MODULE 2

Objectives:

The primary aim of this module is to enable you to:

 Have a deeper awareness of the system of Company form of organization and its
formation processes;
 Gain a thorough understanding about the Memorandum, Articles of Association and the
preparation and contents of a Prospectus;
 Distinguish between Shares and Debentures and their features;
 Understand the procedures for appointment of Directors, their powers & duties and the
conduct of different types of company meetings;
 Explain the different modes of winding up of a company

Module 2 – Corporate Law

Nature, Definitions, Types and Classification of Companies, Incorporation, Memorandum and
Articles of Association, Prospectus, Important provisions of Companies Act 2013 relating to
Management, Corporate Governance and Winding.

What is company?
A Company, in common parlance, means a group of persons associated together for the
attainment of a common end, social or economic.

Introduction for Companies Act, 1956

The Companies Act, 1956 defines the word ‘company’ as a company formed and registered
under the Act or an existing company formed and registered under any of the previous
company laws (Section 3). Section 12 permits the formation of different types of companies.
These may be (i) companies limited by shares, (ii) companies limited by guarantee, and (iii)
unlimited companies. The vast majority of companies in India are with limited liability by
shares.
Definition of Company:
“A Company is a voluntary association of persons formed for some common purpose with
capital divisible into parts known as shares” The common stock so contributed is denoted in
money and is “the 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 in a company are transferable.

Characteristics of a Company:
The following are the characteristic features of company:

1. Incorporated Association: A company must be incorporated or registered under the

Companies Act. Minimum number required for the purpose is 7 in case of a public company,
and 2, in case of a private company (Sec. 12). As per Section 11, an association of more than 10
persons, in case of banking business, and 20 in case of any other business, if not registered as a
company under the Companies Act, or under any other law for the time being in force,
becomes an illegal association.

2. Artificial Person: A company is created with the sanction of law and is not itself a human
being, it is, therefore, called artificial; and since it is clothed with certain rights and obligations,
it is called a person. A company is accordingly an artificial person.

3. Separate Legal Entity: Unlike partnership, company is distinct from the persons who
constitute it. Section 34(2) says that on registration, the association of persons becomes a body
corporate by the name contained in the Memorandum. [Saloman v. Saloman & Co.Ltd. (1877)]

4. Limited Liability: The Company being a separate person, its members are not as such liable
for its debts. Hence, in the case of a company limited by shares, the liability of members is
limited to the nominal value of shares held by them. Thus, if the shares are fully paid up, their
liability will be nil. However, companies may be formed with unlimited liability of members or
members may guarantee a particular amount. In such cases, liability of the members shall not
be limited to the nominal or face value of the shares held by them. In case of unlimited liability
companies, members shall continue to be liable till each praise has been paid off. In case of
companies limited by guarantee, the liability of each member shall be determined by the
guarantee amount, i.e., he shall be liable to contribute upto the amount guaranteed by him.

5. Separate Property: Shareholders are not, in the eyes of the law, part owners of the
undertaking. In India, this principle of separate property was best laid down by the Supreme
Court in Bacha F.Guzdar V. The Commissioner of Income Tax, Bombay (Supara). The Supreme
Court held that a shareholder is not the part owner of the company or its property, he is only
given certain rights by law, e.g., to vote or attend meetings, to receive dividends

6. Transferability of Shares: Since business is separate from its members in a company form of
organization, it facilitates the transfer of members’ interests. The shares of a company are
transferable in the manner provided in the Articles of the company (Sec. 82). However, in a
private company, certain restrictions are placed on such transfer of shares but the right to
transfer is not taken away absolutely.

7. Perpetual Existence: A company being an artificial person cannot be incapacitated by illness

and it does not have an allotted span of life. The death, insolvency or retirement of its members
leaves the company unaffected. Members may come and go but the company can go for ever.

8. Common Seal: A company being an artificial person is not bestowed with a body of natural
being. Therefore, it has to work through its directors, officers and other employees. But, it can
be held bound by only those documents which bear its signatures. Common seal is the official
signature of a company.

9. Capacity to sue: Another fall-out of separate legal entity is that the company, if aggrieved by
some wrong done to it may sue or be sued in its own name.

