Part II

Company Law

1 Introduction
1.1 General
Modern business is characterized, inter alia, by the company from
of business ownership. It happens to be the most popular means of
carrying on a business activity though it may also be floated to
promote art, science, sports or culture in the society. Formation,
day-to-day governance and winding up of companies in India is
regulated presently by the Companies Act 1956. For managers and
other stakeholders interested in a company, the knowledge of its
basic principles and provisions is of paramount importance.
1.2 Meaning and Features of Company
The word company is used generally to mean an association of
persons having common objectives. Every association, however, is
not a company in the eyes of law. Legally, a company refers to an
association which is registered as a company under the
Companies Act, 1956.
The basic features of a company are listed below:
(i)
It is a voluntary association of persons;
(ii)
It is a creation lf law;
(iii) It is incorporated for specific objects only;
(iv) It has a separate legal entity;
(v)
Its members, generally, have limited liability;
(vi) Its capital, if any consists of transferable shares;
(vii) It has separation of ownership and management; and
(viii) It acts through a common seal.
A brief description of the features of a company follows to enable
us to appreciate its true nature.
12.1 Voluntary Association of Persons
A company is a voluntary association of persons. This implies that a
person may become, and may cease to be, its member at his own
volition or discretion. However, under the law, such discretion must
be expressed in writing.

The Companies Act, 1956, lays down the minimum number of

person whose association is necessary to form a company.
According to it, at least 7 person are required to form a public
company and minimum of 2 persons to form a private company.
It also requires that the maximum number of members (excluding
past and present employees who are number also) in a private
company shall not exceed 50. However, there is no such limit on
the maximum number of members in a public company.
1.22 Creation of Law
A company is brought into existence by a legal process called
incorporation which clothes it with a personality. The personality
so conferred enables it to act like a natural person, e.g., it can
enter into a contract, can buy and hold property, cau sue and be
sued in court of law, etc. It, however, does not possess a physique
like a human being and is termed as an artificial person to
distinguish it for him. Being an artifical person, it suffers from
certain disabilities vis--vis natural person. For example, it cannot
marry, cannot appear in person, cannot be appointed as a secretary
in another company, etc.
It may be noted that, like its incorporation, a company ceases to
exist also by a legal process called dissolution.
1.2.3 Incorporation for Specific Objects only
A company is formed for the purpose of attaining certain objects.
These objects are required to be stated expressly in its constitution
which is known as Memorandum of Association. A company is
granted incorporation to enable it to realize such objects only. In
other words, its personality exists only for the particular purposes
of incorporation as defined in its memorandum of association.
Consequently, a company can undertake only those activities which
are designed to achieve the specified objects or are incidental
thereto but nothing else. Such a restriction on the powers of a
company, by confining corporate activities as aforesaid, provides
protection
(i)
to the shareholders by ensuring that the funds contributed by
them shall not be employed in any unauthorized activity and,
thus, their investment would not face an uncontemplated
risk; and
(ii)
to the creditors by ensuring that the corporate funds, to
which they ultimately look for the repayment of their debts or
loans, shall not be wasted away in unauthorized activities.

The objects of a company determine the sphere in which it shall

operate, for it cannot undertake any activity outside it. An act
outside such sphere is known as an ultra vires act and is destitute
of legal consequences, ie., is void. Consequently, it does not bind
the company. Further, such an act cannot be validated even by the
unanimous consent of all its members.
1.24 Separate Leal Entity
As pointed out earlier, the incorporation of a company clothes it
with a legal personality. This personality of a company is in no way
connected with the personalities of its members who constitute it.
In short, a company has a separate legal entity. The law considers
and treats a company and its members as different personalities.
The attribute of separate legal entity of a company gives rise to
many consequences. Some of these may be enumerated as under:
(i)

(ii)

(iii)

(iv)

The Rights and Duties of a company an its Members are

Different. It is so because the company and its members are
different entities. One cannot be held liable for the acts of
another. Consequently, a company, and not its members, can
enforce its rights. On similar grounds, it alone can be sued
for its debts and obligations and its creditors enjoy no rights
against it members.
Contracts between company and its members are Possible. It
stems from the fact that a company and its members are
separate entities. As a necessary consequence, they can be
debtor and creditor of each other. The magic of separate
entities of company and each member enables them to be,
master and servant at the same time.
A Company Enjoys Perpetual Existence Until Dissolved by
Law. Its life remains unaffected by the lunacy, insolvency or
death of its members. During the ware all the members of a
private company, while in general meeting, were killed by a
bomb. But the company survived; not even a hydrogen bomb
could have destroyed it. The members may come and go but
the company can go on for ever.
A Company, Being a Legal Entity, Can Buy and Own Property
in its Own Name. An, being a separate entity, such property
belongs to it alone. Its members are not the joint owners of
the property even though it is purchased out of the funds
contributed by them. Consequently, they do not have even an
insurable interest in the property of the company.

