COMPANY LAW

COMPANY LAW K. B. Rohatgi*

Revised by Lisa P. Lukose**

Companies play a significant role in a country's economy and make a special contribution to national development. The working of companies affects all facets of national life. In a mixed economy, the government 's major economic policies are implemented through corporate sector. A modern company has assumed the character of a major socio-economic institution and public at large is vitally interested in its activities. It should function not simply as an economic machine intended to churn out profits for its shareholders, but rather as an institution which has a social responsibility to a variety of interests. A company's operation must be conducive to the economic growth of the country and for that purpose a comprehensive mechanism is provided in the form of the Companies Act, 1956 for regulating corporate affairs. The primary object of this paper is to give a general survey of the law relating to companies as contained in the Companies Act, 1956 with its various Amendments.

The Companies Act, 1956 consolidates and amends the law relating to companies and certain other associations.1 Section 3(i) of the Act defines a "company" as one formed and registered under this Act or an existing company incorporated prior to the commencement of the Act.2 Section 3 (iii) defines a "private company". A private company is one which has a minimum paid-up capital of one lakh rupees or such higher capitals as may be prescribed3 and by its articles (a) restricts the right to transfer its shares, if any, (b) limits the number of its members to fifty; and (c) prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company. A public Company is defined as one (a) which is not a private company, (b) has a minimum paid up capital of five lakh rupees and (c) is a private company which is subsidiary of a company which is not a private

* Formerly Professor of Law and Director, South Delhi Campus, University of Delhi. ** Asst. Research Professor, Indian Law Institute, New Delhi. 1. The Companies Act, 1956, the Preamble, 2. Previous legislations relating to incorporation of companies in India: The Joint Stock

Companies Acts of 1850, 1857 and 1860, all repealed by the Indian Companies Act of 1866, repealed by the Indian Companies Act of 1882, repealed by the Indian Companies Act of 1913, and finally repealed by Companies Act, 1956.

3. Inserted by the Companies (Amendment Act), 2000.

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company.4 Under section 4(1) of the Act a company qualifies as holding company when it has the power to control the composition of the board of directors of the other company or holds a majority of shares. A company shall be deemed to be the holding company of another if that other is its subsidiary.5 But the holding company cannot claim the subsidiary company as one of its own assets.6 A subsidiary has separate legal entity from that of the controlling (holding) company.

Companies (Amendment) Act, 2002 by inserting Part IXA recognised a new category of company, viz, 'producer companies'.7 Only certain categories of persons- 'primary producers- can participate in the ownership of such companies.8

Incorporation

Under the law a company incorporated under the Act is a distinct entity having independent corporate existence. Although all the shares may be practically controlled by one person, in law a company is a distinct entity and it is not permissible or relevant to enquire whether the directors belonged to the same family or whether it is described as a "one-man company".9 Any seven or more persons, or where the company to be formed is a private company, any two or more persons, may associate for any lawful purpose by subscribing their names to a memorandum of association, and thereby form an incorporated company, with or without limited liability, provided they comply with the requirements of the Act in respect of registration.10 Thus, a company acquires its own separate legal entity distinct from that of its members.

The company, being a separate person, is the owner of its capital, assets and bound by its liabilities. An incorporated company never dies. It is an entity with perpetual succession. Being a legal person it is capable of owning, enjoying and disposing of property in its own name. The company is the owner of its capital and assets and no changes of individual membership affect the title of the company. Although a legal entity, a company is not a citizen either under the Constitution of India or under the Citizenship Act.11 But the company can enjoy fundamental rights; if a fundamental right of a company is infringed the company can challenge the

4. S.3(l)(iv). 5. S. 4 (4). 6. Free Wheel (India) Ltd v. Dr. VedMitra AIR 1969 Delhi 258. 7. S. 581A. 8. S. 581A (k). Primary producers are those persons who are engaged in an activity

connected with, or related to, primary produce. 9. Salomon v. Salomon and Co.(1897) A.C. 22. 10. S. 12 (1). 11. State Trading Officer v. Commercial T.O. AIR 1963 SC 1811.

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same.12 A company incorporated in a particular country does have the nationality of that country, domicile and residence.13 However, in reality the business of the artificial person (the company) is always carried on by, and for the benefit of, some individuals. In the ultimate analysis some human beings are the real beneficiaries of the corporation, and owing to social, economic and moral factors and considerations courts of law ignore the company and concern themselves directly with the members or managers of the company by lifting the veil of the company. It may become necessary to determine the character of a company, to see whether it is enemy;14 or if the corporate entity is used for tax evasion or to circumvent tax obligations;15

or if it is formed to defraud creditors or to avoid legal obligations,16 or in case of economic offences17 or to punish for contempt of court.18 The corporate veil may be pierced in any other circumstances whenever the court deems it fit to do so.19

An incorporated company may be (i) a company limited by shares, or (ii) a company limited by guarantee, or (iii) an unlimited company.

Before a company is registered, it is desirable to ascertain from the Registrar of companies (for the state in which the registered office of the company is to be situated) whether the proposed name of the company is desirable or not. If the proposed name of the company is approved; then the following documents have to be filed with the Registrar: 1. The memorandum of association, 2. The articles of association, if any, 3. The agreement, if any, which the company proposes to enter with any

individual, firm or body corporate.20

4. A statutory declaration by an advocate of the Supreme Court or High Cour t or an attorney entitled to appear before a high court or a secretary or chartered accountant in whole-time practice in India who

12. Chiranjüal Chaudañ v. Union of India (1951) 21 Comp. Cas. 33 (SC) and Bennet Coleman Co.v. «7. O. 7(1972) SCC 788.

13. Gasquev. Commissioner of Inland Revenues (1940) 2 KB 80. 14. Dialmerand Co. v. Continental Tyre and Rubber Co. (1916) 2 A.C. 307. 15. In re Sir Dinshaw Maneekjee Petit AIR 1927 Bom. 37and Commissioner ofIncome Taxv.

Sri Meenakshi Mills Ltd. AIR 1967 SC 819. 16. Gilford Motor Co. v. Home (1933) 1 Ch 935. 17. Santanu Ray v. U. O. I (1989) 65 Comp. Cas. 196 (Delhi). 18. JyotiLtd. v. Kanwaljit KaurBhasin (1987) 62 Comp. Cas. 626 Pelhi). 19. In Delhi Development Authority v. Skipper Constructions Company (P.) Ltd. (1996) 4

SCALE 202 (SC) the court lifted the corporate veil when the company was created as a mere sham for committing illegalities. In New Horizons Ltd v. U. O. I (1995) 1 Comp. LJ. 100 (SC) the court removed the facade of corporate personality to determine the technical competence of the company.

20. S. 33 (1).

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was engaged in the formation of the company or by a director or manager or secretary of the company that all requirements of the Act and Rules thereunder in respect of registration have been complied with.21 The above documents are all that a private company has to file. A public company, having a share capital, must file, in addition to the above, the following documents: L A list of persons who have consented to be directors of the

company, ii. A written consent duly signed by the directors, agreeing to act in

that capacity, iii. An undertaking in writing signed by each such director to take and

pay for their qualification shares, if any. Ordinarily, both private and public companies will file the notice of the

addresses of their registered offices; (or it may be given within 30 days from the date of incorporation).22

The documents for registration must be supported by a declaration stating that all the requirements of the Companies Act and other formalities related to registration have been complied with.

