CHAPTER 2 COMPANY FORMATION STAGES OF COMPANY FORMATION The whole process of formation of a company may be divided into four

r stages namely: 1. Promotion 2. Incorporation 3. Floatation/raising of capital 4. Commencement of business PROMOTION Promotion is a term of wide import denoting the preliminary steps taken for the purpose of registration and floatation of the company. The persons who assume the task of promoters. Who is a Promoter? The Promoter has not been defined in the Companies Act, 1956 but has been extensively used in various provisions of the Act. (Sections 62, 69, 76, 478 and 519 of the Act). Promoter has been defined in Section 62 (6) (Civil liability for misstatements in prospectus) as means a promoter who was a party to the preparation of the prospectus or of the portion thereof containing the untrue statement but does not include person by reason of his acting in a professional capacity for persons engaged in procuring the formation of the company In business parlance, it means A person who originates a scheme for the formation of the company, has the Memorandum and Articles prepared, executed and registered, and finds the first directors, settles the terms of preliminary contracts and prospectus (if any) and makes arrangements for advertising and circulating the prospectus and placing the capital. (Palmer) Under SEBI (Substantial Acquisition of Shares & Takeover) Regulations, 1997 Regulation 2 (1)(h) of SEBI (Substantial Acquisition of Shares & Takeover) Regulation, 1997 [SEBI Takeover Code] defines: (h) Promoter, unless otherwise provided elsewhere, means(i) Any person who is directly or indirectly in control of the company; or (ii) any person named as promoter in any document for offer of securities to the public or existing shareholders or in the shareholding pattern disclosed by the company under the provisions of the Listing Agreement, whichever is later; or

(iii) Any person named as person acting in concert with the promoter in any disclosure made in terms of the Listing Agreement with the stock exchange or any other regulations or guidelines made or issued by the Board under the Act. And includes, The Concept Paper on New Company Law has for the first time proposed a generic definition of `Promoter` (Clause 67). This definition is marketcentric and on the lines of SEBI Takeover Code. Functions of a Promoter Conceiving a business proposition and taking effective steps therefore (1) Discovery of opportunity of profitable business (2) Detailed investigation thereof (3) Persuading a number of persons to form a company (4) Estimating the requirement of capital and planning the procurement of funds (5) Acquisition of necessary assets including building, machinery etc (6) Recruitment of staff Incorporation of the Company Legal position of a Promoter The promoters occupy an important position and have wide powers relating to the formation of a company. He is neither an agent nor a trustee of the proposed. The correct way to describe his legal position is that he stands in a fiduciary position towards the company about to be formed. Liabilities of a Promoter a) For non disclosure 1) Rescind the contract and recover the secret profit. 2) Recover the secret profits without rescinding the contract 3) Claim damages b) Under Companies Act 1) Liable to the original allottee for misstatement in the prospectus. 2) In the course of winding up on an application by Official Liquidator. NCLT may also order for the public examination of the promoter.

CASE EXAMPLES Where a promoter makes some profits in connection with a transaction to which the company is a party and does not make a full disclosure of his profits, the company has the right to affirm the contract and to claim that the promoter should handover his profits to the company (Gluckstein Vs Barnes). A promoter must use his position and powers fairly and reasonably and in the interest of the company and must abstain from exercising undue influence and fraud. (Erlanger Vs New Sombrero Phosphate Co.). Remuneration of and expenses to promoters The inability of a company to contract before its incorporation makes it impossible for its promoters to obtain contractual rights to remuneration for their services rendered before incorporation and indemnity for their expenses incurred before that time. Usually, a promoter is remunerated in any of the following ways: He may sell his own property to the company for cash at a reasonable profit, after making full disclosure to an independent Board of directors or to the intended shareholders. He may sell his property for fully paid shares in the company after making full disclosure. He may be given an option to buy further shares in the company at par. He may take commission on the shares in the company. The company may pay him a lump- sum. The articles may provide for a fixed sum to be paid to him. Preliminary or Pre-incorporation Contracts The formation of a company, which is conceived of any one or more promoters, may involve the acquisition of an existing business concern (a firm or another company) or starting a new business. The acquisition of such property or right of the proposed company requires contracts with the vendors. Such contracts are called preliminary or pre-incorporation contracts. Such contracts are not binding on the company. Because, two consenting parties are necessary to a contract, whereas the company before its incorporation is a non-entity. Therefore, the promoters cannot act as agents of a company which as no existence as yet and the company is not liable for the acts of the promoters done before its incorporation. A pre-incorporation contract on behalf of a company is, therefore, a nullity and the company, after its incorporation can neither sue nor be sued on such contracts. The company cannot ratify or enforce, after it is incorporated a preliminary contract entered into before it incorporation it has to enter into a new contract

with the vendors after incorporation to give effect to the terms of the contract made before incorporation. INCORPORATION Prohibition of association exceeding certain numbers Illegal Association An association of persons or partnership is required to registered as a company under Companies Act 1956 if formed for the purpose of carrying on the business of Banking consisting of more than 10 persons Any other business consisting of more than 20 persons This section shall not apply to a joint family business. Such an association or partnership is an illegal association. It cannot sue but its members are individually liable on such contract. Mode of incorporation (Section 12) A company may be formed when the following number of persons (living/nonliving) by subscribing their names to a Memorandum of Association and otherwise complying with the requirements of the Companies Act in respect of registration: A private limited company - any 2 or more persons A public limited company - any 7 or more persons Such a company may be either(a) Company Limited by Shares - A company having the liability of its members limited by the memorandum to the amount, if any, unpaid on the shares respectively held by them. (b) Company Limited by Guarantee -A company having the liability of its members limited by the memorandum to such amount as the members may respectively undertake by the memorandum to contribute to the assets of the company in the even of its being wound. (c) Unlimited company - A company not having any limit on the liability of its members. Formation of a company A Company is said to have been formed when it has been registered under the Companies Act and has obtained a Certificate a Certificate of Incorporation from the Registrar of Companies. But to prior to incorporation, the promoters (that the persons who conceive of the idea of forming the company are pioneers) have to under take several steps preparatory to incorporation. Incorporation Stage A Company is said to have been incorporated or registered when it obtains the Certificate of Incorporation from the Registrar of Companies (ROC).

