Singhania, the proprietor of B.B. Woollen Mills leased out the mill to J.K. Woollen Manufacturers which was originally a partnership concern but subsequently converted into a Private Limited Company. The terms and conditions of the lease included that Mrs.Singhania was to get a 57.2% of the net profit which the lease would earn subject to the minimum rent of Rs.25,000/- per annum. The Books of Accounts of the company were audited by M/s P.L. Tandon. Mrs. Singhania filed an application to the High Court against the Chartered Accountant Firm, and the Auditor of the company alleging negligence on account of the following: (i) Payment of higher salary to the Manager : A Manager with no technical qualification was appointed and he had some relation with one of the Directors. A very high salary of Rs.1,00,000/- per month was given to him and the Auditor did not give any comment on it; (ii) Payment of exessive remuneration to Directors : The Directors both of whom were the only members of the Private Ltd Co fixed very high sitting charges, allowances and entertainment expenses; (iii) Gratuity was paid to the widow of the deceased Accounts officer of the company and the gratuity amount as fixed by the Board of Directors was Rs.5,00,000/-; and (iv) A contribution of Rs.5,00,000/- was made by the company to Mahatma Gandhi Memorial Fund. According to Mrs. Singhania, the Auditor was negligent in not pointing out these excessive expenditure so as to find out real profit of the company in which case her lease rent would have been much higher. Prepare a list of arguments for defending the case. 3. What do you mean by window dressing ? Critically examine the liability of an Auditor for failure to discover the window dressing. 4. Mr. Banerjee audited the Books of Accounts of Arthur & Green Ltd from 1980 to 1990. Over the period worthless debt to the value of Rs. 1,90,000/- accumulated. Some of the debts had been outstanding for a number of years and a big proportion was actually statute barred and therefore should have been regarded as irrecoverable. The Auditor accepted the figures supplied by the Managing Director and the Board as to the amounts to be written-off for bad and doubtful debts each year. The Managing Director had explained his reason for allowing the old debts to remain on the books by saying that in money-lending business it did not matter how old the debts were, because people would come back and pay in order to be able to obtain further advances. In 1990 the company went into liquidation and the liquidator proceeded against the Auditors and Board of Directors on the ground of breach of duty and misfeasance. Decide, Give reasons and cite the precedent if any 5. Royal Mail Co Ltd which was a non-banking financial institution created a huge secret reserve during the seventies. But during the eighties it started incurring actual trading loss. But their published accounts used to show regularly considerable profits available for dividends. This position was largely brought about by a credit given in the Profit and Loss Account showing taxation reserves earlier created no longer required. A shareholder wanted to challenge the decision of the Board in recommending the dividend in 1985. You are required to prepare a list of arguments on behalf of the shareholder. [ Refer to Rex v. Lelson &
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Moreland [(1931) Acct P.109] or as reproduced in Spicer & Peglers Practical Auditing, edited by S.V. Ghatalia, Allied Publishers Pvt Ltd.] 6. The Registrar of Companies made an inquiry about the affairs of Rural Bank of India Ltd and found the following, based upon which he made a complaint against the Auditor of the company that the Auditor was guilty of professional misconduct : (i) The actual cash in hand was far short of the amount stated in the Balance Sheet. The Auditor admitted in the inquiry that even though he certified that the cash and securities have been verified by him he did not in fact do so. He stated that he verified the cash in hand on several dates, he visited the bank for audit, in each of the years, but those dates were later than the dates of the Balance Sheet concerned. He admitted that he had not verified the intermediate transaction between the dates of the Balance Sheets and the dates on which he actually checked the cash; (ii) The money received from applicants for shares were not deposited and kept in a Scheduled Bank. The Auditor failed to report this to the shareholders. This was admitted before the Court in a case filed against the company on the contravention of relevant provisions of the Companies Act. Of course the Managing Director explained that the Scheduled Bank was hundred miles away and that it could
be reached only by bus and that within a week the certificate to commence business would be obtained; and (iii) Imaginary deposits were created in the Books of Best Security Trust Ltd, one of the shareholders, for the purchase of shares of the bank though the Managing Director admitted that cash was not actually received from the share applicants. It was also not disputed that the bank had on several occassions debited to the accounts of certain persons loans which were bogus. The Auditor failed to make proper enquiries regarding the financial position of Best Security Trust Ltd with a view to satisfy himself as to its capacity for making large investments and verifying whether the fixed deposit receipts of the company held as security of the bank were worth their face value and were sufficient to cover their loans. (a) Do you think that the Auditor is guilty of professional misconduct? (b) If so, explain why? (c) What appropriate punishment may be imposed upon the Auditor for such professional misconduct ? (d) Is the Auditor also negligent ? (e) Who deals with the question of such professional misconduct? [Refer to In Re. P.M. Hedge [(1954)24 Comp.Cas 453]
[Note: Please specify your name, ID number and address while sending answer papers].
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Course No: III Module No: IX
Winding up and Alternative Devices

Materials prepared by: Ms. Sudha Peri Prof. N.L. Mitra Materials checked by: Ms. Archana Kaul Materials edited by: Prof. T. Devidas
National Law School of India University Published by: Distance Education Department National Law School of India University, Post Bag No: 7201 Nagarbhavi, Bangalore, 560 072.
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INSTRUCTIONS
You must have by now understood in detail various stages in corporate character and management. At every stage you have to refer to the bare statute, i.e.. the Companies Act, 1956 amended up-todate. The Act has been amended several dozens times. So you must have purchased the latest form of the Act. It is always advisable to keep the text of the Act by the side when you read a module on Company law. Though it is true that the text of the Act is complicated but if you try to read the same with the help of the reading materials you will be able to understand it properly. In case you have any difficulty kindly write to us immediately so that we can solve your problem. This module refers to winding up. One of the present day observation of multinational firm is that 'exit' is a very difficult, time-consuming and costly affair in this country. 'Going in' and 'going out' both are difficult processes. Any empirical study will show you that winding up procedure of a company goes on for over 8 to 10 years. As such, cost involved in the procedure of winding up is really enormous. Besides, though under the Corporate law a company may go for voluntary winding up simply by a special resolution, labour law poses certain obstacles. All these problems are discussed with reference to judicial interpretation. What you have to do is to read the module with a critical mind. Do please keep the Bare Act always with you while reading this module. 'Liquidator' is an office specially designed to see the Company finally wound up and dissolved. But in India we do not have any specialised agency discharging this function. Lawyers operate as this functionary even when they do not have any formal training and competence. So try to understand the responsibility of this office and the special professional skills that are needed for the job. An Official Liquidator is the Officer appointed by the High Court who may be appointed by the Company as its liquidator, as well. In compulsory winding up by the Court, the Court appoints Official Liquidator for the job. You have to understand clearly his rights and duties. Carefully go through the module and refer to us if you have any questions. N. L. Mitra Course Co-ordinator
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Winding up and Alternative Devices

TOPICS 1. 2. 3. 4. 5. 6. 7. 8. 9 10. 11. 12. Introduction .................................................................................................................... Winding Up by Court ................................................................................................... Voluntary Winding Up ................................................................................................... Winding Up and the Supervision of the Court ........................................................... Some other Forms of Winding up ................................................................................. Conduct of Winding up .................................................................................................. Liquidators ..................................................................................................................... Conclusion ....................................................................................................................... Sick Industrial companies (Special Provision) Act 1985 ............................................. Case Law ......................................................................................................................... Problems ......................................................................................................................... Supplimentary Readings ............................................................................................... 372 374 385 390 391 394 399 402 405 408 411 412
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1. INTRODUCTION
Article 19(1)(g) of the Constitution embodies the right of a person to carry on any business of his choice in the following words: All citizens shall have the right to practice any profession, or to carry on any occupation, trade or business. Naturally enough a right which has been given to a citizen is also available to a group of citizens coming together with an intention of doing business either in the form of a partnership or a Company. This right to carry on business incorporates within it the right not to carry on a business i.e., just as a person cannot be prevented from carrying on business so also he cannot be compelled to do a business. An important question which arises in this regard is that, if a businessman wants to close his business does he have the right to do so? In normal circumstances, there is no problem especially when the business in question is a family concern`. The trouble arises when the business in question is a large one - say an industry or a Company employing a number of people. In such situations, closure of business may adversely affect the interests of the employees who depend on the Company for their livelihood. Or it may adversly affect the society in general by shrinking the market. So does it mean that owners/ managers of a large business concern should be prohibited/ prevented from closing their business ? If yes, then would it not be infringing the guarantee given to them under Article 19(1)(g) that they have the right not to do business if they so chose ? A very difficult question to answer certainly, and one where you cannot have an absolutely black and white answer. One has to take into consideration the various interests involved, balance them with the surrounding circumstances, see which option would serve the best interest of all concerned and then arrive at a conclusion. Some of these questions were raised and answered by the Supreme Court in Excel Wear v. Union of India [AIR 1979 SC 25]. Excel Wear, a registered partnership firm had a garments factory in Bombay employing about 400 people. After 1974, the relations between the management and the employees started becoming extremely strained, resulting in labour trouble of unprecedented nature, compounded by the fact that the factory was running at a loss. In 1977, finding it impossible to carry on the business Excel Wear decided to go in for closure of business and served a notice to the Maharashtra Government seeking its permission for closure. The said permission was refused. Excel Wear approached the Supreme Court by an appeal against the State Government order. Two very important questions amongst others raised for consideration were: Is the right to close down a business a fundamental right? And secondly, can there be a reasonable restriction upon the fundamental right to close down a business? These questions were respectively answered by the Supreme Court in the following words: It is not quite correct to say that a right to close down a business can be equated or placed at par or as high as the right not to carry on business at all. The extreme proposition urged on behalf of the employers by equating the two rights and placing them at par is not quite apposite and sound. Equally so, or rather more emphatically, we do reject the extreme contention put forward on behalf of the Labour Unions that right to close down a business is not an integral part of the right to carry on business, but is a right appurtenant to the ownership of property or that it is not a fundamental right at all. It is wrong to say that an employer has no right to close down a business once he starts it. If he has, it cannot but be a fundamental right embedded in the right to carry on any business guaranteed under Article 19(1)(g) of the Constitution. It further said: we now proceed to examine whether the restriction imposed under the impugned law are reasonable within the meaning of Article 19(6). This is undoubtedly on the footing, as held by us above, that the right to close down a business is an integral part of the right to carry on business. But as no right is absolute in its scope, so is the nature of this right. It can certainly be restricted, regulated or controlled by law in the interest of general public. This view point of the Supreme Court has been consistently followed through the years in a number of cases. Thus, a Company which starts business can also go out of it, the only problem being that just as a Company cannot be born automatically i.e., without effort, it cannot go out of business easily. Just as certain technicalities have to be followed for incorporation, so also for closure a procedure has to be followed. The closure procedure of a Company is known as winding up and this procedure may sometimes take as long as thirty to forty years. Its only at the end of the process that the Company can finally down its shutters and stand dissolved. The following flow chart shows the various ways in which a Company may reach its end.
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END OF A COMPANY
By Winding up (S 425) Under Supervision of the Court (S 522) By Court (Sec.433) Members (S 490-498) Special resolution passed Non-delivery of statutory report Non-commencement of business Reduction of members Compulsory Voluntary
By Dissolution
Applicable only to
Defunct Companies Creditors (S 500-509) Commercial insolvency
Unregistered Companies
Just and equitable
In the following pages we will deal with each of these modes in detail. At this stage it is perhaps necessary to understand the concept of 'winding up'. Though in corporate law 'winding up' has a very significant place, the term is not defined in the law. An author has defined winding up as "a means by which the dissolution of a Company is brought about and its assets are realised and applied in payment of its debts, and after satisfaction of the debts, the balance, if any, is paid back to the members in proportion to the contribution made by them to the capital of the Company" (Ramaiya, p. 2338). Winding up is therefore a procedure through which the Company can be brought to an end. Liquidation is also a procedure through which the Company
comes to an end. In liquidation procedure all assets, tangible and intangible are sold for cash (liquidated) and the liabilities and claims are also settled in cash. Thus liquidation is included in a winding up procedure. But winding up is a bigger concept than liquidation. In winding up the Company may continue to function in the sense that (1) the Company may enter into fresh contracts in order to perform old contracts; (2) it may fulfill the obligations arising from old contracts; (3) gradually set out assets and inventories (4) gradually pay off the debts on the basis of priorities and (5) settle the accounts of the shareholders if some surplus is available. Once all these functions are done, the Company comes to an end. So winding up, liquidation and dissolution are all related concepts.
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2. COMPULSORY WINDING UP BY COURT