12.5 Limited Liability of Members

The liability of the members of a Company is generally limited,

although it can be unlimited also. The Companies Act, 1956,
requires every company to state the extent of liability of its
members in its memorandum of association under the Liability
Clause. The said clause reveals whether the liability is limited, or
unlimited and further, whether it is limited by shares or by
guarantee.
Where the liability of members in a company is limited by shares,
each member undertakes to pay an amount not exceeding the
nominal value of shares held by him. Where such liability is limited
by guarantee each member promises to pay an amount not
exceeding the amount guaranteed by him in the event of its
winding up. The liability of a member in a company limited by
guarantee and having a share capital is equal to the nominal value
of shares held by him and the amount guaranteed by him. It may
be noted that, in all these cases, the liability of a member does not
exceed a certain sum, that is, the nominal value of shares held by
him or/and the amount guaranteed by him. Thus their liability is
limited.
In certain cases, the liability of the member of a company may be
unlimited that is, may not be limited to a certain sum. However,
such companies are rarely formed because the unlimited liability
may have disastrous consequences for the members in case of loss.
12.6 Capital consists of Transferable Shares
The capital of a company is divided into parts and each part is
known as a share. Each shares has a nominal or face value which is
expressed in terms of money and it represents the maximum
amount which its holder may be asked to pay.
The shares in a company are transferable in the manner provided
in its articles. Accordingly, a shareholder in need of money may sell
his shares in the open market and thus satisfy his need without
disturbing the financial position of the company. The characteristic
of transferability of shares provides liquidity to the investor and
financial stability to the company.
It may be noted that a private company puts restrictions on the
transfer of shares through its articles. However, it does not take
away the right to transfer shares absolutely.
12.7 Separation of Ownership and Management
There is separation of ownership and management in a company
which implies that it is not managed by all those who own it in the

ultimate analysis, i.e., its members. As the number of members in a

company, generally, is large, it is neither practicable nor feasible to
entrust its management to all of them in view of the obvious
difficulties involved. Therefore, it is entrusted to their elected
representatives who are knows as directors. However, the ultimate
control of a company rests with its members, for they are
empowered to remove any director and replace him by a new
director, to amend the memorandum or articles of the company etc.
In addition to it the directors cannot act without their approval or
permission in certain cases.
12.8 Common Seal
As a company is devoid of physique, it cannot act in person like a
human being. Alternatively, it employs natural persons to act on its
behalf. To identify the acts done by such people as agents, a seal
exhibiting the name of the company is affixed over the relevant
documents. The seal, knows as Common Seal, is taken, at law, to
be equivalent to the signatures of the company. It, however, must
be affixed in the presence of and must be signed by, at least 2
directors and the secretary or such other persons as the Board may
authorize for this purpose.
1.3 Lifting of Corporate veil
The law courts, in general, respect the principle of separate entity
of a company and treat the company and its members as different
personalities. It contemplates a distinction between company and
members and this is knows as corporate veil. However, whenever
fraudulent use is made of the principle of separate entity or
corporate veil, it would be imprudent to allow the defaulters to
take shelter behind the corporate faade. The courts, in such cases,
try to ascertain the reality by ignoring the rule of separate entity
and treat the company and its members as one. This is known as
piercing of lifting the corporate veil. The circumstances when the
corporate veil may be lifted include the following:
(i)
(ii)
(iii)

(iv)

When it is desired to ascertain the character of the company,

e.g., to find out whether it belongs to an alien enemy.
When it is desired to prevent the evasion of taxes.
When it is desired to check fraud or improper conduct, e.g.,
where a company has been formed to defraud creditors or
avoid legal obligations.
Where the number of members in company is reduced below
7 (in case of public company) or 2 (in case of a private
company) and the company carries on business for more than

