Module VI

Companies Act 1956

Ms.Sandhya K N
15-04-2010
 MODULE 6 (7 Hours)

Companies act 1956: Definition, Characteristics

and Kinds of Companies, Steps in Formation of
Company. Memorandum of Association, Articles
Association and Prospectus. Shares: Kinds of
Shares, Kinds of Debentures. Directors:
Appointment, Power, Duties and Liabilities of
Directors. Meeting and Resolutions: Types of
Meetings. Auditor: Appointment, Rights and
Liabilities of Auditor. Modes of Winding-up of a
Company.
Meaning and Definition of a
Company
 Section 3(1)(i) of the Companies
Act, 1956 defines a company as: “a
company formed and registered
under this Act or an existing
Company”.
 An ‘Existing Company’ means a
company formed and registered
under any of the previous
Companies Law.
 Definitions

According to Justice Lindley a company is

“An association of many persons who
contribute money or money's worth to a
common stock and employed for a common
purpose. The common stock So contributed is
denoted in money and is capital of the
company. The persons who contribute it or to
whom it belongs are members. The proportion
of capital to which each member is entitled is
his share. Shares are always transferable
altough the right to transfer them is aften more
or less restricted”.
 Definitions

A company may be defined as an

incorporated association,which is an
artificial person,having an independent
legal entity,with a perpetual seccession,
a common seal, a common stock capital
comprised of transferable shares and
carrying limited liability in relation to its
members.
 “Characteristics of a company”

1. Separate legal entity

Salomon vs. Saloman & Co Ltd
2. Limited liability
3. Perpetual succession (long continuity)
4. Common seal
5. Transferability of shares
6. Separate property
7. Capacity to sue & to be sued
8. Not a citizen
9. Company's actions limited
 Kinds of Companies

Chart showing kinds of Companies

On the basis of On the basis of On the basis of

Constitution incorporation control

Public Co Private Co Holding &

Govt Co Subsidiary
Co

Statutor
Chartered Registered Foreign
y
Co Co Co
Co

Limited Limited by Unlimited

By Shares Guarantee Co
I. On the basis of Constitution

a. Public Company: A public company means a

company which is not a private company.

 There is no maximum limit as to its number of

shareholders or members

There must be at least seven persons to form a

public company

The shares of a public company are capable of

being dealt in on a stock exchange
b.Private Company: [Section 3(10)(iii)]

A private company means a company which by

its Articles

i) Restricts the rights to transfer its shares

ii) Limits the number of its members to fifty
Iii) Prohibits any invitation to the public to
subscribe for any shares or debentures of the
company
Privileges of a Private Company

1.A private Company may consist of two members

only
2.A private Company is entitled to commence
business immediately on incorporation
3. It may allot shares without issuing a prospectus
or delivering to the Registrar a statement in lieu
of prospectus
4. It is not required to hold a statutory meeting or file
a statutory report with the registrar
5.It can have a minimum of two directors
6. The provisions of section 81 as regards further
issue of capital do not apply to a private
company.
7.It can give financial assistance for purchase of its
shares or its holding company’s shares
8.Copies of Balance sheet and Profit and Loss Account
filed with the Registrar can not be inspected by the
Public
9.A director of a private company need not hold the
share qualification
10.Restriction in regard to overall managerial
remuneration imposed by Section 309 do not apply
to a private company
10.An interested director can participate in the Board
proceedings and exercise his vote
 The privileges mentioned above are not
available to a private company which is a
subsidiary of a public company
Distinction Between Public and Private Co
Basis Public Co Private Co
1.Minimum Number Seven Two
of members
2.Maximum Number No limit Fifty
of Members
3.Commencement of Shall not commence its Can commence its
Business business immediately business as soon as it is
unless it has been incorporated
granted the Certificate
of Commencement of
Business

4.Invitation to public By issuing a Can not extend such

prospectus may invite invitation to the public
public to subscribe to
its shares/debentures
5.Transferability of No restriction on the By its Articles must
Shares transfer of shares restrict the right of
members to transfer the
shares
 Distinction between Public and Private Co