Sub Topics 2.1. Introduction 2.2. Grounds for winding up 2.3. Petitioners for winding up 2.4. Procedure for winding up 2.5. Consequences of a winding up order 2.6. Dissolution of Company 2.7. Conclusion 2.1 INTRODUCTION As seen earlier, winding up is the process by which the dissolution of a Company is brought about, its assets realized and applied in satisfaction of its debts, and any balance amount remaining after such satisfaction is paid to the members in proportion to their holding in the Company. The winding up by Courts may be either compulsory [i.e., when the Company is woundup whether the management/members want it or not] or voluntary [i.e., on request of the members/creditors of the Company] Sec.433 of the Companies Act, deals with the compulsory winding up of a Company by the Court, and states that : S.433 Circumstances in which Company may be wound up by Court - A Company may be wound up by Court(a) If the Company has, by special resolution, resolved that the Company may be wound up by the Court; (b) If a default is made in delivering the statutory report to the Registrar or in holding the statutory meeting ; (c) If the Company does not commence its business within a year from its incorporation, or suspends its business for a whole year ; (d) If the number of members is reduced, in the case of a public Company, below seven, and in case of a private Company, below two; (e) If the Company is unable to pay its debts; (f) If the Court is of the opinion that it is just and equitable that the Company should be wound up. We would now deal with each of these grounds in detail. 2.2 GROUNDS FOR WINDING UP The power of the Court under this section is purely discretionary, and, the Court may not exercise its power if in its opinion, the winding up would be opposed to the public or Companys interest. This ground for winding up is seldom availed of, because when the Company itself wants to be wound up it would go in for voluntary winding up. 2. Default in holding statutory meeting Every Company limited by shares or having a share capital is required under Sec.165(1), to hold a general meeting of the members of the Company, called as statutory meeting, within a period of not less than one month, but not more than six months from the date at which the Company is entitled to commence business. In order to hold this `statutory meeting, a minimum of twenty one days notice must be given to the members, and, the Board of Directors are also required to forward to them a report called as statutory report, setting out the particulars specified in Sec. 165(3) and certified as being `correct by not less than two directors of the Company (one of them being the managing director where such an office exists). The Auditors of the Company are also required to certify those portions of the report which deal with the accounts. Explaining the significance of statutory report and statutory meeting Palmer observes [Palmer, pp. 455-456]: The obvious purpose of a statutory meeting with its preliminary reports is to put the shareholders of the Company in possession of all the important facts relating to the new Company, what shares have been taken up, what money received, what contracts entered into, what sums spent on preliminary expenses, etc. Furnished with these particulars the shareholders are to have an opportunity of meeting and discussing the whole situation, the management methods and prospects of the Company. The Board has to file a copy of this report with the Registrar. Keeping in mind the importance of both the statutory report and meeting, failure to submit the report or hold the meeting has been made one of the grounds for winding up by the Court, though in practice it is very rarely used. 3. Non commencement of business Sec. 149 of the Act provides that, where a Company having a share capital has issued a prospectus inviting the public to subscribe for its shares it shall not commence any business or exercise any borrowing powers, unless (a) shares held subject to the payment of the whole amount thereof in cash have been allotted to an amount not less in the whole than the minimum subscription; (b) every Director of the Company has paid to the Company, on each of the shares taken or contracted to be taken by him and for which he is liable to pay in cash, a proportion equal to the proportion payable on application and allotment on the shares offered for public subscription; (c) no money is, or may become liable to be repaid to applicants for any shares or debentures which have been offered for public subscription by reason of any failure to apply for, or to obtain permission for the shares or debentures to be dealt in on any
Sec.433 itself mentions six grounds on which the Court may wind up a Company. These grounds are as follows : 1. Special Resolution A Company may by special resolution [i.e., a resolution supported by a three fourth majority of shareholders present and entitled to vote at the meeting] resolve or decide to be wound up by the Court. The Court is, not however, bound to order the winding up, merely because the Company so resolves. 374
recognized stock exchange, and (d) there has been filed with the Registrar a duly verified declaration by one of the Directors or the Secretary in the prescribed form, that the above clauses have been complied with. On the filing of the declaration, the Registrar issues a certificate of commencement of business, and this certificate shall be conclusive evidence that the Company is so entitled to commence business from the date mentioned in the certificate [Sec.149(3)]. This provision does not apply to private companies which do not invite public to subscribe for its shares. If a Company does not commence business within a year from its incorporation or has suspended business for a whole year, it may be ordered by the Court to be woundup, if the Court is of the opinion that, there is a fair indication that there is no intention on the part of the Company to commence or resume business. If the suspension or non commencement is satisfactorily accounted for and appears to be due to temporary causes, the Court may refuse to issue an order of winding up. For example, in Murlidhar v. Bengal Steamship Co. [AIR 1920 Cal. 722], a Company employed a steamer and two flats for the purposes of its business. The flats were acquired by the Government during the first world war and the Company was not able to replace them immediately in view of rise in prices. This resulted in suspension of business for more than a year. In a petition for winding up the Company, the Court held that, the suspension of business for a whole year is sufficiently accounted for and does not furnish an indication that there is no intention to carry on the business. The petition was accordingly dismissed. In Registrar of Companies v. Bihar Wire & Wire Products [45 Comp.cas 194], the position has been summarized as follows : (1) The mere fact that business has not been commend within a year or that business has been suspended for a whole year or more, by itself is not a ground for a Court to order winding up, although they give the jurisdiction to the Court to do so; (2) It has to be found out whether the non-commencement or suspension of business was for some good reason accounted for; (3) The mere fact of non-commencement or suspension of business is no evidence which indicates that the Company has no intention of carrying on business or is not likely to do so; (4) The decisive question is whether there is a reasonable hope of the Company commencing or resuming business and doing it at a profit, and whether the substratum of the Company has disappeared [Ramaiya, p.2353]. 4. Reduction of members If the number of members within a Company is reduced below the required statutory minimum i.e., below two members in case of private company and seven members in case of a public Company, the Court may order the Company to be wound up. This ground is meant as a protection to the members of the Company whose membership has fallen below the statutory minimum from incurring a personal liability, which they would otherwise incur under Sec. 45.
5. Inability to pay debts This is the most common ground for winding up. A Company is liable to be wound up when it is unable to pay its debts. Debts means `debt absolutely due - that is, debts for which a debtor could go to Court and demand payment, or per Lindley,L.J., .....a debt is a sum of money which is now payable or will become payable in the future by reason of present obligation [Webb v. Stenton, (1883)11 QBD 518 CA]. In Registrar of Companies v. Kavita Benefit Pvt.Ltd. [48 Comp.Cas.231] Mehta J., held that, ìn order to bring the case within clause (e) the Court must be satisfied, in the first instance, that there are in fact, debts in the sense that there is a liability of the Company in presenti. The Court also rejected as too broad a submission the contention that the liabilities which may crystallize in future would also be relevant for the purpose of determining whether the Company is unable to pay its debts. The word debt cannot be extended to include unliquidated damages or an unidentified sum incapable of ascertainment immediately; it must be a definite and ascertained sum. Evidence of inability to pay debts is given by serving notice under sec. 434, and, on non payment, after expiry of 3 weeks a presumption of inability to pay debts arises and the Company is deemed by law, to be unable to pay its debts. Where a debt is not disputed it is futile for the Company to say, we are able to pay our debts but we do not choose to pay this particular debt. The Court will not listen to such a defence (Sen, p.247). Section 434 enacts that a Company shall be deemed to be unable to pay its debts(1) (a) if a creditor, by assignment or otherwise, to whom the Company is indebted in a sum exceeding five hundred rupees then due, has served on the Company by causing it to be delivered at its registered office, by registered post or otherwise, a demand under his hand requiring the Company to pay the sum so due and the Company has for three weeks there after neglected to pay the sum, or to secure or compound for it to the reasonable satisfaction of the creditor; (b) if execution or other process issued on a decree or order of any Court in favour of a creditor of a Company is returned unsatisfied in whole or in part; or (c) if it is proved to the satisfaction of the Court that the Company is unable to pay its debts, and, in determining whether a Company is unable to pay its debts, the Court shall take into account the contingent and prospective liabilities of the Company. (2) The demand referred to in clause (a) of sub-section (1) shall be deemed to have been duly given under the hand of the creditor if it is signed by any agent or legal adviser duly authorized on his behalf, or in the case of a firm, if it is signed by any such agent or legal adviser or by any member of the firm. We will now take each of these clauses of Sub-sec(1). 375
(a) Statutory notice Firstly, if a creditor to whom the Company owes a sum exceeding Rs.500, serves a notice on the Company demanding payment, and the Company neglects to pay or otherwise satisfy him then, such a creditor can approach the Court for an order of winding up. The debt must be really due and presently payable. If there is a bonafide and reasonable dispute as to a substantial part of the debt on which the petition is based, winding up will be refused, because, when a debtor Company believes even wrongly that it is justified in law to refuse to pay, such a refusal cannot be regarded as neglect to pay [British India Banking Corpn. v. Sylhet Commercial Bank, AIR 1949 Ass. 45]. Where the object of a petition to wind up a Company is to bring pressure upon the Company in order to make it pay the petitioner cheaply and expeditiously, when the Company desires to dispute the debt in the civil Court, the petition is an abuse of the process of the Court and is liable to be dismissed [P.Satyarazu v. Guntur Cotton Jute and Paper Mills, AIR 1925 Mad. 199]. Thus, in re British India General Insurance Co. [AIR 1971 Bom. 102], an insured cricket match had to be abondoned on account of rains. The insurance Company appointed a surveyor to determine whether this type of loss was covered by the terms of the policy. It was held that, it could not be said that the Company had neglected to pay. But, where the dispute is not real but is imaginary, and has been put forward by the Company as a cloak to hide its inability to pay its debts, the application for winding up would be allowed. Thus, in Vanaspati Industries Ltd. v. Firm Prabhu Dayal [AIR 1950 EP 142], the petitioner claimed to be a creditor of the defendant Company. The Company never disputed that the amount claimed was wrong. They only said that they had some kind of a counter claim, which the Court found to be of a highly nebulous character. All they said was that the accounts required scrutiny, and that the petitioner was not presently entitled to the sum claimed, but the why was not clearly stated. The Court, therefore held that, there was no bonafide dispute with regard to the sum due. The effect of a notice under section 434 is to raise a presumption under the statute as to the inability of the Company to pay the debt and its consequent insolvency, rendering the Company liable to the extreme penalty of losing its very existence and being compulsorily wound up by the Court. The statutory notice, therefore, has to be construed strictly and it must comply with all the requirements of the statute in totality. Thus, if the amount due is incorrectly stated in the notice, the petition would fail [Ofu Lynx Ltd. v. Simon Carves India Ltd., (1971) 41 Comp. Cas, 174] Even after the requirements of the notice are complied with, the power of the Court to order winding up is discretionary. In the words of Ray,J. in M.Gordhandas & Co. v. Madhu Woolen Industries (P) Ltd. [AIR 1971 SC 2600]: The wishes of the creditor will be tested on the ground whether the case of the persons opposing the winding up is reasonable; secondly, whether there are matters which should be inquired into and investigated if a winding up order is made. It is also well settled that a winding up order is made on a creditors petition if it would not benefit him or the Companys creditors generally.
This right of the creditor is not an individual right, but a representative right as one of a class. If majority of the creditors of like degree, take a different view, the Court, in the absence at all events of special circumstances making an order just and equitable, gives effect to such right as the majority desire to exercise. (b) Decreed debt Secondly, a Company is deemed as being unable to pay its debts if execution or other process issued on a decree or order of any Court in favour of a creditor of the Company is returned, unsatisfied in whole or in part. Then, such a creditor can file a petition for winding up. It is not necessary for the decree-holder to proceed under this provision, but may serve a statutory demand under sec. 434(1)(a). There is no mutually exclusive dichotomy between clauses (a) and (b). A decree is a nullity if it has been passed without jurisdiction, or obtained by fraud or collusion, or is tainted with illegality, or offends a public statute. A consent decree also stands on the same footing as a decree on contract, and if the contract is founded on the incapacity of the party to the contract, the decree may be set aside on the same grounds as the contract. Once the decree is found to be a nullity, no plea of waiver, estoppel or acquiescence avails the decree holder, nor it is necessary to file a suit to impeach such a decree and the decree can be attacked in collateral proceedings in which reliance is placed on such a decree. If the decree is impeached on any of these grounds, the Company will not fall within the mischief of this presumption. But the dispute must be a bonafide dispute, i.e., it is not enough that the Company has filed a suit for declaration that the decree was obtained by fraud and is a nullity [Goyle, p.17]. For example, in re Steel Equipment & Construction Co. [(1968)38 Comp. Cas 82 Cal.], a Company having been sued on a debt, agreed to a consent decree but failed to satisfy it. In a winding up petition presented on that ground, the Company claimed that the debt comprised in the decree was ultra vires and had already filed a suit to set aside the decree. The Calcutta High Court held that, the petition shall be adjourned till the disposal of the suit. (c) Commercial insolvency Lastly, if it is proved to the Court that the Company is unable to pay its debts, it may order the Company to be wound up. of a winding up under this ground, it should be shown that the Company is plainly and commercially insolvent that is to say, that its assets are such and the existing liabilities are such as to make it reasonably certain to make the Court fully satisfied that the e existing and probable assets would be insufficient to meet the existing liabilities [per Sir William Jones V.C. in re Europe Iife Insurance Society, 1869, 9 Equity, 122]. What has to be ascertained is not whether, the assets of the Company converted into cash would be sufficient to discharge the liabilities of the Company, but whether, in a commercial sense the Company is solvent, i.e., a perusal of the balance sheet of the Company must show that its assets are sufficient to meet its liabilities. Thus, in Sree Shanmugar Mills v. Dharmaraj Nadar [AIR 1970 Mad.
376
203], a Company resisted a winding up petition on the ground that while its liabilities amounted to only Rs. 8,72,414 its assets were of the value of Rs.10,79,130. It was found that these assets included building and machinery, excluding which any a sum of Rs.3,00,000 would be available to discharge the debts. The Court held that, the value of such assets without which the Company could not carry on its business, should not be taken into account. The proper test is whether in a commercial sense the existing liability would be paid by it while it continued to carry on as a Company. However, the Company is entitled to regard its uncalled capital as money available for the discharge of its debts. Moreover, where at the relevant time there is reasonable hope of tiding over the difficulty and emerging into a region in which the Company might be reasonably expected to carry on at a profit, it may not be ordered to be wound up on this ground[Sudhiya v. Bihar National Insurance Co., AIR 1941 Pat 603]. Even where assets are less than liabilities, it does not necessarily follow that the Company is insolvent. For example, in Registrar of Companies v. Janta Lucky Scheme & Investment Co. [(1973) 43 Comp. Cas. 314 (P&H)], the Company was not only able to, but also met its claims as and when they arose; winding up was not allowed although its assets were only worth Rs.6 lakhs and its liabilities amounted to Rs.8.5 lakhs. The Court may further refuse to order winding up if it feels that such an order would be against public interest. Thus, in Bhalchandra Dharmajee Makaji v. Alcock, Ashdown & Co. ltd. [(1972)42 Comp. cas 190 (Bom.)], a Companys business came to a standstill owing to paucity of working capital. The Court explained the extent to which public interest has entered into the management of companies, and, thought it improper to destroy a Company which had worked for nearly 87 years and had acquired experience and expertise in the manufacture of structurals, boat building and ship repairing, and held that the best order to make is to appoint a Special Officer to collect, realize, preserve and maintain the assets of the Company and also to make the necessary investigations. Section 434 thus splits the concept of inability to pay debts under three sub-headings. But this does not mean that these clauses are mutually exclusive. Thus, even if a creditor has obtained a decree, he can claim winding up under any of the other grounds and he need not confine himself to the category of decree holders only [Seethai Mills Ltd. v. M. Perumalsamy, (1980)50 Comp. Cas. 422 (Mad.)]. 6. Just and equitable The last ground on which the Court can order the winding up of a Company is when, the Court is of opinion that it is just and equitable that the Company should be wound up. This gives the Court wide discretionary power to order winding up whenever it appears to be desirable, after giving due weightage to the interests of the Company, its employees, creditors, shareholders and the general public. Though the Court is not bound to construe this clause ejusdem generis as only covering grounds of a like nature with those specified in clauses 1 to 5, yet it will require grounds of a like magnitude before acting
under the clause [Cowasjee v. Nath Singh Oil Co.Ltd., (1921) 59 IC 524]. For a long period ejusdem generis dominated the interpretation of the just and equitable provision. But the rule has been entirely abandoned and the words are to be treated as conferring a discretionary power which is of the widest character and the Courts are left to workout for themselves the principles on which such orders should be granted. [B.H.McPherson, (1964) 27 MLR 288]. There must be a really valid ground for ordering a winding up on this ground, and the Court may refuse to give such an order if, in its opinion some other suitable remedy or relief is available. It is neither desirable nor possible to categorize grounds which would render it just and equitable to wind up a Company, but the circumstances in which the Courts have in the past dissolved companies on this ground can be resolved broadly into the following categories: (i) Deadlock Whenever there is a deadlock in the management of the Company, it may be just and equitable to order winding up. Deadlock occurs when the management is divided into two groups, having two different and opposite directions, and with no chance of a compromise between them. In such situations, since neither group is willing to retreat from the stand they have taken, work comes to a standstill. For example, if group A wants to take up option X and group B wants option Y and neither group wants to compromise, neither X nor Yoption can be taken up. The work would come to a standstill. Thus, in In re Yenidje Tobacco Co. Ltd. [(1916)2 Ch. 426], W and R who traded separately as cigarette manufacturers, agreed to amalgamate their business and formed a private limited Company of which they were the shareholders and the only directors. They had equal voting rights, and therefore, the Articles provided that any dispute would be resolved by arbitration. When a dispute arose, W & R did go in for arbitration and got an award, but later one of them dissented from the award. Both then became so hostile, that neither of them would speak to the other except through the Secretary. Thus, there was a complete deadlock and consequently the Company was ordered to be wound up although its business was flourishing. The Courts, in general do not insist on a paralyzing deadlock before ordering winding up. As Lord Shaw of Dunfermline observed in Loch v. John Blackwood Ltd. [(1924) AC 783]: a justifiable lack of confidence resting on a lack of probity in the conduct of a Companys affairs is sufficient to found a winding up order. But this clause should not be invoked in a case where the only difficulty is the difference of view between the majority of the directorate and those representing the minority. Thus in Veeramachineni Seethiah v. Venkatsubbaih [AIR 1949 Mad. 675], the Madras High Court observed, where nine or ten directors belonging to different communities unanimously and socially take one view as against the minority of three holding the other view and the Company has been earning profits and has accumulated a good will, the mere incompatibility of good relations between the rival factions in the directorate is not sufficient for ordering winding up. 377
Similarly, in re Hind Overseas Ltd. [(1968)2 Comp. LJ 95], Ray.J, observed, winding up cannot be ordered on the grounds of friction and disputes between directors; the scramble for power is at the bottom of it all. (ii) Loss of substratum The Court may pass a winding up order if it is satisfied that the objective or purpose for which the Company was formed has substantially ceased to exist, even if a large majority of shareholders wish to continue with the business. In considering whether the substratum has gone or not, the Court should have due regard to the interest of the shareholders as well as of creditors. Even if the main object has failed, but there are other objects which would permit the Company to carry on its business activities, even though the same may be of lesser volume or importance, it should be allowed to continue, on the ground that the majority shareholders are the best judges to decide how to run the Company under these circumstances. Whether the Companys substratum has gone or not would primarily depend on the true construction of the object clause of the Memorandum of the Company. The word substratum was chosen for a special purpose - so as to signify the foundation of the Company: Once that is removed, the whole edifice or superstructure standing on it must crumble down with no question of possibility of repair work, i.e., it is a situation of total destruction. In other words, in such cases, no further business can be undertaken under the Memorandum and everything comes to a standstill [For example refer to, In re German Dates Coffee Co., [(1882)20 Ch.D.169]. Mere depreciation in the assets of the Company, or temporary difficulty in carrying out the business, which does not knock out the Companys bottom should not be permitted to become a ground for winding up. For example, in re Eastern telegraph Co. Ltd. [(1947)2 All ER 104], the Company was incorporated in 1872, and in 1929 its issued capital was 7 million divided into 2 million in preference stock and 5 million in ordinary stock. The Company was formed for the purpose of acquiring undertakings, telegraph lines, property of four companies, establishment of telegraph stations, amalgamating with and sharing in the business or undertakings of any other telegraph Company or companies. On 30th December, 1929, Imperial & International Communications Ltd. bought the whole of the physical assets of the Company for shares in the Imperial. In 1946, on coming into force of the Cable & Wireless Act,the Treasury acquired the holding of Wireless & Cable Ltd. While the assessment and payment of compensation for the compulsory transfer was pending, some preference stock holders filed a petition on the ground that the Company had ceased to carry on its business for more than a year and that the substratum of the Company had gone. Dismissing the petition the petition, the Court held that, it is true that the Company has been expropriated on terms of receiving compensation by a supervening Act of the legislature. That was an event to which the Company had necessarily to bow. It had no option but to comply with the terms of the Act. But the proper people to look after that matter are the directors of the Company, and it 378
would be quite wrong at this juncture to make a compulsory order which would have the effect of removing them from office and which would bring in a Liquidator who, capable and expert as he might be, would not have the same knowledge as the Directors have...... there was no suggestion that the Directors would adventure the money of the Company on some object which was not contemplated when the Company was formed. There was no confiscation of the property of the Company either, and it would be to the detriment of the Company if the winding up order was made. Some of the conditions which may amount to loss of substratum of the Company are, (a) the subject mater of the Company is gone; (b) the object for which it was incorporated has substantially failed; (c) it is impossible to carry on the business except at a loss; (d) the existing and probable assets are insufficient to meet its existing liability; (e) suspension or non commencement of business for a whole year, etc. (iii) Impossibility of carrying on business at a profit It is considered just and equitable to wind up a Company when it cannot carry on business except at a loss i.e., when there is no hope of achieving the object of trading at a profit. Thus, in Davis & Co. Ltd. v. Brunswick (Australia) Ltd. [(1936) 1 A11 ER 299 PC] the Directors of a subsidiary Company were the holders of all the preference shares in the Company and has also been guaranteed payment of interest for two years after the allotment of shares and also full payment of the value of the shares in the event of its giving in liquidation within two years. The Company however started incurring losses due to general depression. On the petition of the Directors for winding up, the Court held - it is well settled that this clause is not confined to clauses in which there are grounds analogous to those mentioned in the other parts of the section : Lock v. John Blackwood Ltd. [(1924) AC 783 PC]. Nor, on the other hand, can any general rule be laid down as to the nature of the circumstances which have to be borne in mind in considering whether the case comes within the phrase. Where there is no question of deadlock, or of shareholders who have the voting power using that power for their own commercial interests outside the Company in disregard of the interests of the minority, or any question involved of the improper management of the Company by the Directors who are in control, and the problem involved is of the nature of a business problem. The decisive question must be the question whether at the dater of presentation of the winding up petition there was any reasonable hope that the object of trading at a profit with a view to which the Company was formed could be attained. The fact that the Company has made losses over a number of years is by itself insufficient to show that it will never be able to achieve its object of trading at a profit. The principle laid down by Lord Cairns. In re Suburban Hotel Co [(1867) LR 2 Ch. App. 737] that it is not permissible to argue from the mere fact that a Company has consistently made losses in the past, that it has no reasonable prospects of earning profits in the future, has been repeatedly affirmed and the decision itself has been taken to have established that a Company has lost, is losing and will
continue to lose does not of itself justify a winding up order, at least when the capital has not been exhausted. It is not the business of the Court to manage the affairs of a Company (per Scrutton LJ in Shuttelworth v. Cox Brothers & Co. (Maiden head) [(1927) 2KB 9], and the winding up process of the Court, cannot be used and ought not to be used, as the means of evoking a decision as to the probable success or non-success of a Company as a commercial speculation. (iv) Fraud It is just and equitable to wind up a Company if it has been conceived and brought forth in fraud or for illegal purposes. Thus in, re Thomas Edward Brismead & Sons [(1897)1 Ch. 45,406 (CAT], T.E.B. and his sons were relatives of, and has been employed by, persons who carried on the business of piano manufacturers under the name of S.B. & Sons. They left J.B. & Sons and formed a Company called T.E.B. & Sons. Ltd. for carrying on a similar business. A prospectus was issued which stated that the price paid for the business was 76,650, when it was really only 1000 in cash together with 5000 in shares in the Company. Money was subscribed by the public and most of this money found its way into the hands of the persons who were the real, though not the ostensible, promoters. J.B.& Sons obtained an injunction restraining the Company from using the name Brinsonead. It was found that the Company T.E.B. & Sons. Ltd. was formed to filch as much trade as possible from J.B. & Sons. Numerous actions were brought against the Company for fraud in the prospectus. It was held that the Company should be wound up. (v) Oppression of minority It would also be just and equitable to wind up a Company where the principal shareholders have adopted an aggressive or oppressive or squeezing policy towards the minority. In R. Sabhapaty Rao v. Sabapathi Press Ltd. [AIR 1925 Mad. 489], the Directors of a Company were able to exercise a dominating influence on the management of the Company and the Managing Director was able to outvote the minority of the shareholders and retain the profits of the business between members of the family and there were several complaints that the share holders did not receive a copy of the balance sheet, nor was the auditors report read at the general meeting, dividends were not regularly paid and the rate was diminishing, that constituted sufficient ground for winding up. (vi) Incorporated or Quasi-Partnership Generally speaking, there is little in common between the giant corporation and the one-man Company. To apply the same legal principles to such different organisation might result in inconvenience and injustice to avoid which the Act treats them differently in several respects. But even in matters in which the Act treats them alike, the Courts usually make a distinction. One such matter is the interpretation of the just and equitable clause in reference to the winding up of small private companies. The rule of law applied in such cases is one laid down by Lord Wilberforce in Ebrahimi v. Wastbourne Galleries Ltd. [(1972) 2 A11 ER 492], briefly known as the Ebrahimi Principle and states as follows:
The words (just and equitable) are a recognition of the fact that a limited Company is more than a mere judicial entity, with a personality in law of its own; that there is room in Company law for recognition of the fact that behind it, or amongst, it there are individuals, with rights, expectations, obligations inter se which are not necessarily submerged in the Company structure. That structure is defined by the Companies Act and by the Articles of Association by which shareholders agree to be bound. In most companies and in most contexts, this definition is sufficient and exhaustive equally so whether the Company is large or small. The just and equitable provision does not entitle one party to disregard the obligation he assumes by entering a Company, nor the Court to dispense him from it. It does, as equity always does, enable the Court to subject the exercise of legal rights to equitable considerations, that is, of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights, or to exercise them in a particular way. It would be impossible, and wholly undesirable, to define the circumstance of in which these considerations my arise. Certainly the fact that a Company is a small one, or a private Company, is not enough. There are very many of these where the association is a purely commercial one, of which it can safely be said that the basis of association is adequately and exhaustively laid down in the articles. The superimposition of equitable considerations require something more, which typically may include one, or probably more, of following elements; (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence this element will often be found where a pre-existing partnership has been converted into a limited Company; (ii) an agreement, or understanding, that all, or some (for there may be sleeping members), of the shareholders shall participate in the conduct of the business; (iii) restriction on the transfer of the members interest in the Company-so that if confidence is lost, or one member is removed from management, he cannot take out his estate and go elsewhere. It is these, and analogous, factors which may bring into play the just and equitable clause, and they do so directly, through the force of the words themselves. To refer, as so many of the cases do, to quasi-partnerships or in substance partnerships may be convenient but may also be confusing. It may be convenient because it is the law of partnership which has developed the conceptions of probity, good faith and mutual confidence, and the remedies where these are absent, which become relevant once such factors are found to exist: the words just and equitable sum these up in the law of partnership itself. And in many, but not necessarily all, cases there has been a preexisting partnership the obligations of which it is reasonable to suppose continue to underlie the new Company structure. But the expressions may be confusing if they obscure, or deny, the fact that the parties (possibly former partners) are now comembers in a Company, who have accepted in law, new obligation. A Company, however small, however domestic, is a Company, not a partnership or even a quasipartnership and it is through the just and equitable clause that obligations, common to partnership relations, may come in. 379
But this principle has to be read in the light of what has been said by the Supreme Court in the case of Hind Overseas Ltd. v. Raghunath Prasad Jhunjhunwalla where the Court observed : It is now well settled that the sixth clause, namely, the just and equitable is not to be read as being ejusdem generis with the proceeding clauses. While the five earlier clauses prescribe definite conditions to be fulfilled for the one or the other to be attracted in a given case, the just and equitable clause leaves the entire matter to the wide and wise judicial discretion of the Court. The only limitations are the force and content of the words themselves, just and equitable. Since , however, the matter cannot be left so uncertain and indefinite, the Courts in England for long have developed a rule derived from the history and extent of the equity jurisdiction itself and also born out of the recognition of equitable considerations generally. This is particularly so, as 23 (6) of the English Partnership Act 1890 also contains, inter alia, and analogous provision for the dissolution of partnership by the Court. Section 44(g) of the Indian Partnership Act also contains the words just and equitable. But S 433(f) has to be read S 433(2). Under the latter provision, where the petition is presented on the ground that it is just and equitable that the Company should be wound up, the Court may refuse to make an order of winding up, if it is of opinion that some other remedy is available to the petitioners and that they are acting unreasonably in seeking to have the Company wound up instead of pursuing that other remedy. Again under S 397 and 398 there are preventive provisions in the Act as a safeguard against oppression and mismanagement. These provisions also indicate that relief under S 433 (f) based on the just and equitable clause is in the nature of a last resort when other remedies are not efficacious enough to protect the general interests of the Company. 2.3 PETITIONERS FOR WINDING UP As per the requirements of Sec. 439 for purposes of winding up by Court, a petition has to be filed. A petition may be filed by any of the following persons: a. Company A petition for winding up may be presented by the Company on any of the grounds u/s 433, and especially when the Company is being wound up because of a special resolution passed by the Company. The petition must be presented by the Company itself and not the Managing Director or Chairman etc. For example, in re Patiala Banaspati Co. [AIR 1953 Pepsu 195], and application for winding up was made by the Managing Director of the Company. Rejecting the petition, the Court said, the petition by the Company must have behind it the decision of the general meeting. The Managing Director or directors cannot constitute the Company for the purpose. b. Creditors The word creditor includes a secured creditor, debenture holder and a trustee for debenture holders, and winding up is equally 380
good whether it is obtained by a secured creditor or an unsecured one. But whether it is obtained by a secured creditor or an unsecured one. But where the petition is brought about by a contingent or prospective creditor, it can be admitted only with the leave of the Court; which is not generally granted unless the Court is satisfied that there is a prima facie case for winding up of the Company and reasonable security for costs has also been given. Some times a creditors petition is opposed by other creditors. In such cases, the Court may ascertain the wishes of the majority of the creditors, though their opinion wont be really binding on the Court. The decision ultimately depends upon the state of the Company. If the Company is commercially insolvent and the object of trading at a profit cannot be attained, winding up order would follow as a matter of course (ex debitio justitiae). A creditor may present a petition, while he is pursuing his ordinary remedy of a suit for the enforcement of his claim. The Court may order a stay of his suit but cannot disqualify a creditors petition on that ground; what is required under this section is that the creditors claim be enforceable at the time of the petition - even if it becomes unenforceable by the time of the order, such unenforceability shall have no effect. c. Contributory On the commencement of the winding up of a Company, its shareholders are called contributories. Any contributory or contributories may present a petition for winding up, especially if the petition is on the ground of reduction of members. But for a petition on any other ground, the requisite qualification is, that the shares in respect of which the petitioner is a contributory are either originally allotted to him or he has been their registered holder for at least 6 months during the eighteen months immediately before the commencement of the winding up, or the shares have devolved on him through the death of a former holder. In England, a general rule which is followed in case of fully paid up shares is that, where a fully paid up shareholder petitions for compulsory winding up he must show, on the face of his petition, a prima facie probability that there will be assets available for distribution amongst the shareholders. Though previously the Courts in India followed the same principle, Sec. 439 (3) now clearly lays down that, a contributory shall be entitled to present a petition for winding up, notwithstanding that he may be the holder of fully paid up shares or that the Company may have no assets left for distribution among the shareholders after the satisfaction of its liabilities." Hence, the present position in India is that, though want of assets may be an element in determining whether the petition is bonafide, it would not be a relevant consideration for determining whether winding up should be ordered or not. d. Registrar The Registrar of Companies is entitled to present a petition for winding up on all grounds u/s. 433 except where a special resolution passed by the Company is required, after obtaining a sanction from the Central Government for the presentation of petition for winding up. Such sanction shall not be granted by
the government unless the Company has been accorded an opportunity of being heard and to make any representation in that regard. e. Central Government The Companies Act authorises the Central Government to present a petition for winding up in certain situations. For example, Sec. 243 enables the government to present a petition for winding up, if it appears from the reports of the inspectors investigating the affairs of the Company under Sec. 235 that the business of the Company has been conducted for fraudulent or unlawful purposes as explained in sub-clauses (i) and (ii) of clauses (b) of Sec. 237. The Government may authorise any person to act on its behalf for this purpose. f. All or any of them It is not necessary that a petition for winding up u/Sec. 439 must be presented by one of the categories mentioned above. All or any of them together may present a combined petition on the grounds mentioned in the section. Can workers make a petition for hearing either asking for or contesting winding up? This is contested in some cases following Excel Wear (citation given earlier). In Bombay Metropolitan Co Ltd. V. Employers of BTC [(1991) 71 Comp. Cas. 473] the Court held that there was no conflict between the provision of the Industrial Disputes Act 1947 and the Companies Act, 1956. According to the Court prior permission of the state government under Sec. 250 of the ID Act is required for closing down an industrial unit. It contemplates continuation of the Company. But when the Company goes into winding up or a winding up order commences, it is itself a notice of discharge on the officers and employees of the Company. Sec. 250 of the ID Act is not attracted here. Even if the liquidator favours continuation of the corporate activities for the benefit of the winding up, Sec. 250 of the ID Act is not attracted. In Excel Wear the petition challenging the winding up was given a hearing. As such, it may be noted here that though the list of petitioners does not indicate the workers, Indian Courts do not deny them hearing. 2.4 PROCEDURE OF WINDING UP After hearing a petition for winding up the Court may dismiss it, adjourn it, pass an interim order or make an order for winding up. This order may take effect either immediately or after a lapse of certain period, say six months. Commencement of winding up is not from the date of the order, but is deemed to be from the time of presentation of the petition itself. But, where the winding up order is in response to a Special Resolution of the Company, the commencement of winding up is deemed to be from the date of passing of resolution. Application: As mentioned earlier, an application for winding up shall be in the form of petition u/sec. 439, in Form 45, 46 or 47 as the case maybe, with required variations and shall be submitted in duplicate. The Registrar of he Court shall note on the petition the date of its presentation (r. 95). Where the petition
is presented by a contributory, he should state whether he satisfies the conditions in cl. (a) or (b) of Sec. 4439(4); and when the petition is presented by the Registrar or a person authorised by the Central Government, he must annex to the petition the order of sanction or authorisation. Where the Company is being wound up voluntarily or subject to the supervision of the Court, the petition should state the fact that the voluntary winding up or winding up under supervision of Court cannot be continued with due regard to the interests of the creditors or contributories or both. The petition should then conclude with a prayer. It should also append a note to the effect that the petition is intended to be served on such and such person to be specified. Notice: Since the Company is invariably the respondent in a winding up petition, compliance with Rule 28 is mandatory. If default is made in complying, the Judge may either dismiss the petition or give such other directions as he thinks fit. Rule 28 provides that : (i) where a petition is presented against a Company, it shall be accompanied by a notice for service on the Company and an envelope addressed to the Company at its registered office or principal place of business and sufficiently stamped for being sent by registered post for acknowledgment. The Registrar of the Court shall immediately on its admission of the petition send the notice together with the copy of the petition to the Company by registered post. (2) Every petition and, save as otherwise provided by these rules or by an order of the Court, every application, shall, unless presented by the Company, be served on the Company at its registered office, or, if there is no registered office, at its principal or last known principal place of business by leaving a copy thereof with an officer or employee of the Company, and in case no such person is available, in such manner, as the Judge or Registrar of the Court may direct, or, by sending a copy thereof by prepaid registered post addressed to the Company at its registered office, or, if there is no registered office, at its principal or last known principal place of business, or to such person and at such address as the Judge or Registrar of the Court may direct. Where the Company is being wound up, the petition or application shall also be served on the Liquidator, if any, appointed for the purpose of winding up of the Company. Verification: The petition should be signed by a proper person, but in case it is not properly signed it is a mere irregularity and can be cured at any time. It should also be certified by an affidavit of the petitioner, and if there are more than one petitioner, by an affidavit of atleast one of the petitioners The affidavit should be in the proforma given in Form No.3 (Rule 21), and should be filed along with the petition. The rule relating to certification is to be strictly complied with, and if it is not done, then the Courts will not give leave to re-verify the petition. Advertisement: Once the petition is filed, it is posted before the judge in chambers for admission and fixing of date, and also for directions as to the advertisement to be published and the persons, if any, on whom the petition copy is to be served. But, the judge may, if he thinks fit, direct that notice be given to the Company before advertising the petition (Rule 96) Under 381