Under the Stamp Act, 1899 the above documents must be duly stamped before they are presented for registration.23 When the above documents are filed wi th the Registrar , he has to satisfy himself whether all the requirements regarding registration have been duly complied with. If he is satisfied that all the requirements of the Act have been complied with he shall retain and register the memorandum, the articles and other documents filed with him and issue a 'certificate of incorporation, i.e., of the formation of the company. The certificate of incorporation shall be conclusive evidence that all the formalities have been complied with.24

Memorandum of association

In order to form a company, the first step is to prepare the memorandum of association. It is a document that sets out the fundamental conditions for constitution of the company and, as such it is really the foundation on which the structure of the company is based. It defines the limitation on the powers of the company.25 It describes its relations with the outside world and the scope of its activities. Its purpose is to enable shareholders,

21. S, 33(2). 22. S. 146 (2). 23. Stamp duty payable on various documents has been reduced to 50% w. e. f. 01-03-

04. 24. S. 35; Moosa Goolam Ariff v. Ebrabim GooLm Anff I.L.R. 40 Cal. 1 (1913) P.C. 25. Ashbury Railway Carriage & Iron Co. Ltd. v. Ricbe (1875) L.R. 7 H.L. 635.


creditors and those who deal with the company to know what is its permitted range of enterprise. Under section 16 of the Act a company cannot alter the conditions mentioned in its memorandum except in the cases and in the manner and to the extent provided in the Act.26

The memorandum of every company must state:27

(1) the name of the company with 'Limited; as the last word, and 'Private Limited' if the company be a private limited company;

(2) the state in which its registered office is to be situated; (3) in the case of a company in existence before the commencement of

the Companies (Amendment) Act, 1965 the objects of the company, and in the case of company after such commencement, the main objects of the company to be pursued on its incorporation and objects ancillary or incidental to attainment of such objects, and other objects, if any;

(4) the states to whose territories the objects extend where the objects of the company (other than a trading corporation) are not confined to one state;

(5) the fact that the liability of its members is limited, if it is a limited liability company;

(6) the amount of capital and the division thereof into shares of a fixed amount, unless the company is an unlimited one28 and

(7) the association clause and subscription.29

A company being a legal person must have a name to establish its identity. No company can be registered with a name, which, in the opinion of the Central Government, is undesirable.30 The name of the company should not be identical with or should not too nearly resemble the name of another registered company in existence or a registered trademark or a trademark, which is a subject of an application for registration, of any other person under the Trade Marks Act, 1999.31 If the liability of the members is limited, the last word of the company's name must be 'Limited', and in the case of a private limited company the word 'Private ' should precede 'Limited'.32 This is to ensure that all persons dealing with the company shall have a clear notice that the liability of the members is limited. Any default in this respect might involve the officers of the company in most serious

26. Ss. 16 to 19. 27. S. 13. 28. S. 4(a). 29. S. 4 (c). 30. S. 20(1). 31. S. 20 ((2). 32. S. 13 (1) (a).

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consequences. However, in exceptional cases the Central Government may, by licence, allow a company to drop the word "Limited" from its name.33

Also, a company can change its name by complying with the provisions of the Act.34

The memorandum must specify the state in which the registered office of the company is to be situated. A company may change its registered office within the territorial jurisdiction of the state of registration by complying with the provisions of the Act.35 But change of registered office from one state to another is a complicated affair as the Central Government has to be satisfied that the shifting of the office is necessary for any of the purposes detailed in section 17 (1), and also bound to consider the objections of a person or a class of persons whose interest will, in the opinion of the Central Government be affected by the alteration36. The earlier judicial practice of refusing change of registered office from one state to another on the ground of loss of revenue to the state37 was later observed to be parochial. The new approach is to consider the question of revenue in the prospect of total revenues to the Republic of India.38

The memorandum must state the objects for which the proposed company is to be established. The Companies (Amendment) Act, 1965 requires that in the case of companies in existence prior to the amendment, the objects clause has simply to state the objects of the company.39 But in the case of a company to be registered after the amendment, the objects clause must be divided into two sub-clauses, namely:

1. main objects to be pursued by the company on its incorporation and objects incidental and ancillary to the attainment of the main objects;

2. other objects which are not included in the above.40

The statement of objects, therefore, gives a very important protection to the shareholders by ensuring that the funds raised for one undertaking are not going to be risked in another. The objects clause also affords a certain degree of protection to the creditors. The creditors of a company trust the corporation and not the shareholders and they have to seek repayment out of the company's assets only. The fact that the corporate

33. S. 25. 34. S. 21. 35. S. 146. 36. S. 17 (3). 37. Orient Paper Mills Ltd. v. State AIR 1957 Ori. 232. 38. Minerva Mills Ltd. v. Govt. of Maharashtra (1975) 45 Comp. Cas. l(Bom.) Also see

Rank Film Distributors of India Ltd. v. The Registrar of Companies AIR (1969) Cal. 32. 39. S. 13 (c). 40. S. 13 (d).


funds cannot be spent on any project not directly within the terms of the company's objects gives the creditors a feeling of security.41 Thus, the funds of a company under the Act can only be applied in carrying out its authorized objects. If a director of a company makes an ultra vires payment he can be compelled to refund the money. The directors being agents of the company can do nothing which the company itself cannot do under its memorandum of association and, therefore, any contract made by them which is ultra vires the company will be void and of no effect whatsoever. If on the other hand, they make a contract within the powers of the company but ultra vires the powers which the company by its articles has conferred upon them, the company may ratify the contract in general meeting and thereby be bound by it. In the absence of such ratification, the company will not be bound by the contract and the directors may be personally liable to the other party to the contract for the breach of an implied warranty of their authority. Though a contract may be ultra vires the company and, therefore, void, it may have certain indirect effects. First, if money or property obtained under an ultra vires contract has been used to pay debts of the company, then by the principle of subrogation the creditor can, to that extent, stand in the shoes of those creditors of the company who have paid off. Secondly, if the property handed over to the company by virtue of an ultra vires contract exists in specie or if it can be traced the person handling it over can get it back.

Section 17 allows alteration of objects within certain defined limits. The limits imposed upon the power of alteration are of two kinds, namely substantive and procedural. Section 17 provides that a company may alter Memorandum so as to change the place of its registered office from one state to another or with respect to its objects only in so far as the alteration is necessary for any of the following purposes:

1. To enable the company to carry out its business more economically or more efficiently;

2. To enable the company to attain its main purpose by new or improved means;

3. To enlarge or change the local areas of the company's operations; 4. To carry on some business which under existing circumstances may

conveniently or advantageously be combined with the business of the company;

5. To restrict or abandon any of the objects specified in the memorandum;

41. Waman Lai v. Sandia Steam Navigation Co. AIR 1944 Bombay 131. The doctrine of ultra vires has been upheld by the Supreme Court in A. Lakshamanaswamy Mudaliar v. Life Insurance Corporation of India AIR (1963) SC 1185.

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6. To sell or dispose of the whole, or any part of the undertaking of the company;

7. To amalgamate with any other company or body or persons. The procedure of alteration of a memorandum of association to change

registered office from one place to another is as follows:42 a special resolution authorizing the alteration must be passed at a general meeting of the company. But the alteration does not take effect until it is confirmed by the Central Government on petition. Before confirming the alteration, the Central Government must be satisfied that sufficient notice has been given to every holder of the debentures of the company and to other persons whose interest, in its opinion, will be affected by the alteration. The Central Government must further be satisfied that either the consent of every creditor has been obtained to the alteration or his debt or claim has been discharged or secured to the satisfaction of the Central Government. The Central Government must cause a notice of the petition for confirmation of the alteration to be served on the Registrar, as he is also entitled to state his objections and suggestions, if any.43

A certified copy of the Central Government's order and a printed copy of the altered memorandum must be filed with the Registrar within three months of the order.44 Within one month the Registrar will certify the registration. Alteration takes effect when it is so registered.45

Change of registered office of the company from one place to another within a state can be done only with the confirmation of the Regional Director.46

As previously stated the memorandum must have a liability clause. This clause has to state the nature of the liability that the members incur. The company limited by shares or guarantee must also state that the liability of its members is limited.47 This means that no member can be called upon to pay anything more than the nominal value of the shares or the guaranteed amount held by him or so much thereof as remains unpaid.48 The absence of this clause in the memorandum means that the liability of its members is unlimited.

The capital clause states the amount of the nominal capital of the company and the number and value of the shares into which it is divided.49

42. S. 17(2). 43. S. 17 (3). 44. S. 18 (1) (b). 45. S. 19. 46. S. 17A. 47. S. 13 (2). 48. S. 12 (2). 49. S. 13 (4) (a).


The clause lays down the limit beyond which the company cannot issue shares without altering the memorandum.50

The memorandum concludes with the subscription clause. In this clause the subscribers declare:

We, the several persons whose names and addresses are subscribed are desirous of being formed into a company, in pursuance of the memorandum of association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names.

Each subscriber must sign the document and must write opposite his name the number of shares he takes.51 But no subscriber shall take less than one share.52 After incorporation no subscriber can withdraw his name on any ground whatsoever.

Articles of association

Unlimited companies, companies limited by guarantee, and private companies limited by shares have to register, along with the memorandum of association, articles of association signed by the subscribers of the memorandum, prescribing regulations for the company.53 These articles are rules, regulations and by-laws that govern the management of the internal affairs of a company. They establish a contract between the company and its members and the members inter se. Articles usually contain the following matters: I. adoption of preliminary contracts; 2. share capital, kinds of shares and right of shareholders; 3. lien of shares; 4. calls on shares; 5. transfer and transmission of shares; 6. forfeiture of shares; 7. alteration of capital; 8. conversion of shares into stock; 9. share certificates; 10. meetings; 11. voting rights and proxies; 12. directors, managing directors, their appointment, qualifications, and powers etc.; 13. borrowing powers; 14. dividends and reserves; 15. accounts and audit; and 16. winding up.