Basis Public Co Private Co

6. Number of Directors Must have at least three May have two directors
directors

7.Statutory Meeting Must hold as statutory There are no such

meeting and file with the obligations
Registrar a Statutory
report
8.Restrictions on Shall file with the These restrictions do not
appointment of Directors Registrar a consent to act apply
as such
9.Manageral Total Managerial These restrictions do not
Remuneration Remuneration can not apply
exceed 11% of the Net
Profits

10.Further issue of Proposing further issue Is free to allot new issues

Capital of shares must offer them to outsiders
to the existing members
 II.On the basis of Incorporation
a. Chartered company: The Crowning the exercise of
the royal prerogative, has power to create a corporation
by the grant of a charter to persons assenting to be
incorporated. Such companies or Corporations are
known as Chartered Companies
Examples: Bank of England, East India Company

b.Statutory Companies: A company may be

incorporated by means of a special Act of the
Parliament or any State
Legislature. They are generally formed to carry out some
special public undertaking. Examples:
Railways,waterworks,electricity generation,LIC,RBI,UTI
etc
 # Statutory companies are governed by the Acts
creating them

# They are not required to have any memorandum or

articles of Association changing in their structure are
possible only by amendment in the Acts creating them.

# A statutory company though owned by the

Government has a separate legal entity

# It can not be regarded as a department of the

Government
C.Foreign Company : A company incorporated outside
India and having a place of business in India
i.Documents
ii.Accounts
iii.Names
iv.Winding up
 d.Registered Companies : Companies registered
under the Companies Act,1956 or the earlier
Companies Act are called Registered Companies
Such companies come into existence when they are
registered under the Companies Act and a certificate of
incorporation is granted to them by the registrar

i.Companies limited by shares

ii.Companies limited by guarantee
iii.Unlimited Companies
 i.Companies limited by shares: This is a company
where the liability of its members is limited to the
amount fixed by the memorandum of the company,if
any unpaid on the shares respectively held by them.
The liability can be enforced during the existence of the
company as well as during the winding up
Where the shares are fully paid up, no further liability
rests on them
 ii.Companies limited by guarantee: This is a
company where the liability of its members is limited to
such amounts as they may respectively undertake as
fixed by the memorandum to contribute to the assets
of the company in the event of its being wound up.
iii.Unlimited Companies : It is a company where the
liability of its members is not limited at all. In such a
company, the liability of each member extends to
the whole amount of the company’s debts and
liabilities, but he will be entitled to claim rateable
contribution from other members.
 III. On the basis of Control

a. Government company : Section 617 of the

Companies Act defines a government company
as a 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 partly by the central Government
and partly by one or more state governments.

It also includes a company which is a subsidiary

of a Government company
 b. Holding Company & Subsidiary Company

A company which controls another company is known

as the holding company and the company so controlled
is termed as subsidiary company

A holding company is one of it:

1.controls the composition of board of directors of
another company or
2.holds more than half of the nominal value of equity
share capital of another company or
3.controls more than ½ of the total voting power of the
other company
4.is a subsidiary of any company which is in turn a
subsidiary of another company
Example: Company P is a subsidiary of company
Q, and company R is a subsidiary of company P.
Company R will be a subsidiary of company Q

Q P

R
 Other companies
One man company and family Company

These are companies in which one man holds

virtually the whole of the share capital with a few
extra members holding the remainder,who may
be his relations and nominees.
Being the largest holder ,such a person is
generally the sole or the managing director and
enjoys complete control over the company
Licensed Companies or Companies not for
Profit(Section 25)
These licensed companies are formed for a non
trading object or for a noble cause,like the promotion
of art,science,education,commerce etc.
Charitable associations,sports clubs,trade
associations,chamber of commerce etc are examples
of companies not for profit

Such companies can be formed only on obtaining the

license from the Government i,e they can be
registered only after such licence
 Steps in Formation of Company

Company formation is an elaborate,time

consuming and an expensive affair. A typical
formation involves three stages:
a)Registration
b)Capital raising and
c) Commencement of business
a) Registration
The registrar of companies is the appropriate official to
register companies. Before registration, the registrar
expects the promoters to submit a list of names of the
proposed company, memorandum of association, articles of
association and a list of directors

The memorandum of association is an important document,

it contains such details as the name of the company, the
purpose of the company, the place of its registered office,
the fact that the members' liability is limited and capital of
the company. The memorandum should be printed, be
divided in to suitable paragraphs and be affixed with stamps
worth Rs 120.