Rule 24 (2), a winding up petition cannot be placed for hearing unless it is advertised, but it is not necessary that the moment a petition is admitted it should be advertised The Supreme Court has said that when a petition is field the Court may (i) issue notice to the Company to show cause why the petition should not be admitted, (ii) admit the petition and fix a date for hearing and issue a notice to the Company for giving directions about the advertisement of the petition, or (ii) admit the petition, fix the date of hearing of the petition and order that the petition be advertised and direct that the petition be served upon persons specified in he order. In answer to a notice to show cause as to why a petition for winding up be not admitted, the Company may sow cause and contend that the filing of the petition amounts to an abuse of the process of the Court There is however no prescribed form for notice, nor is there s right in a Company to be issued a notice before the petition is admitted or before the Court fixes the date for hearing. Withdrawal : Once the winding up petition is filed, it cannot be withdrawn without leave of the Court, and if the petition has been advertised in accordance with the 99, the application for leave to withdraw shall not be heard at any time before the date fixed in he advertisement for hearing of petition. A winding up petition differs from an ordinary civil suit because the petitioner has to show a preponderance of justice and equity in favour of winding up. This can be generally done by evidence given through affidavits on broad questions rather than by weighing in golden scales the evidence on both sides. Hearing: According to Sec. 443(i) , on hearing a winding up petition, the Court may - (a) dismiss it with or without costs; or (b) adjourn the hearing conditionally or unconditionally; or (c) make any interim order that it thinks fit, or (d) made an order for winding up the Company with or without costs, or make any order that it thinks fit, provided that the Court shall not refuse to make a winding up order on the ground only that the assets of the Company have been mortgaged to an amount equal to or in excess of those assets, or that the Company has no assets. Winding up of a Company being of utmost importance involving grave consequences, expedition in the winding up process is the hall-mark of an efficient winding up. The application for winding up should be considered at the earliest. As far as possible, the Court should, either make an order to find up the Company, or dismiss the petition for, if the petition is adjourned, and a winding up order is ultimately made, the order would date back to the presentation of the petition and avoid or imperil anything done by the Company in the meantime [Central Bank of India v. Mikenzies Ltd., 47 Comp. Cas 306]. Despite such observations made by the Courts over the years, in practice it is seen that, from the date of presentation of petition to the final order takes any where between 20 and 30 years. Provisional Liquidator: After the presentation of the winding up petition and before the making of a winding up order, the Court may appoint a provisional Liquidator to take charge of
the Company. But before finalising such order, the Court must give a notice to the Company and also give it a reasonable opportunity to make its representation, unless in the special circumstances the Court decides to dispense with this provision. If a winding up order is made, the Provisional Liquidator becomes the Official Liquidator. Unfortunately, the Act itself does not provide any set criteria for the appointment of a Provisional Liquidator. In re London, Hemburg and Continental Exchange Bank, Emmersons case [(1886) 2 LR Eq 231], Lord Romily said, It is perhaps convenient that I should state what my practice is with reference to the appointment of Provisional Liquidators, where there is no opposition to winding up, I appoint a provisional Liquidator as a mater of course on the presentation of the petition. But where thee is an opposition to it, I never do, because I might paralyse all the affairs of the Company, and afterwards refuse to make the winding up order at all. But when the directors themselves apply, or do not oppose the winding up, then I appoint the Provisional Liquidator. The present position appears to be, that though the Court can appoint a Provisional Liquidator when the company is obviously insolvent or its assets are in jeopardy; this is not the extent of its power. Sec. 450 is framed in general terms and confers on the Court a discretionary power to be exercised in a proper judicial manner, since exercise of this power may have serious consequences for the Company. Particularly, when the petition is presented by a nominee of the Central Government on grounds that it is expedient in the public interest that the Company should be wound up, the public interest must be given full weight, though that fact by itself is not conclusive enough for the appointment of the Provisional Liquidator. Stay of proceedings: On commencement of winding up, any suit or proceeding pending against the Company, may be stayed on a an application made by a creditor or a contributory of the Company under Sec. 441(2). If the suit or proceeding is pending in any other Court, he may apply to the Court having jurisdiction to wind up the Company to restrain further proceedings in the suit/proceeding under Sec. 442. In Official Liquidator v. Dharti Dhan Pvt. Ltd. [47 Comp. Cas. 420] the Supreme Court has held, The clear object of the section is that claims in suits and proceedings pending elsewhere, which have a bearing on Company liabilities, may be stayed only until the winding up order is made, because after the winding up order has been passed, Sec. 46 begins to operate so as to automatically transfer, with certain exceptions, proceedings against the Company being wound up to the Court exercising the jurisdiction to wind up.... Section 442 and 446 of the Act have to be read together. It is only where the object of the two sections, when read together, is served by a stay order that the stay order can be justified. That order is to expeditiously decide and dispose of pending claims in the course of winding up proceedings. A stay is not to be granted if the object of applying for it appears to be... merely to delay adjudication on a claim, and thereby to defeat justice. In other words, a stay under S. 442 cannot be made mechanically, or, as a matter of course, on
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showing fulfilment of some fixed and prescribed conditions. It can only be made judicially upon an examination of the totality of the facts which vary from case to case. It follows that the order to be passed must be discretionary and the power to pass it must, therefore, be directory and not mandatory. After a winding up order is made or a Provisional Liquidator is appointed, no suit or other legal proceedings shall be commenced, or if pending at the date of winding up order, shall be proceeded with against the Company except [Sec. 446(01)]. This section does not extend to actions or proceedings which have been commenced abroad, but where the plaintiff is within the jurisdiction of the Court, it may exercise its equitable jurisdiction to restrain him from pro secuting the proceedings. Statement of affairs: Once a winding up order is made, a statement of the affairs of the Company made in the prescribed format is to be submitted to the official Liquidator who should at his earliest and not later than 6 months from the date of order or such extended period as the Court may allow, submit a preliminary report to the Court, under Sec. 455 (a) as to the amount of capital issued, subscribed, and paid up, and the estimated amount of assets and liabilities, giving separately, particulars of (1) cash and negotiable securities, (ii) debts due from contributorirs, (ii) debts due to the Company and securities, if any, available in that respect, (iv) movable and immovable properties belonging to the Company; and (v) unpaid calls; (b) if the Company has failed, as to the causes of failure; and (c) whether, in his opinion, further inquiry is desirable as to any matter relating to promotion, formation, or failure of the Company, or the conduct of the business. Committee of Inspection: The Court also if it deems fit, direct that a Committee of Inspection be appointed to act with the Liquidator. Such a Committee shall not consist of more than 12 members who shall be from amongst the creditors, or the contributories or their attorneys and in such proportions as may be agreed upon or as the Court determines [Sec. 465(1)]. The Committee shall have the right to inspect the accounts of the Liquidator. But neither the Liquidator nor any member of the Committee have the right to purchase any part of the Companys assets except by leave of the Court, and if any such purchase is made it shall be set aside. So also, no member can derive any profit from any transaction relating to the winding up of the Company, or receive out of its assets any payment for administration of assets, or goods supplied to the Court and if he does so receive then he is liable to restore it. These rules are based on equity, because a Liquidator or a committee member is in a fiduciary position in relation to the Company and so they cannot make a secret profit out of its assets. Settlement of list of contributories : Under Sec. 467(1) soon after the making of a winding up order, the Court shall settle a list of contributories, and distinguish between persons who are contributories in their own right and those who are contributories as being representative of or liable for, the debts of others. But where there is no need to make calls, the Court may dispense with the list. According to Sec. 428, a contributory is a person who is liable to contribute to the assets of the Company in the
event of its being wound up and includes the holder of fully paid up shares. Though apparently the expression any person liable to contribute to the assets of the Company in the event of its being wound up is wide enough to include persons other than members, it is now well settled that a contributory refers to a member, either past or present, or his legal representative, a Director or Manager with unlimited liability. Liability of a present member is limited to the amount of money remaining unpaid against the shares allotted to him; or to the extent of amount guaranteed by him. If a contributory dies before or after he has been placed on the list, then his legal representative shall be liable. If he makes a default, then proceedings will be undertaken for administering the estate of such deceased member, compelling the estate to make the payment. If a member is adjudged insolvent, whether before or after his name has been placed on the list, his assignees in insolvency shall represent his for all purposes of winding up, and shall also be contributories for the purposes of this Act. A past members liability to contribute is similar to that of a present member but he cannot be made liable: (i) if he had ceased to be member I year upward before commencement of winding up; (ii) in respect of any debt or liability of the Company after he ceased to be a member; (iii) unless it appears to the Court that the present members are unable to satisfy the contributions required to be made by them. Private and Public examination: Sec. 477 gives the Court the power to summon before it (a) any officer of the Company or person, (i) known or suspected to have in his possession any property, books, or papers of the Company, (ii) or known or suspected to be indebted to the Company, or (b) any person whom the Court thinks is capable of giving information about some aspect of the Company affairs, for the purpose of examination on oath or interrogation as also to require him to produce any books etc. relating to the company in his custody. Sec. 478 provides that when an order for winding up has been made, and the Official Liquidator gives a report that in his opinion a fraud has been committed by any person either in promotion or formation of the Company or since its promotion, direct such a person to appear before the Court on the appointed day and publicly examine him in this regard. The Official Liquidator is to take part in this examination and may employ such legal assistance as needed or allowed by the Court. A creditor or contributory may also take part in the examination either personally or though his attorney. In order to invoke this jurisdiction, it is necessary that the allegations must be made specifically, unless it is averred that several persons acted with a common object and intention. In Official Liquidator v. Haridas Mundhra [41 Comp. Cas. 70], the Court observed: A public examination, says the judgement, is a roving enquiry to discover facts in regard to the fraud alleged in the promotion or formation or dealings of the business of the Company or in regard to the conduct and dealings of the officers who are so examined . Those facts may or may not be covered by the misfeasance summons but a certain amount of overlapping between the facts elicited in the course 383
of public examination and the facts relied upon for the purpose of misfeasance summons u/s 543 is inevitable. The phrase fishing inquiry, generally speaking, has, no doubt, an obnoxious connotation in law. It is, however, perfectly a proper term to apply to a public examination, so long as the public examination is not being used for a purpose collateral to s. 478." Section 478(5) provides that the person whose is being examined shall answer such questions as the Court may put, or allow to be put, to him. These words are of the widest amplitude and the only limitation on the Courts power is that it has to exercise its discretion judicially and not arbitrarily or capriciously. In exercising those powers, all that the Court would require to consider would, therefore, be whether the questions put, or allowed to be put, are such as will subserve the purposes of s. 478 and not a purpose collateral to it. The legislature has advisedly conferred these wide powers because the very nature of liquidation proceedings would require incriminating questions to be put and answered without any reservation in regard to their future use in proceedings, civil or criminal. In view of this it has also to be held that provisions of Sec. 478(5) override the provisions of s. 132 of the Evidence Act. Moreover, the omission of the words in civil proceeding in s 196 (7) of the Indian Companies Act 1913 from s 478(8) clearly shows that the use of answers given by the delinquent officer in the course of public examination is permissible against him not only in civil proceedings but also in criminal proceedings. 2.5 CONSEQUENCES OF WINDING UP ORDER A winding up order results in the following consequences, viz., 1) The Court has to send an intimation of the winding up to both the Official Liquidator and the Registrar. It is also the duty of the petitioner and the Company to file with the Registrar a certified copy of the order within 30 days who is then required to make minutes of the order in his book relating to the order and notify in the Official Gazette that such an order has been made. (2) A winding up order is deemed to be a notice of discharge to the officers and employees of the Company, except when the business of the Company is continued. (3) The order operates in favour of all the creditors and all the contributories of the Company. (4) On the making of the order, the Official Liquidator, by virtue of his office, becomes the Liquidator of the Company. (5) Lastly, after the order, no suit or proceedings can be proceeded with or commenced, against the Company except by leave of Court.
2.6 DISSOLUTION OF THE COMPANY Section 481 of the Act provides that when the affairs of the Company have been completely wound up or when, the Liquidator is unable to proceed any further with the winding up due to lack of funds, or if the Court feels that it is just and equitable to do so, the Court shall make an order that the Company be dissolved from the date of the order. Within 30 days of passing such an order for dissolution, a copy of the order is to be filed with the Registrar. After dissolution, the Company ceases to exist and the Liquidator cannot represent a non-existing Company. He also becomes a functus officio. But the dissolution does not absolve the Liquidator of his liability if he has committed a breach of duty to any creditor by distributing assets of the Company without complying with the requirements of the Act. A judgement obtained against a dissolved Company is invalid as being infructous. So also, on dissolution, the surplus assets of the Company go to the Government as escheat, and the shareholders or creditors of the Company cannot maintain an action for recovery of such assets. Winding up of the Company is deemed to be concluded on the date on which the order dissolving the Company is reported to the Registrar by the Liquidator. 2.7 CONCLUSION Section 433 confers the right on various parties to approach the Court for a winding up order on any of the grounds thereunder. The jurisdiction to wind up a Company lies with the High Court of the State where the registered office of the Company is situated. Despite the fact that any person can approach the Court for the order, the power of the Court to pass an order of winding up is discretionary, and an order is passed only if the Court after taking all the circumstances into account decides that an order of winding up would be in the best interests of the Company, members and the general public. In Bombay Metropolitan Transport Corpn. Ltd. v. Employees of BMTXC (CIDCO) [(1987) 3 Comp. LJ 21 Bom] it was held that the public interest will matter deciding whether to order the winding up of a Government Company. The fact that a special resolution has been passed by the shareholders is only one factor and it cannot overrule the discretion of the Court in the mater. Here, the creditors were not pressing for payment, nor was there any evidence that the Company could not be carried on except at a loss. The application of the Company for closure under the Industrial Disputes Act had been rejected for the same reasons. The Company was providing public utility services and this fact was given due importance. The Court observed that a special legislation, such as the Industrial Disputes Act, must prevail over general legislation like the Companies Act and dismissed the petition for winding up.
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3. VOLUNTARY WINDING UP
SUB-TOPICS 3.1. 3.2. 3.3. 3.4. 3.5. 3.6. Introduction Preliminaries to winding up Members voluntary winding up Creditors voluntary winding up Provisions applicable to every voluntary winding up Conclusion (2). Generally speaking, the Court does not interfere if the resolution of the Company is valid. The voluntary winding up itself may be either the members voluntary winding up or the creditors voluntary winding up - depending on whether the Directors make a declaration of solvency at the time of passing the resolution for winding up. As we have already dealt with winding up under a special resolution we would now deal with winding up in other situations. 3.2 PRELIMINARIES TO WINDING UP Victory in battle may depend as much upon thoughtful planning as upon skill and bravery in the field. So also the Liquidators capacity to produce the base outcome for creditors, shareholders, employees and others may be substantially determined by the conduct of the pre-winding up procedure. In extreme cases the future of an industry or the well-being of a whole community may be at stake. Important decisions may have to be made well before the appointment of a Liquidator and prior to consultation with creditors at a time when the Company is still under the control of its Directors who may, at this stage, be under such pressures that they are emotionally unable to make objective decisions [Grier, p.5]. It is advisable, therefore, that Directors faced with the possibility of liquidation, should not only consult an expert for professional advice, but should also take certain preliminary steps to facilitate the eventual take over by the Liquidator. Some of these steps may be as follows: 1. The Decision to liquidate Liquidation may take place for reasons other than insolvency, for example, (a) upon completion of a project for which the Company was formed; (b) upon elapse of the time period for which the Company was formed; (c) in order to resolve a dispute between shareholders; (d) upon sale of business etc. In all these cases, if the directors can swear a declaration of solvency (discussed below), the liquidation may proceed as a members voluntary winding up. In cases where the Company is declared insolvent, the decision to wind up is usually taken out of the hands of the Directors, as the decision to liquidate is not made till there is no other alternative left, Many insolvencies could be avoided by sound management and paying proper attention to early warning signals. In cases where the decision to liquidate is not left so as to become inevitable, Directors may have to consider the possibility to liquidate in the following circumstances: (a) Company though yet solvent is suffering constant losses; (b) Where the Company is faced with sudden and unavoidable crisis which may in all probability have adverse repercussions, for example, loss of key personnel, or technological change making the product obsolete, etc.; (c) lack of adequate finance; (d) inability to meet its liability as and when they arise; (e) where liabilities exceed assets, etc. 385
3.1 INTRODUCTION It is not necessary that a creditor or member or the Registrar should go in for the winding up. As seen in Sec. 433, the Company itself may voluntarily go in for winding up. When the Company wants to wind itself up it can to do only after the passing of a resolution as shown below.
Companys Voluntary Winding Up Ordinary Resolution Special Resolution For any other reason When duration for its existence comes to an end When an event specified in the Articles for dissolution of Company occurs.
An ordinary resolution means one passed by a simple majority of the persons present and voting. A Company may pass and ordinary resolution for winding up in two situations- (a) if the Company was formed for a fixed time period, say for 5 years, then at the efflux of the period, and (b) if the Articles of the Company specify an event, say for example earning Rs. 20 lakhs as profits for 3 consecutive years, on the happening of which the Company would go in for dissolution, then the Company may pass an ordinary resolution for dissolution on the happening of this event, But it is only in rare cases that a Company would make such a provision in its Articles. Further, merely because an ordinary resolution to wind up has been passed by a Company does not mean that the Courts should wind up the Companybut the resolution is a relevant factor which the Courts do take into consideration. As seen in the earlier chapter, a Company may pass a special resolution for winding up of the Company in all other situation, not covered above. It is neither necessary to assign any reason for passing such a resolution nor is one normally given. The only requirement for a valid resolution is that it should comply with the requirements mentioned under Ss. 171-173 and 189
Even at the last state, the Company should consider whether there are other viable alternatives to winding up, for example reconstruction and / or amalgamation, and arrangement can be arrived at with the creditors having a vested interest in seeing the Company survive not only for recovery of debt but also to preserve a customer. The management should try to take all steps to rescue the Company, before giving in to the ultimate decision to wind up. Once this end decision is reached, then the Directors should take care to see to the preservation of business run by the Company as distinct from the Company itself. In a number of cases, the Liquidators managed to sell off a lot of projects as going concerns, which later on thrived and prospered, thus not only achieving the best realisation for creditors, but also benefiting the community. This area of pre-liquidation planning requires particular care and systematic planning in order to provide the best results. 2. Declaration of solvency In case of solvent companies, before members voluntary liquidation takes place, a 'declaration of solvency must be completed, sworn and filed in accordance with Sec. 488, which provides that, (i) such a declaration has to be made by a majority of the Directors at a Board meeting and verified by an affidavit declaring that they have made a full inquiry into the affairs of the Company and have formed an opinion that the Company has no debts or that it will be able to pay its debts in full within 3 years from commencement of winding up; (2) the declaration to be effective must be made within 5 weeks immediately before the date of the resolution and delivered to the Registrar for registration before that date; (3) the declaration should be accompanied by a copy of the auditors report on profit and loss accounts and balance sheet of the Company prepared upto the date of the declaration and should also carry a statement of Companys assets and liabilities upto that date; or a punishment of imprisonment of 6 months and or fine of Rs.5000/- attaches to the Directors making this declaration without having any reasonable basis to do so. If the Company fails to pay off its debts within the specified period then it will be presumed that reasonable grounds for making the declaration did not exist, and, in such cases the Liquidator should call forth a meeting of the creditors, as the winding up then has to proceed as creditors voluntary winding up. 3. Notice to creditors In case of insolvent companies, following the decision to liquidate, the Directors are required to send a notice to the creditors. The normal rules relating to notice are to be followed. A statement of the affairs of the Company are to be put before the creditors and thereafter, the winding up proceeds as if it is a creditors voluntary winding up. 3.3 MEMBERS VOLUNTARY WINDING UP After making the declaration of solvency, the Company must hold a general meeting and pass the requisite resolution for winding up. A notice of the resolution must be given in the Official Gazette and also in some newspapers circulating in the 386
district where the registered office of the Company is situated within 14 days of the passing of the resolution [Sec. 485(1)]. Non compliance with this requirement entails a fine of Rs.50/per day of default. If at that meeting a Liquidator has also been appointed, then he is also deemed to be an officer of the Company and is liable to be fined. Failure to advertise in the newspapers is a curable irregularity. The winding up is deemed to commence from the time of passing of the resolution. It is important to note that commencement is with reference to time and not the date. After commencement of the winding up, the Company ceases to carry on its business, except to the extent necessary for the beneficial winding up of the Company. The Company however continues to retain its corporate status and power till it is finally dissolved. Appointment of Liquidator: In the meeting where the resolution is passed, or in a separate meeting of the shareholders, one or more Liquidators are appointed and their remuneration fixed. The remuneration so fixed cannot be increased under any circumstances whatsoever, with or without the sanction of the Court [Sec. 490 (2)]. Within 10 days of appointment, the Company should give a notice to the Registrar [Sec. 493], and if a vacancy occurs, the Company may appoint another Liquidator in a general meeting and re-notify the Registrar again within 10 days [Sec.492]. The Liquidator has also to inform the Registrar of his appointment within thirty days and publish the fact in the Official Gazette. A Liquidator cannot take charge till his remuneration is fixed by the Company. On appointment of the Liquidator, all the powers of the Board of Directors shall come to an end, except when the Company or the Liquidator gives them sanction to continue. Though the Director loses most of the powers, he does not cease to be a Director [In re Windsor Steam Coal Co. [1929]1 Ch. 151]. Reconstruction in winding up: Sec. 494 provides that, where the Company in liquidation proposes to sell its business or property to another Company, the Liquidator may, with the sanction of a special resolution of the Company, received as consideration for the transfer, shares or other like interest in the transferee Company for distribution among members of the transferor Company, or enter into any other arrangement whereby the members of the Company participate in the profits of the transferee Company or receive any other benefit there from either in lieu of receiving cash, shares, policies or other like interests or in addition to them [Sec.494(1)]. The resolution so authorising the Liquidator, may be passed any time before or concurrently with a resolution for voluntary winding up or for appointing Liquidators and will not be invalid by reason only that it was so passed. Such a sale/arrangement shall be binding on the members of the Company, but if any member, who has not voted in favour of the solution expresses his dissent from it in writing addressed to the Liquidator and leaves a copy of the same at the Companys registered office within 7 days after the passing of the resolution, he may require the Liquidator either to abstain from carrying the resolution into effect, or to purchase his interest at a price to be determined by agreement or by arbitration. If, however, the Liquidator elects to purchase the members interest, he shall pay the purchase money before the Company is dissolved.
Sec. 494 is applicable to purely voluntary winding up and where it is not so, it is not necessary to pass a special resolution. In the latter case, the dissenting shareholder also does not have a right. Sale under this section is also binding on the creditors. The assets that can be disposed of are those which exist at the time of liquidation and not the assets which come to the Company by subsequent calls. So also, no disposition of assets will be valid if it imposes a condition precedent on any shareholder to pay premium on the shares of the transferee Company, though the agreement many provide for partly paid up shares in lieu of fully paid up shares. The sale/transfer contemplated under Sec.494 is to an existing Company and not to a person about to form a Company. It is also permissible to adopt a scheme providing for compensation to the Directors for loss of office. Further, though the scheme may provide for allotment of partly paid up shares, it is not open to the transferor Company to stipulate that if the members do not subscribe to the shares of the transferee Company, their shares would be sold and applied in payment of debts and liabilities of the Company in relief of the obligations of the transferee Company; nor can they make a call on the shares of the transferee Company. No scheme under this section can override the rights of the shareholders. Duty to call creditors meeting: Sec. 495(1) provides that, if a Company has not been able to, or, in the opinion of the Liquidator will not be able to, pay its debts in full within the period stated in the declaration of solvency, he should immediately summon a meeting of the creditors and lay before them a statement of the assets and liabilities of the Company, and, thereafter the winding up shall proceed in the manner of a creditors voluntary winding up. Where the liquidation continues for more than a year the Liquidator has to call a general meeting of the Company at the end of first year and at the end of each subsequent year, within 3 months from the end of each year or such longer period as the Central Government may allow [Sec. 496(1)]. He is required to lay before the meeting an account of his acts and the progress of the winding up during the year. Final meeting and dissolution: Sec. 497 marks the final stage in winding up. It provides that as soon as the affairs of the Company are fully wound up, the Liquidator shall, (a) make up an account of the winding up, showing how the winding up has been conducted and the Company property disposed of, and (b) call a general meeting of the Company for the purpose of laying the account before it and explaining it. The words as soon as the affairs of the Company are fully wound up do not import a condition precedent to dissolution and it cannot be contended that if outstanding claims remain, the affairs cannot be said to have been wound up. What the phrase signifies is, as far as the Liquidator can wind them up or in the words of Pennyquick J. in re Cornish Manures Ltd [(1967)2 All ER 875]. it is atleast sufficient that they (the affairs of the Company) should have been fully wound up so far as the Liquidator is aware. The meeting is to be called by advertisement specifying the time, place and object of the meeting and published atleast a month
before the meeting in the Official Gazette alongwith some other newspapers circulating in the district where the registered office is situated. Failure to call the meeting is punishable with a fine which may extend to Rs.500/-. After holding the meeting, the Liquidator is required to send a copy of the account to both the Registrar and the Official Liquidator, and, also make a return to each of them of the holding of the meeting and the date of holding it. If there is no quorum at the meeting, then the Liquidator is to make a return that, a meeting was called but no quorum was present. Any creditor or contributory may inspect any of the statements filed u/Sec. 497 and also make copies of them on payment of token fees. On receipt of the account and return, the Registrar is required to immediately register them. So also, the Official Liquidator is required to make a scrutiny of the books and papers of the Company, and for this purpose may ask for the cooperation of both the Liquidator and the past and present officials of the Company. If after scrutinizing the books, he comes to the conclusion that the affairs of the Company have not been conducted in a manner prejudicial to the interests of either its members or the public, then from the date of the submission of the report to the Court, the Company shall be deemed to be dissolved [Sec. 497 (6)]. This date thus determines the termius a quo for the dissolution of a Company. But if the Official Liquidator makes a report that the affairs of the Company have been conducted in a manner prejudicial to either the members or the public or both, the Court shall direct the Official Liquidator to make further investigations of the affairs of the Company, and for this purpose the Official Liquidator is invested with the necessary powers u/Sec. 497 (6-A). After completing his investigation, the official Liquidator shall again submit a report, on receipt of which, the Court may either declare that the Company shall stand dissolved from the date specified in the order, or make such other order as it deems fit [sec. 497 (6-B)]. 3.4 CREDITORS VOLUNTARY WINDING UP As mentioned earlier, the test for distinguishing between members voluntary winding up and creditor voluntary winding up is 'whether a declaration of solvency has been made. If it has been made it is a members voluntary winding up, if it is not made then it is a creditors winding up, even if the Company be solvent and in such situations the provisions under Ss. 500-509 becomes applicable. The procedure to be followed in such cases is: 1. Creditors Meeting: In this form of winding up, the Company must call a meeting of the creditors either on the same day on which it has called a general meeting of its members or the very next day. Notices of this meeting must be sent to the creditors simultaneously with notices of the meeting of members and should also be advertised at least once in the Official Gazette and once in two newspapers circulating in the district where the registered office/principal place of business is situated. In G.R. Deo v. F. Karim [16 Comp. Cas 104], it was held that since the creditors cannot influence the right of the Company 387
to voluntarily wind up, omission to convene creditors meeting is only an irregularity and can be cured, and not an illegality which vitiates the resolution for winding up the Company. The Board of Directors are to lay in the creditors meeting, a complete and comprehensive statement relating to the Companys affairs, along with a list of the creditors of the Company and the amount of their claim against the Company. One of the Directors is appointed u/Sec. 500(3) to preside over this meeting and he shall be duty bound to do so. Failure to comply with this provision will render both the Company and the Directors liable to a fine extending upto Rs. 1000/- but merely because a fine has been imposed will not make the proceedings of the meeting invalid. Rules relating to holding of creditors meeting are the same as in case of meeting held under a compulsory winding up order. Thus, all resolutions must be passed by a majority in value and number, and if they are passed by a majority in value only they are invalid. All valid resolutions passed at the meeting must be notified to the Registrar within 10 days of their passage, and any default in the this regard is punishable with a fine of Rs.50/- per day of default. In case a Liquidator has also been appointed, he would be deemed to be an officer of the Company for this purpose and would also be held liable. 2. Committee of Inspection : The creditors have been given an additional right under Sec. 503, to appoint a Committee of Inspection, consisting of not more than 5 members. But once the creditors appoint such a committee, then, the members also get a right to appoint not more that 5 members to the committee. If the creditors object to any one or all of the members the nominees appointed by members to act as such the matter becomes subject to the direction of the Court, and the Court may, in such situations also appoint some other persons to act as members. The following rules shall apply to the Committee: i) The Liquidator or any member of the Committee may call a meeting of the Committee; ii) The Committee shall meet at such times as may be appointed from time to time; iii) One third of the number of members subject to a minimum of two shall form the quorum. iv) The Committee may act by majority. v) A member may resign from the Committee by submitting a notice to the Liquidator. vi) Continuing members shall continue the formalities of the Committee not with standing vacancy provided there are at least two members. vii) Committee has the right of inspection of the books of accounts maintained by the Liquidator [Rule 14 of the Companies (Central Government ) General Rules and Forms 1956] 3. Appointment of Liquidator: It is permissible for both the creditors and the members to appoint their own Liquidators but in case they appoint different persons, then, as per provisions 388
of Sec. 502(2) the creditors appointment would prevail. In such cases a Director or member or even a creditor may apply to the Court for an order that the members appointee be allowed to act as the Liquidator either on his own or jointly with the creditors nominee. Application can also be made for an official Liquidator to act as the Liquidator of the Company. The words appoint and nominate are synonymous for the purposes of Sec. 502(2). The remuneration of the Liquidator (s) is to be fixed either by the creditors or the committee; and this remuneration cannot be increased under any circumstance. On appointment of Liquidator, all the functions of the board cease, except so far as sanctioned by the committee or the creditors in their general meeting. In case of vacancy in the office of the Liquidator, the creditors may fill it up in a general meeting but not if the original Liquidator had been appointed by the Court, in which case only the Court can fill up the vacancy. Sec. 507 makes the provision of Sec. 494 applicable to creditors winding up also with the modification that the Liquidator shall not exercise his powers except with the sanction of either the Court or the committee. 4. Meeting and Dissolution : In case the winding up continues for more tan a year, the Liquidator is required to call a meeting of the creditors., at the end of the first year and end of the each subsequent year, and lay before them a comprehensive statement in the prescribed format, containing detailed particulars in respect to the proceedings and the position of the winding up. A copy of the statement along with an affidavit - verification is to be filed with the Registrar also. As soon as the affairs of the Company are finally wound up, the Liquidator must make an account of the winding up, showing how it has been conducted and the property of the Company disposed of, and call a general meeting of the Company and the creditors to lay these matters before them. The final meeting must be called by means of advertisement in the Official Gazette, published atleast a month in advance of the meeting, and also in some newspaper circulating in the relevant district. Failure to call a meeting is punishable with a fine which may extend to Rs. 500/-. The quorum for the meeting is two. A copy of the accounts and return of holding the meeting is to be sent to both the Registrar and the Official Liquidator, within one week of the meeting (if the meetings are held on different days then within a week of the later meeting). Failure to comply with this provision will make him liable to a fine of Rs. 500/per day of default. On receiving the statement and the return the Registrar shall immediately register them. Just as in case of members voluntary winding up, the Official Liquidator would scrutinize the books of accounts etc., and if he is of the opinion that the affairs of the Company have not been carried out in a manner prejudicial to its members, or public, he shall give a report stating that fact, and, the Company shall stand dissolved from the date of submission of such report. In case the report is adverse, he may be required by the Court to submit a second report, and the Court may either dissolve
the Company on receipt of a second report or make any other suitable order. But winding up shall not be deemed to have been concluded unless compliance had been made with rule 284 (b) which states as follows: In case of the Company wound-up voluntarily, or under the supervision of the Court, at the date of dissolution of the Company, unless at such date any funds or assets of the Company remain unclaimed or undistributed in the hands or under the control of the Liquidator, or any person who has acted as the Liquidator, in which case the winding up shall not be deemed to be concluded until such funds or assets have either been distributed or paid into the Companies Liquidation Account in the Reserve Bank of India. 3.5 PROVISIONS APPLICABLE TO EVERY VOLUNTARY WINDING UP Though the Act has classified the voluntary winding up under two categories - members voluntary winding up and creditors voluntary winding up - both following slightly different procedures, there are certain provisions given under Ss. 510521 which are common to both these kinds of winding up. These basically deal with the position and functions of a Liquidator. These provisions can be studied under the following headings: a) Statement of affairs : Under Sec. 511-A , a statement of affairs of the Company is to be submitted to the Liquidator. This statement is to be verified by the Directors, Managers, Secretary, or other chief officers of the Company. The statement should contain : (i) assets of the Company, showing separately the cash in hand, at bank and negotiable securities; (ii) the debts and liabilities of the Company; iii) names and addresses of the Companys creditors, indicating the amount of secured or unsecured debts; (iv) the debts due to the Company and the names and addresses of the debtors and the amounts likely to be realised from them; and (v) such other information as may be required. b) Powers of the Liquidator : These will be dealt with in a later chapter. 3.6 CONCLUSION A voluntary winding up does not put an end to the corporate existence of the Company. The Company continues to exist till
it is dissolved. The powers of the Directors continue to the extent allowed by the Liquidator. A voluntary winding up, in contrast to a compulsory winding up by Court, does not operate as a stay of any existing proceedings or prevent the institution of any new proceeding. The Liquidator in these cases is treated as an agent of the Company, performing his duties in accordance with the provisions of the Act. Further, the passing of a resolution for voluntary winding up does not act as a notice of discharge to the employees of the Company, unlike the position in compulsory winding up. As per Sec. 512(1) (a) the Liquidator may, with the sanction of the Company, or creditors or Committee of Inspection, carry on the business of the Company so far as may be necessary for beneficial winding up. Where he carries on business, he can do all things reasonably necessary for carrying it on, and accordingly he can buy and sell and make contracts and draw, accept and endorse bills of exchange. All debts and liabilities incurred in the course of carrying on the business being in the nature of salvage, will rank for payment in priority to the general debts and liabilities of the Company. He is not personally liable on the contracts he makes, provided that he acts in the name of the Company, and discloses the fact of its being in liquidation, in all transactions. [Ramaiya, p. 1261]. A Liquidators powers come to an end with the dissolution and he has no power for instance, to endorse pronotes payable to the Companys order after dissolution of the Company. He becomes functus officio on the dissolution and any subsequent exercise of power by him will be void. But, dissolution does not always relieve a Liquidator from responsibility for non performance of his duty. If he had been negligent, he would be liable in damages to the creditors or contributories affected thereby. So also, if he has left some debt of which he had notice, unpaid, he may be made personally liable for his neglect and default. Since a voluntary winding up of the Company is undertaken usually when the Company is still solvent, the role of the Liquidator assumes even greater importance, as it is in his power to see that the business of the Company is continued in such a manner and the property of the Company so disposed off, as to result in maximum benefit to all parties concerned. It is for this reason, that, though the duties, rights and powers of a Liquidator are mentioned in the Act itself, they are couched in such wide terms that a vast amount of discretion is vested in him so as to leave him free to function an a manner he deems suitable to achieve his goals.
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4. WINDING UP UNDER THE SUPERVISION OF THE COURT

