You are on page 1of 17

Advantages and disadvantages of incorporation

Advantages of incorporation The following are the advantages of incorporation they are:1.Independent corporate existence; 2.Limited liability; 3.Perpetual succession; 4.Transferable shares; 5.Capacity to sue and be sued; and 6.Accumulation of large capital.

1.

Independent corporate existence;


The company is juristic person. It has separate legal entity. The company is an association of persons formed for the purpose of some business or undertaking carried on the name of association. But at the same time it has its own independent corporate existence, which is called corporate personality. It is also known as rule of Salomon vs. Salomon. It is formed with the members and at the same time it is independent of its members. It is corporate aggregate; it functions like a corporate

sole. The company is at law a different person altogether from its members. This is also called as the veil of corporation the theory of corporate personality entity is indeed, the basic principle on which the whole law of corporation is based. The theory which explains about the corporate personality is known as organic theory. Organic theory: - the human body is composed with several organs with a brain to think and other parts to think and other parts to functions. Similarly the company also functions. It is called organic theory. Denning L J. explains organic theory in the following words: a company shall have a residence registered office. It has a purpose and business motto. The civil and criminal liabilities are imposed upon the company, when it acts ultra vires. But certain criminal offences, viz. murder, etc., where the mens rea acts and a mandatory period of imprisonment or punishment to death, are mentioned, the corporate liability is clearly excluded. In the cases, viz. breach of trust, forgery, defamation, etc. the criminal liability is imposed upon the company under organic theory this theory also accepts respondent superior in case of torts and civil liabilities. This theory recognized 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 acts of the board as acts of the company itself. Salomon vs. Salomon & co. ltd. (1897 AC 22)

It is the leading case showing independent corporate existence. Brief facts: Salomon was a boot and shoe manufacture and had a good reputation and profitability too. He formed Salomon & co. Ltd, with the share capital of 30,000/- pounds. His wife, one daughter and four sons and he, totally 7 members, were the subscribers to the company. Each share was @1 pound. Salomon paid his share amount. He also paid 10,000/- pounds towards debentures in the company. After some years the company was in loss, and was winded up. At the time of winding up, the company had left property worth 6,000/- pounds, and the liabilities were 17,000/- pounds (10,000/- pounds towards debentures of Salomon and 7,000/- pounds towards due to unsecured creditors =totally 17,000 ponds). Unsecured creditors claimed their importance over the property of 6,000 pounds. Salomon also claimed that he had charge over the company and he was a secured creditor, being he was the holder of debentures worth of 10,000/- pounds, which created a charge over the company. The created by Salomon and his family members and in fact Salomon and the company were one and the same person and that the company was a mere agent for Salomon, and therefore they should be paid in priority than Salomon. Judgment: the House of Lords gave the judgment in favour of Solomon treating his debentures being secured

debt, created a charge on the property of the company, and also declared that the company was, in the eyes of the law, a separate person independent from Salomon. Salomon was not the agent or trustee of the company. Case law Lee vs. lees air farming ltd. (1961 ac 12) Brief facts of the case; Mr. Lee was a pilot. He formed lees air farming ltd. He took 2,999 shares out of total shares 3,000. He was the managing director of that company. He himself voted for the appointment of pilot in the company. Thus he was appointed as a pilot. Some year after, he was killed in an aero plane accident. Mrs. Lee claimed the compensation from lees air farming ltd., and its insured. The insures contended that Mr. lee was not an employee of lees air farming ltd, because he himself retained the shares 2.999 out of 3.000 shares, and the company and he were the same person. Judgment; the House of Lords gave the judgment in favor of Mrs. Lee. Their lordships held that the company lees air farming ltd had legal entity. It was independent with Mr. Lee. In effect, the magic of corporate personality enabled lee to be the master and servant at the same time. It accepted the claim of Mrs. Lee.
2.

