Unit 5: Companies Act, 2013

1. Definition and Nature of a Company

a. Definition of a Company

As per Section 2(20) of the Companies Act, 2013, a "company" means a company incorporated under this Act or under any previous company law.

In simple terms, a company is an artificial person created by law, having a separate legal identity, with a perpetual succession and a common seal (optional since 2015). It is an association of persons who contribute money or money's worth (capital) to a common stock and employ it in some trade or business, sharing the profit and loss arising therefrom.

b. Nature and Characteristics of a Company

The key characteristics that define the nature of a company are:

• Corporate Personality / Separate Legal Entity:

  • A company is a legal person, distinct and separate from its members (shareholders). It can own property, have a bank account, enter into contracts, incur debts, and sue or be sued in its own name.
  • The liability of the members is limited to their investment in the company and they are not personally liable for the company's debts.
  • Landmark Case: Salomon v. A. Salomon & Co. Ltd. (1897). In this case, Mr. Salomon sold his business to a company he formed, with himself and his family members as shareholders. When the company went into liquidation, it was held that the company was a separate legal entity from Mr. Salomon. The debts of the company were its own and not Mr. Salomon's, even though he owned almost all the shares.

• Limited Liability:

  • The liability of the members is limited to the nominal value of the shares held by them. If a member has already paid the full amount for their shares, their liability is nil.
  • In the case of a company limited by guarantee, the liability of members is limited to the amount they have undertaken to contribute to the assets of the company in the event of its winding up.

• Perpetual Succession:

  • A company has a continuous existence and is unaffected by the death, insanity, or insolvency of its members.
  • The life of the company continues until it is legally wound up. This is often summed up by the phrase, "members may come and go, but the company goes on forever."

• Separate Property:

  • A company can own, enjoy, and dispose of property in its own name. The shareholders are not the owners of the company's property; the company itself is the true owner.

• Transferability of Shares:

  • The shares of a public company are freely transferable, subject to the conditions laid down in its Articles of Association.
  • The shares of a private company are subject to certain restrictions on transferability. This feature provides liquidity to the investment.

• Capacity to Sue and be Sued:

  • Being a legal person, a company can sue others to enforce its rights and can be sued by others for breach of its obligations, all in its own name.

• Common Seal (Now Optional):

  • Historically, the common seal was the official signature of the company.
  • The Companies (Amendment) Act, 2015 has made the common seal optional. If a company does not have a common seal, any document requiring the company's signature can be signed by two directors or by a director and the company secretary (if one is appointed).

• Lifting the Corporate Veil:

  • While a company is a separate entity, courts can, in exceptional circumstances, ignore this principle and look at the reality behind the company to identify the individuals who are actually in control. This is known as "lifting or piercing the corporate veil."
  • Grounds for Lifting the Veil:
    1. To Determine the Character of the Company: To see if the company is an "enemy" company during wartime. (e.g., Daimler Co. Ltd. v. Continental Tyre & Rubber Co.)
    2. To Protect Revenue or Tax: If the company is used for tax evasion.
    3. To Prevent Fraud or Improper Conduct: If the company is formed to defraud creditors or to avoid a legal obligation. (e.g., Gilford Motor Co. Ltd. v. Horne)
    4. Where the Company is an Agent or Sham: When the company is merely acting as an agent for its shareholders.

2. Types of Company

Companies can be classified on various bases:

a. On the Basis of Liability

• Company Limited by Shares: [Section 2(22)]
  • The liability of its members is limited to the unpaid amount, if any, on the shares held by them. This is the most common type of company.
• Company Limited by Guarantee: [Section 2(21)]
  • The liability of members is limited to a specified amount which they undertake to contribute to the assets of the company in the event of it being wound up. These companies are typically non-profit organizations (e.g., clubs, charities).
• Unlimited Company: [Section 2(92)]
  • There is no limit on the liability of its members. The members are personally liable for the company's debts if the company's assets are insufficient.

b. On the Basis of Number of Members

• One Person Company (OPC): [Section 2(62)]
  • A company which has only one person as a member.
  • It is a form of a private company.
  • The member must nominate another person who will become the member in case of the subscriber's death or incapacity.
• Private Company: [Section 2(68)]
  • A company that, by its Articles of Association:
    • Restricts the right to transfer its shares.
    • Limits the number of its members to 200.
    • Prohibits any invitation to the public to subscribe for its securities.
  • It must have a minimum of 2 members.
• Public Company: [Section 2(71)]
  • A company which is not a private company.
  • It can offer its shares and securities to the public.
  • It must have a minimum of 7 members. There is no maximum limit.
  • A subsidiary of a public company is deemed to be a public company, even if it is a private company by its articles.