(v)

(vi)

6 months with reduced members, every member, who is

cognizant of this fact, shall be personally liable for the
repayment of debts contracted during period after the said 6
months.
Where a person enters into any contract, accepts a bill of
exchange or orders for goods on behalf of the company but
without disclosing the name of the company fully and the fact
of his agency, he would be personally liable for his acts
unless the liability contracted is paid off by the company.
Where during the course of winding up of company, it
appears that any business of the company has been carried
with intent to defraud creditors of the company, any other
person or any fraudulent purpose, those responsible for such
conduct of business may be held liable for the debts of the
company.

1.4 Company person but not citizen

The law confers personality on a company for limited purposes,
e.g., to enable it to enter into contracts to accomplish corporate
goals. Hence, many of the rights, privileges and abilities of a
natural person are not enjoyed by it. The constitution of India as
also the Citizenship Act, 1955, does not bestow it with citizenship.
It can, enjoy those fundamental rights as are available to all
persons but not the ones which are available to citizens only.
1.5 Nationality and Domicile of Company
A company, being a person, has a place of domicile or residence
which is determined with reference to the place of its registered
office. A company having registered office in Delhi would be a
resident of the place. Further, the domicile determines the
nationality of a company. In nutshell, a company has a nationality
depending upon its place of residence.
1.6 Types of Companies
The companies which can be formed and registered under the
Companies Act, 1956, may be of the following two types:
(i)
Public, and
(ii)
Private.
1.6.1 Public and Private Companies
A public company means a company which has a minimum paid up
capital of five lac rupees and is not a private company. A private

company means a company which has a minimum paid up capital

of one lac rupees and which, by its Articles,
(i)
restricts the right to transfer its shares, if any;
(ii)
limits the number of its members to 50 (excluding those
members who are or were in the employment of the
company); and
(iii) prohibits any invitation to the public to subscribe to its
shares or debentures.
Private companies are generally family concern and are formed to
carry on business on a small scale. Unlike a public company, its
activities are financed by the funds contributed by its members and
not by the general public. Since such companies do not employ
public funds, the need to control their activities is less as compared
to public companies. Therefore, they are exempted from the
operation of several sections of the Companies Act, 1956, and
enjoy certain privileges. Some of these are as follows:
(i)
The formation of a private company requires only two
persons.
(ii)
It may allot shares without issuing a prospectus of filing a
statement in lieu of prospectus.
(iii) It can commence business immediately on its incorporation
and is not required to obtain the certificate to commence
business for this purpose.
(iv) It may allot its new shares to the outsiders without offering
them first to the existing members.
(v)
It is not required to hold a statutory meeting or to deliver a
statutory report to the Registrar.
(vi) At its meetings, only two members can demand a poll.
(vii) It may have only two directors and enjoy the following
exemptions as regards the appointment of directors:
(a) all its directors may be appointed as directors for life or as
permanent directors;
(b) they are not required to retire by rotation;
(c) they can be appointed en bloc by single resolution; and
(d) they can be appointed without signing and filing with the
Registrar the consent in writing to act as such.
(viii) The annual accounts and balance sheet of a private company
filed with the Registrar are not open for inspection to the
general public.

1.7 Conversion of Private company into public company

A private company may be converted into a public company in the
following ways:
(i)
Conversion by default
(ii)
Conversion by choice
1.7.1 Conversion by Default
A private company enjoys various exemptions under the Companies
Act only so long as it complies with restrictions contained in its
Articles that make it private. If it defaults in complying with any of
them, the provisions of the Companies Act become applicable to it
as if it were a public company.
1.7.2 Conversion by Choice
A private company may convert itself into a public company by
passing a special resolution altering thereby its Articles of
Association and deleting the relevant restrictions contained
therein. Within 30 days of passing the resolution, the company
shall file with the Registrar of Companies, a prospectus of
statement in lieu of prospectus. It shall also raise the number of its
members to the statutory minimum 7 and that of its directors to a
statutory minimum 3, if required. It will, after the conversion,
follow the provisions of the Companies Act as are applicable to a
public company.
1.8 Conversion of public company into private company
A public company can be converted into a private company by
taking the following steps:
(i)
The Articles of the company should be altered so as to:
(a)
restrict the right of its members to transfer shares, if
any;
(b)
limit the number of its members (excluding past and
present employees of the company who are its
members also) to 50;
(c)
prohibit invitations to the public to subscribe to its
shares and debentures; and
(d)
to delete any other provision contained therein which
the Articles of a private company should not contain,
e.g., power to issue share warrants.