Lifting Of the Corporate Veil:

In case of a dishonest and fraudulent use of the facility of incorporation, the law lifts the
corporate veil and identifies the persons (members) who are behind the scene and are
responsible for the perpetration of fraud. The concept of lifting the corporate veil is a changing
concept. The veil of corporate personality, even though not lifted sometimes, is becoming more
and more transparent in modern jurisprudence.

The following are some such cases:

 For the protection of revenue.

 Where the company is acting as agent of the shareholders,
 Where a company has been formed by certain persons to avoid their own valid
contractual obligation,
 Where a company has been formed for some fraudulent purpose or is a “sham”,
 Where a company formed is against public interest or public policy,
 Where the holding company holds 100 per cent shares in a subsidiary company and the
latter is created only for purposes of holding company Where the number of members
falls below statutory minimum (Section 45)
 Where prospectus includes a fraudulent misrepresentation.
  Where a negotiable instrument is signed by an officer of a company [Section 147 (4)(c)].
 Holding and Subsidiary Companies (Secs. 212 – 213).
 Investigation into related companies (Section 239).
 For investigation of ownership of a company. (Sec 247).
 Where in the course of winding of a company (Section 542).
 Where breach of economic offence is involved.
 Where company is used as medium to avoid welfare legislation.
 Where device of incorporation is used for some illegal or improper purpose.
 To Punish for contempt of Court
 For determination of technical competence of company.
 Where company is a mere sham or cloak.

THE VARIOUS KINDS OF COMPANIES

I. On the Basis of Incorporation

1. Chartered Companies: Companies set up as a result of a royal charter granted by a king or

queen of a country are known as chartered companies. Example: East India Company, the Bank
of England etc.

2. Statutory Companies: Companies set up by Special Acts of Parliament or State Legislatures

are called Statutory Companies. Example: Reserve Bank of India, Life Insurance Corporation of
India, Unit Trust of India etc.

3. Registered Companies: Companies registered under the Indian Companies Act, 1956 or
under any of the previous Companies Acts are called registered companies. Most of the
companies in India belong to this category.

4. Licensed Companies: Companies established for the promotion of arts, science, religion,
charity or any other similar objects can obtain license under Sec.25 from the Central
Government and enjoy certain privileges.

5. Foreign Companies: A company incorporated outside India under the law of the country of
incorporation but having established its business in India is called a foreign company.

II. On the Basis of Liability

1. Companies with Limited Liability: It is a company where the liability of the shareholder
remains limited to the nominal value of the shares held by him.

2. Companies Limited by Guarantee: In a guarantee company the liability of a shareholder is

limited to the amount he has voluntarily undertaken to contribute towards the assets of the
company to meet out any deficiency at the time of it winding up. Such a company may or may
not have a share capital.

3. Unlimited Companies: Here the liability of its members is unlimited. In other words, their
liability extends to their private properties also. Unlimited companies are almost non-existent
these days.

III. On the Basis of Number of Members

1. Private Company: As per Section 3(1) (iii), a private company means a company which by its
Articles restricts the right to transfer its shares if any, and limits the number of its members to
fifty and prohibits invitation of shares from the public.

2. Public Company: According to Section 3(1) (iv), a public company means a company which is
not a private company.
IV. On the Basis of Control

1. Holding Companies: A company exercising control over another company is called a holding
company. [Sec.4 (4)].

2. Subsidiary Companies: The company so controlled is called a subsidiary company. [Sec.4 (1)].

V. On the Basis of Ownership

1. Government Company: Definition (Sec.617): A Government company means 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 or Governments, or partly by one or more State Governments and
includes a company which is a subsidiary of a Government company

2. Foreign Companies (591 to 602): A foreign company is a company which is incorporated in

a country outside India under the law of that foreign country and has a place of business in
India. They are of two types: (1) Companies incorporated outside India, establish a place of
business in India after April 1, 1956; and (2) Companies incorporated outside India, which
established a place of business in India before that date and continue to have an established
place of business in India.

3. Deemed Public Company: The Companies (Amendment) Act. 2000 has, by introducing a sub-
section (11) to Section 43A, made that a private company will not automatically become a
public company on account of shareholding or turnover.

