Company Law

Company Law
PROF. S. S. GULSHAN
COMPANY LAW
Copyright © 2012 S S Gulshan
All rights reserved
Produced & Printed by

EXCEL BOOKS PRIVATE LIMITED
Plot No. 1E/14, Jhandewalan Extension,
New Delhi-110055
(June 2012)
Company Law
Objectives: The objective of these (eBook) is to understand and evaluate the legal framework of Corporate Environment in
India and to gain elementary knowledge of Indian Corporate Law.
Sr. No. Topics
1. Definition of company, characteristics of company, lifting the corporate veil, company distinguished
from partnership, kinds of companies, incorporation of company, promoter and their legal position.
2. Memorandum of Association: contents, alteration, Doctrine of ultra vires.
3. Articles of Association: contents, alteration, Doctrine of Indoor Management, Constructive notice of

memorandum and articles, Articles and memorandum- their relation and distinction, legal effect of
Memorandum and Articles.
4. Prospectus: Definition, contents, shelf prospectus, information memorandum, red herring
prospectus, abridged prospectus, Misstatements in prospectus and their consequences, statement in
lieu of prospectus, underwriting commission and brokerage,
5. Membership in a company: Members and shareholders, modes of becoming member, cessation of
membership, rights and liabilities of members.
6. Shares and share capital: kinds of share capital, alteration and reduction of capital, reorganization of
capital, voting rights.
7. Corporate Governance: Directors-Qualification; appointment and remuneration; disclosure; service
contracts; removal; retirement and disqualification; powers and fiduciary duties; Role and duties of
directors in relation to good corporate governance
8. Company meetings and proceedings: general meetings of shareholders, requisites of a valid
meeting, proxies, voting and poll, resolutions.
9. Borrowing power, debentures and charges: ultra vires borrowings, Prevention of oppression and
mismanagement: Principal of majority rule, remedial actions for prevention of oppression and
mismanagement.
10. Winding up: Meaning, Modes, and Consequences of winding up.
CONTENTS
Unit 1: Nature of the Companies Act, 1956 1

Unit 2: Meaning and Nature of a Company 13
Unit 3: Kinds of Companies 28
Unit 4: Formation of Company 43
Unit 5: Memorandum of Association 54
Unit 6: Articles of Association 74
Unit 7: Prospectus 87
Unit 8: Membership in a Company 102
Unit 9: Share and Share Capital 116
Unit 10: Management of Company 143
Unit 11: Corporate Governance 175
Unit 12: Company Meetings and Proceedings 187
Unit 13: Borrowing and Debentures 204
Unit 14: Winding Up of Companies 216
Unit 1: Nature of the Companies Act, 1956
Introduction
Objectives
After studying this unit, you will be able to:
Define application and scheme of the Company Act;
Explain Company Law administration;

Describe other specific definitions related to Company Act.
Introduction
The subject of company law is codified in the Companies Act, 1956. The basic concepts of company
law are incorporated in the Act. The Act is a formidable document, containing a large number of
Sections and Schedules. It provides a broad legal framework for the operation of companies
registered under the Act.
1
Company Law
1.1 Extent, Application and Scheme of the Act
1.1.1 Extent of the Act
The Act extends to the whole of India except:
1. As regards the State of Nagaland, it applies, subject to such modifications, if any, as the
Central Government may, by notification in the Official Gazette, specify [s.1 (3)];
2. As regards Goa, Daman and Diu, some of the provisions of the Act shall not apply or shall
apply only with such exceptions and modifications or adaptations to any existing company
registered under the Act and for such a period or periods as may be specified by notification
by the Central Government in the Official Gazette (s.620B); and
3. As regards Jammu and Kashmir, some of the provisions of the Act as the Central
Government may, by notification in the Official Gazette, direct, shall not apply or shall
apply only with such exceptions and modifications or adaptations to any existing company
or any company registered under the Act as may be specified, after the commencement of
the Central Laws (Extension to Jammu and Kashmir) Act, 1968 (i.e., 15 August, 1968)
(s.620C).
1.1.2 Application of the Act
The Act applies to the following companies:
1. Companies formed and registered under the Companies Act, 1956.
2. Companies formed and registered under the previous company laws, i.e., the existing
companies (s.561).
3. Companies registered but not formed under any previous company laws to the extent and
in the manner declared in Part IX (dealing with ‘Companies authorized to register under
the Act’) of the Act (s.562).
4. Unlimited companies registered as limited companies in pursuance of any previous