SUB-TOPICS 4.1 Power to order winding up 4.2 Effect 4.1 POWER TO ORDER WINDING UP According to Sec. 522 after a company passed a resolution for voluntary winding up, the Court may make an order for voluntary winding up to proceed but under the supervision of the Court. In making such an order the Court will have regard to the opinions and prayers of the creditors and contributors as proved to it with sufficient evidence. One has to distinguish 'compulsory winding up by the Courts' and 'winding up under the supervision of the Court.' In compulsory winding up by the Court, the Court gives an order to the Company to go for compulsory winding up in stipulated situations and on fulfillment of certain conditions. Under Sec. 433 a power is given to the Court to pass an order of winding up in appropriate cases. The effect of the order of winding up is to put the Company in the hand of the Official Liquidator for completing the process of winding up. But an order of winding up under the supervision of the Court is essentially a voluntary winding up. The Court is only competent to direct the winding up proceedings to be done under the supervision of the Court in order to protect any special interest in question. As for example, in Re Baranards Banking Co [(1866) 14 WR 722] the Court was of opinion that a proper investigation into the affairs of the Company was necessary and the assets happened to be large. So the Court gave an order for winding up under the supervision of the Court. In such a case the Liquidators appointed by the members or creditors or both, continue to take winding up proceedings and open to the direction and supervision of the Court. According to S 440 when a Company is already in a voluntary winding up under the supervision of the Court, the official Liquidator or anyone who can apply for compulsory winding up may apply to the Court for an order of the Court for compulsory winding up., If such an order is given the Official Liquidator takes over the winding up process from the Liquidator appointed by the members and or creditors. Of course the Court may give order for winding up under its supervision and appoint additional Liquidator in addition to those appointed by the members and creditors or may remove the liquidator appointed by the members/creditors and appoint another Liquidator or may appoint Official Liquidator as the Liquidator of the Company. Where an order has been made for winding up under the supervision of the Court which was later on replaced by another order for compulsory winding up by the Court, the Court may direct the Liquidators already appointed to act as provisional or permanent Liquidator in addition to and subjects to the Control of the Official Liquidator [S. 527] 4.2 EFFECT OF THE ORDER One of the advantages of winding up under the supervision of the Court is that the Liquidator is allowed to continue to have same powers and functions, as a voluntary Liquidator has, subject to restrictions imposed by the Court if any. Courts can also exercise same powers as its can do in case of compulsory winding up. Thus the order is quite flexible based upon the needs of the Company. Sec. 526 provides the following as the effects of the order: (a) voluntary Liquidator may continue having same powers and functions, unless altered directly by the order of the Court, (b) the Court will have full authority to make calls or to enforce calls made by the Liquidator; (c) the Court is empowered to exercise all powers as its may do in a compulsory winding up; (d) the Court can direct any act or thing to be done to and in favour of the Liquidator; and (e) the petition is to be deemed to be a petition for winding up by the Court [Sec. 523].
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5. OTHER TYPES OF WINDING UPS