4. One Man Company: A member may hold virtually the entire share capital of a company.
Such a company is known as a “one-man company”. This can happen both in a private company
and a public company. The other member/ members of the company may be holding just one
share each. Such other members may be just dummies for the purpose of fulfilling the
requirements of law as regards minimum membership [Salomon v. Salomon & Co.Ltd.].

5. Non-Trading Company/Non-Profit Association: Such a company must have the objects of

promoting of commerce, arts, science, religion, charity or any other useful object and must
apply its profit, if any or other income in promoting its object and must prohibit payment of any
dividend to its members. As soon as it obtains a license and is registered accordingly, it will
have the same privileges and obligations that a limited company has under the Companies Act,
1956.

6. Investment Companies: An investment company is a company the principal business of

which consists in acquiring, holding and dealing in shares and securities. It involves only the
acquisition and holding of shares and securities and thereby earning income by way of interest,
dividend, etc.
7. FERA Companies: The FERA companies are those companies which are incorporated in India
in which the non-resident interest (viz., foreign equity share capital) was more than 40%. After
the Amendment of FERA 1973 in the year 1993, the erstwhile FERA companies would not in
future be subjected to obtain the prior approval of the RBI in respect of certain matters.

8. Finance Companies: A finance company means a nonbanking company which is a financial

institution within the meaning of clause (c) of sec.45 of the RBI Act, 1934.

9. Public Financial Institutions (Sec. 4-A): The following financial institutions shall be regarded,
for the purposes of the Companies Act, as public financial institutions, namely:-

i. The Industrial Credit and Investment Corporation of India Limited (ICICI)

ii. The Industrial Finance Corporation of India (IFCI)

iii. The Industrial Development Bank of India (IDBI)

iv. The Life Insurance Corporation of India (LIC)

v. The Unit Trust of India (UTI)

vi. The Infrastructure Development Finance Company Ltd.

Sub-section (2) of Sec. 4-A empowers the Central Government to specify any other institution,
as it may think fit, to be a public financial institution by issuing a notification in the Official
Gazette.

Formation of A Company

We shall discuss the formation in three heads:

1. Promotion

2. Registration

3. Floatation

1. Promotion:
Promotion is a term of wide import denoting the preliminary steps taken for the purpose of
registration and floatation of the company.
Duties and Liabilities of Promoters:
Duties: The promoters to make a full disclosure of all material facts relating to the formation of
the company. He should not make any secret profit at the expense of the company he
promotes, without the knowledge and consent of the company and if he does so, the company
can compel him to account for it.

Liabilities:
For Non-disclosure: In case a promoter fails to make full disclosure at the time the contract was
made, the company may either:

 Rescind the contract and recover the purchase price where he sold his own property to
the company, or
 Recover the profit made, even though rescission is not claimed or is impossible, or
 Claim damages for breach of his fiduciary duty. The measure of damages will be the
difference between the market value of the property and the contract price.

Registration (Sec 12, 33):

Availability of Name: Section 20 states that a company cannot be registered by a name, which
in the opinion of the Central Government is undesirable. Therefore, it is advisable that
promoters find out the availability of the proposed name of the company from the Registrar of
companies.

Procedure:

The promoters will have to get together at least seven person in the case of public company, or
two persons in the case of a private company to subscribe to the Memorandum of association.

Documents to Be Delivered:

 Section 33 states that the following three documents are required to be presented for
the purpose of registration of a company:
 The Memorandum of the company;
 The articles, if any;
 The agreement, if any, which the company proposes to enter into with any individual for
appointment as its managing or whole time director or manager.
Statutory Declaration of Compliance:

Section 33 also requires a declaration to be filed with the registrar of companies along with the
Memorandum and the articles. This is known as “Statutory Declaration of Compliance.”

Consent of Directors:

In case of a public company, if the first directors are appointed by the articles, then the
following must be complied with before the registration of articles with the Registrar of
Companies:

Written consent of those directors to act, signed by themselves, or by an agent duly authorized
in writing, and

An undertaking in writing signed by each such director to take from the company and pay for
his qualification shares (if any).

