Statutory Information

Company Formation

I. Promotion: \Promotion refers to the entire process by which a company is brought into existence. It starts with the conceptualization of the birth a company and determination of the purpose for which it is to be formed. The persons who conceive the company and invest the initial funds are known as the promoters of the company. The promoters enter into preliminary contracts with vendors and make arrangements for the preparation, advertisement and the circulation of prospectus and placement of capital. However, a person who merely acts in his professional capacity on behalf of the promoter (e.g. lawyer, CA, etc) for drawing up the agreement or other documents or prepares the figures on behalf of the promoter and who is paid by the promoter is not a promoter.
The promoters have certain basic duties towards the company formed: -

  1. He must not make any secret profit out of the promotion of the company. Secret profit is made by entering into a transaction on his own behalf and then sell to concerned property to the company at a profit without making disclosure of the profit to the company or its members. The promoter can make profits in his dealings with the company provided he discloses these profits to the company and its members. What is not permitted is making secret profits i.e. making profits without disclosing them to the company and its members.
  2. He must make full disclosure to the company of all relevant facts including to any profit made by him in transaction with the company.

    Remedies available to a company against the promoters: -
    1. Rescind or cancel the contract made and if he has made profit on any related transaction, that profit also may be recovered
    2. Retain the property paying no more for it then what the promoter has paid for it depriving him of the secret profit.
    3. If these are not appropriate (e.g. cases where the property has altered in such a manner that it is not possible to cancel the contract or where the promoter has already received his secret profit), the company can sue him to for breach of trust. Damages up to the difference between the market value of the property and the contract price can be recovered from him.

    A promoter may be rewarded by the company for efforts undertaken by him in forming the company in several ways. The more common ones are: -
    1. The company may to pay some remuneration for the services rendered.
    2. The promoter may make profits on transactions entered by him with the company after making full disclosure to the company and its members.
    3. The promoter may sell his property for fully paid shares in the company after making full disclosures.
    4. The promoter may be given an option to buy further shares in the company.
    5. The promoter may be given commission on shares sold.
    6. The articles of the Company may provide for fixed sum to be paid by the company to him. However, such provision has no legal effect and the promoter cannot sue to enforce it but if the company makes such payment, it cannot recover it back.
    If the promoter fails to disclose the profit made by him in course of promotion or knowingly makes a false statement in the prospectus whereby the person relying on that statement makes a loss, he will be liable to make good the loss suffered by that other person. The promoter is liable for untrue statements made in the prospectus. A person who subscribes for any shares or debenture in the company on the faith of the untrue statement contained in the prospectus can sue the promoter for the loss or damages sustained by him as the result of such untrue statement.

    II. Incorporation by Registration
    The promoters must make a decision regarding the type of company i.e. a public company or a private company or an unlimited company, etc and accordingly prepare the documents for incorporation of the company. In this connection the Memorandum and Articles of Association (MA & AA) are crucial documents to be prepared.

Memorandum of Association of a company
Memorandum of Association of a company is the constitution or charter of the company and contains the powers of the company. No company can be registered under the Companies Act, 1956 without the memorandum of association. Under Section 2(28) of the Companies Act, 1956 the memorandum means the memorandum of association of the company as originally framed or as altered from time to time in pursuance with any of the previous companies law or the Companies Act, 1956.
The memorandum of association should be in any of the one form specified in the tables B, C, D and E of Schedule 1 to the Companies Act, 1956. Form in Table B is applicable in case of companies limited by the shares, form in Table C is applicable to the companies limited by guarantee and not having share capital, form in Table D is applicable to company limited by guarantee and having a share capital whereas form in table E is applicable to unlimited companies.
Contents of Memorandum:
The memorandum of association of every company must contain the following clauses: -

Name clause:
The name of the company is mentioned in the name clause. A public limited company must end with the word 'Limited' and a private limited company must end with the words 'Private Limited'. The company cannot have a name, which in the opinion of the Central Government is undesirable. A name which is identical with or the nearly resembles the name of another company in existence will not be allowed. A company cannot use a name which is prohibited under the Names and Emblems (Prevention of Misuse Act, 1950 or use a name suggestive of connection to government or State patronage.