A public company limited by shares need not have articles of its own. In such a case model articles contained in Table A of schedule I will apply.54

The articles must be signed by each subscriber of the memorandum (who must add his address, description and occupation, if any) in the presence of at least one witness who will attest the signature and likewise add his address, description and occupation, if any.55 The articles must be

50. S. 94. 51. S. 13 (4) (c). 52. S. 13 (4) (b). 53. S. 26. 54. S. 28. 55. S. 30 (c).

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printed and divided into paragraphs numbered consecutively.56

A company can at any time alter or add to its articles by passing a special resolution.57 Articles can never be altered by an ordinary resolution. A company has unlimited power to alter its articles and any alteration so made will be valid as if originally contained in the articles.58 But it will not give the a l terat ion a retrospective effect.59 Any provision in the memorandum and articles, which deprive the company of its powers to alter its articles, is void and inoperative.60

Articles can be fully altered without any of those restrictions which are contained in the Act for altering the memorandum. There are, however, certain limitations on the powers of the company to alter its articles.

1. Articles cannot be altered so as to be in conflict with or contrary to the Companies Act.61

2. Articles must be subject to the conditions contained in the memorandum. They should not be repugnant to the memorandum. In case of conflict the memorandum will prevail.

3. N o member of a company will be bound by any alteration made in the memorandum or articles after he became a member which requires him to take or subscribe for more shares or in any way increase his liability to contribute to the share capital of, or otherwise to pay money to, the company unless he agrees in writing before or after the alteration is made.

4. The alteration must be made bonafide for the benefit of the company as a whole.62

Sometimes an alteration of articles operates as a breach of contract with an outsider. In case the contract be wholly dependant upon the provisions of the articles the alteration would naturally be operative. But where, apart from the articles, the company has entered into an independent agreement, the company may, by altering the articles, repudiate that contract.

Also, the alteration must not constitute a fraud or oppression on the minority by the majority.63

56. S. 30 (a) and (b). 57. S. 31. 58. S. 31 (2). 59. PyareLal Sharma v. Managing Director, J & KIndustries Ltd. (1989) 3 Comp. L. J. 70. 60. All India Railwomen's Benefit Fund v. Bakeskwarnatb AIR 1945 Nag. 187. 61. S.9. 62. However, the alteration is not bad merely because it inflicts hardship on an

individual shareholder if it is otherwise bonafide for the benefit of the company as a whole. See Side Bottom v. Kershaw Leese & Co. (1920) Ch. 154 (C.A).

63. Mathrubhumi Printing & Publhhing Co. Ltd. v. Vardhaman Publishers Ltd. (1992) 73 Comp. Cas. 80 (Ker.). Also see Brown v. Abrasive Wheel Co. (1919) 1 Ch. 290.


The memorandum and articles, when registered, bind the company and its members to the same extent as if they respectively had been signed by the company and by each member.64 Hence, the company is bound to the members and the members are bound to the company. Member inter se are also bound by both these documents.65 But in relation to articles neither the company nor its members are bound to outsiders.

Both memorandum and articles are registered with the Registrar before the company is incorporated. Then it becomes public documents. These documents are available for inspection by the public66 and every person dealing with the company is deemed to have constructive knowledge of the contents of these documents even if they do not have actual notice of the same. This is known as 'doctrine of constructive notice'. Persons dealing with incorporated company must take notice of disabilities imposed on the companies and its officials. If any one deals with the company in matters inconsistent with the powers so given, he must bear the consequences of his own negligence.67

Although outsiders are affected with notice of all that is contained in these two documents, they are not concerned whether all matters of internal management have been complied with. Outsiders need not inquire into the regularity of the internal proceedings. This is known as the doctrine of indoor management.68 The doctrine is based upon the principles of justice and public convenience. The reason is that while the memorandum and the articles of association are public documents open to public inspection, the details of internal procedures are not thus open to public scrutiny.69

The doctrine is of great practical utility. It has been applied in a great variety of cases to secure justice. It has been used to cover acts done on behalf of a company by defacto directors who have never been appointed,70

or whose appointment is defective,71 or who having been regularly appointed, have exercised an authority which could have been delegated to them under the company's articles, but never has been so delegated,72 or who have exercised an authority without proper quorum. Thus where the directors of a company having the power to allot shares only with the

64. S. 36 (1). 65. Ramkrisbna Industries (P.) Ltd. v. P. R. Ramaknshnan (1988) 64 Comp. Cas. 425, also

see Shiv OmkarMaheswari v. Bansidharjagannath (1957) 27 Comp. Cas. Bom. 255. 66. S. 610. 67. KotL· Venkataswamy v. Chima Ramamurthy AIR 1934 Mad. 579. 68. This doctrine has its genesis in Royal British Bank v. Turquand (1856) 119 ER 886. 69. Official Liquidator v. Commissioner of Police (1969) 1 Comp. L J. at page 27. 70. Imperial Oil and General Mills v. WazirSingh AIR 1915 Lah. 478. 71. Pudamjee and Co. v. N.H. Moos AIR 1926 Bom. 28. 72. Kishan Rathi v. Mondal Bros. (1966) 1 Comp. LJ. 10.

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consent of the general meeting allotted them without any such consent;73 or where the managing director of a company granted a lease of the company's properties, something which he could do only with the approval of the board,74 the company was held liable.

The doctrine of indoor management is not applicable in all cases. The scope of its applicability has been restricted in certain respects. In the first place, a person who has actual knowledge of the internal irregularity cannot obviously claim the protection of the doctrine. Thus where a transfer of shares was approved by two directors, one of whom within the knowledge of the transfer or was disqualified for reasons of being the transferee himself and the other was never validly appointed, the transfer was held to be ineffective.75 Also, a person cannot claim the benefit of the rule if he would have discovered the irregularity, had he made proper inquiries.

The doctrine of indoor management does not apply if a document is forged so as to purport to be the company's document.76 The doctrine does not protect those who behave negligently and transact contract in suspicious circumstances that requires enquiry.77

Articles of association generally contain what is called the power of delegation, namely, that a person who contracts with an individual director of a company knowing that the board has power to delegate its authority to such an individual, may assume that the power of delegation has been exercised. But if the act of the officer of the company is one which would ordinarily be beyond the powers of such an officer, the plaintiff cannot claim the protection of the doctrine of indoor management simply because under the articles power to do the act could have been delegated to him.

Promoters

Before a company is formed, some persons must take the initiative in taking necessary steps to form it. Promoters are the persons who form or float a company. A promoter may be an individual, association, partner, syndicate or company. A promoter has been described as 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. A promoter stands in fiduciary position towards the company he promotes.78 When a promoter desires to sell his own property to the company he must disclose his interest in the property to an independent board of directors and make a full

73. Agricultural I. T. v. H. S. Mills AIR 1965 Pat. 98. 74. Khulna Loan Co. v. Jahir Goldar (1914) 24 I.C. 209. 75. A. T. Judah v. R. Gupta AIR 1959 Cal. 715. 76. Ruben v. Great Fingall Consolidated (1906) AC 439. 77. AnandBihari Lai v. Dinshaw & Co AIR 1942 Oudh 417. 78. Erlangerv. New Sombrero Phosphate Co. (1878) App. Cas. 1218 at 1236.


disclosure of profits he is making in that deal.79 If it is not possible to constitute an independent board of directors, the disclosure must be made to the whole body of shareholders.80 If the promoter fails to make a disclosure the company may rescind the contract and recover the purchase money paid. But the right of rescission will be lost if the parties cannot be restored to their original positions, for example, if the character of the property has been altered or third parties have acquired valuable rights. In such cases damages can be recovered from the promoters for breach of duty of good faith.

When the public is invited to subscribe for shares or debentures in a company, a document called prospectus is issued setting out the advantages to accrue from an investment in the company. A private company is, by its very constitution, prohibited from inviting subscription for its shares.81

Even a public company need not necessarily go to the public for money. The promoters may be confident of obtaining the required capital through private contacts. In such a case no prospectus need be issued to the public. Yet the promoters are required to prepare a draft prospectus containing the information required to be disclosed by schedule III of the Act. This document is known as a statement in lieu of prospectus.82 The Act defines prospectus as "any document described or issued as a 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.83 There are three ways in which a company can invite the public to subscribe to its shares and debentures:

1. by issue of prospectus by or on behalf of the company, 2. by offer of sale to an issue house which then invites the public to

buy shares and debentures from the issue house itself and not from the company,84

3. by placing shares and debentures with issue houses or brokers who can sell and transfer them to their own clients.