Other documents are usually delivered along with the aforesaid documents:

The address of the registered office of the company (Sec. 146).

Particulars regarding directors, manager and secretary, if any (Sec 303).

These two documents are required to be submitted within 30 days of registration of the
company:

Certificate of Incorporation/Consequences Of Incorporation:

This certificate serves the same purpose in the case of a company which a birth certificate does
in the case of a natural person.

Effect of Certificate Of Incorporation: The certificate of incorporation is conclusive evidence

that all the requirements of the Companies Act in respect of registration and of matters
precedent and incidental thereto have been complied with.

Floatation/Capital Subscription:

When a company has been registered and has received its certificate of incorporation, it is
ready for “floatation”, i.e., it can go ahead with raising capital sufficient to commence business
and to carry it on satisfactorily. Section 70 makes it obligatory for every public company to take
either of the following two steps:

i. Issue a prospectus in case public is to be invited to subscribe to its capital, or

ii. File a ‘statement-in-lieu of prospectus’ with the registrar, in case capital has been arranged
privately. It must be done at least 3 days before allotment.

Certificate to Commence Business:

Where the company has issued a prospectus – Section 149(1), it shall not commence business
or exercise any borrowing powers unless:

a. Minimum subscription

b. Every director of the company has paid to the company.

c. No money is, or may become, liable to be repaid to the applicants.

d. Filed with the registrar a duly verified declaration by one of the directors or the secretary.

Memorandum and Article of Association

The Memorandum of Association of a company is its charter which contains the fundamental
conditions upon which alone the company can be incorporated. It tells us the objects of the
company’s formation and the utmost possible scope of its operations beyond which its actions
cannot go. If anything is done beyond the powers, that will be ultra vires (beyond powers of) of
the company and so void. It enables shareholders, creditors and all those who deal with the
company to know what its powers are and what is the range of its activities.

BASIS FOR MEMORANDUM OF

Sl.No ARTICLES OF ASSOCIATION
COMPARISON ASSOCIATION
Memorandum of Association is
Articles of Association is a
a document that contains all the
document containing all the rules
1 Meaning fundamental information which
and regulations that governs the
are required for the
company.
incorporation of the company.
2 Defined in Section 2 (56) Section 2 (5)
The memorandum is the Any provision, as opposed to a
3 Validity dominant instrument and memorandum of association, is
controls articles. invalid.
The articles provide the regulations
The memorandum contains the
by which those objectives and
4 Objectives objectives and powers of the
powers are to be conveyed into
company.
impact.
5 Scope The Memorandum is the The articles demonstrate
charter, which characterizes and obligations, rights, and powers of
limits powers and constraints of individuals, who are endowed with
the organization. the responsibility of running the
 organization and administration.
It is subordinate to the It is subordinate to the
6 Status
Companies Act. memorandum.
The memorandum of
Retrospective association of the company The articles of association can be
7
Effect cannot be amended amended retrospectively.
retrospectively.
Major A memorandum must contain The articles can be drafted as per
8
contents six clauses. the choice of the company.
A public company limited by shares
9 Obligatory Yes, for all companies. can adopt Table A in place of
articles.
Compulsory
filing at the
10 Required Not required at all.
time of
Registration
Alteration can be done, after
passing Special Resolution (SR)
Alteration can be done in the
in Annual General Meeting
Articles by passing Special
11 Alteration (AGM) and previous approval of
Resolution (SR) at Annual General
Central Government (CG) or
Meeting (AGM)
Company Law Board (CLB) is
required.
Regulates the relationship between
Defines the relation between
12 Relation company and its members and also
company and outsider.
between the members inter se.
Acts done
13 beyond the Absolutely void Can be ratified by shareholders.
scope

Definition of Prospectus:

Sec 2 (36) A prospectus 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 in or debentures
of a body corporate. Thus, a prospectus is not merely an advertisement; it may be a circular or
even a notice.

A document shall be called a prospectus it satisfies two things:

1. It invites subscriptions to shares or debentures or invites deposits.
2. The aforesaid invitation is made to the public.
The Board attends to the following matters:
 1. Appointment of various expert agencies such as bankers, auditors, secretary, etc.
2. Entering into underwriting contract, brokerage contracts.
3. Making arrangements for the listing of shares on stock exchanges.
4. Drafting a prospectus for the purpose of issue to the public.