The articles of association contain details about the way in

which the internal affairs of the company are to be carried
out. The article should be printed, be divided in to suitable
paragraphs and be affixed with stamps worth Rs 120.
The registrar will scrutinize all documents submitted
to him and will ensure that all formalities are complied
with. The registrar will then enter the name of the
company in the Register maintained by him for the
purpose and will issue certificate of incorporation. It is the
birth certificate of the company.

On registration, the company becomes an independent

person in the eyes of law. For registration the registrar will
charge a fee which depends on the authorized capital of
the company. For an authorized capital of Rs. 1 lakh the
registration fee is Rs. 750. and for a capital of Rs. 1 crore
the fee is Rs. 18,500.
b) Raising of Capital
The next step in company formation is the raising
of the capital. A public company raises its capital
by inviting the public to subscribe to its share
capital. The steps involved in raising the capital
are :

(i) obtain the SEBI clearance

(ii)entering in to an agreement with the underwriter
(iii) applying to the stock exchange for listing of its
share
(iv) inviting the public to subscribe its share
capital through a prospectus
(v) allotment of shares
c) Commencement of Business
A private company can commence its business
immediately after it is incorporated. But a public
company can't commence its business unless it obtains
a certificate for the purpose. To obtain a certificate the
following statement must be submitted to the registrar :
• A declaration that a copy of the prospectus is filed with
him
• A declaration that minimum subscription has been
received.
•A declaration that directors have taken up the
qualification shares and have paid for them.
• A certificate issued by a director or secretory to the
effect that all conditions for the commencement of
business have been fulfilled
The Registrar then issues a certificate to
commence business, following which a
public company can now commence its
chosen activity

The stage of formation of a company

apparently comes to an ends. Before the
new company commences its business a
team of people who can manage the
company must be constituted. Management
is entrusted to directors, who are
collectively call the board of directors.
Promoter
A promoter is one “who undertakes to form a
company with reference to a given object and to
set it going and who takes the necessary steps to
accomplish that purpose”.

The promoter of a company decide the scope of its

business activities

A promoter stands in fiduciary position towards the

company
Alteration of Memorandum
 Various clauses of memorandum of
association can be altered by
following the procedure laid down in
the Act. Different requirements are
prescribed for different clauses:
1. Name Clause: can be altered by:
(a)Passing a special resolution; and
(b)Obtaining the approval of the Central
Govt.
 Alteration of Memorandum
2. Registered Office Clause: may be
shifted:
(a)within the same city by passing
Directors’ Resolution;
(b)From one city to another city within the
same State:
 by passing special resolution only, if
no change in jurisdiction of Regional
Director
 by passing special resolution, and
 Obtaining the approval of Regional
Director.
 Alteration of Memorandum
3. Objects Clause
 Special Resolution
 Only on Grounds stated in Sec.17(1).
4. Liability Clause
 Cannot be increased without written
consent of each and every member.
 Can be reduced:
 by passing special resolution
 Confirmation of court
 Alteration of Memorandum
5. Capital Clause
 Authorised capital may be
increased by passing an ordinary
resolution at a meeting of the
shareholders.
 Articles of Association
 The articles of association of a company are its
bye-laws or rules and regulations that govern
the management of its internal affairs and the
conduct of its business.
 The articles regulate the internal management of
the company. They define the powers of its
officers. They also establish a contract between
the company and the members and between the
members inter se. This contract governs the
ordinary rights and obligations incidental to
membership in the company [Naresh Chandra
Sanyal v. Calcutta Stock Exchange Association
Ltd. (1971)].
Companies which must have Articles