Limited liability;

Limited liability;- means the liability of the member is limited to the extent of his share only. In a partnership firm, the partner is liable to the complete extent, even

personal liability also in a partnership firm, A and B partners invest Rs. 1.00.000 towards the capital of the firm, each @Rs 50.000/- the firm brings one lakh rupees loan, and becomes insolvent. B also becomes insolvent. A is solvent. The creditors sue A for the recovery of one lakh rupees. A is liable to pay entire amount, being the partner of the firm. He is personally also liable for the loan of the partnership firm. In the partnership firms, the principle of principal and agency is applied. A partnerships firm does not contain separate legal existence it is not a juristic person. But a company incorporated protects the members of it in way of limited liability. In a company, the principle of principal and agency does not apply. The shareholder is liable to the extent of his share amount only, not exceeded that. This is the main distinction between partnership firm and company. Examples; a company is started with 100crores of share amount. Suppose you have purchased 100 shares each worth Rs. 10/- . Totally you paid Rs. 1.000/- if the company is the in profit you will get profit at the rate divided for each share. If the company is in loss you will get loss on Rs. 1.000/-. at the rate divided for each share. Supposes you paid 1000 towards the share amount and you are due to pay Rs. 500as call if the company is wounded up due to losses you have to pay the remain grs 500 call amount. If you have already paid Rs. 1.000 towards your hundred shares and the debt is in excess of share value, your share amount is paid towards the debt,

and you are not liable to pay additional money towards the debt.
3.

Perpetual succession;

A man dies. But an incorporated company never dies. It is an entity with perpetual succession. Blackstone explains. Perpetual succession therefore means that the membership of a company may keep changing from time to time but that does not affect the companys continuity in the like manners as the river Thames is still the same river, though the parts which compose it are changing every instant. Grower, the jurisprudent says; the members may come and go but the company can go on forever. During the war all the members of one private company, while in general meeting, were killed by a bomb but the company survived not even a hydrogen bomb could have destroyed it.
4.

Separate property;

The company is a juristic person. It has its own legal property. It is liable for its own debts it is independent to its members. The members liability is limited to the extent of their shares only. Case law Macaura vs. northern assurance co. ltd (1925AC 619)

Brief facts: - A timber merchant owned timber business. He formed northern assurance co. ltd. and became the managing director. The timber yard was transferred to the company, the timber merchant insured entire timber yard on his personal name. Later, the timber yard was destroyed in a fire accident. The company claimed insurance the insurance company contended that the timber yard was owned by the company and insured by another person therefore they could not pay the compensation. Judgment; The House of Lords admitted the contention of the insurance company. Principle: Walton, judge explained the property of the company is not the property of shareholders. It is the property of the company.
5.

Transferable shares;

The shares of a public company can easily be transferable. The transferee and transferor shall have to sign on form no. 7-c and other, necessary from under sec. 108 and shall submit them along with the original share certificate to the Registrar of companies and register the name of the transferee the name of the transferee. The name of the transferee shall also be entered in the Register of members of the concerned company, and the name of the transferor shall be struck out.
6.

Capacity to sue and be sued;

The company comes into existence from the date on which the certificate of incorporation is granted. This certificate brings the company into existence as a legal person. It can sue can be sued in its own name 7. Accumulation of large capital;

A large capital can be accumulated by way of incorporation. Such large amount cannot be procured by a proprietorship or partnership firm. The company limited company and all multi-national companies can accumulate huge capital by way of sale of shares throughout the country and each at the global level. The budget of some of the multi-national corporation exceeds several folds than Indians annual budget, the budget of Microsoft. A multi-national corporation of Bill Gate of America is several times greater than our countrys budget.

8.

Centralized management;

All the companies are managed under the centralized management, i.e., the board of directors the shareholder indirectly. Therefore fast and quality decisions and their implementation take place.