company laws (s.563).
5. Unregistered companies for the purpose of winding up under Part X (dealing with ‘Winding up
of Unregistered Companies,) of the Act (Ss.582, 583 and 589).
6. Foreign Companies (s.592 to 602).
7. Insurance companies, banking companies, electricity companies and any other company
governed by any special Act for the time being in force, except as far as the provisions of
the Companies Act, 1956 are inconsistent with the provisions of the Insurance Act, 1938;
Banking Regulation Act, 1949; Indian Electricity Act, 1910; or the Electricity Supply Act,
1948; or any Special Act respectively.
The provisions of the Companies Act, 1956 apply to these special classes of companies to the
extent that such provisions are not inconsistent with those of the Special Acts governing them
[clauses (a) to (d) of s.616].
8. Such corporate body incorporated by any Act for the time being in force as the Central
Government may, by notification in the Official Gazette, specify on its behalf subject to
such exceptions, modifications or adaptations as may be specified therein [clause (e) of
s.616].
2
9. Government Companies (s.617).
10. Nidhis or Mutual Benefit Societies declared as such by the Central Government by
notification in the Official Gazette [s.620A(2)].
11. Producer Companies (s.581A to 581ZT).
1.1.3 Non-applicability of the Act
The Companies Act, 1956 is not applicable to certain associations. These are:
1. Companies established under Special Acts of Parliament, such as Life Insurance

Corporation of India, Indian Airlines Corporation, (s.616).
2. Partnership firms which are governed by the Indian Partnership Act, 1932.
3. Co-operative Societies which are governed by the Co-operative Societies Act, 1912.
4. Trusts which are governed by the Indian Trusts Act, 1882.
5. Societies registered under the Societies Registration Act, 1860.
1.1.4 Scheme of the Act
The scheme of the Act may be considered broadly under five heads, corresponding to the
different parts it has. They are:
1. Formation of Company (Parts II to IV): The provisions of the Act relating to the formation
of a company include: (a) Incorporation of a company. (b) Memorandum and articles of
association. (c) Prospectus. (d) Issue of shares and debentures. (e) Certificate to commence
business.
2. Management and Administration of Company (Part VI): Under this head, the following
provisions are included: (a) Registered office and name of the company; (b) Members and
debenture holders; (c) Meetings and proceedings; (d) Managerial personnel; (e) Managerial
remuneration; (f) Accounts; (g) Audit; (h) Investigation; (i) Directors; (j) Managing directors;
(k) Managers; (l) Arbitration, compromises, arrangements and reconstructions;
(m) Prevention of mismanagement and oppression.
3. Winding up of Company (Part VII): The Act contains the following provisions as regards
to the winding up of companies, viz., (a) Modes of winding up; (b) Winding up by the court;
(c) Voluntary Winding up; (d) Winding up subject to the supervision of the court.
4. Miscellaneous Provisions (Parts V and VIII to XIII): These include: (a) Registration of
charges; (b) Application of the Act to companies formed under previous company laws;
(c) Winding up of unregistered companies; (d) Foreign companies; (e) Registration offices and
officers and fees; (f) General. The Act is then followed by 15 schedules which, deal with various
matters provided in the Act.
5. Producer Companies (Part IX A).
Self- Assessment
Fill in the blanks:
1......................................... s codified in the Companies Act, 1956.
2. Companies formed and registered under the ......................................
3
Company Law
3. Companies registered but not formed under any previous company laws to the extent and
in the manner declared in ........................................
4. Companies Act, 1956 is not applicable to.................................
5. The Central Government is the supreme authority responsible for the administration of
..............................................
1.2 Company Law Administration