Prospectus

N o one can issue any form of application of shares in or debentures of a company unless it is accompanied by a prospectus complying with the Act. A prospectus issued by or on behalf of a company or in relation to any

79. Ibid. 80. Gluckstein v. Barnes (1900) AC 240. 81. S. 3(iii)(c). 82. S. 70. 83. S. 2(36). 84. S. 64.

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intended company must be dated and that date will, unless the contrary is proved, be taken as the date of publication of the prospectus.8 5 A prospectus must not be issued by or on behalf of the company, unless on or before the date of its publication, a copy of it has been delivered to the Registrar signed by every director or proposed director or his duly authorized agent. Where a prospectus is generally issued, that is, to the members of the company and outsiders, it must be accompanied by a copy of every contract relating to the appointment or remuneration of a managing director, or managers and of every other material contract. Where auditors or accountants have made their reports in connection with part II of schedule II and have made some adjustments in figures, a signed written statement by them setting out the adjustments and reasons thereof must be annexed to every copy of the prospectus generally issued.

The Registrar must not register a prospectus if the requirements of the Act have not been complied with and the prospectus is not accompanied by the consent in writing of the persons named therein as the auditor, legal adviser, attorney, solicitor, banker or broker of the company or intended company to act in that capacity.86

A prospectus must not be issued more than ninety days after the date on which a copy thereof is delivered for registration and if a prospectus is so issued, it will be deemed to be a prospectus a copy of which has not been delivered to the Registrar.87

If a prospectus is issued without a copy thereof being delivered to the Registrar or without the required documents or consent attached thereof, the company and every person who is knowingly a party to the issue of the prospectus will be punishable with fine which may extend to Rs. 5,000/-.

It is necessary for every public company, before offering shares or debentures for public subscription by issue of a prospectus, to make an application for listing the security in one or more recognised stock exchanges.88 This is known as listing of the shares.

A prospectus must contain the necessary information to enable the public to decide whether or not to subscribe for its shares and debentures. Every prospectus must state the matters specified in part I of schedule II and set out the reports specified in part II of schedule II and part I and part II will have the effect subject to the provisions contained in part III of that schedule.89 As per the SEBI90 (Disclosure and Investor Protection) Guidelines,

85. S. 55. 86. S. 60 (3). 87. S. 60 (4). 88. S. 73 (1), as amended by the Companies (Amendment) Act, 1988. 89. S. 56 (1). 90. Securities and Exchange Board of India. The Government of India established SEBI

in 1988. In 1992 it became an autonomous statutory board with the passing of the


2000 every prospectus or offer document must also contain information about the promoters' contribution and details of their 'buy- back' and 'stand by' arrangements for purchase of securities.

The Companies (Amendment) Act, 2000 has introduced section 60A and section 60B relating to shelf prospectus and information memorandum respectively. Shelf prospectus means a prospectus issued by any financial institutions or bank for one or more issues of the securities or class of securities specified in that prospectus. A public company making an issue of securities may circulate information memorandum to the public prior to filing a prospectus to elicit the demand for securities proposed to be issued. The company is required to file a prospectus prior to the opening of the subscription list and to offer as a red-herring prospectus at least 3 days before opening of offer.91

Provisions relating to prospectus are most stringent and the duty of preparing and filing it in accordance with the law is mandatory. A company should not, at any time, vary the terms of a contract referred to in the prospectus or statement in lieu of prospectus except subject to the approval of or except on authority given by the company in general meeting.92

Section 65 of the Act provides that a statement included in a prospectus will be deemed to be untrue if the statement is misleading in the form and context in which it is included or if there is omission of any matters from the prospectus which is calculated to mislead. If the prospectus contains an untrue statement, an applicant for shares is entitled to rely on it and is not bound to verify it. A person who has been induced to buy shares or debentures in a company on the basis of false or misleading statement in the prospectus has a cause of action either against the company or against the directors or both. The aggrieved person has two remedies, namely, rescission of contract and damages for fraud. The remedy against the company is for rescission of contract with or without damages for fraud. The remedy against directors is for fraud or compensation under the Act.93

An allottee must move for the recession of the contract as soon as he comes to know of the misrepresentation but in any case before the company goes into liquidation. On winding up the right of the company's creditors intervenes and the right of rescission is lost. On winding up he is deemed to be a contributory unless he has commenced an action for rescission before

Securities and Exchange Board of India Act, 1992. The basic objectives of the Board are to (a) protect the interests of investors in securities; (b) promote the development of Securities Market and (c) regulate the securities market.

91. A red- herring prospectus is a prospectus, which does not have complete particulars on the price of securities offered and the quantum of securities offered.

92. Pramatha N. Sanyalv. KaliDutt AIR 1925 Cal. 714. 93. S. 62.

COMPANY LAW 573

the date of the winding up of the company.94

Apart from the rights available to an allottee under the general law of the land in respect of a false or misleading prospectus, section 62 provides that where a prospectus invites persons to subscribe for shares in or debentures of a company, the persons enumerated in the section will be hable to pay compensation to every person who subscribes for any shares or debentures on the faith of the prospectus for any loss or damage he may have sustained by reason of any untrue statement included therein.

If a prospectus includes any untrue statement, every person who authorized the issue of the prospectus will be punishable with imprisonment for a term which may extend to two years or with fine which may extend to Rs. 5,000/- or with both unless he proves that the statement was immaterial or that he had reasonable ground to believe that the statement was true.95

Also any person who, either by knowingly or recklessly making any statement, promise or forecast, which is false, deceptive or misleading, or by any dishonest concealment of material facts, induces or attempts to induce another person to acquire, dispose of, subscribe for or underwrite shares or debentures, will be punishable with imprisonment for a term which may extend to five years, or with fine which may extend to one lakh rupees or with both.96

Members

A share is the interest of a member in a company measured by a sum of money- usually the nominal value of share- and also by the rights and obligations belonging to it. According to section 2 (46) of the Act, share means share in the capital of a company, and includes stock where a distinction between stock and share is expressed or implied. Section 82 provides that shares or debentures or other interests of any member in a company will be movable property, transferable in the manner provided for in the articles. Shares are included in the definition of "goods" under the provisions of the Sale of Goods Act, 1930.97

A person may become a shareholder in a company in one of the following ways:

1. by subscribing to the memorandum of association98

2. by agreement and registration99

94. Shrimani Sugar Mills v. Debi Prasad AIR 1950 All. 508. 95. S. 63. 96. S. 68. 97. S. 2(7) of the Sale of Goods Act, 1930. 98. U. P. Oil Mills v. Jamma Pd. (1933) 3 Comp. Cas. 256 (All). 99. S. 41 (2).


3. by consenting to acquire the qualification shares for directorship . 4. by application and allotment 5. by transfer of shares 6. by transmission of shares 7. by estoppel. O n the incorpora t ion of a company, the subscribers to the

memorandum automatically become its members and they are deemed to have taken shares set opposite their names. In their case neither allotment nor registration of their names in the register of members is essential. Section 41(1) provides that the subscribers of the memorandum of a company will be deemed to have agreed to become members of the company, and on its registration, must be entered as members in its register of members. This section also provides that every person who agrees in writing to become a member of a company and whose name is entered in its register of members will be a member of the company. Allotment is usually made by the directors at a board meeting in pursuance of a power given in the articles. Where the board is not properly constituted, the allotment is valid if there is a subsequent ratification by a properly constituted board.

Any person who is competent to contract may become a member of a company. A company may become a member of another company if so authorized by its articles but subject to provisions of section 42 and certain restrictions as to maximum holding in other bodies corporate.100

A subsidiary company cannot be a member of its holding company and any allotment or transfer of shares in a company to its subsidiary will be void except under certain circumstances.101

An allotment of shares must be made by a resolution of the board of directors. Such an allotment must be made within a reasonable period of time. The allotment must be communicated to the applicant in accordance with a manner expressly or impliedly indicated by him. Allotment is valid only if permission is granted by every stock exchanges named in the prospectus for listing the security.102 A person cannot be treated as a shareholder unless a notice of allotment has been sent to him.103 Allotment must be absolute and must conform with the terms and conditions of the application.104 An allottee of shares is entitled to have from the company a document known as a share certificate,105 certifying that he is the holder of

100. S. 372. 101. S. 42(1). 102. Ruhyashringa Jewellery Ltd v. Stock Exchange 1995 SCL (SC) 227 and Rich Paints Ltd.

v. Vadodara Stock Exchange Ltd. (1998) 15 SCL 128. 103. Changa Mal v. Provincial Bank (1914) 36ILR 412 (All). 104. Ramanbhai v. GhasiRam (1918) Bom. LR 595. 105. S. 113.