Underwriting
Underwriting, in its simplest form, consists of an undertaking by some person or persons that if
the public fails to take up the issue, he or they will do so. In return for this undertaking, the
company agrees to pay the underwriter a commission on all shares or debentures, whether
taken up by the public or by the underwriters.

Sub-Underwriting
The underwriters usually choose to spread their risk by using sub-underwriters who agree to
take a certain number of shares for which they accept responsibility and for which they receive
a commission out of the commission received by the underwriters. The difference between the
commission paid by the company to the principal underwriters and the commission paid by
them to the sub-underwriters is known as overriding commission.

Brokerage Contracts
There must be authority in the articles to pay brokerage, and the brokerage must be disclosed
in the prospectus, or statement in lieu of prospectus, as the case may be, and it should pay a
reasonable brokerage (Sec. 76).

Listing of Shares on A Stock Exchange

The eligibility criteria for listing of securities of a company are:
 Minimum issued equity capital of a company should be Rs.5 crores [Rs. 3 crores where
trading is screen-based], and
 The minimum public offer of equity capital shall be not less than 25 per cent.

Time of Floatation:
The Board of Directors will decide about the time of issue of prospectus. It is advisable to
consider the condition of the capital market, the investors’ mood, fiscal and monetary policies
of the Government and the state of business conditions before issuing a prospectus.

Dating Of Prospectus:
Sec. 55 states that every prospectus must be dated and the date is deemed to be the date of
publication of the prospectus. Section 56 of the Companies Act lays down that the matters and
reports stated in Schedule II to the Companies Act must be included in a prospectus.

Abridged Form Of Prospectus:

Instead of appending full prospectus, now ‘abridged prospectus’ need only be appended to the
application form. Form 2-A has been prescribed as a format of abridged prospectus.
When ‘Abridged Prospectus’ not necessary?
In the following circumstances, an ‘abridged prospectus’ need not accompany the application
forms:
 A bonafide invitation to a person [Sec. 56(3)(a)]
 When shares or debentures are not offered to the public [Sec.56 (3)(b)].
 Where offer is made only to existing members/debenture holders of the company by way
of rights, whether with or without the right of renunciation [Sec.56 (5) (a)].
 In the case of issue of shares or debentures which are in all respects similar to those
previously issued and dealt in and quoted on a recognized stock exchange [Sec.56(5) (b)].

Registration of the Prospectus (Section 60):

A copy of the prospectus duly signed by every director or proposed directors must be delivered
to the registrar before its publication.

Is the issue of prospectus compulsory: when prospectus is not required to be issued?

The following are the circumstances:
 A private company
 If the promoters or directors feel that they can mobilize resources through personal
relationship and contacts.
 A Memorandum containing the prescribed salient features of a prospectus.
 A bonafide invitation to a person to enter into an underwriting agreement Sec.56(3)
 Application form is issued in relation to shares or debentures not offered to the
public [Sec. 56(3)]
 Offered to existing holders of shares or debentures[Sec. 56(5)]
 The issue relates to shares or debentures previously issued [Sec. 56(5)]
 Where invitation is made in the form of an advertisement, ordinarily called as
“prospectus announcement’ [Sec. 66]

Shelf Prospectus and Information Memorandum [Section 60A and 60 B]:

The Companies (Amendment) Act, 2000 has introduced two new sections, viz., Sections 60A
and 60B relating to ‘Shelf Prospectus’ and ‘Information Memorandum’ respectively. ‘Shelf
prospectus’ means a prospectus issued by any financial institution or bank for one or more
issues of the securities or class of securities specified in that prospectus.

Information Memorandum (Section 60B):

‘Information Memorandum’ means a process undertaken prior to the filing of a prospectus
by which a demand for the securities proposed to be issued by a company is elicited, and
the price and the terms of issue for such securities is assessed by means of a notice,
circular, advertisement or document [Section 2(19B)].
Winding Up
Winding Up By Court
A winding up by the court, or compulsory winding up, as it is often called, is initiated by an
application by way of petition presented to the Appropriate court for winding up order.