Domicile clause:
The state in which the registered office of company is to be situated is mentioned in this clause. If it is not possible to state the exact location of the registered office, the company must state it provide the exact address either on the day on which commences to carry on its business or within 30 days from the date of incorporation of the company, whichever is earlier. Notice in form no 18 must be given to the Registrar of Companies within 30 days of the date of incorporation of the company. Similarly, any change in the registered office must also be intimated in form no 18 to the Registrar of Companies within 30 days. The registered office of the company is the official address of the company where the statutory books and records must be normally be kept. Every company must affix or paint its name and address of its registered office on the outside of the every office or place at which its activities are carried on in. The nam must be written in one of the local languages and in English.

Objects clause:
This clause is the most important clause of the company. It specifies the activities which a company can carry on and which activities it cannot carry on. The company cannot carry on any activity, which is not authorized by its MA. This clause must specify: -

(i) Main objects of the company to be pursued by the company on its incorporation
(ii) Objects incidental or ancillary to the attainment of the main objects
(iii) Other objects of the company not included in (i) and (ii) above.
In case of the companies other than trading corporations whose objects are not confined to one state, the states to whose territories the objects of the company extend must be specified.

Doctrine of the ultra-vires :
Any transaction which is outside the scope of the powers specified in the objects clause of the MA and are not reasonable incidentally or necessary to the attainment of objects is ultra-vires the company and therefore void. No rights and liabilities on the part of the company arise out of such transactions and it is a nullity even if every member agrees to it.
Consequences of an ultra-vires transaction: -

  1. The company cannot sue any person for enforcement of any of its rights.
  2. No person can sue the company for enforcement of its rights.
  3. The directors of the company may be held personally liable to outsiders for an ultra vir

However, the doctrine of ultra-vires does not apply in the following cases: -

  1. If an act is ultra-vires of powers the directors but intra-vires of company, the company is liable.
  2. If an act is ultra-vires the articles of the company but it is intra-vires of the memorandum, the articles can be altered to rectify the error.
  3. If an act is within the powers of the company but is irregularly done, consent of the shareholders will validate it.
  4. Where there is ultra-vires borrowing by the company or it obtains deliver of the property under an ultra-vires contract, then the third party has no claim against the company on the basis of the loan but he has right to follow his money or property if it exist as it is and obtain an injunction from the Court restraining the company from parting with it provided that he intervenes before is money spent on or the identity of the property is lost.
  5. The lender of the money to a company under the ultra-vires contract has a right to make director personally liable.

Liability clause:
A declaration that the liability of the members is limited in case of the company limited by the shares or guarantee must be given. The MA of a company limited by guarantee must also state that each member undertakes to contribute to the assets of the company such amount not exceeding specified amounts as may be required in the event of the liquidation of the company. A declaration that the liability of the members is unlimited in case of the unlimited companies must be given. The effect of this clause is that in a company limited by shares, no member can be called upon to pay more than the uncalled amount on his shares. If his shares are already fully paid up, he has no liability towards the company.
The following are exceptions to the rule of limited liability of members: -

  1. If a member agrees in writing to be bound by the alteration of MA / AA requiring him to take more shares or increasing his liability, he shall be liable up to the amount agreed to by him.
  2. If every member agrees in writing to re-register the company as an unlimited company and the company is re-registered as such, such members will have unlimited liability.
  3. If to the knowledge of a member, the number of shareholders has fallen below the legal minimum, (seven in the case of a public limited company and two in case of a private limited company) and the company has carried on business for more than 6 months, while the number is so reduced, the members for the time being constituting the company would be personally liable for the debts of the company contracted during that time.

Capital clause:
The amount of share capital with which the company is to be registered divided into shares must be specified giving details of the number of shares and types of shares. A company cannot issue share capital greater than the maximum amount of share capital mentioned in this clause without altering the memorandum.

Association clause:
A declaration by the persons for subscribing to the Memorandum that they desire to form into a company and agree to take the shares place against their respective name must be given by the promoters.

Articles of Association:
The Articles of Association (AA) contain the rules and regulations of the internal management of the company. The AA is nothing but a contract between the company and its members and also between the members themselves that they shall abide by the rules and regulations of internal management of the company specified in the AA. It specifies the rights and duties of the members and directors.
The provisions of the AA must not be in conflict with the provisions of the MA. In case such a conflict arises, the MA will prevail.
Normally, every company has its own AA. However, if a company does not have its own AA, the model AA specified in Schedule I - Table A will apply. A company may adopt any of the model forms of AA, with or without modifications. The articles of association should be in any of the one form specified in the tables B, C, D and E of Schedule 1 to the Companies Act, 1956. Form in Table B is applicable in case of companies limited by the shares. Form in Table C is applicable to the companies limited by guarantee and not having share capital, form in Table D is applicable to company limited by guarantee and having a share capital whereas form in table E is applicable to unlimited companies. However, a private company must have its own AA.
The important items covered by the AA include: -
1. Powers, duties, rights and liabilities of Directors
2. Powers, duties, rights and liabilities of members
3. Rules for Meetings of the Company
4. Dividends
5. Borrowing powers of the company
6. Calls on shares
7. Transfer & transmission of shares
8. Forfeiture of shares
9. Voting powers of members, etc