 Unlimited Companies:
The Articles of such a company
must state:
Total number of members; and
Share capital.
 Companies limited by Guarantee:
Articles of such company must
state total number of members.
Companies which must have Articles
…contd.
 Private Companies limited by
shares:
must include requirements of
Section 3(1)(iii).
No Article Company
 A public limited company having
share capital may be registered
without Articles.
Alteration of Articles
 Articles may be altered by a
company by passing special
resolution at a general body meeting
of shareholders.
 However, where alteration has the
effect of converting a public
company into a private company (i.e.,
introduction of restrictive clauses of
Section 3(1)(iii), approval of Central
Government must be obtained.
 Doctrine of Constructive Notice
 According to Section 610, every person
dealing with the company is deemed to
have read M/A and A/A and understood the
contents thereof in the correct perspective.
 Doctrine of Indoor Management
 The rule was first laid down in Royal British
Bank v. Turquand.
 Rule of Indoor Management is an exception
to the Doctrine of Constructive notice.
 Exceptions of Indoor Management
1. Knowledge of irregularity : Case: Howard
v. Patent Ivory Co.
2. Negligence : Case: Anand Behari Lal v.
Dinshaw & Co. (Bankers) Ltd.
3. Forgery : Case: Ruben v. Great Fingal
Consolidated [Secy. Forged signatures of
two directors]
4. No knowledge of articles : Case: Rama
Corporation v. Proved Tin & General
Investment Co.
 Prospectus
 A prospectus, as per Section 2(36),
means any document described or
issued as prospectus and includes any
notice, circular, advertisement or other
document inviting deposits from the
public or inviting offers from the public
for the subscription or purchase of any
shares or debentures of a body
corporate.
 Prospectus … contd.

 Thus, a prospectus is not merely an

advertisement; it may be a circular or
even a notice. A document shall be
called a prospectus if it satisfies two
things:
(a) It invites subscription to shares or
debentures or invites deposits.
(b) The aforesaid invitation is made to the
public.
 What constitutes Invitation to
Public
 As per Section 67, Invitation to public
includes:
 invitation to any section of the public
howsoever selected provided the
invitation is made to all the members of
that section of public indiscriminately.
Invitation calculated to be made
available even to those who do not
receive the same.
Invitation to 50 or more persons.
 Mis-statement in a Prospectus and
its consequences
What is Mis-statement?
 According to Section 65(1) of the Act:
(a) a statement included in a prospectus shall
be deemed to be untrue, if the statement is
misleading in the form and context in which it
is included; and
(b) where the omission from a prospectus of
any matter is calculated to mislead, the
prospectus shall be deemed in respect of
such omission, to be a prospectus in which
an untrue statement is included. Case: Rex
 Remedies
Liability for Mis-statements in a Prospectus

Civil Liability (Sec.62 & 56) Criminal Liability (Sec. 63)

Against the Promoters, Against the Promoters,

mpany Directors, other
Officers and Experts
Against the Company Directors and Other officers
(not available against experts)

Compensation under Sections Fine upto

Rescission of Contract Imprisonment
62 and 56 Rs. 50,000

Damages Fine upto R

Claim for Damages Bot

 Share and Share Capital
 According to Section 2(46), A ‘Share’
represents a unit into which capital of a
company is divided. However, courts have
held that a share is not merely a unit of
capital, it represents a bundle of rights and
obligations. Holder of a share is entitled to
certain rights (say, right to receive dividends,
to receive notice of meetings, to participate in
the proceedings of a meeting, to elect
directors) and is also subjected to a number
of obligations (say, to abide by Articles of
Association, to maintain decorum of the
meetings).
 Kinds of Shares
 The following kinds of shares may be
issued by a company:
1. Equity shares carrying voting rights.
2. Equity shares carrying differential
rights as to voting or dividend
(commonly called Non-Voting Equity
Shares)
3. Preference Shares
4. Cumulative convertible Preferable
Shares
 Kinds of Shares … contd.
 Preference Shares carry preference
with respect to two things:
1. Preference with respect to dividend at
a fixed rate or of a fixed amount.
2. Preference with respect to return of
capital in case of winding up.
 Equity Shares means a share which is
not a preference share.
 Allotment of Shares
 ‘Allotment’ is an acceptance to an offer
for purchase of shares.
 Where allotment does not conform to
the statutory requirements, it is called
irregular allotment. For allotment to be
valid, following requirements must be
satisfied:
1. A copy of prospectus or statement in
lieu of prospectus must have been
delivered to Registrar of Companies.
 Allotment of Shares … contd.