COMPANY LAW 575

the specified number of shares in the company. Accordingly, every company making an allotment of shares is obliged "to complete and have ready for delivery the certificates of all shares" within three months after the allotment.106

Shares can, now, also be held in dematerialized form. Dematerialized securities are securities that are not on paper and a certificate to that effect does not exist. They exist in the form of entries in the book of depositories. This system works through a depository. The Companies (Amendment) Act, 2000 mandates that every initial public offer made by a listed company in the excess of rupees ten crores has to be issued only in dematerialized form by complying with the provisions and regulations of the Depositories Act, 1996.107

Share certificate is the prima facie evidence of the title of a member to shares.108 A share certificate once issued binds the company in two ways. In the first place it is a declaration by the company to the entire world that the person in whose name the certificate is made out, and to whom it is given, is a shareholder in the company.109 Secondly, if the certificate states that on each of the shares full amount has been paid, the company is estopped, as against a bonafide purchaser of the shares, from alleging that they were not fully paid.110

Section 82 of the Act provides that the shares of a member in a company shall be movable property capable of being transferred in the manner provided by the articles of the company. The articles of association of a private company as against those of a public company contain more rigorous restrictions on the right of its members to transfer shares.

Within thirty days of the allotment of shares, a company is required to send to the Registrar a report, known as return as to allotment.111

The Companies Acts have always discouraged issue of shares of a price less than their face value. But section 76 permits a company to pay commission to any person for his subscribing or agreeing to subscribe for shares or debentures or for procuring or agreeing to procure subscription for shares or debentures of the company. The Act, however, permits the company to pay brokerage for selling its shares at a price higher than their nominal value. There is no restriction whatever on the sale of shares at premium.112 The Act has also imposed a ban by imposing penal sanctions

106 107 108 109 110 111 112

Ibid. S. 68B. S. 84. Dixon v. Kennaway (1900) 1 Ch. 833 Bloonmentbal v. Ford (1897) AC 156. S. 75. S. 78.


on personation for acquisition of shares.113

A public company limited by shares, if permitted by its Articles, may issue, with the previous approval of the Central Government, share warrant in respect of fully paid up shares stating that the bearer of the warrant is enti t led to the shares therein specified.114 A share warrant can be reconverted into shares subject to the provisions in the Articles.115

The words "member" and "shareholder" are used interchangeably and, generally speaking, apart from a few exceptional cases, they are synonymous. The liability of a shareholder to pay the full value of the shares held by him is enforced by making "calls". If a member, having been called upon to pay, defaults, the company may, bring an action against him. But articles of association often provide that in such a case the company may proceed to forfeit his shares. Shares cannot be forfeited unless there is a clear power to that effect in the articles.

Every surrender of shares, like forfeiture, amounts to reduction of capital. But while forfeiture is recognized by the Act, surrender is not.

Every company is bound to keep a register of shareholders containing their names, addresses, ere.116 The appropriate place for keeping the register is the registered office of the company.117 Every member and a debenture holder have the right of inspection without a fee.

A company may provide by its articles that the shareholders who are indebted to the company would not be permitted to dispose of their shares without paying their debts and that the company might have a lien on their shares for the debts.118

Every company has to file with the Registrar an annual re turn containing certain particulars. This is to enable the Registrar to record the changes that have occurred in the constitution of the company during the year.119 The return has to be filed within sixty days from the date of the annual general meeting. Some formal certificates have to be presented along with the return. In the case of a private company the certificate must also state that the company has not during the year issued any invitation to the public to subscribe for shares or debentures of the company.120

113. S. 68A. 114. S. 114. 115. S. 115 (2). 116. S. 150(1). 117. S.163. 118. AmarNath v. Kama! Electric Supply Co. AIR 1952 Punj. 411. 119. Ss. 159-161. 120. S. 161 (2) (6). See also S. 162 which contains provision about penalty etc.

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Capital

The word 'capital' is used in a company in various senses. It may mean the nominal, issued, paid-up or reserve capital of the company. Nominal capital is the amount of capital with which the company is registered. It must be stated in the memorandum and may be increased in the manner provided in the Act. Issued capital is that part of the nominal capital of the company which is offered to the public for subscription. Subscribed capital is that part of the issued capital of the company which has been subscribed or taken up by the public. Paid-up capital is that portion of the issued capital of the company which has been paid up by the shareholders. A shareholder is liable to pay in full the nominal value of the shares taken by him as and when calls are made by the company. Paid up capital is that part of the called-up capital of the company which has been paid-up by the shareholders. Reserve capital is that part of the uncalled capital of the company which, the company may by a special resolution determine, will not be called up. The reserve capital cannot be called up except in the event and for the purposes of the company being wound up.121

The Companies (Amendment) Act, 2000, has substituted section 86 with new provisions which state that the share capital of a company limited by shares shall be only of two kinds, viz., (a) equity share capital (i) with voting rights; or (it) with deferential rights as to dividend, voting or otherwise in accordance with such rules and subject to such conditions as may be prescribed and (b) preference share capital. Preference share capital is that part of the share capital of the company which fulfils the following requirements: as respects dividends, it carries a preferential right to be paid a fixed amount; and as respects capital it carries, on a winding up, a preferential right to be repaid the amount of capital paid up. Equity share capital means all share capital which is not preference share capital.122

The Companies (Amendment) Act, 2000 has introduced some other categories of shares such as derivative and hybrids.123

A limited company with a share capital can alter the capital clause of its memorandum of association in any of the following ways, provided authority to alter is given by the articles:124

1. it may increase its capital by issuing new shares

121. S. 85. 122. Ibid. 123. Derivative has the same meaning as in section 2 of the Securities Contracts

(Regulation) Act, 1956. Section 2 (19-A) of the Companies Act defines hybrid as any security which has the characteristics of more than one type of security, including their derivatives.

124. S. 94(1).


2. consolidate the whole or any part of its share capital into shares of larger amount

3. convert shares into stock or vice versa 4. sub-divide the whole or any part of its share capital into share of

smaller amount 5. cancel those shares which have not been taken up and reduce its

capital accordingly. Any of these acts can be done by the company by passing a resolution

at a general meeting, but does not require to be confirmed by the court except in the case of reduction of capital.

An equity shareholder has a right to vote in respect of equity capital, on every resolution placed before the company and his voting right on a poll will be in proportion to his share of the paid-up equity capital of the company. A holder of preference shares will have a right to vote only on resolutions which directly affect the rights attached to his preference shares. He will also be entitled to vote on every resolution if the dividend due has remained unpaid for a specified period.

Company, like individual businessman, requires money from time to t ime . Part of this requirement is met by share capital raised from shareholders and for the rest a company has to depend on public borrowings. Every trading company has implied power to borrow unless expressly prohibited by the memorandum or the articles. Sometimes memorandum or articles may impose restrictions on the borrowing powers of the company, although that is very rare. There is nothing in the Act which restricts the borrowing powers of a company. Where a company has borrowing power, it includes as incidental to it, the power to give security for the loan by creating a mortgage or charge on all or any of its property.

Debenture means a document evidencing the debt which the company has taken from the public. A debenture need not be under seal although usually it is. Debenture is the description of an instrument while debenture stock is the description of a debt or sum secured by an instrument . Debentures may be registered, bearer, secured, unsecured, redeemable or irredeemable. A debenture generally contains a charge on the undertaking of the company, or on some class or part of its assets. But a debenture, which creates no such charge, is perfectly valid. The charge, which a company may create on its assets, may be of two kinds, namely: fixed charge; and floating charge. The remedies of debenture holders depend upon the terms of their agreement with the company. But one of the remedies which is always open to them as mortgagees under the Transfer of Property Act is to bring the property charged to sale.125 Also, they may appoint a receiver to take charge

125. Naram Singh and Co. v. U. P. Oil Industries Ltd. (1954) 1 Comp. L.J. 225 (All.).

COMPANY LAW 579

of the assets subject to the charge. Section 125 provides that prescribed particulars of every charge126 together with the instrument, if any, by which the charge is created or evidenced or a copy thereof must be filed with the Registrar for registration within 21 days after the date of its creation. On regis t ra t ion of a charge, the Registrar must give a certificate of registration.127 If any charge required to be registered is not registered, it will be void against the liquidator and any creditor of the company so far as any security on the company's property or undertaking is conferred thereby. But non-registration will not prejudice any contract or obligation for the repayment of the money secured by the charge.