The aforesaid amendments can be made by passing special

resolutions. A copy of each such resolution must be filed with the
Registrar within 30 days of passing it.
(iii)

(iv)

(v)

(vi)

The name clause in the Memorandum of Association of the

company shall also be changed by passing a special
resolution as the new name of the company shall end with
the words Private Limited. A copy of such a resolution is
also required to be filed with the Registrar within 30 days of
its passing.
The company should obtain approval of the Central
Government to the alteration of Articles which has the effect
of converting it into a private company. From the date of
approval by the Central Government the company ceases to
be public company and becomes a private company.
A printed copy of the altered Articles must be filed with the
Registrar within one month of the date of the receipt of the
order of approval passed by the Central Government.
Lastly, the company should take steps to follow the provisions
as are applicable to a private company. For example, it should
take steps to reduce the number of members and limit it to
50. Similarly, it should convert its share warrants into share
certificates, and so on.

1.9 Holding Company and Subsidiary Company

A company is termed as a holding company only if it has a
subsidiary. A company shall be deemed to be a subsidiary of
another if:
(i)
that other controls the composition of its Board of Directors;
(ii)
that other exercises or controls more than half of the total
voting powr or more than half in nominal value of its equity
share capital; or
(iii) It is subsidiary of any company which is that others
subsidiary.
It maybe noted that (i) the composition of companys Board of
Directors shall be deemed to be controlled by another company if,
but only if, that other company by the exercise of some power
exercisable by it at its discretion, without the consent or
concurrence of any other person, can appoint or remove the
holders of all or a majority of the directorships; (ii) that other
company shall be deemed to have power to appoint to a

directorship with respect to which any of the following conditions

is satisfied, that is to say :
(a)
that a person cannot be appointed thereto without the
exercise in his favour by that other company of such a power
as aforesaid;
(b)
that a persons appointment thereto follows necessarily from
his appointment as director (managing agent, secretaries and
treasures) or manager of, or to any other office of
employment in that other company; or
(c)
that the directorship is held by an individual nominated by
that other company or a subsidiary thereof.

1.10 Government Company

Government company means a company in which not less than
fifty-one per cent of the paid-up share capital is held by the Central
Government, or by any State Government or Governments, or
partly by the Central Government and partly by one or more State
Governments and includes a company which is a subsidiary of a
Government company as thus defined.
1.11 Prohibition of Association exceeding twenty persons
No company, association or partnership consisting of more than 20
persons shall be formed for carrying on any business (more than 10
in case of banking business) for profit unless it is registered as a
company under the companies Act, 1956 or is formed in pursuance
of some other Indian Law.
The aforesaid rules do not apply to a joint family or Hindu
Undivided Family. Where two or more joint families carry on a
business together, the said rules apply but in computing the
number of persons, minor members of such families shall be
excluded.
Every member of a company, association or partnership carrying
on business in violation of the above rules shall be personally liable
for all liabilities incurred in such business and shall also be
punishable with fine which may extend to one thousand rupees.
1.12 Incorporation of Company
A company is brought into existence by a legal process called
incorporation. This process, broadly speaking, entails:
(i)
promotional activities, and

(ii)

filing of documents

1.12.1 Promotional Activities

These include making decisions and performing acts that lead to
incorporation, such as, the nature of business, the members who
would constitute the company, the type of company to be floated
public or private, size business and capital, plae of registered
office, the first directors of company, etc. The people wo undertake
these promotional activities are knows as promoters. They, with
the help of professionals like advocates, chartered accountants,
engineers, company secretaries, etc., formulate project report on
business to be carried on and get the legal documents drafted. In
particular, they should arrange for approval of Registrar of
Companies to the proposed name of the company. In addition, they
should keep in mind the following requirements.
(i)
Any seven or more persons (or where the company to be
formed will be a private company, any two or more persons)
associated for any lawful purpose may form an incorporated
company, with or without limited liability. For this purpose,
they need to subscribe their names to the memorandum of
association and also have to comply with the other
requirements in respect of registration.
(ii)
Such a company may be either.
(a)
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 (termed a
company limited by shares);
(b)
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 event of
its being would up (termed a company limited by
guarantee); or
(c)
a company not having any limit on the liability of its
members (in this Act termed an unlimited company).
1.12.2 Filing of Documents
The following documents, duly stamped, are required to be filed
with the Registrar of Companies having jurisdiction over the state
in which the registered office of the company shall situate:
(i)
The Memorandum of Association duly signed by 7
subscribers in case of a public company and by 2 subscribers
in case of a private company.