SUB TOPICS 5.1. Introduction 5.2. Defunct Companies 5.3. Unregistered Companies 5.4. Foreign Companies 5.1. INTRODUCTION Though in general when we talk of winding up, the immediate picture which rises in front of our eyes is that of winding up of existing and operational companies either compulsorily by the Courts or voluntarily by the members or creditors. But in practice there are certain other winding ups - for example, winding up of a defunct Company which technically speaking is not a winding up since it is more in the nature of a dissolution of a Company which is not functioning, or the winding up of an unregistered Company etc. These operations although not prominent are important enough in their own way. We will now be looking into these forms of winding up briefly. 5.2. DEFUNCT COMPANIES A defunct Company means a Company which is not carrying on any business or which is not in operation. Now the very purpose of forming a Company is carrying on business, whether the business be of a commercial nature of not. When a Company after incorporation does not do any business, there is no reason for its continued existence. It may be said to have never come into existence as far as the commercial world is concerned or to have stopped existing in the eyes of the world, and in such situations there can be no good reason to allow its paper existence` in the Registrars office. Section 560 of the Act has been incorporated for this reason and briefly states that: (a) The Registrar shall send a preliminary notice to such a defunct Company inquiring whether the Company is still in operation or not. (b) If he does not receive any response within a month of sending the letter, then within 14 days of the expiry of the month he shall send a registered letter, reminding the Company of the first letter and informing them that if they do not respond within a month, he would publish a notice in the Official Gazette with a view to striking off the Company from his register. (c) If the Company does not respond even to the registered letter or informs him that it is not carrying on any business, then the Registrar may publish a notice in the Official Gazette and send a registered notice to the Company stating that, at the end of a 3 month period (from the date of notice) he would strike off the name of the company from his register, unless and until the company is able to convince him as to why it should not be dissolved. (d) When the name is actually struck off, the fact has to be notified in the Official Gazette; and the Company then stands dissolved. (e) The same procedure is to be followed where the company is being wound up and the Registrar has reasonable cause to believe that no Liquidator is acting or that the affairs of the company have been completely wound up, but returns have not been filed. (f) The liability of every Director, Managing Agent or other officer and of every member shall continue and may be enforced as if the Company had not been dissolved. This raises an important question as to the extent of liability. Does it mean that the management or the members shall remain indefinitely liable? This question was answered in the negative in Sri Krishna Dhoot v. Kamlapurkar [(1965) 1 Comp LJ 233}. Here, the plaintiff who had deposited certain notes with the Hyderabad Bullion Exchange Ltd., as membership security, instituted a suit against the Company, its Directors and members of its sub-committee for the recovery of the value of the notes when the Company had become defunct and was dissolved by the Registrar by removing it from the register. The Directors and other officers were however held not liable as there would have been no claim against them prior to the dissolution of the Company. As for the liability of the Company, the Court held that a suit against a Company which is struck off the register and therefore stands dissolved is not maintainable. Explaining the scope of this section it was held, This only means that the existing liability of any Director or member prior to the dissolution of the Company will continue in spite of the dissolution. If the Directors are not personally liable for the plaintiffs claim prior to the dissolution of the Company, they will not be liable after dissolution. Restoration: Section 560(6) provides that if any member or creditor feels aggrieved he may, within 20 years, move the Court. If the Court feels that the Company was actually carrying on business or it was just and reasonable to do so, it may order the Registrar to restore the name of the Company. Thus, in Bhogilal v. Registrar of Joint Stock Companies (AIR 1954 MB 70), a creditor of a defunct Company filed a petition for restoration of its name. The petitioner alleged that he had obtained a decree against the Company a day before the publication of the notification. The Directors of the Company on being asked by the Registrar misinformed him that the Company was not in operation. It was also found that the entire share capital was sufficient to satisfy the decree. Holding that it was just and equitable to restore the name of the Company to the register, the Court observed: No steps were taken to discharge the liability which the Company owned to the petitioner. The effect of the order of removal would be to make it difficult for the petitioner to obtain the fruits of his decree. Had the Registrar known that the Company was actually defending a suit, it is extremely unlikely that he would have ordered the name of the Company to be removed from the register. The provisions relating to restoration seems primarily intended for companies 391
which were active at the moment of their mortal wound re Test Holdings [(1969) 3 All ER 517],. Restoration operates retrospectively. Thus, in re Boxco Ltd. [(1970) 2 All ER 183], a Company in ignorance of the fact that it has been struck off the register, created a legal charge on two of its properties. On an application by the Company the Court restored it to the register and gave it a retrospective effect so as to validate the charges and their registration. In Pazhaniappa Chettiar v. South Indian Planting etc., Co. [AIR 1953 TC 161], the effect of registration was thus stated, It is clear from the section that on the restoration of a Company back to the register after its being struck off the consequence is as though it had never been struck off the register. The Company will be deemed to have had its existence all through. Another consequence is that the rights of all parties would be as though there had been no cessation or interruption in the existence of the Company on account of the striking off and subsequent restoration. Winding Up: Section 560(5) also preserves the power of the Court to wind up a Company, once its name has been struck off the register, the reason being that striking off is different from winding up. In winding up the assets of the Company are liquidated and applied in discharge of the liabilities of the Company. But, if the name of the Company is struck off the register, its undisposed property is not appropriated towards its liabilities. It vests in the Crown as bona vacantia [Y.R.Bhide v. I.T.O. (1974) 44 Comp. Cas. 293]. 5.3 UNREGISTERED COMPANIES Section 582 of the Act defines an unregistered Company and includes any partnership, association or Company consisting of more than 7 members at the time when a petition for its winding up is presented, but does not include a railway Company incorporated under some Indian law or the Act of Indian or United Kingdom Parliament, or a Company registered under the Companies Act either (the current Act or the previous Acts) excluding a Company whose registered office was in Burma, Aden or Pakistan immediately before the separation of those countries from India. Section 583(3) specifies that an unregistered Company cannot be wound up except by Court. This section however cannot override the provisions of any other contemporary enactments providing for any partnership, association or Company winding up or winding up under the Companies Act of 1913 or other earlier Acts (Sec. 590). The question which now arises is, whether an unregistered Company is the same as an illegal association under Sec. 11 ? If the answer to this question is yes then we arrive at a contradiction, because we have seen earlier that an illegal association cannot go in for winding up because the Courts do not entertain any suits by or against such associations. In Raghubar Dayal v. Sarrafa Chambers (24 Comp Cas 388), it was specifically stated that before any Company can be wound up it must not have been formed contrary to the provisions of Section 11 of the Companies Act, 1956.` Thus an unregistered Company is one which suffers from technical irregularity which in certain 392
situations is overlooked by the Courts, but is not tainted with illegality as the associations falling under Sec. 11 are An unregistered Company may be wound up under the following circumstances: 1) if the Company is dissolved or has ceased to carry on business or is carrying on business only for the purposes of winding up of its affairs; 2) if the Company is unable to pay its debts i.e., it is commercially insolvent (the phrases have the same meaning as under Sec. 433); and 3) if the Court is of the opinion that it is just and equitable that the Company should be wound up [(Sec. 583(4) and (5)]. For the purpose of winding up, an unregistered Company shall be deemed to be registered in the State in which its principal place of business is situated and if it has principal place of business in more than one State, then in the State where proceedings for winding up are instituted. The purpose of ascertaining the principal place of business is to see which Court will have jurisdiction over the winding up. The jurisdiction is however discretionary. An unregistered Company may be wound up in the same manner as a registered Company (subject to some exceptions and additions), and so all the provisions which apply to a compulsory winding up by Court also apply to the winding up of unregistered companies. In the event of winding up of an unregistered Company, every person who is liable to pay or contribute to the payment of (a) any debt or liability of the Company; (b) any sum for the adjustment of the rights of the members among themselves; or (c) the costs, charges and expenses of winding up of the Company, shall be deemed to be a contributory of the Company[Sec. 85(1)]. In case any such contributory dies or is declared insolvent, then the relevant provisions of the Act relating to the legal representatives or assignees of such contributories become applicable. Once an order of winding up has been made, no suit or other legal proceeding shall be proceeded with or commenced against any contributory of the Company in respect of any debt of the Company except by leave of the Court and on such terms only as the Court may impose, and the Court shall have the same powers as under Sec. 442. If an unregistered Company has no power to sue and be sued in a common name, or if for any reason it appears expedient to do so, the Court may by an order direct that all or any part of the property movable or immovable (including actionable claims) belonging to the Company shall vest in the Official Liquidator. On the passing of such an order, the Official Liquidator may, after giving such indemnity the Court may direct, bring or defend in his official name any suit or legal proceeding relating to that property or which it is necessary to bring or defend for the purpose of effective winding up of the Company and recovering its property [Sections 588(1) and (2)]. Section 589 of the Act makes it clear that the provisions of Part X with respect to unregistered companies shall be in addition
to, and not in derogation of, any provisions contained in the Companies Act with respect to the winding up of companies by the Court; and the Official Liquidator has the same powers, rights and duties as he would have had if the Company was a registered one; except that an unregistered Company shall not except in the event of its being wound up be deemed to be a Company under this Act and even then only to the extent provided for under Part X of the Act. 5.4 FOREIGN COMPANIES As seen earlier, a foreign Company is one which has been incorporated outside India but have established a place of business in India. When such a Company wants to go in for winding up while still solvent, the laws of the country where it has been incorporated would apply, and the Indian Courts will not have any jurisdiction to supervise or order the winding up of such a solvent foreign Company. The position is different when it comes to a non-functioning Indian branch of a foreign Company, i.e., a branch which has ceased to do business. Section 584 of the Act, states that, such a branch can be wound up under Part X of the Act as if it was an unregistered Company, despite the fact that the parent body has been dissolved or has otherwise ceased to exist in accordance with the laws of the country of incorporation. The important point to be noted is that such a winding up can only be through the Court. The wordings of the section make it clear that a foreign Company may be wound up here irrespective of the fact that it may already have been dissolved with the parent Company, and the proof of such dissolution is to be disregarded. For a winding up order under this section to be justified it is sufficient to show two things: (a) the existence of some valuable asset of the Company; and (b) the presence of some creditor either an Indian or a foreigner whose debt has not been satisfied. It is totally unnecessary to further show that this Company had an established place of business in India at some point of time [Re Azoff Don Commercial Bank, (1954) 1 All ER 947]. After the winding up is over and the creditors paid off, the surplus assets are dealt with in accordance with the provisions of the Indian Act, irrespective of any provisions in this regard for the parent Company or the foreign company. The assets should be distributed among the shareholders in pari passu in the same proportion as their share holding has to the total paid up capital
[In re Banquedes Marchands de Moscou (Koupetschesky), (1957) 3 All ER 182(ChD)]. Ceasing to carry on business in India is the sine qua non for the application of this section, as only in such situations can it be said that the substratum of the Company has gone. Similar result can be achieved if the Company is carrying on an ultravires business, and in either case the Company can be wound up under the just and equitable` clause [Rajan Nagindas Doshi v. British Burma Petroleum Co. Ltd., (1972) 42 Comp Cas 197 (Bom)]. Remittance Abroad of Winding up Proceeds Applications for remittance of winding up proceeds abroad will be entertained by Reserve Bank of India only after the winding up has been completed and the actual net remittable surplus established. Applications should be made on Form A2 supported by following particulars/documents: a) Number and date of Reserve Banks approval for establishing the branch/office in India. b) Number and date of Reserve Banks approval for sale of immovable properties, if any, held by the branch/office. c) Auditors certificate containing the following. 1) Manner in which remittable amount has been arrived at, duly supported by a statement of all assets and liabilities of the applicant, the manner of disposal of assets, name/s, and addresse/s of the purchaser/s, Reserve Banks approval number/s and date/s under Section 31 of FERA, 1973 for disposal of immovable properties, etc; 2) Confirmation that all liabilities in India including arrears of gratuity, employee benefits, etc., in respect of the applicant have either been fully met or adequately provided for; and 3) Confirmation that no income accruing from sources outside India (including proceeds of exports) has remained unrepatriated to India. d) NOC or Tax Clearance Certificate from Indian Income Tax authorities for the remittance of net surplus. e) Confirmation from applicants that no legal proceedings in Indian Courts or enquiries from Enforcement Directorate are pending against them and that after remittance of the net surplus, no further remittance facilities will be asked for [R.B.I. Exchange Control Manual, 1993, para 11C-5].
393
6. CONDUCT OF WINDING UP
SUB TOPICS 6.1. Liability of the contributories 6.2. Payment of liabilities by the Liquidator 6.3. Adoidance of certain transfers 6.4. Proceedings against delinquent officers 6.1 LIABILITY Every winding up, whether it be by the Court or a voluntary winding up, is conducted in accordance with set rules and pattern. One of the first act undertaken in a winding up is the appointment of a Liquidator, who takes under his charge all of the Companys assets and manages the affairs of the Company in a manner which would prove to be the most beneficial to the interests of the creditors, shareholders and the Company itself. Since a Liquidator is required to take into his charge the assets of the Company, he has the right to apply to the Court, for recovery of any property of the Company in possession of some person. One of the most important assets of the Company is the uncalled capital` of the Company, because as Sec. 36(2) specifies, all money payable by any member to the Company...shall be a debt due from him to the Company. If some amount remains unpaid on the shares of a member, the Liquidator has the power to make a call on those shares. For this purpose a Liquidator has to draw up a list of contributories`. A contributory is defined under Sec. 428 as a contributory means a person liable to contribute to the assets of a Company in the event of winding up and includes the holders of any shares which are fully paid up. Of these contributories the Liquidator has to make two lists: List A of the present members and List B of the past members. Liability of Contributors under List A (Section 429) List A is drawn up on the basis of the names appearing in the Register of Members, at the time when winding up commenced. If a person knowingly allows his name to appear on the register, he is later estopped from denying his liability as a member, i.e., he will not be allowed to say that though his name appears on the register he is not in reality a member. This is because, a members liability during winding up does not arise ex contractu [i.e., by virtue of a contract] but is ex lege [i.e., by virtue of his name appearing on the register]. This situation would be different if there was a total absence of contract initially, for example, if shares are allotted to a person without his applying for them. In such a situation, the Liquidator cannot place his name on the list of contributories [H.H.Manabendra Shah v. Official Liquidator, (1977) 47 Comp Cas 356(Del)]. Though a member may own the Company some money on the face value of his shares, he cannot be forced to pay anything until and unless there is a Court order to that effect and the Liquidator serves a call notice on the member in accordance 394
with the order [In re Sonardih Coal Co. Ltd., AIR 1930 All 617]. Such an order will be passed by the Court only if it is assured that the financial situation of the Company is so bad, that unless such a call is made, the liabilities of the Company cannot be discharged [Section 470]. The Liquidator can make a call on the shares without sanction of the court in case of a voluntary winding up. Once a valid call by the Liquidator is made, the contributories liability becomes a statutory debt, i.e., a new liability to pay the unpaid balance commences. In Pokhar Mal v. Flour and Oil Mills Co. Ltd. [AIR 1934 Lah 1015], it was held, It is settled in a long course of decisions that the members of a Company in liquidation are liable in respect of unpaid calls even though the calls were made by the Company before it went into liquidation and the suit of the Company for its realization had become barred by time. The principle of these decisions is that Sec. 429 creates a new liability on the shareholders in respect of such calls, which is distinct from and independent of the rights which the Company had against them before the winding up. Certain other points to be noted in regard with liability of present members, are: a) If the list does not include a persons name, he may give notice to the Liquidator to make good the default. If the Liquidator fails to act within 14 days, necessary directions under Section 556 can be issued by the Court. b) If a contributory dies either before or during winding up proceedings, then his liability automatically passes on to his legal representatives (Section 430). c) If a contributory is adjudged insolvent, his assignee in insolvency proceedings takes his place [Section 431]. d) If the contributory is a Company which is itself in the process of being wound up, the Liquidator of this Company will be the contributory on behalf of the Company. Liability of Past Members [Section 426] Under certain specified circumstances even the past members may also be held liable as contributories, in accordance with the qualifications and conditions laid down in Section 426, viz: i) If a past member has ceased to be a member for more than a year before the commencement of winding up, then he cannot be made liable. ii) The liability of a past member is limited to only those debts which were incurred by the Company during the period when he was a member, i.e., he cannot be made liable for any debts incurred by the Company after he ceased to be a member. iii) A past members liability to contribute does not arise unless in the opinion of the Court, the present members cannot satisfy in full the Companys liabilities, i.e., the liability of the past members is only secondary, the primary liability being that of the present members. iv) A person whose shares have been forfeited is also liable as a past member if the liquidation of the Company commences within .
Officers with Unlimited Liability [Section 427] Even if a Company is limited, Section 322 provides for an unlimited liability of any of its Directors or Manager, if a specific provision to this effect is made in the Memorandum. In winding up proceedings such members are not only liable as an ordinary shareholder, but are also required to make additional contribution as if they are members of an unlimited Company. The unlimited liability attaches to both present and past officers but in case of past officers the qualifications under Section 426 would apply. 6.2 PAYMENT OF LIABILITIES BY LIQUIDATOR Once the Liquidator makes a call, collects the unpaid call money, converts the assets into cash, determines the value of total available assets and the extent of the Companys debts, his primary duty then becomes the paying off of the liabilities of the Company. Any person having a claim against the Company has the right to claim it from the Liquidator. A secured creditor need not go through the usual channels for claiming his debt since he has the right to realize his security in settlement of his claim, but he is required to compensate the Liquidator for expenses incurred by him in preserving the security from being realized by other creditors. But he has been given an option of relinquishing his security and proving his claim like the other unsecured creditors. Previously under this scheme, a secured creditor could override the claims of all other creditors, including the legitimate claims of the workmen. But since the Amendment Act of 1985, which amended Sec. 529, workers claims are now equated with those of the secured creditors, by providing that the security of every creditor shall be subject to a pari passu charge in favour of the workmen, i.e., whenever a secured creditor wants to enforce his security, the Liquidator shall have the power to represent the workmen in order to enforce the presumed charge in their favour. Further, Sec. 529-A was also added which provides for payment of the workmens dues in priority of all other dues, and if the available assets are not sufficient to pay off all the liabilities in full, then the payment shall abate in equal proportion. Sec. 530 which provides for preferential payments has also been made subordinate to the provisions of Sec. 529-A. Once the Liquidator settles the list of claimants [i.e., persons whom the Company ows money], he is required to start making payments to them out of the available assets in his hand. Preferential Payments [Section 530] The first payments to be made are called preferential payments. They have to be paid in priority to all other debts. Such payments are listed below: 1. All revenues, taxes, cesses and rates due to the Central or a State Government or to a local authority. The amount should have become due and payable within twelve months before the winding up. 2. All wages or salary of any employee, in respect of services rendered to the Company and due for a period of four months only within twelve months before the winding up
3.
4.
5.
6.
7.
and any compensation payable to any workman under Chapter V-A of the Industrial Disputes Act, 1947. The amount is not to exceed one thousand rupees in the case of any one claimant. All secured holiday remuneration becoming payable to any employee on the termination of his employment before, or by the effect of the winding up. All amount due in respect of contributions payable during the twelve months before the winding up under the Employees State Insurance Act, 1948 or any other law. All amounts due in respect of any compensation or liability for compensation under the Workmens Compensation Act, 1923 in respect of death or disablement of any employee of the Company. All sums due to any employee from a provident fund, a pension fund, a gratuity fund or any other fund for the welfare of the employees, maintained by the Company. The expenses of any investigation held in pursuance of Section 235 or 237 in so far as they are payable by the Company.
After retaining sums necessary for meeting the costs and expenses of winding up, the above debts have to be discharged forthwith so far as assets are sufficient to meet them. Where the Liquidator carries on business for beneficial winding up, the taxes that become due on the profits are expenses of winding up. The fee payable to a chartered accountant for preparing the statement of affairs is also an expense of winding up. The preferential claims rank equally among themselves and have to be paid in full. But when the assets are insufficient to meet them, they shall abate in equal proportion. By virtue of the provision in Section 178 of the Income Tax Act, 1961, Income Tax authorities have been claiming preference over other preferential payments. But the Courts have always held that there is nothing in the Income Tax Act which interferes with or abrogates the provisions for priority of debts laid down in Section 530(1)(a) of the Companies Act.[Avtar Singh, Company Law,IX Edn., Eastern Book Co., Lucknow, Pp.506-508]. Insolvency Laws and Preferential Payments If a Company is being wound up on grounds of insolvency, Section 529 providing for application of insolvency laws to the payment of debts of the insolvent Company becomes applicable. Section 46 of the Provincial Insolvency Act, 1920 provides that, if there have been mutual dealings between the debtor and the insolvent (creditor), only that amount which remains after giving a set-off can be recovered from the debtor. For example, A has borrowed Rs.5000/- from B and B also has borrowed Rs.3000/ - from A. If B is declared insolvent, then his assignee can claim only Rs.2000/- [the amount remaining after deducting Rs.3000/ - from money owed by A] from A. This right of set-off is also available to insolvent companies regardless of the provisions of Sec.530. In Official Liquidator v. Laxmikutty [(1981)3 SCC 32], this apparent conflict between Sections 529 and 530 was attempted to be resolved by Bhagwati,J., in the following
395
words. It is true that Section 530 provides for preferential payments, but the provision cannot in any way detract from full effect being given to Section 529 and in fact the only way in which these two sections can be reconciled is by reading them together so as to provide that whenever any creditor seeks to prove his debt, the rule enacted in Section 46 of the Provincial Insolvency Act would apply and only that amount which is ultimately found due from him at the foot of the account in respect of mutual dealings should be recoverable from him and not that the amount recoverable from him should be recovered fully while the amount due to him should rank in payment after the preferential payments. We find that the same view has been taken by the English Courts on the interpretation of the corresponding provisions of the English Companies Act, 1948, and since our Companies Act is modelled largely on the English Companies Act, we do not see any reason why we should take a different view, particularly when that view appears fair and just. Finally, if any surplus amount is left it is utilized in paying back the shareholders in accordance with their rights, with the preference shareholders being paid off first wherever the articles provide that the preference shareholders would be entitled to their arrears of dividends whether earned, declared or not, in the event of winding up. Such a provision would entitle them to claim arrears even if the Company had neither commenced business nor earned any profits [Globe Motors Ltd. v. Globe United Engg. and Foundry Co. Ltd., (1975)45 Comp Cas 429 (Del)]. This dividend which is paid to the members is not construed as their income but deemed to be a refund of capital, even in cases where the dividend includes profits earned by the Liquidator [cases where he carries on the Company business for a more beneficial winding up]. If dividends remain unclaimed by either the creditors or contributories for a period of 6 months, they should be deposited in the R.B.I., from where they can be claimed by any person after obtaining a Court order. If the dividends remain unclaimed for a period of 15 years they merge in the general revenue of the Central Government, but the amount remains available for payment of liabilities which have been subsequently confirmed, for example, - income tax dues. Before such merging, the deposits being to the contributions cannot be claimed back by the Liquidator or the Company revived under a scheme of compromise. 6.3 AVOIDANCE OF CERTAIN TRANSFERS Fraudulent Preference Under the insolvency laws we have a concept of fraudulent transfers which implies that a transfer or conveyance made by a debtor in favour of some particular creditor with an intention of either giving a preferential treatment to that creditor or of defrauding the other creditors, then, such a transfer would be void, if made within 3 months of an insolvency petition being presented against him, and he is adjudged an insolvent. This concept of fraudulent transfers` has been borrowed by the Company law also under Section 531 and states that, any transaction with a creditor entered into by a Company in 396
preference of other creditors, within six months prior to the date of commencement of winding up is deemed to be a fraudulent preference of its creditors and is accordingly invalid. But if a Company makes payment to a creditor who is pressurizing the Company with a threat of a suit and attachment of property, then such a payment can not be called fraudulent` provided the debt was really due. Thus in Official Liquidator v. Venkatratnam [(1966)1 Comp LJ 243 (Andh)], one of the creditors of a Motor Transport Co., sued the Company for debt and attachment of its buses before delivery of judgement. A compromise decree was passed by the Court, under which three of the Company buses were given to the creditor. A few days later this Company went into liquidation. The Liquidator claimed the buses back on the ground that it was a fraudulent preference of creditors and hence the transfer was invalid. Rejecting the claim, the Court said: If a debtor prefers one creditor to another on account of pressure that is put upon him, the payment cannot be regarded as a fraudulent preference...Persons in charge of the management thought that it is profitable to discharge the debts by allotting some of the buses to the creditors. Ultimately whether a transaction is fraudulent or not, depends entirely on the intention of the debtor` and nothing else. Further, under Sec. 532, a transfer or assignment by a Company of all its properties to a trust/trustee for the benefit of all its creditors shall also be void. Voluntary Transfer Under Sec. 531-A, a transfer of property whether movable or immovable or any delivery of goods, by the Company within a one year period prior to the presentation of a winding up petition, is void as against the Liquidator, unless and until the following conditions are satisfied: a) the transfer/delivery was made in the usual course of Company business; and b) the transfer was in favour of a purchaser or encumberancer in good faith and for real and valuable consideration. Transfer of Shares When a Company is undergoing voluntary winding up, any transfer of shares or change in the status of member after commencement of such proceedings is void, unless a prior permission of the Liquidator is taken [Sec. 536]. The same position prevails in case of winding up by Court or under supervision of Court, with the difference that such transfer is valid if permission of Court had been taken either before or after the transfer is made. In respect of attachments executions etc., the Liquidator has been given a free hand in deciding what is just, fair or reasonable in all such cases of transfer (either of shares or property etc.), attachment, distress of property or execution put in force without leave of Court, after commencement of winding up. Such transfers can be avoided [Sec. 537]. The effect of this section was seen in Rajratna Naranbhai Mills v. New Quality Bobbin Works [(1973)43 Comp Cas 131 (Guj)]. Here, a suit for recovery of debt was
filed against the Company by a creditor and he also got some shares of the Company attached on the same day. A while later, a winding up petition was presented against the Company. After this, but before passing of a final order, a consent decree was passed in execution of which these attached shares were sold off, and later the winding up order was passed, and the Liquidator sought an order declaring the sale of shares as void and the consequential relief of recovery of the sale proceeds. Under Sec. 537(1) any attachment or sale of a Company property without sanction of Court after commencement of winding up is void, and under Sec. 441(2), the commencement of winding up is from the time of presentation of petition. In view of these provisions, the Court had no option apart from declaring the sale void (as it had taken place after commencement of winding up) and that the Liquidator was entitled to the sale proceeds. Onerous Property Under Sec. 535, a Liquidator of a Company has the power to abandon any onerous or burdened property belonging to the Company. Some instances of onerous property are: a) A land burdened with restrictive covenants; b) Shares or stocks in companies; c) A property not having a ready market as it requires its possessor to either perform certain acts or pay some money; and d) Unprofitable contracts. Before disclaiming such property the Liquidator has to seek prior permission of the Court. The Court is reposed with the duty to help the Liquidator in this regard, if it feels that such an act would be in the best interests of the creditors and shareholders of the Company. The procedure to be followed for disclaimer is as follows: 1. the Liquidator should make a written application for disclaiming the property, within 12 months of winding up commencement. If necessary, the Court may extend this period; 2. in case the Liquidator comes to know of the existence of some onerous property only after a month of commencement, then the 12 month period will start from the time he first comes to know of the existence of such property;
3. disclaimer of property only determines the rights interests and duties of the Company with respect to the property, i.e., it releases it from all liability towards the property. But the rights and liabilities of a third party regarding such a property remain unaffected. Hence, the Court may ask the Liquidator to give a notice to all such persons who have an interest in the property. 4. Occasionally such an interested party may ask the Liquidator to decide whether he intended to disclaim the property or not. In such cases, the Liquidator is required to make clear his intention within 28 days, and, if he does not do so then he cannot disclaim the property. When the property in question is a contract` and the Liquidator has not disclaimed it then he would be deemed to have adopted it [Sec. 535(4)]. 6.4 PROCEEDINGS AGAINST DELINQUENT OFFICERS Once a Company goes in for winding up, the Liquidator takes into his charge all the books and papers of the Company. While going through these books, or during the course of his investigation he may come across information about the underhand dealings of some of the officers. These dealings may be either in their self interest or they in connivance with the company defrauding the creditors either in general or at least some of the creditors by giving a preferential treatment to one or more creditors [i.e., fraudulent preference]. When the Liquidator comes across these instances he has been given the power under various sections of the Act to prosecute these defaulting/delinquent officers and in some instances he can also make them pay back to the company the amount which the Company has lost due to their default (be it intentional or unintentional i.e., through negligence). The basic objective of these provisions seem to be that, the Directors and other officers of the Company are owe a fiduciary duty towards the Company and hence should be held liable when they fail in their duty by not acting in the best interests of the Company, creditors and shareholders. Since a Liquidator, on his appointment, takes the overall charge of the Company, he is automatically put in a fiduciary position and so is duty bound to prosecute such officers. The various sections under which a Liquidator may approach the Court seeking to prosecute the officers are listed below with a very brief description of the offence involved and the prescribed punishment.
SR. No
Sec. No.
GROUND OF OFFENCE FINE
PUNISHMENT IMPRISONMENT
a.
538
Non-disclosure of relevant information to the Liquidator to deliver property or books etc., in his custody; concealment of Company property of value of Rs.100/- or more; fraudulent removal of property; material omission in statement given to the
at the discretion of Court
between 2 to 5 years.
397
Liquidator; failure to inform Liquidator of false claims against the Company made within his knowledge; prevention of production of books of account etc; concealment, mutilation or destruction of Company books or papers; etc. b. 539 Falsification, destruction, mutilation etc., of books/paper with intent to defraud. Fraud by officers, in inducing person to give credit to Co., or fraudulent transfer by him; or hiding/removal of Co. assets with intent to defraud creditors. Non-maintenance of proper accounts throughout 2 years period prior to winding up. Fraudulent conduct of business with an intent to defraud creditors or for other fraudulent purpose. debts Same as under Section 542 or briefly for misfeasance. Wrongful withholding of Company property or wrongful refusal to deliver it. Personal Liability for such '' upto 1000/If he defaults upto 2 yrs. at discretion of Court at discretion of Court up to 7 yrs.
c.
540
up to 2 yrs.
d.
541
upto 1 yr.
e.
542
f. g.
543 630
Apart from the Liquidator applying to the Court for permission to prosecute, the Court may itself direct the Liquidator to prosecute personally or refer the matter to the Registrar, if during the course of compulsory winding up or winding up under supervision of Court, the Court becomes aware that any past or present officer of the Court has been guilty of some offence
against the Company [Sec. 545]. When the matter is referred to the Registrar he may further refer it to the Central Government for investigation if necessary; but where he does not see the case as one where he ought to prosecute then he could inform the Liquidator accordingly, who would then with sanction of the Court undertake the proceedings himself.
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7. LIQUIDATOR
SUB TOPICS 7.1 Definitions 7.2 Appointments - General principles 7.3 Powers & Functions and duties 7.4 Responsibility for dissolution 7.1 DEFINITIONS Liquidator - A Liquidator is a person appointed to take charge of the assets of the Company, once it goes into winding up. He may be any person chosen by the members/creditors (depending on what kind of winding up proceeding it is). Official Liquidator - He is a Liquidator who is permanently attached to a High Court, and is an officer of the Court appointed by the Central Government. An Official Liquidator, is appointed as a Liquidator of the Company in all cases of winding up by Court. Official Assignee - He is also an officer of the Court who takes charge of the assets of the company in case of the winding up due to insolvency of the Company. He performs the same kind of functions as an official Liquidator does. The basic difference between an official Liquidator and a Liquidator is that the former is an officer of Court who takes charge in cases of winding up by Court, whereas the latter is an ordinary person (i.e., one who is not an officer as above) who is appointed by either the members/creditors, when the Company goes in for voluntary winding up. A Liquidator is appointed in all cases of winding up whether due to commercial insolvency or otherwise, but an Assignee is appointed only in cases of winding up due to insolvency of the Company. 7.2 APPOINTMENTS As mentioned earlier, an Official Liquidator is appointed by the Central Government, whereas the Liquidators in other cases are appointed wither by the members or the creditors. The terms and conditions of service and remuneration etc. is fixed by the appointing authority. Sec. 502 gives certain rules regarding the appointment of a Liquidator in case of creditors voluntary winding up viz: a) If the Company and the creditors appoint different persons to act as Liquidator, then the choice of the creditors will prevail. b) If the Company is aggrieved with the creditor's choice of the Liquidator, then an application can be made to the Court within 7 days of such appointment by any Director, member or even creditor. c) Such an application can be validly made only if there has been a prior meeting of the creditors as envisaged u/sec. 500, wherein the decision to appoint a Liquidator has been taken. d) If the creditors fail to appoint a Liquidator, then the one appointed by the Company shall take charge. e) If the Company fails to appoint a Liquidator, then the one appointed by the creditors shall take charge. The Companies (Court) Rules, 1959 [the Rules] also mentions the rules relating to the appointment, etc. of the Liquidators as given below: R. 106. Appointment of Provisional Liquidator (1) After the admission of a petition for the winding up of a Company by or of the Company, and upon proof by affidavit of sufficient ground for the appointment of a Provisional Liquidator, the Court, if it thinks fit, and upon such terms as in the opinion of the Court shall be just and necessary, may appoint the Official Liquidator to be Provisional Liquidator of the Company pending final order on the winding - up petition. Where the Company is not the applicant, notice of the application for appointment of Provisional Liquidator shall be given to the Company unless the Court, for special reasons to be recorded (in writing), dispenses with the notice. (2) The order appointing the Provisional Liquidator shall set out the restrictions and limitations, if any, on his powers imposed by the Court. The order shall be in Form 49, with such variations as may be necessary. R. 315 Notice of appointment of Liquidator - The notice of his appointment which every Liquidator is required to publish in the official gazette under section 516, shall be in Form N. 151 and the notice of the appointment to be delivered to the Registrar of companies shall be in Form No. 152. R. 317. Security by Liquidator appointed by Court. (1) Unless otherwise ordered, every Liquidator appointed by the Court in a voluntary winding up, other than the official Liquidator shall, before entering upon his duties as a Liquidator, furnish security in such sum and in such manner as the Court may direct, for the due discharge of his duties as a Liquidator. The cost of furnishing the required security, including any premiums which he may pay to a Guarantee Society, shall be borne by the Liquidator personally, and shall not be charged against the assets of the Company as an expense incurred in the winding up. (2) If it shall appear at any time to the Court that the security furnished by the Liquidator is inadequate, the Court may require the Liquidator to furnish additional security. Where the security required is excessive, the Liquidator may apply to the Court for reducing the amount of security, and the Court may make such order thereon as it thinks fit. 7.3 POWERS AND FUNCTIONS A Liquidator is by way of being an agent of the Company, whereas an Official Liquidator is not an agent of the Company but is an officer of the Court. But when it comes to their powers
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or functions there is no difference between them, i.e., the mode of appointment makes no difference to the duties which a Liquidator performs of the powers which he yields. His powers and duties are briefly discussed below. Powers A Liquidator replaces the Board of Directors and hence exercises the same powers which the Board had, for example, a) control over the assets of the Company - though he cannot deal with them arbitrarily; b) enter into contracts on behalf of the Company, if he decides to continue with the Company business; c) take legal action on behalf of the Company; d) make calls for any unpaid amount on the shares; e) press for repayment of any debts owned to the Company; f) ask for the return of Company property in possession of any director or member; g) sign cheques etc. on behalf of the Company; h) make a list of contrubutoirs, and creditors of the Company, decide on the extent of their claims and settle them; and i) such other powers necessary for the beneficial conduct of winding up. Most of these powers are given under sec. 457 of the Act, and they can be exercised with or without sanction of the Court depending on the nature of the power; Functions a) to take into their custody the property of the Company; b) to maintain proper accounts and have them regularly audited; c) to make reasonable enquiries into any debts or claims made by a member/creditor before allowing them; d) to ascertain the debts or claims owned to the Company and take steps to realize them; e) if he decides to continue with the business of the Company then to conduct it in a reasonable and prudent manner to serve the best interests of the parties concerned; f) to make a report to the Court within 6 months of the order in cases of winding up by Court; g) to ascertain whether any fraud has been committed by any officer of the Company and to make such a report to the Court; h) in case of members voluntary winding up if the debts have not been paid off within prescribed period he is required to call a meeting of the creditors and lay before them a statement of assets and liabilities of the Company; and i) if the winding up continues for more than a year he is required to call a general meeting at the end of first year and of each succeeding year, to inform the meeting of the progress made and of the assets and liabilities of the Company; j) in case where a Committee of Inspection is to be appointed, he is required to call a meeting of the committee within 2 400
months convene a meeting of the creditors to decide on the committee, and within 14 days of this meeting call a meeting of the members to inform them of the result of creditor's meetings who can accept the suggestions or reject it. If the members reject the Committee, he shall apply to the Courts for directions. k) On completion of the winding up process, he shall make final accounts of the conduct of winding up and call a general meeting to place before it this account, etc. l) The Liquidator is in a fiduciary position in relation to the Company and is required to act keeping the best interests of the Company in mind primarily and to see that interests of creditors, members etc. do not suffer unduly due to his acts. 7.4 ON DISSOLUTION A Liquidator is appointed for the purpose of winding up the affairs of the Company - i.e., the ultimate intention is that he would dissolve the Company and end its existence. For this purpose, he is required to take charge of the Company, settle claims and debts, wind up the affairs etc. and finally when all such acts have been done which he is required to do for a successful winding up, he can then go ahead with the dissolution of the Company. Sec 497 of the Act provides for the final meeting and dissolution of the Company as follows: S. 497. Final meeting and dissolution. (1) Subject to the provisions of section 498, as soon as the affairs of the Company are fully wound up, the Liquidator shall(a) make up an account of the winding up, showing how the winding up has been conducted and the property of the Company has been disposed of; and (b) call a general meeting of the Company for the purpose of laying the account before it, and giving any explanation thereof. (2) The meeting shall be called by advertisement (a) specifying the time, place and object of the meeting; and (b) published not less than one month before the meeting in the Official Gazette, and also in some newspaper circulating in the district where the registered office of the Company is situate. (3) Within one week after the meeting, the Liquidator shall send to the Registrar and the Official Liquidator a copy each of the account and shall make a return to each of them of the holding of the meeting and of the date thereof. If the copy is not so sent or the return is not so made, the Liquidator shall be punishable with fine which may extend to fifty rupees for every day during which the default continues. (4) If a quorum is not present at the meeting aforesaid, the Liquidator shall, in lieu of the return referred to in subsection (3), make a return that the meeting was duly called and that no quorum was present thereat.
Upon such a return being made within one week after the date fixed for the meeting, the provisions of sub-section (3) as to the making of the return shall be deemed to have been complied with. (5) The Registrar, on receiving the account and either the return mentioned in sub-section (3) or the return mentioned in subsection (4), shall forthwith register them. (6) The Official Liquidator, on receiving the account and either the return mentioned in sub-section (3) or the return mentioned in sub-section (4), shall, as soon as may be, make, and the Liquidator and all officers, past facilities to make, a scrutiny of the books and papers of the Company and if on such scrutiny the Official Liquidator makes a report to the Court that the affairs of the Company have not been conducted in a manner prejudicial to the interests of its members or to public interest, then, from the date of the submission of the report to the Court the Company shall be deemed to be dissolved.
(6-A). If on such scrutiny the Official Liquidator makes a report to the Court that the affairs of the Company have been conducted in a manner prejudicial as aforesaid, the Court shall by order direct the Official Liquidator to make a further investigation of the affairs of the Company and for that purpose shall invest him with all such powers as the Court may deem it. (6-B) On the receipt of the report of the Official Liquidator on such further investigation the Court may either make an order that the Company shall stand dissolved with effect from the date to be specified by the Court therein or make such other order as the circumstances of the case brought out in the report permit]. (7) If the Liquidator fails to call a general meeting of the Company as required by this section, he shall be punishable with fine which may extend to five hundred rupees.
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8. CONCLUSION
In the preceding chapters we have seen as to how the existence of a Company can be brought to an end, by following a well defined procedure. A question may very well arise - why should the closure of a Company or industry involve such a lot of technical detail ? In order to answer the question one has to remember certain basic facts. There are three interest groups which are majorly affected by the closure of a Company, namely, the creditors, the shareholders and the employees especially the workmen. Of these, the first two groups have invested in the Company in the form of capital` which leaves behind extremely visual signs, i.e., when a person gives credit to the Company he is usually given a visual acknowledgment of the debt, in the form of an IOU, share certificate, promissory note, security etc. Hence their position is comparatively safer as they can satisfy their claims from the assets of the Company. But when it comes to the workmen' of the Company it is an entirely different story. Their investment in the Company is in the form of labour` which though instrumental in the progress the Company is neither identifiable nor ascertainable, i.e., one cannot say that workman A has been instrumental for .01% of Company profits and workman B for 5%. Theirs is a collective investment lost in anonymity, with no visual signs of individual identity. Thus, though in the words of Gower, the lot of the 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 the officials to act on its behalf (Gower, p.153 referring to doctrine of indoor management] It is really the lot of the workmen which is an unhappy one sandwiched as they are between the shareholders and the creditors and falling in neither category. If a Company could be brought to an end without any restrictions, then their lot would be unhappier still with none to heed to their grievances. Atleast with a settled winding up procedure they are assured that `their livelihood cannot be taken away from them without they being given a chance to be heard. In National Textile Workers Union v.Ramkrishna [(1983)1 SCC 228], the Supreme Court held that, the workers had a right to be heard in all winding up proceedings, so that their view point can be conveyed to the Court and their interests safeguarded. This is one of the basic reasons why the Courts have been given a discretionary power to order winding up i.e., even in cases where a special resolution has been passed by the Company to go in for winding up, the Court does not have to pass a winding up order. It may refuse to pass such an order if it feels that it would be against public interest to pass such an order. Winding up vis-a-vis Exit Policy India being a welfare state, the Government has always tried to look at the various problems connected with winding up, closures, sick industries etc. from a view point more sympathetic 402
to the workmen. The sickness syndrome is something to be kept in check, corrected and cured by using appropriate measures (official winding up being the last resort to be used). The legislature and judiciary have always tried to see that when an industry/Company makes an EXIT, it does not leave the workmen high & dry. Sufficient provisions are made both in the Companies Act and the Industrial Disputes Act, 1947, to this end. We have already seen in the preceding chapters how the Court and the Liquidators treat the claims of the workmen on part with those of secured creditors, and as to how workmen have to be given a chance to be heard in every winding up proceedings. We would now try to see the relevant provisions in the I.D. Act relating to EXIT. Chapter V-A of the Act relating to lay off and retrenchment of workmen was introduced as early as 1953. In 1957 closure compensation was provided for and in 1971 limitations on compensation payment was removed. Then in 1976, Chapter V-B was introduced which provided for prior permission of the Central /State Government before going in for lay-off, retrenchment or closure. This chapter was later amended after the striking down of sec.25-O by the Supreme Court in Excel Wear v. Union of India. Apart from these provisions which provided for benefit to the workmen either on their exit from the industry via retrenchment etc. or on the exit of the industry itself via. closure, the government has introduced many other schemes. For example, a soft loan scheme for modernizing 5 select industries was provided in 1976, in 1977 a scheme for merger of sick units with healthy ones was introduced with a view to revive the sick units, etc. These were schemes to prevent units from closing down. Since the introduction of the New Economic Policy, Dr. Manmohan Singh has been talking of introducing a new Exit Policy- to facilitate structural readjustment in our economy in accordance with the IMF & World Bank directions, so that production units of both private and public sector may avail of the same. On the basis of the statements issued by the Finance Minister and World Bank, it was found that, for the first time since 1947, this proposed Èxit Policy would lead us from a policy of restraint on sickness and closure to facilitation of the same in the interest of structural adjustment. This shift in policy would have an effect on the entire economy and especially on the workers of organized sector and the effect would not necessarily be positive. This fear led to an all India strike on 29-11-91. The main point to be remembered is that thought there have been frequent talks and statements on the new Exit Policy and its resultant consequences, the policy has neither been formulated nor legislated upon. So we have to contend
with the exit provisions given in chapter V-A & V B of the I.D. Act. Some of these provisions in V-A are briefly discussed below : 1. 50% wages prescribed as layoff compensation. 2. Layoff continued for 45 days could be converted into retrenchment, and the worker would be paid a retrenchment compensation @ 15 days wages for every completed year of service. 3. The principle of last come first go to apply in case of retrenchment of workers. 4. If the industry was in need of additional labour later, then these retrenched workers had to be given a priority based on their seniority. 5. Advance notice of 60 days to the State Government was to be given in case of closure. 6. Prior notice/payment in lien of notice also had to be complied with in case of retrenchment. 7. Compensation to a maximum of 3 months wages was to be given when the closure was for reasons beyond control of the employer. This limit was removed in 1971, and a full compensation on quantum fixed for retrenchment was made payable even for closures. 8. During emergency, the most stringent restriction was imposed in the form of Ch. V-B, providing for prior permission of the government before resorting to either layoff, retrenchment or closure, by all industries employing more than 100 workmen. Naturally enough, these restrictions did not find favour with the employers and they challenged the constitutional validity of section 25-O in Excel Wears case, The Supreme Court struck down this section in 1978. As a consequence the most stringent of the restrictions imposed on the employers right to closure` was held to be unconstitutional thereby giving a free reign to the employers to close down an industry on their own volition i.e., there was no necessity to seek any permission from anyone, and they could do it by paying a nominal compensation of 15 days of wages for every completed year of service. Thus, by its decision the Supreme Court reduced a stringent exit policy into a liberal exit policy. This state of affairs did not continue for long. Section 25-O was amended in 1982 incorporating within it many of the SCs observations in Excel Wear. The present exit-policy as contained in Sections 25-M, 25-N and 25-O is quite comprehensively drafted and the interests of the workmen are adequately safeguarded. Is there a conflict between Companies Act and I.D.Act ? Section 2(j) of I.D.Act, 1947, defines industry as: industry means any business, trade, undertaking, manufacture or calling
of employers and includes any calling, service, employment, handicraft, or industrial occupation or avocation of workmen. This definition is wide enough to cover a Company, since a Company has not been specifically defined in the Companies Act except for saying that a Company is one incorporated under the Act. Thus, a Company doing business falls under the definition of an industry` under Section 2(j). The question that arises is does a Company also have to follow the stringent provisions laid down in Chapter V-A, V-B and V-C of the I.D.Act, while going in for winding up ? To answer this question we must try to analyze the basic scheme and objectives of both the I.D.Act and the Companies Act generally and Sections 25-M, 25-R and 25-O of the I.D. Act in particular. Though originally this enactment was framed with a limited purpose of serving as a dispute settlement machinery, it has to be remembered that it is the most important legislation governing the relationship between the constantly growing capital and labour in the country, and hence this Act is subjected to continuous pressure if it has to adapt to the ever changing socio-economic needs. Chapter V-A, V-B were introduced to deal with the entire gamut of questions pertaining to job losses`, and to as far as possible regulate job losses. Section 25-O helps in continuing the employer-employee relation till the question of whether the industry should be continued or wound up is finally decided. If a particular unit is found viable, then it may be revived under the same owner by giving it a money infusion` or it may be handed over to some other entrepreneur or workers cooperative etc. It is only when the Board for Industrial and Financial Reconstruction (BIFR) comes to a conclusion that the unit in question is not viable, then winding up proceedings can be undertaken to bring an end to the industrys existence. Thus, in effect, the Companies Act brings a business to existence, whereas the I.D.Act helps to regulate the relationship between the Company (employer) and its employees. The Companies Act itself provides for claims of workmen to be satisfied in priority to other claims, the I.D.Act simply specifies the claims which a worker has if he is laid-off, retrenched or when the industry closes down. The Companies Act lays down the general provisions which are added to and clarified by the specific provisions in the I.D.Act. The Companies Act is a general Act which has to submit to the I.D.Act which is a special effect. In effect there is no conflict between the provisions of the Companies Act and the Exit provisions in the I.D. Act as one merely supplements the other. The following flow-chart depicts some of the major causes for industrial sickness.
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INDUSTRIAL SICKNESS
Natural Causes
Man made or Induced Causes
Winding up may be the only feasible solution Mismanagement Labour Problems Usually due to Union rivalry Deliberate Due to negligence or incompetance Government Policies Time and cost over run in new units.
Failure to move with times (especially true for textile industry
Diversion of working capital for expansion etc
Delay in providing material, subsidies etc.
Power Cuts & power failure
Sudden changes in import-export policies
Failure to provide infrastructure in rural areas.
Heavy dependance on loans high interst paid
Delay by govt. in granting licenses & permits, power etc., delay in commencement of production
Faculty appraised by financial agencies
The BIFR cannot help an industry which has become sick due to natural causes; for example, those arising due to acute competition, market recession or product having absolutely no market etc., which may be common to an industry as a whole in a market economy. The BIFR can play an effective role only in
situations where the sickness is induced/manmade i.e., either because of mismanagement or due to governmental policies or neglect. We would now briefly study the Constitution and working of BIFR.
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9. SICK INDUSTRIAL COMPANIES (SPECIAL PROVISION) ACT, 1985