Meetings

Meetings of shareholders of a company are of three kinds: 1. statutory meeting; 2. annual general meeting; and 3. extraordinary general meeting. Besides this, a company may hold class meetings, board meetings and meetings of creditors, debenture-holders and contributories.

Every company limited by shares, and every company limited by guarantee and having a share capital, must hold a general meeting of the members of the company called the "statutory meeting".128 The meeting is to be held within a period of not less than one month but before more than six months from the date at which the company is entitled to commence business. This meeting is held once in the lifetime of a company.

Every company is required to call at least one meeting of its shareholders in each year. This meeting is known as the annual general meeting.129 The first annual general meeting of a company must be held within 18 months from the date of its incorporation. The gap between one meeting and the next should not be more than 15 months. If a company fails to hold annual general meeting any member can apply under section 167 of the Act to the Central Government and the latter will order the calling of the meeting. If the company fails to call the meeting, the company and every officer who is responsible for this default shall be liable to pay fine ere.130

Clause 47 of Table A provides that all general meetings other than annual general meetings shall be called extraordinary general meetings.131

Not only the board of directors but also a requisite number of shareholders can call forth a general meeting.132

126. Charge includes a mortgage; see s. 124. 127. Ss. 132 and 133. 128. S. 165 (1). 129. S. 166. 130. S. 168. 131. S. 169. 132. Ibid.


A requisite of a valid meeting is that it should be called by a proper authority, i.e., the board of directors or in their default by the Central Government.133 Also, a proper notice of the meeting should be given to every member.134 Section 174 of the Act provides that unless the articles provide for a larger number, five members personally present in the case of a public company and two in the case of a private company shall be the quorum for a meeting.

The business of a meeting is done in the form of resolutions passed at the meeting. Shareholders have the right to discuss every proposed resolution and to move amendments. A member may vote either in person or by proxy.135

Resolutions are of two kinds: ordinary and special. An ordinary resolution is one passed by a simple majority of the members voting at the meeting. A special resolution, on the other hand, requires the support of three-fourth majority of shareholders present and voting at a meeting.136

Every company has to keep a record of the proceedings of its general meetings and the meetings of its board of directors.

Under section 193 every company shall keep minutes containing correct and fair summary of all proceedings of the meetings. The section further imposes a statutory obligation on every company to cause minutes of all proceedings of general meetings, board meetings and meeting of the committee of the board to be recorded.

Dividends

One of the objects of commercial enterprises is the earning of profits which are distributed to shareholders by way of dividends. There is no specific definition of the term dividend in Indian law. Dividend means the share of profit that falls to the share of each individual member of a company. The power to pay dividend is inherent in every company.

The Amendment Act, 2000 added subsection (1-A) to section 205, which provides that the board of directors may declare an interim dividend. The amount of dividend including interim dividend has to be deposited in a separate bank account within five days from the date of declaration.

The declaration of dividends is bound by two fundamental principles. The first is that dividends must never be paid out of capital. And, second, dividends shall be paid out of profits.137 Dividends can be paid by the company out of the following funds: (1) profits of the company for the year

133. 167, 134. Ss. 171 and 172. 135. S. 176. 136. S.189. 137. S. 205.

COMPANY LAW 581

for which dividends are to be paid; (2) undistributed profits of the previous financial years; and (3) moneys provided by the Central Government or a state government for the payment of dividends in pursuance of a guarantee by the government concerned. Once a dividend is declared it becomes a statutory debt from the company to its shareholders.138 Section 205 (2-A) requires creation of Compulsory Reserve in which certain amount shall be transferred before any dividend is declared or paid.139 If there is inadequacy of profits in a particular year the company has to pay dividend out of previous years' reserves. Section 205C brought into existence a new fund known as the Investor Education And Protection Fund to credit inter alia the amounts in unpaid dividend accounts of companies.140 If the articles so authorize, a company has the "power to conven its accumulated profits into bonus shares".141

Audit and accounts

Section 209 requires that every company is to keep at its registered office proper books of account. The auditors of a company are appointed at its annual general meeting. An auditor appointed at one general meeting holds office from the conclusion of that meeting until the conclusion of the next annual general meeting. An auditor may be re-appointed; and may be removed before the expiry of his term.142

The Central Government has the power in the following cases to direct the special audit of a company's accounts:143

1. when the affairs of any company are not being managed in accordance with sound business principles or prudent commercial practice or

2. when any company is being managed in a manner likely to cause serious injury or damage to the interest of the trade, industry or business to which it pertains or

3. when the financial position of any company is such as to endanger its solvency.

The Central Government may also appoint one or more persons as inspectors to investigate the affairs of any company in the following

144 cases:1"

138. BachaGuzdarv. Commissioner ofIncome Tax, Bombay AIR 1955 SC 74. 139. Inserted by the Companies (Amendment) Act, 1974. 140. Inserted by the Companies (Amendment)Act, 1999. 141. Sbri Gopal Paper Mills v. Commissioner of Income Tax(l970) 2 SCC 80. 142. Ss. 224 to 233. 143. S. 233A. 144. S. 235.


(a) in the case of company having a share capital, on the application of 200 members or members holding not less than one-tenth of total voting power.

(b) in the case of company not having a share capital on the application of at least one-fifth of its members.

(c) in the case of any company on a report by the Registrar under section 234.145 The Central Government is also required to appoint inspectors if the company by special resolution or the court by order declares that the affairs of the company ought to be investigated.146

The Central Government may as well appoint inspectors whenever in its opinion there are circumstances suggesting:

1. that the business of the company is being conducted with intent to defraud its creditors, members or any other persons or for a fraudulent or unlawful purpose or in a manner oppressive of any of its members or that the company was formed for any fraudulent or unlawful purpose.

2. that persons concerned in the formation of the company or the management of its affairs have been guilty of fraud, misfeasance or other misconduct towards the company or its members.

3. that the members of the company have not been given all the information with respect to its affairs which they might reasonably expect.

The books of accounts and other books can be inspected by Registrar or the authorized officers of the Central Government without giving previous notice to the company.147 The Companies (Amendment) Act 2000 has also conferred the right of inspection upon SEBI authorized officers. The Amendment of 1999 has prescribed that every profit and loss account and balance sheet shall comply wi th accounting standards.1 4 8 The Amendment also provided for the constitution of National Advisory Committee on Accounting Standards. 149

Directors

A corporation is an artificial person, invisible, intangible and existing only in the contemplation of law.150 It has neither a mind nor a body of its own.

145. 146. 147. 148. 149. 150.

S. 234 (6). S. 237 (a). S. 209A. S. 211. S. 210A. Marshall, L.J., in Trustees of Dartmouth Collegev. Woodward (1819) 17 US 518.

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This makes it necessary that the company's business should be entrusted to human agents. Hence the necessity of directors. Every private company shall have at least two directors and every public company shall have at least three directors.151

The directors of a company are persons elected by shareholders to manage and control the affairs of the company. It does not matter whether they are designated directors, trustees or governors, so long as they are charged with the responsibility of management. Directors may be appointed by the articles (first directors)152 or by the company in general meeting153 or by the board of directors154 or by third parties (nominee director) or by the principle of proportional representation155 or by the Central Government156

or by National Company Law Tribunal157 for prevention of oppression and mismanagement.1 5 8 The Act does not require a director to hold any qualification shares in the company; however, the articles may provide a share qualification but the nominal value of the qualification shares shall not exceed Rs. 5000/- except when the nominal value of a single share exceeds that amount.

A company may by ordinary resolution remove a director before the expiry of his period of office.159 A director may also be removed at the initiative of the Central Government160 or by the National Company Law Tribunal.161 Also, a director can at any time resign his office162 and the articles usually contain express provision to that effect.

A meeting of the board of directors must be held once in three months.163 Acts done by a person as a director will be valid, notwithstanding that it may afterwards be discovered that his appointment was invalid by reason of any defect, etc.

151. S. 252. 152. S. 254. 153. S. 255. 154. Ss. 260, 262 and 313. 155. S. 265. 156. S. 408. 157. Companies (Second Amendment) Act, 2002 dissolved Company Law Board and

constituted National Company Law Tribunal under section 10FB by inserting Part IB. It consists of a President and judicial and technical members not exceeding sixty-two. Appeals from the NCLT can be preferred to the National Company Law Appellate Tribunal constituted under section 10FR.