Disadvantages of incorporation

Comparatively, advantages of incorporation are very large and convenient than disadvantages of incorporation disadvantages are very less and very few these are; 1.Lifting the corporate veil; 2.Formality and expenses; 3.Company is not a citizen; and 4.Criminal liability.

1.

Lifting the corporate veil;


Meaning: - the rule in Salomon vs. Salomon & co. ltd. It is also known as the veil of corporation, independent corporate existence, corporate personality the courts are bound to honour this principle. The veil of corporation is only a fictional veil, and it is not a wall between the company and its members. But sometimes, the person creates the company for their pure selfishness with fraud means, under such circumstances. Courts lift the veil. And withdraw the corporate personality from such corporation. It is called lifting the corporate Veil. Definition: the supreme court of America Corporation will be looked upon as a legal entity as a general rule but when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud or defend crime, the law will regard the corporation as an association of persons.

Exception to Salomons rules: - lifting of corporate veil is the exception to Salomon vs. Salomon &co. ltd. Rule. Salomon rule is a general rule. It is an exception to lifting of corporate veil. This lifting of corporate veil can be studies in in the following sub-heads. a.enemy character b.to prevent tax evasion c. fraud or improper conduct d.acting as agent or trustee of the shareholders e.where the company is a sham f. protection of public policy g.arrangement or amalgamation
a.

Enemy characters: - the function, purpose, object, etc. of a company should be in accordance with the nations interest, besides its own profitability motto. The company should strengthen the nations economy. It should not encourage the enemy country. This is called. Determination of enemy character if any sings of enemy characters are shown in any company. Then the court can interfere, and can lift the corporate veil. DAIMLER CO TIRE VS. CONTINENTAL TIRE & RUBBER CO.is the leading case on this topic. To prevent tax evasion: in fact, incorporation of company is intended for the tax benefits every

b.

country gives certain tax benefits to companies. This is the important reason for the development of companies all over the world However; some persons try to evade the taxes. To prevent such tax evasion, the corporate veil may be lifted. SIR DINSHAW MANECKJEE PETIT is the leading case. In re sir dinshaw maneckjee petit (AIR 1927 Dom 371) Brief facts; dinshaw maneckjee petit was a very rich man. With an intention to evade the taxes he formed four companies I which he was the managing director and filled those companies with his family members. After incorporation, he diverted all his black-money to those companies. Thereafter, he obtained loan from those companies. The resources of income to those companies were not disclosed. The fact to evade the tax evasion was apparent on the face of record. Judgment; the Bombay high court held that the four companies were fake, and lifted corporate veil of them.
c.

Fraud or improper conduct; some persons create a fake company with an intention to defraud the opposite parties and to avoid legal obligations. When the fraud is apparent on the face of the record, the court could interfere and decide the company as improper.

Jones vs. lip man (1962)

Brief fact of case; lip man had certain lands. He entered into an agreement to sell the land to jones. Later, he changed his mind. He approached an advocate and asked the way to evade the agreement. The advocate advised him to form a company and to sell the land to it. According to the advice, lip man formed a company with him and the clerk of advocate. After incorporation, he registered the sale deed on the land to that company. Jones sued lip man for the specific performance of the contract. Lip man & co. interfered and contended that it had purchased the land. Judgment; the house of lord held that incorporation of lip man& co. was a fake and intended to defraud the original purchase-jones. It ignored the transfer between lip man and lip man & co., and ordered lip man to convey the land to jones.
d.

Company acting as agent or trustee of the share holders; where a company is acting as agent for its shareholders and such acting may be set aside by the courts in certain appropriate case. In those circumstances, the corporate veil is lifted by the courts. In re F.G. films ltd. (1953) Brief facts; an American company wanted to film in India. That American company wanted to incorporate a company in Britain, with 90%shares of the company and 10% shares of British people the board

of trade of Great Britain refused to register the firm as a British firm. The American company challenged the decision of the board. (The incident of this case occurred before the independence of India, which was under the control of Great Britain.) Judgment; the House of Lords upheld the decision of the board.
e.