The preamble of this Act states as follows: An Act to make in the public interest, special provisions with a view to securing the timely detection of sick and potentially sick companies owing industrial undertakings, the speedy determination by a board of experts of the preventive, ameliorative, remedial and other measures which need to be taken with respect to such companies and the expectations enforcement of the measures so determined and for matters connected therewith or incidental thereto. This clearly shows that this Act was passed to provide an alternative to companies contemplating winding up, by providing for a preventive mechanism to check the deterioration which might have set it either due to lack of funds, labour problems or some technical problems, the intention of the Act being to prevent closure of industries as far as practicable and of nurturing sick industries back to health. Despite having such laudable objectives the Act itself is pretty short and consists of only 41 sections, which provide for the constitution and working of the Board for Industrial and Financial Regulation or BIFR. When one looks at things at the macro level, then one would be perfectly justified in saying that industrial sickness is a logical consequence of modern industrial civilization. Industrial revolution and development can be achieved only by constant revising and revolution of technology, by introducing new processes and products. This inevitably leads to old technologies and products becoming obsolete. It is a fundamental law of nature that the old order is replaced by new - it is neither possible nor advisable to change or prevent this law. But at the micro level i.e., at the level of individual industries, it is essential to make an attempt to cure their sickness and to rehabilitate them. India has one of the largest unemployment rate, which has been steadily rising since independence. It is therefore essential to try and prevent loss of employment wherever possible, by reviving of industry and resorting to liquidation only in extreme cases. And this is where BIFR plays a major role. Section 4 provides for the constitution of BIFR by the Central Government, consisting of a minimum of 3 and maximum of 15 members one of whom shall be the Chairman. The basic qualification for being appointed as BIFR member is that the concerned person should not have any financial or other interest which might adversely affect his working. His tenure is for 5 years, but he is eligible for re-appointment, provided he has not attained the age of 65 years [section 6, which also deals with some other terms and conditions]. A member may either resign from his service by writing to the Central Government or he may be removed from service on any of the grounds given under section 7, viz: a) he has been adjudged insolvent; or b) he has been convicted of an offence involving moral turpitude; or c) he has physically/mentally become incapable of acting as a member; or d) he has acquired some conflicting interest which adversely effect his functions as a member; or e) he so abuses his position that it is inadvisable to continue him, in view of public interest. Despite such specific grounds being given, a member can be removed only on an order passed by the Supreme Court, which investigates the case thoroughly on a reference made to it by the Central Government before passing the order. This ensures that members can discharge their functions relieved from the threat of arbitrary removal at the pleasure of the Government. Section 9 also ensures this free working of members by providing that their salaries etc., should be paid from the Consolidated Fund of India, and further proviso to section 6(7) states that this salary etc., cannot be varied to the disadvantage of the member after his appointment. The BIFR in a quasi-judicial body and under Section 14, the proceedings before the Act are judicial proceedings. The moment an industry suffers accumulated losses either equal to or exceeding the net worth of the Company and this cash loss is experienced for two consecutive years, then the Company is deemed sick under section 3(1)(o) of the Act. Such a Company is required to make a reference to the BIFR within sixty days from date of audit. The report is to be filed in a prescribed proforma (the format of which is given in the annexure of the Act) and consists of about 58 entries or questions dealing with various aspects of the industry to be answered. This wealth of information itself provides sufficient material for the BIFR to atleast arrive at a preliminary conclusion regarding the industrys sickness or otherwise. Once it reaches the conclusion that the industry is sick, then the BIFR begins an investigation into the viability of the industry i.e., it tries to find out if by adoption of some scheme the sickness can be checked and cured. This viability study is done by inviting rehabilitation schemes prepared either by the promoters themselves or by some other new entrepreneurs or even by the workers cooperative. The scheme so submitted is then subjected to intense scrutiny by experts in operating agency on BIFR orders. This operating agency is usually a Financial Institution having the necessarily skill and expertise. Once the agency submits a report its recommendations are taken account of, and after giving a fair hearing, the BIFR may adopt the sanctioned scheme` which may to be successful involve the assistance and cooperation of the Government, management, workers, financial institutions, banks etc. The assistance may take various shapes and forms, for example, it may be in the form of financial assistance, technical/managerial assistance, negotiation and counsels of the management and workers etc. The basic intention of adopting the new scheme being to remove the causative factor of the sickness` and to nurse the industry back to health. 405
If after investigation the BIFR finds that the industrial unit is non-viable i.e., no scheme can either prevent or cure the wide spread rot in the industry, then, the BIFR may pass an order for winding up and inform the High Court having jurisdiction over the Company accordingly. Once such a recommendation is made the winding up will proceed as per the procedure prescribed in the Companies Act and provisions under Sections 25-M, 25-R and 25-O of the I.D.Act. Concluding Remarks The need for a new Act on the lines of SICA was felt, because the I.D.Act with its pre-constitutional framework was unable to cope up with the varied new problems arising with modernization and rapid industrialisation, resulting in problems like excess labour, rationalization and retrenchment. Even this was being coped with, but then a trend started where healthy industries were made sick and then closed, or there were closures for no identifiable reasons, or industries started being closed merely to make money, i.e., there was an unhealthy trend of closure, which consequently resulted in high rate of job loss, and unemployment problems increased. The I.D.Act and the Companies Act were unable to cope with this trend, especially since they had not expertise to test the viability of a unit. A need was strongly felt to counter this lacuna and this resulted in the passing of SICA, 1986 and formation of BIFR under it which has been given sufficient powers to check this trend. In an excellent article by M.S.Narayanan [1994, EPW, p.362] he has tried to analyze the functioning of the BIFR upto the end of 1993 beginning from its inception in mid-1987, with special emphasis on 472 cases (of which he has made indepth analysis) disposed of by the BIFR upto end of 1991. Some of the statistics he has given are reproduced below: Number of references received upto 31.7.1993 Number of references rejected as incomplete Number of references dismissed under sec. 17(1) as non-maintainable Number of references in which order passed under sec.17(2) Number of references in which schemes were sanctioned under Section 18(4) Number of companies wound-up under Section 20(1) Number of draft schemes circulated Notice to show cause why Company should not be wound up had failed and fresh schemes were under consideration Balance of cases were under various steps of consideration. 1,897 512 268 119 295 225 41 66 35 336
institutions. Thus, it can only persuade them or to convince them but cannot force them to act in accordance with its wishes. Though the R.B.I. has issued set guidelines to the banks to be followed in respect of sick industries, and the BIFR proposals till now have been well within these guidelines, the banks have not been taking prompt action on them. The State Governments have not lagged behind in their apathy. Most of these governments have issued policy packages for sick industries, but are able to find innumerable delays in implementing them. The next hurdle to be crossed by it is the delay by the operating agency` in the preparation and submission of a report, which may be caused either by the non-cooperation of the management of the concerned agency or the apathy and ennui of the agency officials themselves. This problem is now practically under control because of the time limit of 90 days set by the BIFR for the agency to submit its report. Further, the maximum number of members constituting the Board is 15. These members function by forming benches, of which four are presently working. The vacancies in the membership have not been filled up. With the number of industries making references steadily rising and even the public sector units coming under the purview of SICA it is essential for a mere efficient working of BIFR that its strength should be increased with immediate effect. The constraints mentioned above are not the only ones hampering the efficient working of BIFR, but they definitely are the major ones. Does it mean that these constraints cannot be removed? Certainly not. What is required is for the BIFR to be armed with more teeth - either by making its orders mandatory (which might not be very advisable) or giving it the power to impose sanctions whenever it feels that the delay in adopting or implementing its proposal/scheme is unreasonable. Some other suggestions which might prove helpful in this regard are: a] The approval by the Bank/State government to any scheme proposed by BIFR should be automatically given provided such scheme falls within the set of guidelines given by either the R.B.I. or the concerned State government. b] In case, the said scheme does not come within the guidelines, then a fixed time limit of about 90 days should be given within which the bank etc., has to record its objections etc., to the said scheme. If the objections are not filed within this prescribed period then the scheme should be deemed to have been adopted. c] The BIFR is a public office and its members public officials. The BIFR directives should be given force of law` so that any public servant (ex: a government officer) who does not comply with the directives for no valid reason becomes personally liable and punishable under Section 166 I.P.C. which states as follows: Whoever, being a public servant, knowingly disobeys any direction. If the law as to the way in which he is to conduct himself as such public servant, intending to cause, or knowing it likely that he will, by such disobedience, cause injury to any
Number of cases where scheme under section 17(2) or 18(4)
Despite the formulation of BIFR as an autonomous body, it performs its functions under a lot of constraints, the major one being that a BIFR directive is persuasive rather than mandatory especially as regards to the government, banks or other financial 406
person, shall be punished with simple imprisonment for a term which may extend to one year, or with fine, or with both`. The same personal liability should be affixed to the BIFR personnel if they fail in performance of their duty. d] Though under Section 19(3) a sanctioned scheme is binding on all parties who have given their consent to it, parties usually refuse to go ahead with their commitment. The remedy for such situations is provided under the Act itself under Section 33. What is needed is that BIFR should employ people well versed in law so that they can prosecute such parties. Such an action would prove a deterrent to others not having an intention to fulfill their commitments.
Merely because BIFR is working under so many constraints does not mean that another superior body should be constituted to either supervise the BIFR working or implement its schemes. What is needed is a bit more power given to BIFR and a bit more cooperation from the concerned agencies. The basic objective of SICA is not the mere constitution of BIFR but it is to see that neither do industries have to wind up merely due to lack of funds, technological inputs etc., nor do the workers suffer unduly in the eventuality of a winding up taking place. If this objective is not aimed for then what we would end up with is a parody of exit policy where in the colourful words of Narayanan, the management will exit with the funds and workers will exit without their dues.
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10. CASE LAW