c. On the Basis of Control

• Holding Company: [Section 2(46)]
  • A company which controls the composition of the Board of Directors of another company or holds more than one-half of the total voting power of another company.
• Subsidiary Company: [Section 2(87)]
  • A company that is controlled by a holding company.
• Associate Company: [Section 2(6)]
  • A company in which another company has a "significant influence," but which is not a subsidiary. "Significant influence" means control of at least 20% of the total voting power.

d. Other Types

• Government Company: [Section 2(45)]
  • Any company in which not less than 51% of the paid-up share capital is held by the Central Government, or by any State Government(s), or partly by the Central and partly by one or more State Governments.
• Foreign Company: [Section 2(42)]
  • A company incorporated outside India which has a place of business in India (whether by itself or through an agent, physically or through electronic mode) and conducts any business activity in India.
• Section 8 Company:
  • Formed for promoting commerce, art, science, sports, education, research, social welfare, religion, charity, protection of environment, or any such other object.
  • They must apply their profits in promoting their objects and are prohibited from paying any dividend to their members.
• Small Company: [Section 2(85)]
  • A private company with:
    • Paid-up share capital not exceeding a prescribed amount (currently ₹4 crore), AND
    • Turnover not exceeding a prescribed amount (currently ₹40 crore).
  • It enjoys certain exemptions and privileges under the Act.

3. Difference Between Company and Limited Liability Partnership (LLP)

4. Legal Position of a Promoter

a. Who is a Promoter?

A promoter is a person who conceives the idea of forming a company and takes the necessary steps to incorporate it. They undertake the preliminary work incidental to the formation of a company, such as deciding its name, objects, capital structure, and preparing the necessary documents.

Section 2(69) of the Act defines a promoter as a person:

• who has been named as such in the prospectus or is identified by the company in the annual return; OR
• who has control over the affairs of the company, directly or indirectly; OR
• in accordance with whose advice, directions or instructions the Board of Directors is accustomed to act.

b. Legal Position of a Promoter

• A promoter is neither an agent nor a trustee of the company they are promoting because the company is not yet in existence.
• However, the promoter stands in a fiduciary relationship (a relationship of trust and confidence) towards the company. This requires the promoter to act in good faith and in the best interests of the company.

c. Duties of a Promoter

1. Duty to Disclose Secret Profits: A promoter must not make any secret profit at the expense of the company. If any profit is made, it must be fully disclosed to the company and handed over.
2. Duty to Disclose Personal Interest: If a promoter sells their own property to the company, they must disclose their personal interest in the transaction.
3. Duty of Due Care: The promoter must act with reasonable care and skill in their promotional activities.

d. Liabilities of a Promoter

• Liability for Pre-Incorporation Contracts: A promoter is personally liable for contracts entered into on behalf of the proposed company before its incorporation.
• Liability for Misstatements in Prospectus: A promoter can be held liable (civilly and criminally) for any untrue statements made in the company's prospectus.
• Liability for Breach of Fiduciary Duty: The company can take action against a promoter for breach of their fiduciary duties, such as to recover secret profits.

5. Memorandum of Association (MOA)

a. Definition and Purpose

The MOA is the charter or constitution of the company. It is the most important document as it defines the scope of the company's activities and its relationship with the outside world. It sets out the fundamental conditions upon which the company is allowed to be incorporated.

b. Doctrine of Ultra Vires

• The term "Ultra Vires" means "beyond the powers".
• Any act done by the company that goes beyond the powers stated in the Objects Clause of the MOA is ultra vires and therefore void and cannot be ratified, even by a unanimous vote of all shareholders.
• Purpose: The doctrine protects investors by ensuring their money is used only for the stated objects, and it protects creditors by ensuring the company's funds are not risked in unauthorized businesses.
• Landmark Case: Ashbury Railway Carriage and Iron Co. Ltd. v. Riche (1875). The company's MOA stated its object was to make and sell railway carriages. The directors entered into a contract to finance the construction of a railway line in Belgium. The contract was held to be ultra vires and void.

c. Clauses of the MOA [Section 4]

1. Name Clause: States the name of the company, with "Limited" as the last word for a public company and "Private Limited" for a private company. The name must not be identical to or resemble an existing company's name or be considered undesirable by the Central Government.
2. Registered Office Clause (or Domicile Clause): States the name of the State in which the registered office of the company is to be situated.
3. Objects Clause: This is the most crucial clause. It defines the purpose and scope of activities for which the company is formed. It is divided into:
   • The objects for which the company is proposed to be incorporated.
   • Any matter considered necessary in furtherance thereof.
4. Liability Clause: States the nature of the members' liability, i.e., whether it is limited by shares or by guarantee.
5. Capital Clause: States the amount of authorized share capital with which the company is to be registered and its division into shares of a fixed amount.
6. Subscription Clause: Contains a declaration by the subscribers (the first members) that they desire to form a company and agree to take the number of shares indicated against their names.