Alteration of articles of association:
A company can alter any of the provisions of its AA, subject to provisions of the Companies Act and subject to the conditions contained in the Memorandum of association of the company. A company, by special resolution at a general meeting of members, alter its articles provided that such alteration does not have the effect of converting a public limited company into a private company unless it has been approved by the Central Government.
The articles must be printed, divided into paragraphs and numbered consequently and must be signed by each subscriber to the Memorandum of Association who shall add his address, description and occupation in presence of at least one witness who must attest the signature and likewise add his address, description and occupation. The articles of association of the company when registered bind the company and the members thereof to the same extent as if it was signed by the company and by each member.

III. Registration of the Company
Once the documents have been prepared, vetted, stamped and signed, they must be filed with the Registrar of Companies for incorporating the Company. The following documents must be filed in this connection: -

  1. The MA & AA
  2. An agreement, if any, which the company proposes to enter into with any individual for appointment as its managing director or whole-time director or manager.
  3. A statutory declaration in Form 1 by an advocate, attorney or pleader entitled to appear before the High Court or a company secretary or Chartered Accountant in whole - time practice in India who is engaged in the formation of the company or by a person who is named as a director or manager or secretary of the company that the requirements of the Companies Act have been complied with in respect of the registration of the company and matters precedent and incidental thereto.
  4. In addition to the above, in case of a public company, the following documents must also be filed:
    1. Written consent of directors in Form 29 to agree to act as directors
    2. The complete address of the registered office of the company in Form 18
    3. Details of the directors, managing director and manager of the company in Form 32.

    Certificate of Incorporation
    Once all the above documents have been filed and they are found to be in order, the Registrar of Companies will issue Certificate of Incorporation of the Company. This document is the birth certificate of the company and is proof of the existence of the company. Once, this certificate is issued, the company cannot cease its existence unless it is dissolved by order of the Court.

IV. Commencement of Business
A private company or a company having no share capital can commence its business immediately after it has been incorporated. However, other companies can commence their activities only after they have obtained Certificate of Commencement of Business. For this purpose, the following additional formalities have to be complied with: -

1. If a company has share capital and has issued a prospectus, then: -
a) Shares up to the amount of minimum subscription must be allotted.
b) Every director has paid to the company on each of the shares, which he has taken the same amount as the public has paid on such shares.
c) No money is or may become payable to the applicants of shares or debentures for failure to apply for or to obtain permission to deal in those shares or debentures in any recognized stock exchange.
d) A statutory declaration in Form 19 signed by one director or the employee - company secretary or a Company secretary in whole time practice that the above provisions have been complied with must be filed.
2. If a company has share capital but has not issued a prospectus, then: -
a) It must file a statement in lieu of prospectus with the Registrar of Companies
b) Every director has paid to the company on each of the shares, which he has taken the same amount as the other members have paid on such shares
c) A statutory declaration in Form 20 signed by one director or the employee - company secretary or a
Company secretary in whole time practice that the above provisions have been complied with must be filed.
Once the above provisions have been complied with, the Registrar of Companies grants "Certificate of Commencement of Business" after which the company can commence its activities.
Proposed amendments to Indian Companies act 1956

Corporate governance is the talk of the day. Towards this end and for investor protection the Government has introduced in the Lok Sabha Companies (Second Amendment) Bill, 1999. The majority of the clauses relate to increasing the amount of fine prescribed under the Companies Act by ten times and delete the provisions relating to managing agents , secretaries and treasurers as they have become redundant after the abolition of this system by the Amendment Act 1969.Some of the major amendments proposed are mentioned hereinafter.