A. Shanmugham v. Official Liquidator [(1992) 75 Comp Cas (Mad)1811] Madras Pen and Ink Factory was ordered to be woundup in 1978 on the grounds that it was unable to pay its debts. An Official Liquidator was appointed, who drew up a list of creditors, after adjudicating upon claims lodged with him. They covered claims of ex-workmen of the Company including closure compensation under section 25-FFF of I.D.Act, 1947. The proviso to this section states that if the undertaking is closed down on account of unavoidable circumstances beyond the control of the employer the compensation payable to the workman shall not exceed his average pay for 3 months. The issue in consideration was whether the present undertaking was closed down on account of unavoidable circumstances beyond the control of the employer. Held that the Company was ordered to be wound up pursuant to a petition for winding up filed by a creditor. Hence, the root cause for closure was undischarged debts of the Company which is due to the financial difficulties of the Company. Explanation to the proviso to Section 25FFF(1) of the I.D.Act specifically provides that closure of an undertaking due to financial strain etc., shall not be deemed to be due to unavoidable circumstances beyond control of employer...The petitioner/workmen are entitled to closure compensation @ 15 days pay for every years continuous service, as prescribed under the first part of Section 25-FFF(1) of I.D.Act. They are further entitled to an interest @ 12% p.a. Thus, the Court held, (1) the workmen become secured creditors by operation of law from the date of winding up order, (ii) the workmen have a pari passu charge over the security which is held by the secured creditor under the contract, and (iii) the cutoff date for arriving at the ratio at which the sale proceeds should be divided on pari passu basis under Section 529 of Companies Act, 1956, should be the date of the winding up order and not the date of sale. The workmen are entitled to claim interest from the date of winding up order till the date of realization of security. Trilok Chand Jain v. Swastika Strips Pvt. Ltd. [(1992)75 Comp Cas 275 (P & H)] The respondent Company entered into partnership with a firm S, which was later dissolved. On dissolution of S, its assets and liabilities were taken by the Company. At the time of the firm's dissolution, its goodwill value was shown as Rs.1 crore. The accounts of the petitioners (who were Ss partners) showed certain amounts to their credit as their share of goodwill. On the ground that the Company had failed to pay the said amount the petitioners sought the winding up of the Company. The Company contested on the grounds that, (a) the capital in the accounts of the erstwhile partners of the firm S would be payable at the time of final dissolution of the firm S, and (b) it was with the intention of setting off the huge losses of the firm S that its goodwill was shown at the inflated figure of Rs.1 crore. Dismissing the petition for winding up it was held prima facie 408
it could not be said that an admitted debt was due from the Company. The claim to a share in an imaginary figure representing goodwill was not sufficient to wind up a running Company. The very fact that the petitioners had sought dissolution of the firm led to the inference that there was no admitted debt yet. No relationship of debtor and creditor could come into existence without the final dissolution of the firm S and finalization of accounts fixing the rights and liabilities of each partner. Moreover, the petitioners as partners of the erstwhile firm S, were jointly and severally liable to the firms secured creditors, and were entitled only to their share in the assets of the firm remaining after the creditors were paid. It would not be just to wind up a Company solely on the ground that some amount had been shown to be due to the petitioners on the basis of some self-assessed goodwill, that some money fell to the share of the petitioners even without meeting the liabilities of the firm towards secured creditors. There was no evidence to show this incapability of the Company to pay its debt. Winding up cannot be ordered solely on the creditors claim; it is the liability of the Company to pay which is the primary consideration. Shree Chamundi Mopeds Ltd. v. Church of South India Trust Association [(1992) 75 Comp. Cas. 440 (S.C)] The appellant Company had taken on rent premises belonging to the respondent, who filed a petition in the Karnataka High Court for winding up of the appellant Company under Section 433(e) for failure by the Company to pay its rental dues. While the petition was pending, the Company filed a reference to the BIFR under Section 15(1) of SICA, in which the Board passed an order expressing its opinion that the Company should be wound up. An appeal by the Company against this order was dismissed by the Appellate Authority for Industrial and Financial Reconstruction. The Company filed a writ in Delhi High Court against the Appellate Authoritys orders which was admitted, and an interim stay order was passed. After dismissal of the appeal by the Appellate Authority, winding up petition was taken up for consideration and allowed by a single judge, and Companys appeal against this order was dismissed by a Division Bench. The respondent had also filed a petition under Section 21(1) of Karnataka Rent Control Act, 1961, for eviction of the Company, while the reference to BIFR was pending and the trial judge allowed the eviction petition. In an appeal filed before the Supreme Court, the issues raised were: (a) whether, after Delhi High Court ordered stay of operation of the order of Appellate Authority, proceedings under SICA could be said to be pending so as to bar proceedings in Karnataka High Court on the winding up petition; and (b) whether proceedings instituted by a landlord for eviction of a tenant which is a sick industrial Company are suspended by virtue of Section 22(1) of SICA, 1985, which is applicable in respect of an industrial Company, where: (i) an inquiry under Section 16 is pending; or (ii) a scheme referred to in section 17 is under preparation or consideration; or (iii) a sanctioned scheme is under
implementation; or (iv) where an appeal under section 25 relating to industrial Company is pending. In the instant case it could not be said that any proceedings under the Act were pending before the Board or Appellate Authority...Section 22(1) could not be invoked and there was no impediment to the High Courts dealing with the winding up petition filed by the respondents. Further, the proceedings which are automatically suspended under Section 22(1) of the Act are proceedings (i) for winding up of the industrial Company; (ii) for execution, distress or the like against the properties of the sick industry; and (iii) for appointment of a receiver. Proceedings for eviction instituted by a landlord against a tenant who happens to be a sick industrial company cannot be regarded is falling in this category, and the eviction order was not passed in contravention of Section 22(1) of SICA, 1985. Upper India Couper Paper Mills Co. Ltd., v. Appellate Authority for Industrial and Financial Reconstruction [(1992) 75 Comp. Cas. 653 (Delhi)] The petitioner was declared a sick industrial Company under Section 3(1)(o) of SICA, 1985. An operating agency was appointed. The petitioner submitted a proposal for scheme of rehabilitation, by sale of all its assets and establishment of a new plant at a different place. The operating agency denied that such a proposal had been made. BIFR recommended that the petitioner be wound up. On appeal, the Appellate Authority dismissed the appeal in limine on the ground that the establishment of an entirely new plant of at far off place did not amount to rehabilitation and was not covered under the Act. The Company filed a writ against the dismissal. Held, that the Board having determined that provisions of Section 17(1) were not applicable and that no scheme under sections 17(3) and (18) could be prepared, came t the conclusion that, under Section 20 of the said Act, a report should be submitted to the High Court for the winding up of the Company. The Appellate Authority purported to interpret section 18(1)(a) and came to the conclusion that establishment of a new plant at a far off place did not amount to rehabilitation and was not covered under the Act, overlooking the fact, that section 18 did not apply here. The provisions of Section 18 would have been relevant only if a proposal had been submitted by the operating agency appointed under Section 17(3). No proposal being submitted, the interpretation of scope and effect of Section 18 could not arise. The Appellate Authority did not apply its mind to the question whether a scheme should have been formulated by the operating agency. The Appellate Authority would have to see whether a proper workable scheme under Sections 17(3) and 18 could be formulated but if it came to the conclusion that this was not possible, then the only alternative left was to uphold the finding of the Board that the Company should be wound up. S.Sundaresan v. Plasto-O-Fibre Industries Pvt. Ltd., [(1993)76 Comp. Cas. 38 (Mad)] The respondent, a private limited Company was incorporated for the manufacture of fibre glass reinforced plastic light fittings, on the understanding that the petitioner, his relatives and friends
would hold approximately 50% of the shareholding and the remaining 50% to be held by the Managing Director P V and his group, and that the petitioner would be made a working director on a salary. The petitioner filed a petition in the High Court for winding up under Section 433(7) on the grounds that (a) the substratum of the Company was lost and there was no hope of revival of the respondent Company; (b) there was complete deadlock in the Company on account of lack of probity in the management of the Company and there was no hope or possibility of smooth and efficient continuance of the Company as a commercial concern; (c) the Company was really in the nature of a partnership and the circumstances would justify the dissolution of a firm; (d) there was no alternative remedy except to wind up the Company; (e) the majority of the creditors and shareholders of the Company supported the winding up. The petitioner alleged that he had been made a Director only 3 years after the Company was incorporated, and had not received any salary yet, that he was kept out of the affairs of the Company, and was unjustly removed from directorship and that there were several irregularities in the Companys bank dealings. Held that (i) on a perusal of various documents, it was evident that the subtratum of the Company had disappeared because the object for which the Company was incorporated had completely failed and the respondent Company had not been able to manufacture and sell such products on a commercial basis. It had also not paid any interest to the financial institutions, and the activities of the Company had virtually come to a standstill and in the present state of affairs, there was no hope of the respondent Co. becoming a viable unit. (ii) The manner in which the petitioner had been excluded from the affairs of the Company and removed as Director, failure to pay his salary etc., showed complete lack of probity in company management. Further, as no attempt had been made after removal of petitioner to revive the Company the Company was table to be wound up on this ground also. (iii) Where a private limited company in the nature of partnership is formed on the basis of an understanding that a certain person would act as a Director, his expulsion from office would be a ground for winding up. Principles of partnership applied to the case and the Company was liable to be wound up. Bellary Spinning and Weaving Co. Ltd., v. Syndicate Bank [(1993)76 Comp. Cas. 426 (Kar)] The petitioner Company was registered as a public limited Company. It commenced business in 1962 and had never declared any dividend. For commencement of business it availed of a loan of Rs.36,24,000 from the respondent bank. Till the date of presentation of winding up petition by the bank, the Company owed more than Rs.2 crores to the bank the nonpayment of which had led the bank to file the petition. During the course of hearing, the workers of the Company got themselves impleaded and raised the objection that as the industry was being run under the provisions of SICA it was not open to the Company Court to order winding up. This contention was rejected by the Company judge, who came to the conclusion that winding up was the only alternative left 409
open for the Company. The Company appealed against this order of winding up. It was held that: (i) section 15(1) of SICA, makes it mandatory for the Board of Directors of a sick industrial Company to make a reference to the BIFR within 60 days of the end of financial year in which the Company becomes sick. The Board of Directors had not made such a reference nor was there any explanation of their failure to do so. They could not now insist that the bank should have made a reference under section 15(2) of SICA and so exhausted its remedy before BIFR, before seeking winding up, when under section 15(2) the discretion of doing so was left to the bank. Since the Board of Directors of the Company had not acted under section 15(1) of SICA, the provisions of the Act did not apply to the Company nor to the winding up proceedings in question. (ii) that, when the Company was neither in a position to discharge its debts or to generate funds,nor had it placed any scheme before the Court for improvement of its industry, the only course open was to order winding up. No purpose would be served, in the absence of any viable scheme, to allow the Company to exist, which would only result in increasing its liabilities. The winding up order would not therefore be set aside. Faizabad Distilleries Pvt. Ltd. v. Salim Tailor [(1993) 73 Comp. Cas. 127 (All)] The case arose out of an application by the official Liquidator of the petitioner Company, to the Company Court for: (1) rent due from respondent for a period of 10 months alongwith interest thereon and (2) eviction of the respondent from property owed by the Company. The Liquidator had sent registered notices to the respondent asking him to pay the dues, but the letter came back with a postal remark dukan band rahiti hai,` before the filing of this application. A copy of this Court application was also sent to Salim but was sent back to the High Court showing an endorsement that it was refused. The Court in these circumstances held, The aforesaid Salim is probably under the impression that there will be separate proceedings by the Liquidator to engage him in litigation on his home ground. What the opposite party forgets is that upon a winding up order being passed under section 446 of the Companies Act no suit or legal proceedings can be filed or be pending on the date of winding up order nor can be proceeded with against the Company except
by leave of Court and subject to such terms as the Court may impose. Further, notwithstanding anything under any other law for the time being in force, if a proceeding is to be initiated by or against the Company, it doesnt preclude the High Court from initiating proceedings straightway as if they were proceedings of the Court of appropriate jurisdiction. The legislative intent for this purpose is clear that there can be no impediment in the way of the Liquidator getting involved in unnecessary litigation as there is public accountability after a winding up order has been passed. ....Tenants of companies under winding up proceedings, cannot stretch the winding up proceedings to suit their personal interest. They have to wind-up also, alongwith the winding up of the Company. The tenant thus was held a defaulter for not paying the rents to the official Liquidator and a trespasser rendering him liable for eviction alongwith rent due and interest and damage till the date of possession was delivered to the Liquidator. Daulat Makanmal Luthria v. Solitaire Hotels Pvt. Ltd. [(1993) 76 Comp. Cas. 215 (Bom)] The appellant filed a petition for winding up of the respondent co., making allegations inter alia, of lack of probity on the part of the respondents in relation to the functioning of the Company siphoning off of the funds of the Company to private coffers, omission to account for money actually received, manoeuvring of transfers of certain shares and manipulations of entries in the minutes and other books maintained by the Company. This petition was dismissed by a single judge who recorded several findings of facts adverse to the appellant. The appellant filed an appeal. Dismissing the appeal, the High Court held, A winding up has to be resorted to only when other means of healing an ailing Company are of absolutely no avail. Remedies are provided by the statute for matters concerning the management and running of a Company. The extreme and irretrievable step of winding up must be resorted to only in very compelling circumstances. The Company being at the threshold of commencement of commercial operations, and public financial institutions having got involved in the working of the Company by giving sizable financial support, it would be against the interests of all including the appellant to halt the activities of the Company at a crucial stage and to dismantle the entire corporate achievement. The appeal was dismissed.
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11. PROBLEMS
1. BIFR passed an order declaring industry A as a sick industry under section 3(i)(o) of SICA, and appointed X and Y corporation as operating agency for revival of the industry. The operating agency submitted a report to the BIFR that a scheme of revival under section 17 of the Act was under preparation. In the meanwhile, demand notices for sales tax dues of the Company were served on the Company, warning that in default of payment coercive processes of recovery would be adopted, and garnishee notices under section 23(1) of the M.P.General Sales Tax Act, 1958 were served on various banks prohibiting them from making any payments to the Company. Discuss whether such notices are barred by virtue of Section 22(1) of SICA. [(1993) 77 Comp Cas 381 (MP)] 2. Misfeasance proceedings were initiated against a Director of the Company under section 543 of Companies Act. The concerned Director died at an early stage of the misfeasance proceedings. The Liquidator wants to proceed against the legal representatives of the Director on the same charges decide. [(1993) 77Comp Cas 6 (Kar)] 3. The Liquidator of a Company in voluntary winding up did not decide or determine the claims of a creditor for 10 years prejudicially affecting the creditors rights. The creditors want to have the Liquidator removed and a new one appointed. Decide whether the Court has the power to remove a Liquidator on this ground alone. [(1993) 77 Comp Cas 128 (P&H)] 4. The R.B.I. files an application in the Court for the winding up of a Company incorporated outside India, but which had carried on a substantial part of its business in India until suspension of its business. The Company claims that the Indian Courts have no jurisdiction to order winding up of a foreign Company. Decide. [(1993) 78 Comp Cas 207 (Bom)] 5. A winding up order was made against a Company in December 1978 and 1st June 1982 the Liquidator filed an application ordering X to pay a sum of Rs.3 lakhs owed by him to the Company and for which he had acknowledged his liability in April 1977. The winding up petition was presented on 1.5.1978. The debtor claims that the debt due is time barred and hence was unenforceable. Decide. [ (1984) 56 Comp Cas 441 (Kar)] 6. A Company was incorporated with the main object of setting up a cement factory for which purpose it leased a limestone quarry from the Government. Despite best efforts of the Company, finances were not available and a resolution for voluntary winding up was passed. The office furniture was sold off and the creditors were paid off, but the formalities for dissolution of the Company were not completed. The shareholders filed a petition in the Court for a stay of the voluntary winding up, and for reviving of the Company on the grounds that the limestone quarry lease had great potential and production of increased quantity of cement was in national interest. Discuss whether such a petition is maintainable. [1984) 56 Comp. Cas 360] A pledge of the Company machinery was made in favour of person who was not creditor of the Company. Later a winding up order was passed against the Company. The Liquidator claims that the said pledge is invalid on grounds of fraudulent preference to creditors. The pledgee resists the claim. Decide. [(1984) 56 Comp Cas 435 (Kar)] A creditor of a Company obtained a decree against the Company for a sum of Rs.50,000/- owed to him by the Company. Instead of applying for execution of the decree, he applied for winding up of the Company. The Company resisted the petition on the grounds that the assets of the Company were much more than the liabilities of the Company, and hence the petition for winding up was per so not maintainable. Decide. [(1991) 72 Comp Cas 165 (Gauhati)] A Company was ordered to be wound up by the Court. The official Liquidator sold the assets and invested the amount he received in a bank, where it continued to earn interest. There was no other evidence of any business being carried out. The Liquidator wants to claim the expenses incurred by him by way of salaries, legal fees etc., as business expenditure. Discuss whether such a claim is maintainable. [(1991) 72 Comp Cas 740 (SC)] X deposited certain notes with Hyderabad Bullion Exchange Ltd., as membership security. The Company became defunct and was dissolved by the Registrar by removing it from the register X filed a suit against the Company, its directors and members of its sub-committee for the recovery of the value of the notes. Discuss the liability of the Company, the directors and members of the Company. [(1965) 1 Comp LJ 233]
7.
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[Note: Please specify your name, ID number and address while sending answer papers].
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12. SUPPLEMENTARY READING