1. Application money must not be less

than 5% of the nominal value.
2. Minimum subscription (i.e., at least 90%
of the issue) must have been received.
3. Application money must be kept
deposited in a Scheduled Bank till the
minimum subscription has been
received.
4. Shares must have been listed on the
stock exchange(s) mentioned in the
 Administration/Management of
a company
 A company functions through the medium
of Board of Directors. However, certain
powers have been reserved to be exercised
by shareholders in general body meetings.
Section 291 of the Companies Act, 1956
confers general power on the Board of
Directors. It provides: “Subject to the
provisions of the 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.
 Powers which are exerciseable
only by the shareholders.
1. Sell, lease or otherwise dispose of the
whole, substantially the whole, of the
undertaking of the company, or where the
company owns more than one undertaking, of
the whole or substantially the whole, of any
such undertaking.
2. Remit or give time for the repayment of any
debt due by a director except in the case of
renewal or of continuance of an advance made
by a banking company to its directors in the
ordinary course of business.
 Powers …contd.

3. Invest, otherwise than in trust securities,

the amount of compensation received by the
company in respect of compulsory acquisition
of any property or fixed assets of the
company.
4. Borrow monies exceeding the aggregate of
the paid-up capital of the company and its free
reserves. ‘Borrowing’ does not include
temporary loans (i.e., loans payable on
demand or within six months but excluding
loans for capital expenditure) obtained from
the company’s bankers in the ordinary course
of business.
 Powers …contd.
The resolution passed at the general
meeting must specify the total amount upto
which moneys may be borrowed by the Board
of directors in any financial year.
5. Contribute in any year, to charitable and
other funds not directly relating to the
business of the company or the welfare of its
employees any amount exceeding Rs. 50,000
or five per cent of its average net profits of
the last three financial years, whichever is
higher.
Powers …contd.
 However, the resolution must specify the
total amount that may be contributed by
the Board of directors in any financial
year.
 However, contributions to National
Defence Fund, the Prime Minister’s
National Relief Fund or any other fund
approved by the Central Government* for
the purpose are exempted from the above
provisions.
 Qualifications and
Disqualifications for Directors
Qualifications
 A public company cannot prescribe any
qualifications for directorship except
share qualification. Again, share
qualification requirement cannot exceed
holding of shares exceeding Rs. 5000/-
in nominal value or value of one share
where nominal value of one share
exceeds Rs.5000/-. A director may
obtain his share qualification within 2
Disqualifications
 Section 274 of the Companies Act,
1956 provides that the following
persons shall not be capable of being
appointed as directors of any
company :
(a) a person found by a competent court to
be of unsound mind and such finding
remaining in force;
(b) an undischarged insolvent;
(c) a person who has applied to be
 Disqualifications …contd.
(d) a person who has been convicted by a Court
of an offence involving moral turpitude and
sentenced in respect thereof to imprisonment for
not less than six months, and a period of five
years has not elapsed from the date of the expiry
of the sentence;
(e) a person who has not paid any call in respect
of shares of the company held by him, whether
alone or jointly with others and six months have
elapsed from the last date fixed for the payment
of the call; and
 Disqualifications …contd.

(g) a person who is already a director of a

public company which,—
(i) has not filed the annual accounts and
annual returns for any continuous three
financial years commencing on and after the
first day of April, 1999; or
(ii) has failed to repay its deposit or interest
thereon on due date or redeem its
debentures on due date or pay dividend and
such failure continues for one year or more.
 Number of Directorships
Whole-time Directorship
 A person cannot be appointed as a
whole-time director in more than
one company.
Part-time Directorship
 Not more than 15 companies
excluding the directorships of,
No. of Directorships …contd.

i. private companies [other than

subsidiaries or holding companies of
public company(ies)].
ii. unlimited companies,
iii. associations not carrying on business
for profit or which prohibit payment of a
dividend, and
iv. alternate directorships (i.e., he is
appointed to act as a director only during
the absence or incapacity of some other
director).
 Remedies
Liability for Mis-statements in a Prospectus

Civil Liability (Sec.62 & 56)

Civil Liability (Sec.62 & 56) Criminal Liability (Sec. 63)
Criminal Liability (Sec. 63)

Against the Promoters, Against the Promoters,

Against the Against the
Directors, other Directors and Other
Company Company
Officers and Experts officers (not available
against experts)
Claim for
Rescission Fine upto Rs. 50,000
Damages
of Contract

Compensation
Sections 62 and Imprisonment Rs.50,000Fine upto
Damages Compensation under Imprisonment Fine upto Both
Damages under Sections 56 upto 2 years Both
upto 2 years Rs.50,000
62 and 56