6. Articles of Association (AOA)

a. Definition and Purpose

The AOA are the by-laws, rules, and regulations for the internal management of the company. They govern how the company's affairs are to be conducted and define the rights, duties, and powers of the directors and members. The AOA is subordinate to both the Companies Act and the MOA.

b. Relationship between MOA and AOA

• The MOA is the dominant document, and the AOA is subordinate to it.
• The AOA cannot contain any provision that is contrary to the MOA. If there is a conflict, the MOA will prevail.
• The MOA defines the company's external scope, while the AOA governs its internal administration.

c. Doctrine of Indoor Management (Turquand's Rule)

• This doctrine is an exception to the rule of constructive notice. It protects outsiders dealing with the company in good faith.
• According to this rule, an outsider is entitled to assume that the internal procedures and formalities of the company have been complied with as required by the AOA. They are not required to inquire into the regularity of internal proceedings.
• Landmark Case: Royal British Bank v. Turquand (1856). The company's AOA allowed the directors to borrow money if authorized by a resolution of the shareholders. The directors borrowed money without such a resolution. It was held that the lender could assume the resolution had been passed and could enforce the loan against the company.
• Exceptions to the Rule: The doctrine does not apply if the outsider had knowledge of the irregularity, was put on inquiry by suspicious circumstances, or if the transaction involved forgery.

7. Formation of a Company

The process of incorporating a company is governed by the Companies Act, 2013 and is primarily done electronically through the Ministry of Corporate Affairs (MCA) portal.

Step 1: Obtain Digital Signature Certificate (DSC) & Director Identification Number (DIN)

• DSC: The proposed directors must obtain a DSC, which is the digital equivalent of a physical signature.
• DIN: Any person intending to be a director must obtain a DIN by making an application to the Central Government.

Step 2: Name Reservation

• An application for reserving a name for the proposed company is filed in Part A of the SPICe+ (Simplified Proforma for Incorporating Company Electronically Plus) form.
• The Registrar of Companies (RoC) will check the availability and suitability of the name.

Step 3: Preparation of Documents

The following key documents must be prepared:

• Memorandum of Association (MOA): Duly signed by all subscribers.
• Articles of Association (AOA): Duly signed by all subscribers.
• Declaration by a professional (Advocate, CA, CS, etc.) engaged in the formation of the company, and by a person named in the articles as a director, manager, or secretary, stating that all requirements of the Act have been complied with.
• Affidavits from each subscriber to the MOA and from the first directors, stating they are not convicted of any offense, are not guilty of fraud, and that all information given is correct.
• Proof of address for the registered office.

Step 4: Filing of Incorporation Application

• All the prepared documents are filed with the RoC through the integrated web form SPICe+ (Part B).
• This single form also applies for DIN allotment, PAN, TAN, GSTIN, and other registrations.

8. Certificate of Incorporation

a. Issuance and Content

• If the RoC is satisfied that all legal requirements for incorporation have been met, they will register the company and issue a Certificate of Incorporation under Section 7(2) of the Act.
• The certificate will state the name of the company, the date of its incorporation, and will be allotted a unique Corporate Identity Number (CIN).

b. Legal Effect of Incorporation [Section 9]

From the date mentioned in the Certificate of Incorporation, the company:

• Becomes a body corporate or a legal person.
• Acquires perpetual succession.
• Gains the power to acquire, hold, and dispose of property.
• Gains the ability to enter into contracts.
• Can sue and be sued in its own name.

c. Conclusiveness of the Certificate of Incorporation

• Section 7(4) states that the certificate issued by the RoC is conclusive evidence that all requirements of the Act regarding registration have been complied with.
• Once the certificate is issued, the validity of the company's incorporation cannot be challenged on procedural or other grounds.
• Landmark Case: Moosa Goolam Ariff v. Ebrahim Goolam Ariff (1913). The court held that once a certificate of incorporation is issued, it is conclusive for all purposes, and the court cannot go behind it to question the legality of the incorporation.