1.Private and public Company
The proposal is that a private company shall have minimum paid-up share capital of Rs. 1 lakh or such higher amount as may be prescribed. Such company is also proposed to be prohibited to make any invitation or acceptance of deposit from persons other than its members, directors or their relatives. A public company should have a minimum paid up share capital of Rs. 5 lakh or such higher amount as may be prescribed. The Bill also proposes that a private company with less than Rs. 1 lakh paid-up capital and a public company with less than Rs. 5 lakh paid up capital will have to increase their respective capitals to Rs.1 lakh and Rs.5 lakh within a period of two years from the commencement of this Amendment Act. In case the above companies do not increase their paid up capital, they would be deemed to be defunct company under section 560 of the Act and their names shall be struck off by the Registrar of Companies.{Section 3}

2.Deemed public company
The Bill lays down that provisions of the Companies Act for deemed public company, i.e. private companies which are treated as public companies under the Act, will not apply from the effective date of the new law. It is significant that the position of the existing deemed public company will not undergo any change. {Section 43 A}

3.Registered office
Another proposal is that shifting of registered office of a company from one place to another within a state would require a confirmation by the regional director. Significantly, the notes to the Clause given in the Bill states that the confirmation of regional director would be required only where the registered office is shifted from the jurisdiction of one Registrar of Companies to another within the same state. It appears that the words of the Clause do not conform to its notes and therefore appropriate amendment is required. {New section 17A}

4.Interim Dividend
The Bill proposes to define dividend to include interim dividend as these two are not considered same. Pertinently, the existing Companies Act does not contain any provision relating to interim dividend. The model Article under Table A only empowers the Board of directors to pay interim dividend as justified by the profits of the company. Thus under the existing provisions, restrictions applicable to declaration and payment of dividend does not apply to interim dividend. With this new law coming in force, the restrictions of dividend will apply to interim dividend. {New section 2 {14A}}

5. Dividend
The time limit for payment of dividend is sought to be reduced from 42 days to 30 days which seems to have limited benefit. It may be mentioned that the amendment made in 1960 had reduced the period from three months to 42 days , which was significantly beneficial. {Sections 205A & 207}

6. Powers to SEBI
Certain powers relating to administration of provisions like acceptance of deposits, issue and transfer of securities are sought to be conferred on Securities and Exchange Board of India {SEBI} in case of listed public companies and those public companies which purport to be listed {New section 55A}. In respect of section 209A, the Bill gives powers to officers of SEBI for inspection of books of accounts etc. of companies. The question arises as to why SEBI should be empowered in areas which do not have link with stock market related matters and investor protection.

7. Fixed deposits
This provision is proposed for the benefit of small depositors. It is provided that where a company makes any default in repayment of deposits or any interest thereon to the small depositor, an intimation has to be given to Company Law Board {CLB} within 60 days from the date of default, and CLB has to pass an appropriate order within 30 days of receipt of intimation. Small depositor means who has invested up to Rs. 20,000/- in a financial year. The section also mentions that a company shall not accept further deposits from small depositors unless each of those whose deposit has matured has been paid the amount of deposit and interest accrued. Exemption has been granted in case of deposits which have been renewed or whose repayments have become impracticable due to the death of the depositor or have been stayed by competent court/authority.{New section 58AA}

8. Offering shares or debentures to the public etc.
Companies issue shares and debentures on private placement or preferential basis to large number of select persons with the condition that such issue is not calculated to result, directly or indirectly, in the shares or debentures becoming available for subscription or purchase by any person other than those receiving the offer or invitation, or, such issue is a domestic concern of the person making and receiving the offer or invitation. Thus pursuant to section 67 {3} {a} and {b} of the Companies Act there is no issue to the public and strictness of public issue are avoided. The proposed amendment states that where an offer or invitation to subscribe for shares or debentures is made to 50 or more persons, such offer or invitation would tantamount to being made to public and thereby all the restrictions of public issue will apply. {Section 67}

9. Shares held in Trust
The Sections 153A, 153B , 187B relating to appointment of public trustee, declaration of shares and debentures held in trust and exercise of voting rights in respect of shares so held are sought to be made inapplicable. The section 187C which provides for declaration by persons not holding beneficial interest in any shares is also proposed not to apply to shares held in trust.