158. S. 402. 159. S. 284. 160. Ss. 388B to 388E. 161. S. 402. 162. S. 318. 163. S. 285.


A company must not, without obtaining the previous approval of the Central Government, make directly or indirectly any loan to, or give any guarantee or provide any security in connection with a loan made by any other person to, any director of the company.164

Every director who is in any way interested in a contract or arrangement entered into or to be entered into by the company, must disclose the nature of his interest at a meeting of the board of directors.165

There may be three kinds of directors, namely, managing directors, whole time directors, director other than a managing or a whole time director. Remuneration paid to a director who is neither a whole time director nor a managing director or when there are more than one such director, to all of them together shall not exceed

(a) one percent of the net profits of the company, if the company has managing or whole-time director or a manager.

(b) Three per cent of the net profits of the company in any other case.166

The company in general meeting may, however, with the approval of the Central Government, authorize the payment of remuneration higher than 1% or 3% as the case may be.167 Each director, in addition, is also entitled to a sitting fee for each meeting of the board or a committee thereof provided the same is authorized by the articles. The remuneration payable to any such director shall be inclusive of the remuneration payable to such director for services rendered by him in any other capacity unless the services rendered are of a professional nature and in the opinion of the Central Government the director possesses the requisite qualifications for the practice of the profession.168

A whole time director or a managing director may be paid remuneration either by way of monthly payment or at a specified percentage of the net profits of the company or partly by one way and partly by the other provided that except with the approval of the Central Government such remuneration shall not exceed 5% of the net profits for one such director and where there are more than one such director 10% for all of them together.169

The total managerial remuneration payable to the directors and the manager of a public company or a subsidiary of a public company in respect

164. 165. 166. 167. 168. 169.

S. 295. Ss. 299 to 302. S. 309 (4). Ibid S. 198 (2). S. 309(3).

COMPANY LAW 585

of a financial year shall not exceed eleven per cent of the net profits of the company.170

Section 269 (2) states that no appointment of a managing or whole time director for the first time in an existing company and no reappointment of a person as such director for the first time after December 28, 1960 in the existing company shall be effective unless approved by the Central Government. In case of a public company incorporated after December 28, 1960, the appointment may be made without previous approval of the Central Government, but such approval must be obtained before the expiry of three months from the date of incorporation otherwise the appointment will cease to have effect from the date. N o managing director can be appointed for a time exceeding five years, but he can be reappointed on the basis of five year's tenure on each occasion.

When a person is a managing director of one public company, he can be managing director of one more company, whether public or private; however, section 316 empowers the Central Government, in appropriate cases, to permit, by order, the same person to be managing director of more companies, if it is satisfied that it is necessary for their proper working that the companies should function as a single unit and have a common managing director.

A managing director, as defined in section 2 (26) means a director who, by virtue of an agreement with the company, or a resolution passed by the company in general meeting or by board of directors or by virtue of its m e m o r a n d u m or articles, is entrusted wi th substantial powers of management which would not otherwise be exercisable by him, and includes a director occupying the position of a managing director by whatever name called.

Directors are not, as such, employees or servants of the company. It is difficult to define their true position. For some purposes they are agents of the company, while for the other they are trustees for it. In the eyes of law directors are agents of the company for which they act and their relationship with the company is governed by the law of agency. Also, directors are called trustees.171 They are no doubt trustees of assets which have come into their hands or which are under their control. The directors enjoy such powers as are given to them by the statute, memorandum or articles. Within these limits they are competent to exercise all powers of the company except those which are to be exercised by the company in general meeting. When directors act within their power they cannot be overruled even by the general meeting of the company.

170. S. 198. 171. Ramaswami Iyer v. Brahmayya & Co. (1966) 1 Comp. LJ 107.


The board of directors is entitled to exercise all such powers, and do all such acts and things, as the company is authorized to do and exercise.172

The residuary powers of a company reside in the general meeting of shareholders. Shareholders intervention is permissible only in exceptional circumstances such as (i) mala fide behaviour of the directors (ii) incompetency of the board of directors 1 7 3 (Hi) deadlock in the management174 etc. The board cannot exercise any power or do any act which is to be exercised or done by the company in general meeting.175

The directors may be liable to outsiders, to the company, or for breach of statutory duties. Directors are not personally liable on contracts entered into as agents on behalf of the company. They will be liable only where ordinary agents will be liable under those circumstances.

N o director can hold any office or place of profit except that of managing director, manager, legal or technical adviser, banker or trustee for the debenture holders of the company under the company or its subsidiary unless the company consented thereto by a special resolution which may be passed at the first general meeting of the company held for the first time after the holding of such office or place of profit.176

The Act also imposes penalty upon directors for omitting to comply with or contravening certain provisions of the Act.177

The fundamental principle relating to the administration of a company is that its board of directors should direct and control its affairs. But the Act allows a person to accept directorship in not more than fifteen178 companies and does not prescribe the time and attention he should devote to a particular company.

The Central Government can also make a reference to the Tribunal against any managerial personnel if in the opinion of the Centra l Government, there are circumstances suggesting:

(a) that any person concerned in the conduct and management of the affairs of a company is or has been guilty of fraud, misfeasance, persistent negligence or default in carrying out his obligations and functions under the law or breach of trust or

(b) that the business of a company is not or has not been conducted and managed by such person in accordance with sound business principles or prudent commercial practices or

172. S. 291 (1). 173. Glucoseries (P)Ltd. v. DebKanta Ray (2000) 38 CLA 39 Cal. 174. Barron v.Pottter (1914) 1 Ch 895. 175. Ibid 176. S. 314. 177. Ss. 150, 144, 151, 168, 192, 303, etc. 178. S. 275.

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(c) that a company is or has been conducted and managed by such person in a manner which is likely to cause or has caused, serious injury or damage to the interest of the trade, industry or business to which such company pertains or

(d) that the business of a company is or has been conducted and managed by such person with intent to defraud its creditors, members or any other persons or otherwise for a fraudulent or unlawful purpose or in a manner prejudicial to public interest.179

The Central Government may state a case against the person aforesaid and refer the same to the Tribunal with a request that the Tribunal may inquire into the case and record a finding as to whether or not such a person is a fit and proper person to hold the office of director or any other office connected with the conduct or management of any company.180

If during the pendency of the case the Tribunal finds it necessary, in the interest of the members or creditors of the company, it may, either on the application of the Central Government or of its own motion direct that the respondent shall not discharge any of the duties of his office until further orders and appoint in his place another suitable person to discharge the duties of the respondent.181

The Central Government may, on the basis of finding of the Tribunal, by order, notwithstanding any other provisions contained in the Companies Act, 1956, remove the delinquent respondent from his office.182

Interests of shareholders

The affairs of a company are governed in accordance with the wishes of the holders of the majority of shares. Like any democratic set up, the majority has its way, though due provision must be made for the minority to have its say. The Companies Act, therefore, contains a large number of provisions for the protection of the interest of investors. The aim of these provisions is to require those who control the affairs of a company to exercise their power according to certain principles of natural justice and fair play.

The basic principle relating to the administration of the affairs of a company is that

The court will not, in general, intervene at the instance of the shareholders in matters of internal administration; and will not interfere with the management of a company by its directors so

179. S. 388 B (1). 180. Ibid. 181. S. 388 C. 182. S. 388 E (1).


long as they are acting within the powers conferred on them under the articles of the company.183

A shareholder is entitled to bring an action against the company in respect of matters which are ultra vires the company and which no majority of shareholders can sanction. The conduct of a majority of shareholders can also be impeached if it constitutes a "fraud on the minority." The court will interfere to protect the minority where the majority of company propose to benefit themselves at the expense of the minority.

There are certain acts which can only be done by passing a special resolution at a general meeting of shareholders. Accordingly, if the majority purport to do any such act by passing only an ordinary resolution or without passing special resolution in the manner required by law, any member or members can bring an action to restrain the majority. Sometimes an obvious wrong may have been done to the company, but the control l ing shareholders would not permit an action to be brought against the wrongdoer. In such cases, to safeguard the interest of the company, any member or members may bring an action in the name of the company.184

Also, every shareholder has, vested in him, certain personal rights against the company and his co-shareholders. A large number of such rights have been conferred upon the shareholders by the Act itself, but it may also arise out of articles of association. Such rights are usually known as "individual rights", and respecting them, the rule of majority simply does not operate.185

Any member of the company can complain to the Tribunal if the affairs of the company are being conducted in a manner prejudicial to public interest or in a manner oppressive to any member or members.186 Likewise any member of the company can apply to Tribunal for relief in case of mismanagement in the company.187 The number of members necessary to make such application (i) in the case of a company having share capital, 100 or 10% of the total number of members whichever is less or any member or members holding 10% of the issued capital of the company provided that the applicants have paid all calls and other sums due on the shares; (ii) in the case of a company not having share capital, not less than one-fifth of its total number of members.188 The Tribunal's order may include:

183. Rajahmundry Electric Supply Corporation v. A. Nageshwara Rao AIR 1956 SC 213. The principle of 'majority supremacy' is originated from Foss v. Harbottle (1849) 67 ER 189.