(ii)

(iii)

(iv)
(v)

(vi)

The Articles of Association signed by the subscribers to the

Memorandum of Association. A public company limited by
shares may, if it so desires and does not file its own Articles,
give a declaration that it has adopted Table A in Schedule I to
the Companies Act, 1956, either fully or partially.
The agreement, if any, which the company proposes to enter
into with any individual for appointment as its managing or
whole time director or manger.
The written consent of the people who have agreed to act as
first directors.
Undertaking by first directors to take up and pay for
qualification shares, if any
It may be noted that requirements stated as point number
(iii) and (iv) above are not applicable to a private company.
A statutory declaration that all the requirements of the
Companies Act, 1956, pertaining to registration of the
company have been complied with. The declaration shall be
signed by any one of the following:
(a)
an advocate of the Supreme Court or of a High Court.
(b)
An attorney or a pleader entitled to appear before a
High Court.
(c)
A practicing secretary or a chartered accountant who is
engaged in the formation of the company.
(d)
A person named in the Articles as a director, manager
or secretary, of the Company.
Fee for registration should also be paid.

1.12.3 Award of Certificate of Incorporation and its Effect

If the Registrar is satisfied that all the requirements aforesaid have
been complied with by the company and that it is authorized to be
registered under this Act, he shall retain and register the
memorandum, the articles, if any, and the agreement relating to
appointment of managerial personnel, if any.
On the registration of the memorandum of a company, the
Registrar shall certify under his hand that the company is
incorporated and, in the case of a limited company, that the
company is limited.
From the date of incorporation mentioned in the certificate of
incorporation, such of the subscribers of the memorandum and
other persons, as may from time to time be members of the
company, shall be a body corporate by the name contained in the
memorandum, capable forthwith of exercising all the functions of

an incorporated company, and having perpetual succession and a

common seal, but with such liability on the part of the members to
contribute to the assets of the company in the event of its being
wound up.
1.12.4 Conclusiveness of Certificate of Incorporation
A certificate of incorporation given be the Registrar in respect of
any association shall be conclusive evidence that all the
requirements of this 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.
1.13 Pre-Incorporation Contracts
The law stipulates that at least two persons are essential to form a
contract. Since a company, before incorporation, does not exist, no
contract can be made by it or by an agent on its behalf.
Accordingly, pre-incorporation contracts are nullity and cannot be
enforced either by or against a company. The board effects of such
contracts are as under:
(i)
A company is not bound by pre-incorporation contracts.
(ii)
It cannot enforce a pre-incorporation contract against the
other parties.
(iii) The promoters are personally liable on such preincorporation contracts since the Indian Contract Act makes
an agent personally liable for contracts entered into on
behalf of a principal not in existence.
The promoters, however, can avoid their liability by disclosing to
the other party the fact of non-existence of company at that point
of time and by providing in the contract that they would be
absolved of their liability.
(a)
if the company, after incorporation, enters into a fresh
contract with the other party on terms and conditions as
contained in pre-incorporation contract.
(b)
If the company does not enter into a fresh contract as stated
in (i) above, either of the parties may rescind the contract.
(iv)

The specific performance of a contract may be obtained by

any party when the promoters of a company have, before its
incorporation, entered into it for the purposes of the
company and such contract is warranted by the terms of its
incorporation provided that the company has accepted the

same and has communicated such acceptance to the other

party to the contract.
1.14 Certificate to commence business
A private company can commence business immediately on grant
of certificate of incorporation. But, a public company can do so only
after it has obtained another certificate which is knows as the
certificate to commence business or the trading certificate. It is
granted after a public company has completed specified procedure
and submitted certain specified documents and fee for the purpose.