10. Postal Ballot
The concept of passing general meeting resolution by postal ballot is new. The clause states that where the Central Govt. has notified that certain businesses have to be conducted only by postal ballot, such businesses cannot be transacted in a general meeting. Thus a company will be obliged to resort to only postal ballot. {New Section 192A}

11. Auditors - Private companies
Existing restrictions on auditors of a company are that he should not be in whole time employment elsewhere and can hold only specified number of appointments as auditor. It is proposed that these restrictions will not apply in case of a private company. Thus private companies shall be excluded in reckoning the number of companies which an auditor can audit. {Section 224}

12. Auditors- Dis-qualifications
It is proposed that where an auditor holds any securities of the company after one year from the commencement of the new law, he is disqualified to be appointed as an auditor. Significantly the restriction is in relation to appointment and it may not apply if securities are held by him during the course of his appointment and divested before next appointment. Moreover, it appears unreasonable that holding of even one security would attract disqualification. Holding of minority stake in a company cannot make an auditor prejudiced while conducting his audit of the company. Therefore, there should be significant holding by the auditor to attract this restriction. {Section 226}

13. Auditors - Observations
In respect of powers and duties of auditors it is proposed that the auditors' report has also to give, in thick type or in italics, observations or comments which have any adverse effect on the functioning of the company. Also, the report has to include whether any director is disqualified from being appointed as director under the proposed amended section 274 of the Act. The meaning of the words "adverse effect" is not clear and neither one can interpret what areas of functioning will be covered by the auditors. In absence of this, the matter could become subjective which is undesirable. {Section 227}

14. Audit committee
The new section proposed is in relation to constituting audit committee of the Board and it is a major step towards good corporate governance. The scope of the committee, inter alia, is to review of the half yearly and annual financial statements. It is well known that financial statements are prepared quarterly as per listing agreement. There is, therefore, no justification for providing for the review of half yearly financial statement, more particularly for listed companies. Another provision that the recommendation of the committee would be binding on the Board seems to be not proper. The Board being a superior body should always have the discretion to accept or reject the recommendation of the audit committee which should be a subordinate body. Further, provision that the chairman of the committee has to attend Annual General Meeting also seems to be impracticable. The chairman or in his absence any member of the committee should be permitted to be present at the AGM for giving clarification on matters relating to audit. It may also be considered to make mandatory the attendance of the auditor or his representative at the AGM. {New Section 292 A}

15. Directors' Report
The law is sought to be changed to provide giving of additional information in the Board's report. This is in respect of Directors fulfilling their responsibilities in relation to the accounts of a company. {Section 217 [2AA]}

16. Small shareholders' director
It is provided that a public company having a paid up capital of Rs. 5 crore or more and 1000 or more small shareholders shall have at least one director elected by such small shareholders in the prescribed manner. The words "small shareholders" have been defined to mean shareholders holding shares of nominal value of Rs. 20,000 or less. It is not clear as to why the word "members" has not been used in place of "shareholders" as has been done in other sections like 172,174,175,176 etc. It is well known that a shareholder need not be member unless his name is entered in the Register of Members u/s 41 of the Act. So what happens if a shareholder who has not got his shares registered in his name wants to exercise his rights. Will the company allow him this? Surely, law should be unambiguous. {Section 252}

17. Directors
This section in respect of dis-qualifications of directors is sought to be made wider by adding two more dis-qualifications for public companies. The first one is in relation to a company not filing annual accounts and annual returns for continuous 3 financial years w.e.f. 1-4-1999 and the second relates to failure to repay the deposits or interest on due date, or redeem debentures on due date or pay dividend and such failure continuing for one year or more. The non eligibility for appointment as director is for five years from the date of failure. It is to be made transparent at what point of time the failure to pay dividend commences. Is it on expiry of 30 days from the date of declaration of dividend as provided sections 205 A and 207, or absolute non payment of dividend? {Section 274}

18. Number of directorships
The proposal is to reduce the number of directorships held by a person from 20 to 15. If the reason for the proposal is to allow the directors more time and energy to attend to their responsibilities in lesser number of companies, it is doubtful whether this will have any significant impact in actual practice. {Sections 275 to 277 & 279}

19. Depreciation
The words "the amount calculated with reference to the WDV of the assets" in the section are proposed to be substituted by the words "amount of depreciation assets". The intention of the new law is that for the purpose of calculation of managerial remuneration the amount of depreciation will be the same as provided in the profit and loss account of the Company. {Section 350}

20. Secretarial audit
The Bill proposes that every company not required to appoint wholetime company secretary and having paid up share capital of Rs. 10 lakh or more, shall file with the Registrar of Companies a certificate from a practicing company secretary as to whether provisions of the Act have been complied or not. Keeping in view that there would be numerous companies whose paid up share capital is less than Rs. 10 lakh it is not evident as to how such companies are taken out of the ambit. Does this mean that it is not required to monitor such companies diligently? This does not seem to have rationality. Hence the ceiling of Rs. 10 lakh should be lowered to Rs. 1 lakh. {Section 383A}

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