184. /. P. Singh v. Chairman, Metropolitan Council AIR 1969 Del. 295. 185. Nagappa Chettiarv. Madras Race Club (1949) 1 M.L.J. 662. See also Ss. 397 to 409 of

the Act. 186. S. 397 (1). 187. S.398 (1). 188. S. 399(1).

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(a) the regulation of the conduct of the company's affairs in future (b) the acquisition of the shares or interests of any members by other

members of the company and the consequent reduction of the share capital

(c) termination, setting aside or modification of any arrangement, howsoever arrived at, between the company and the manager, managing director or any other director

(d) termination, setting aside or modification of any agreement between the company and any other person with the latter's consent

(e) setting aside of any transfer, delivery of goods, payment, execution or any other act relating to property made or done by or against the company within 3 months of the application which would amount to fraudulent preference in case of an individual's insolvency

(f) any other matter for which in the opinion of the court it is just and equitable that provision should be made.189

Section 408 provides another measure to prevent oppression and mismanagement and confers powers on the Central Government to do so. The Central Government may appoint such number of persons as the Tribunal may specify as directors of the company for a period not exceeding three years at a time. The Central Government may, instead of passing the above order, direct the company to alter its articles so as to provide for election of its directors on the basis of proportional representation. The Central Government has also the power to prevent any proposed change in the board of directors if it is likely to affect the company prejudicially.

Winding up

Winding up of a company is a proceeding by means of which a company is dissolved and in the course of such a dissolution its assets are collected and its debts paid out of the realized assets or from contributions by its members, if necessary. The surplus assets are then distributed to the members in proportion to their holdings in the company. The proceeding is not confined to cases where a company is "insolvent' but extends to all cases where it is desired to wind up a company. A winding up mav be:

1. by the order of the Tribunal, and 2. voluntary.190

A company may be wound up by the court in the following 191

circumstances :Lyi

189. S. 402. 190. S. 522 which provided for 'winding up subject to the supervision of the court' was

omitted by the Companies (Second Amendment) Act, 2002. 191. S. 433.


1. if the company has, by special resolution, resolved that the company may be wound up by the Tribunal

2. if default is made in delivering the statutory report to the Registrar or in holding the statutory meeting

3. if the company does not commence its business within a year from its incorporation, or suspends its business for a whole year

4. if the number of members is reduced, in the case of a public company, below seven, and in the case of private company, below two

5. if the company is unable to pay its debts 6. if the Tribunal is of opinion that it is just and equitable that the

company should be wound up 7. if the company has made any default in filing with the Registrar its

balance sheet and profits and loss account or annual return for any five consecutive financial years.

An application to the Tribunal for the winding up of the company may be presented by the company or by any creditor or creditors or by any contributory or by the Registrar or by any person authorized by the Central Government under section 243 (after inspection of the company 's affairs).192

An order for winding up a company will operate in favour of all the creditors and of all the contributories of the company as if it had been made on the joint petition of a creditor and a contributory.193 It is the duty of the petitioner in the winding up proceedings and of the company to file with the Registrar a certified copy of the order.

When a winding up order has been made or the official liquidator has been appointed as provisional liquidator, no suit or other legal proceedings will be commenced, or if pending, on the date of the winding up order, will be proceeded with, against the company except by leave of the Tribunal and subject to such terms as the Tribunal may impose.

Voluntary winding up means winding up by the creditors or members of a company without interference from the Tribunal. Voluntary winding up has certain advantages over winding up by the Tribunal, as there are fewer formalities to be complied with. A company may be wound up voluntarily under the following circumstances:

1. when the period fixed for the duration of the company by the articles has expired, or the event on the occurrence of which the company is to be dissolved has occurred and the company passes a special resolution to be wound up voluntarily

192. S. 439. 193. S. 447.

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2. if the company passes a special resolution that it be wound up voluntarily.194

Within 14 days of the passing of such a resolution, the company must give notice of the resolution by advertisement in the official gazette and also in some newspaper circulating in the district where the registered office of the company is situated. A voluntary winding up will be deemed to commence at the time when the resolution for the winding up is passed.195

Voluntary winding up is of two kinds: 1. members' voluntary winding up. 2. creditors' voluntary winding up. In a members' voluntary winding up directors of the company make a

declaration of solvency, namely, the company has no debts or it will be able to pay its debts in full within a period of three years.196 No such declaration is made in a creditors' voluntary winding up.

In the case of voluntary winding up, the company ceases to carry on its business from the commencement of the winding up except so far as required for the beneficial winding up of such business.

In a members ' voluntary winding up, on the appointment of a liquidator, all the powers of the board of directors, managing or whole time directors and manager will cease, except for the purpose of giving notice of such appointment to the Registrar in pursuance of section 493 or so far as the company in general meeting or the liquidator may sanction the continuation thereof.197

In a creditor's voluntary winding up, on the appointment of a liquidator, all the powers of the board of directors will cease, except in so far as the committee of inspection, or if there is no such committee, the creditors in general meeting, may sanction the continuation thereof.198

In a winding up, the assets of the company must, subject to preferential payments, be applied in satisfaction of its liabilities pari passu and unless the articles otherwise provide, be distributed among the creditors according to their rights and interests in the company.199

In every winding up, all debts payable on a contingency and all claims against the company, present or future, certain or contingent, or ascertained will be admissible to proof against the company.200 In the winding up of an

194. S. 484. 195. S. 486. 196. S. 488. 197. S. 491. 198. S. 505. 199. S. 511. 200. S. 528.


insolvent company, the same rules will prevail with regard to debts provable, the valuation of annuities and future and contingent liabilities and the respective rights of secured and unsecured creditors.201 All persons who are entitled to prove for and receive dividends out of the assets of the company may come in and make their claims.202

If, in the course of the winding up of a company, it appears that any person who has taken part in the promotion or formation of the company or any past or present director has misapplied or retained or become liable or accountable for any money or property of the company or has been guilty of any misfeasance or breach of trust in relation to the company, the Tribunal may, on the application of the official liquidator, etc., examine the conduct of the person concerned and compel him to repay or restore the money or property or any part thereof, as the case may be.203

Suggested Readings

1. Avtar Singh, Indian Company Law, 14th ed., Eastern Book Company, Lucknow, 2004.

2. C. R. Datta, Datta on the Company Law, 3rd ed., Orient Law House, Allahabad, 1982.

3. Gulshan S.S and Kapoor G. K, Business Law Including Company Law, 9til

ed., New Delhi, New Age International Publishers, 2001. 4. Indian Chamber of Commerce, Calcutta, A Handbook on the Companies

Act, 1965. 5. Indian Law Institute, Problems of Corporate Law, Management and Practice,

1964. 6. K. M. Ghosh, The Indian Company Law, 11 th ed., Eastern Law House,

Calcutta, 1963. 7. K. Venkoba Rao, Commentaries on the Companies Act, 1956. 8. L. V. Rangacharya, Modern Company Law, Andhra Law Times,

Hyderabad, 1965. 9. M.J. Sethna, Indian Company Law, 7th ed., Lakhani, Bombay, 1967. 10. Majumdar, A. K. and Kapoor G.K., Company Law and Practice, Taxman,

8th ed., 2002. 11. Ministry of Finance, Department of Company Law Administration, A

Layman's Guide to the Indian Company Law, 1956. 12. Ministry of Finance, Department of Company Law Administration,

Report of the Companies Act Amendment Committee, 1957.

201. S. 529(1). 202. S. 529 (2). 203. S. 543.

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13. Ministry of Law, The Companies Act, 1956. 14. N . C. Chatterjee and N. Krishnamurthi, Company Law, 1957. 15. S. C. Sen, The New Frontiers of Company Law, 1971. 16. S. D. Singh Chauhan and N. K. Sharma, Indian Company Law and

Secretarial Practice, 3 rd ed., Sahitya Bhavan, Agra, 1971. 17. S. M. Shah, Lectures on Company Law, 19th ed., Tripathi, Bombay, 1990. 18. V.D. Kxilshreshtha, Changing Dimensions of Company Law in India, 1971.

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