1. Avtar Singh, Company Law, 1989, Eastern Book Company, Lucknow. 2. Chakraborti, A.M., Taxmans Company Law, Volume 2, 1994, Taxman Allied Services (P) Ltd., New Delhi. 3. Goyle, L.C., Law and Practice of Company Winding up, 1987, Eastern Law House Pvt. Ltd., Calcutta. 4. Gurbir Singh, [1992], Another victim of a spreading sickness, Economic and Political Weekly, December 5: 2630-49 & 50. 5. Gurbir Singh, [1992], The Murphy Story, Economic and Political Weekly, August 15: 1724-33. 6. Grier, J.S. and Floyd, R.E., Voluntary Liquidation and Receivership: A Practical Guide, 1985, Ozez Longman Publishing Ltd., London. 7. Narayanan, M.S., [1994], Industrial Sickness, Review of BIFRs Role, Economic and Political Weekly, February 12: 3627. 8. Ramaiya, A., Guide to the Companies Act 1, Part 2, 1995, Wadhwa and Company, Nagpur. 9. Tulpule, B., [1994], Industrial Sickness and Corporate Restructuring, Economic and Political Weekly, April 9:833-15.
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Corporate Law 2

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Master in Business Laws Part I Corporate Law

Course No. : III Module Nos. : I - IX

Distance Education Department

National Law School of India University

Master in Business Laws Corporate Law

Distance Education Department

National Law School of India University

National Law School of India University

FORMATION OF A COMPANY AND COMMENCEMENT OF BUSINESS

1. FEATURES OF A COMPANY FORM OF BUSINESS ORGANISATION: AN INTRODUCTORY NOTE

Joint Hindu Family business

Private Ltd Company

Public Ltd Company

(Sys 4) - D:\shinu\lawschool\books\module\corporate law

Flow Chart - 2 Types of Companies

1 on the basis of liability

2 on the basis of nature of incorporation

3 on the basis of size & shareholding

4 5 on the on the basis of basis of inter-Company listing in relation Stock Exchange

6 on the basis of functions

7 on the basis of nationality

8 on the basis of capital

9 on the basis of aims

Company without profit motive

Limited byRegistered shares Chartered

Subsidiary Co Group Companies

Limited by guarantee Deemed Public Joint Venture or Partnership Unlisted Companies

Multi-National Companies Companies not having Share Capital

2. HISTORY OF COMPANY LAW

3. FORMATION OF A COMPANY AND ITS CONSTITUTIONAL DOCUMENTS

4. DETAIL PROVISIONS OF CONSTITUTIONAL DOCUMENTS: MEMORANDUM

Dated the.............................day of ....................19 . Witness to the above signatures X,Y, of.....................

Number of shares taken by each subscriber 3 2 1 2 2 1 1 12

5. CONSTITUTIONAL DOCUMENT: ARTICLES

1. _____________________________ 2. _____________________________ 3. _____________________________ 4. _____________________________

1. _____________________________ 2. _____________________________ 3. _____________________________ 4. _____________________________ Signature of Witness

Transferee(s) (Buyer(s) Particulars Names(s) in full 1. _______________________________ 2. _______________________________

Signature(s) 1. ____________________________ 2. ____________________________

___________________________________________________________________________________ Corresponding Certificate Nos. ___________________________________________________________________________________

___________________________ Name of delivery Broker or Date Clearing Number ___________________________

______________________________________ Power of Attorney Probate Death Certificate ______________________________________

66. 67. 68.

Master in Business Laws Coporate Law

Characteristics of Corporate Personality

Distance Education Department

National Law School of India University

CHARACTERISTICS OF CORPORATE PERSONALITY

By Guarantee Public Multinational Transnational Subsidiary

Salient Features of Organisations

Configuration of assets and capabilities

Decentralized and nationally sufficient

Centralized and globally operated

Role of overseas operation

Sensing and exploiting local opportunities

Implementing parent company strategies

Developments and diffusion of knowledge

Knowledge developed and retained within each unit. Federal subsidiaries

Knowledge developed and retained at centre Country wide Branching

Share & Stock Holders Production Workers Supervisors Technicians Executives

3. LIFTING OF THE VEIL

Now we will try to look at each of these situations briefly.

50/- per day 10/- per copy

3 years 3 years 3 years 5 years -

1. _______________ 2. _ 3. _ 4. _______________

1. _______________ 2. _ 3. _ 4. _______________ Signature of Witness

Transferee(s) (Buyer(s) Particulars Names(s) in full 1. _ 2. _

Signature(s) 1. 2.

_ Corresponding Certificate Nos. _

_ Name of delivery Broker or Date Clearing Number _

Power of Attorney Probate Death Certificate