Where the company is a shame; competition is the basic principle of the business. But such competition must be within some limits, and should not encroach and defraud others. Where some of the employees or subscribers of a company want to destroy that company and want to establish a rival company then that new company is a sham company. The court may lift the veil of tat Sham Company to protect the original company. Gilford motor co. ltd vs. Horne (1933(1)1 Ch 935) Brief facts; Horne was the employee of Gilford motor co. ltd. There was a contract between Horne and that company not to solicit its customers. Due to misconduct, Horne was removed from the services by the company as soon as he was removed, he formed another company and solicited the customers of Gilford motor co. ltd. Gilford motor co. ltd sued Horne. Judgment: the court described the company formed by Horne as a device, a stratagem and also as a

mere cloak or sham for the purpose of enabling the defendant to commit a breach of his conenant against solicitation.
f.

Protection of public policy: the courts may intervene with the fake companies, whose functioning and objects are against the public policy. To protect the public policy, the courts may lift the corporate veil of such companies. Arrangement or amalgamation: the compromise or arrangement between company and its creditors or members or any class of them leads to amalgamation of one company with another. In that circumstances, the amalgamation company losses its separate existence. Miheer H. mafatlal vs. mafatlal industries ltd. (1997)1 SCC 579 SC

g.

Brief facts: the majority shareholders of mafatlal fine spinning and manufacturing company ltd. (MFL) resolved to amalgamate in with mafatlal industries ltd. a scheme of compromise and arrangement was prepared between the transferor-company and transferee-company. One of the shareholders challenged it under minority rights. JUDGMENT: the Supreme Court gave the judgment in favour of amalgamation
2.

Formality and expenses: - the incorporation of a company requires Many formalities, time, money etc.

The promoters have to submit several forms as per requirements of the companies act and rules. It is also expensive comparing with partnership firm, it is very hard and difficult job to form and continue a company. To form a partnership firm it is very easy and also free from all these complication several restriction are imposed upon the promoters, directors and even on shareholders. Practically the board of directors is responsible for the acts ultra vires or for non-implementing procedure form time to time that is why JENKINS said corporate directors wake up each morning as potentials criminals.
3.

Company is not a citizen: - a company is a juristic person. It has legal entity. But it is a citizen, whether the fundamental rights can be granted to accompany. These are certain questions arose before the Supreme Court whether the corporation or a company is regarded as a citizen. Whether the fundamental rights can be granted to company. This are the some of the important questions posed before the supreme court citizenship is granted to a human being born in india company is also a person the man is a human person, whereas the company is a juristic person. The fundamental rights especially article 19 of the constitution is conferred on a human person. Until 1963, the Supreme Court did not recognize company or corporation as a citizen for the purpose of fundamental rights.

4.

Criminal liability: - the companies act and rules impose very strict civil and criminal liabilities on the directors, promoters managing directors, managers tec. These civil and criminal liabilities are imposed for safeguarding the shareholders. The executive of the company have to file several returns and information to the registrar of companies regularly. The companies shall have to pay fees for every kind of returns filed before the registrar. In case, the company does not file all of such returns in time. It would become breach of the companies act and rules. Such circumstances lead to civil and criminal liabilities including imprisonments upon the directors, promoters, executives, etc. JENKINS SAID corporate directors wake up each morning as potential criminals. Due to these restrictions, several persons fear to form private limited and public companies, and prefer partnership businesses, which are comparatively fee from all these complications. Conclusion: - while disposing secy., HSEB vs. Suresh (Banerjee, J.) (1999) 3 SCC 601) The Supreme Court observed: while it is true the doctrine enunciated in Salomon vs. Salomon &co. ltd. Came to be recognized in the corporate jurisprudence but its applicability in the present context cannot be doubted, since the law court

invariably has to up to the occasion to do justice between the parties in a manner as it deems fit.