The present set up dealing with Company Law Administration, directly or indirectly, at various
stages and providing for various administrative authorities is as follows:
1. The Central Government
2. The Company Law Board
3. National Advisory Committee on Accounting Standards
4. Securities and Exchange Board of India
5. Official Liquidator
6. Advisory Committee
7. Courts.
1.2.1 The Central Government (s.637)
The Central Government is the supreme authority responsible for the administration of company
law. It acts through the Department of Company Affairs in the Ministry of Law, Justice and
Company Affairs. It is, however, not possible for the Central Government to directly look after
the day-to-day administration of company law. It has, therefore, delegated its powers to the
Company Law Board which acts as the executive arm of the Department of Company Affairs.
The Company Law Board exercises powers which have been conferred on it by the Companies
Act and those powers which are delegated to it by the Central Government.
Section 637 empowers the Central Government to delegate any of its powers and functions, by
notification in the Official Gazette (except the power to appoint Public Trustee under s. 153A) to
some other authority as may be specified in the notification.
A copy of every notification shall, as soon as, after it is issued, be placed before both the Houses
of Parliament.
Now, for all practical purposes, the day-to-day administration of company law is carried out by
the Company Law Board.
1.2.2 Constitution of Board of Company Law Administration
Section 10 E provides as follows:
1. It empowers the Central Government to constitute the Board of Company Law

Administration (CLB).
2. The Company Law Board shall exercise and discharge such powers and functions as may
be conferred on it by or under the Companies Act, 1956 or any other law. Further, it shall
also exercise and discharge such other powers and functions of the Central Government
under this Act or any other law as may be conferred on it by the Central Government, by
notification in the Official Gazette under the provisions of the Companies Act, 1956 or that
other law.
4
3. The CLB shall consist of such number of members, not exceeding nine, as the Central
Government deems fit, to be appointed by that Government by notification in the Official
Gazette.
4. The members of the CLB shall possess such qualifications and experience as may be
prescribed.
5. One of the members of the Board shall be appointed by the Central Government to be the
Chairman of the CLB.
6. No act done by the CLB shall be called in question on the ground only of any defect in the
constitution of, or the existence of any vacancy in the CLB.
7. The CLB may, by order in writing, form one or more Benches from among its members
and authorise each such Bench to exercise and discharge such of the Board’s powers and
functions as may be specified in the order. Every order made or act done by a Bench in
exercise of such powers or discharge of such functions shall be deemed to be the order or
act, as the case may be, of the Board.
8. The CLB shall in the exercise of its powers and the discharge of its functions under the Act
or any other law be guided by the principles of natural justice and shall act at its discretion.
9. The CLB shall have power to regulate its own procedure.
Appeals against the Orders of the CLB
Section 10 F provides that any person aggrieved by any decision or order of CLB may file an
appeal to the high court within 60 days from the date of communication of the decision or order
of CLB to him on any question of law arising out of the order.
This period of 60 days may be extended by a further period not exceeding 60 days if the high
court is satisfied that the appellant was prevented by sufficient cause from filing the appeal
within the said period of 60 days.
1.2.3 National Advisory Committee on Accounting Standards
Section 210 A provides that the Central Government may, by notification in the Official Gazette,
constitute National Advisory Committee on Accounting Standards, to advise the Central
Government on the formation and laying down of accounting policies and accounting standards,
for adoption by companies or class of companies under the Companies Act, 1956.
1.2.4 The Securities and Exchange Board of India
Section 2(45B) provides that the Central Government may, by notification in the Official Gazette,
establish the Securities and Exchange Board of India (in short - SEBI) for the protection of
investors in securities.
Powers of SEBI
Section 55A provides that the provisions contained in sections 55 to 58, 59 to 84, 108, 109, 110, 112,
113, 116 to 122, 206, 206 A and 207 shall be administered by SEBI, so far as they relate to issue and
transfer of securities and non-payment of dividend in case of:
(i) Listed public companies;
(ii) Those public companies which intend to get their securities listed on any recognised stock
exchange in India.
5
Company Law
Section 209A provides that the books of account and other books and papers of every company
shall be open to inspection during business hours, inter alia, by the officers of SEBI as may be
authorised by it. However, an inspection may be made without giving any previous notice to the
company or any officer thereof. Further, an inspection can be made in respect of matters
covered under sections referred to in s.55A.
Further, under s.621, a court may take cognizance of offence relating to the issue and transfer of
securities and non-payment of a dividend, on a complaint in writing, by a person authorised by
SEBI.
Task Discuss the application of companies act in respect of J&K state.
1.2.5 Official Liquidator
For the purpose of winding up of companies by the court, there shall be an official liquidator,
who may be:
appointed from a panel of professional firms of chartered accountants, advocates, company