Grounds for Compulsory Winding Up:

a. Resolved to be wound up by the court.
b. If default is made in delivering the statutory report to the registrar or in holding the
statutory meeting.
c. If the company does not commence its business within a year from its incorporation, or
suspends its business for a whole year.
d. If the number of members falls below seven (or in case of a private company, below two).
e. If the company is unable to pay its debts.
f. If the court is of opinion that it is just and equitable that the company should be wound
up.
g. Just & equitable: (a) Main object failed (b) Deadlock in management (c) Cannot carry on
business except losses. (d) Mere bubble – and does not carry any business or does not
have any property. (e) Majority of shareholder have adapted an aggressive policy towards
the minority.

Who May Petition:

The following persons may file petition: (1) the company; (2) creditor; (3) contributory; (4) all or
any of the above parties; (5) the registrar; (6) any person authorized by the Central Government
(7) by virtue of Sec. 440, when a company is already being wound up voluntarily, the court may
order winding up by it.

Voluntary Winding Up:

A company may be wound up voluntarily: (i) when the period (if any) fixed for its duration has
expired or an event on the happening of which the company is to be wound up has happened
and the company in general meeting has passed an ordinary resolution to wind up; or (ii) if the
company passes a special resolution to wind up voluntarily (Sec. 484). There are two kinds of
voluntary winding up, namely: Member’s or Creditors’.

Winding Up Under Supervision:

Where a company is being wound up voluntarily by the court may order the continuation of
voluntary winding up subject to its supervision with any terms or conditions. The liquidator will
continue to exercise all powers subject to any restrictions laid down by the court.

Consequences of Winding Up
As To Shareholders:
A shareholder is liable to pay full amount of shares held by him.
As To Creditors:
A secured creditor may either (i) rely on the security and ignore the liquidation, or (ii) value his
security and prove for the balance of his debt, or (iii) give up his security and prove for the
whole amount. Unsecured creditors of an insolvent company are paid in this order: (i)
preferential payment under Sec.530, (ii) other debts pari passu.

As to Servants and Officers:

A winding up order operates as a notice of discharge to the employees and officers of the
company except when the business of the company is being continued (Sec. 444). A voluntary
winding up also operates as a notice of discharge.

Liquidators
Compulsory Winding Up:
The official Liquidator attached to each High Court will become the liquidator on a winding up
order being passed.

Powers of Liquidator:
institute or defend any suit, prosecution, or the legal proceeding in the name of the company,
(ii) carry on the business of the company for its beneficial winding up, (iii) sell company’s
property, (iv) raise money on the security of the company’s assets, and (v) do all other things
necessary for the winding up.

Duties Of Liquidator:
Summon meetings of creditors or contributories get in the property and pay the debts and
distribute the balance among contributories. Keep the proper books of account, minutes books,
and allow inspection thereof. Keep all the funds of the company in “the public account of India”
in the Reserve Bank of India.

Voluntary Liquidator:
The voluntary liquidator is appointed by resolution in general meeting of the company and or of
the creditors and his remuneration fixed. A voluntary liquidator is a paid agent of the company
and is liable in damages, if he neglects his duties as such.

Disclaimer by a Liquidator:
Sections 535(1) empower the liquidator, with the leave of the court to disclaim any onerous
property of the company.

Chapter Summary

 A Company, in common parlance, means a group of persons associated together for the
attainment of a common end
 In case of a dishonest and fraudulent use of the facility of incorporation, the law lifts the
corporate veil
 Companies are classified based on four categories, Incorporation, Liability, Control,
Transferability of shares
 Promotion is a term of wide import denoting the preliminary steps taken for the purpose of
registration and floatation of the company
 The Memorandum of Association of a company is its charter which contains the
fundamental conditions upon which alone the company can be incorporated
 Articles of Association are a document containing all the rules and regulations that governs
the company.
 A prospectus 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
 ‘Abridged prospectus’ need only be appended to the application form.
 A winding up by the court, or compulsory winding up, as it is often called, is initiated by an
application by way of petition presented to the Appropriate court for winding up order
 The official Liquidator attached to each High Court will become the liquidator on a winding
up order being passed