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Certain steps have to be taken and necessary legal formalities completed for that purpose. STEPS FOR THE INCORPORATION Application to concerned ROC for approval of name No company shall be registered by a name, which, in the opinion of the Central Government, is undesirable, identical with or too nearly resembles the name of an existing company. The promoter shall make the application in prescribed form (Form 1A) duly filled in along with fee of Rs. 500/-. Exception When the proposed company and the existing company are under the same with a view to having advantage of the goodwill attached to the management or group name, such a name may be allowed. Example K G Khosla Compressors Ltd. and Prashant Khosla Pneumatics Ltd.; The ROC will make preliminary inquiries to ensure that the name allowed by him is not misleading or intended to deceive with reference to its Object Clause. The promoters are required to complete all the related formalities for incorporation of the company within within 3 months from the date of intimation of availability of name by the ROC, which be extended by another period of 3 months. Preparation of Memorandum of Association The Memorandum of Association is the constitution of the company which the objects and scope of the companys activities and its relation with the outside world. It should contain the clauses prescribed in Sec 13 of the Companies Act and should be in the format laid down in Table B of Schedule I of the Act or in a format as near thereto as the circumstances permit. Statutory clauses of the Memorandum (Sec 13) are: 1. Name Clause 2. Domicile clause 3. Objects Clause (a) Main Objects Objects incidental to the attainment of the main objects (b) Any other Objects 4. Liability Clause 5. Capital Clause 6. Association Clause Preparation of the Articles of Association Along with the Memorandum the promoters have also to prepare the Articles of Association. A company may decide to have its own Articles or it may adopt all

or any of the Regulations contained in Table A of Schedule I of the Companies Act 4. Printing, signature and stamping of Memorandum and Articles The memorandum and Articles of Association must be printed, after vetting by the ROC, divided into paragraphs, numbered consecutively and signed by each subscriber to the memorandum. Each subscriber should give his address, description and occupation and sign in the presence of at least one witness who shall attest his signature giving his address, description and occupation. Each subscriber to the memorandum must also indicate the number and class of shares taken by him. An agent may also sign the memorandum on behalf of a subscriber, if he is duly authorized by a Power of Attorney (Sec 15). The Memorandum and Articles of Association must be stamped and he value of stamp differs from State to State as per respective State Stamp laws. 5. Power of Attorney The promoters may appoint an attorney empowering him to carry out he instructions/requirements stipulated by the Registrar. 6. Preparation and filing of other documents The following documents are required to be filed with the ROC of the State in which the company is proposed to be incorporated, along with prescribed registration and requisite filing fees (Sec 33) i. Memorandum of Association ii. Articles of Association, if any iii. Copies of Preliminary Agreements, if any iv. Power of Attorney v. Copy of ROC`s letter approving the name vi. Consent of the Directors and undertaking to take the qualification shares in Form No. 29 vii. Particulars of Directors etc in Form 32 viii. Notice of Registered Address in Form 18 ix. Statutory declaration in Form 1. 7. Certificate of Incorporation a conclusive proof After scrutinizing the documents filed and on being satisfied that these are in order that the requisite fee have been paid and that all the legal requirements have been complied with the Registrar will enter the name of the company in the Register of Companies and issue a Certificate of Incorporation. The date mentioned in the Certificate is the date of incorporation of the company. A certificate of incorporation given by the Registrar shall be conclusive evidence that all the requirements of the Act have been complied with in respect

of registration and matters precedent and incidental thereto, and that the association is a company authorized to be registered and duly registered under this Act. (Section 35) CASE EXAMPLE The memorandum of association of a company was signed by two adults and by a guardian of other five members, who were minors. The ROC however, registered the company and issued under his hand a certificate of incorporation. The court held the certificate to be conclusive for all purposes. (Moosa v. Ibrahim) Where the object of a company is unlawful, it has been held that the certificate of registration is not conclusiveness for this purpose (Performing Right Society Ltd. Vs. London Theatre of Varieties) Effect of Certificate of Incorporation From the date of incorporation mentioned in the Certificate of Incorporation, a company by that name shall be deemed to have been created. The Company shall be capable of exercising all the functions of an incorporated company and having perpetual succession and a common seal. The subscriber of the memorandum shall be deemed to be the members of that Company. FLOATION/RAISING OF CAPITAL When a public company has been registered and has received its certificate of incorporation it is ready for floatation it can go ahead with raising capital sufficient to commence business and to carry it on satisfactorily. Since a private limited company is prohibited from inviting public to subscribe to its share capital, the requisite capital has to be obtained from friends and relatives by private arrangements. COMMENCEMENT OF BUSINESS A private company or a company having no share capital may commence business and exercise its various powers immediately after it is incorporated. A public limited shall obtain Certificate of Commencement of Business (COB) before it can commence it business or exercise its borrowing powers. Following documents are required to be filed with ROC for the purpose (Section 149): i. Prospectus (only where it is proposed to issue prospectus for raising capital from public) ii. Statement in Lieu of Prospectus (where no prospectus is proposed) iii. Declaration by Director(s) regarding qualification shares, if any. iv. A duly verified declaration by a Director or Company Secretary or Company Secretary in whole time practice affirming duly compliance of related provisions.