secretaries, cost and works accountants which the Central Government constitutes for the
court.
a body corporate, consisting of such professionals as may be approved by the Central
Government.
a whole time or a part time officer, appointed by the Central Government.
1.2.6 Advisory Committee
Section 410 provides that for the purpose of advising the Central Government and the Company
Law Board on the matters arising out of the administration of the Companies Act, 1956, as may
be referred to it by the Central Government or the Company Law Board, the Central Government
may constitute this Committee consisting of not more than 5 persons with suitable qualifications.
The Central Government is, however, not bound to constitute an Advisory Committee.
Moreover, even if an Advisory Committee is constituted neither the Central Government nor the
Company Law Board is bound to accept its advice.
1.2.7 Courts
According to section 2, the ‘Court’ means:
(a) With respect to any matter relating to a company (other than any offence against the Act)
the Court having jurisdiction under this Act with respect to that matter relating to that
company, as provided in s.10;
(b) With respect to any offence against this Act, the Court of a Magistrate of the First Class or,
as the case may be, a Presidency Magistrate, having jurisdiction to try such offence.
6
Jurisdiction of Courts
As regards to the jurisdiction of Courts, section 10 provides as follows:
1. The court having jurisdiction under this Act shall be:
(a) The High Court having jurisdiction in relation to the place at which the registered
office of the company concerned is situated, except to the extent to which jurisdiction
has been conferred on any District Court or District Court subordinate to that High
Court in pursuance of (2) below; and
(b) Where jurisdiction has been so conferred, the District Court in regard to matters
falling within the scope of the jurisdiction conferred, in respect of companies having
their registered offices in the district.
2. The Central Government may, by notification in the Official Gazette and subject to such
restrictions, limitations and conditions as it thinks fit, empower any District Court to
exercise all or any of the jurisdiction conferred by this Act upon the court, not being the
jurisdiction conferred by this Act upon the court:
(a) In respect of companies generally, by Sections 237, 391, 394, 395 and 397 to 407, both
inclusive;
(b) In respect of companies with a paid-up share capital of not less than 1 lakh of rupees, by
Part VII (Sections 425 to 560) and the other provisions of this Act relating to the
winding up of companies.
3. For the purposes of jurisdiction to wind up companies, the expression ‘registered office’
means the place which has longest been the registered office of the company during the six
months immediately preceding the presentation of the petition for winding up.
Self- Assessment
6. What is the correct sequence of the following assignments?

(i) Internal control (ii) Test check
(iii) Internal check (iv) Statutory audit
Select the correct answer using the codes given below:
Codes
(a) (i), (ii), (iii), (iv) (b) (iii), (i), (iv), (ii)
(c) (iii), (i), (ii), (iv) (d) (iv), (iii), (ii), (i)
7. Which of the following conditions must be satisfied in a claim for loss by fire?
(i) There must be actual fire.
(ii) Fire must be accidental.
(iii) Cause of fire must be ascertainable.
(iv) The goods must have been destroyed, not damaged by fire.
Codes
(a) (i) and (ii) (b) (i) and (iii)
(c) (ii) and (iii) (d) (iii) and (iv)
7
Company Law
1.3 Some Important Definitions
Some important definitions related to companies act are:
Officer: Section 2(30) provides that the term ‘Officer’ includes any director, manager or
secretary or any person in accordance with whose directions or instructions the board of
directors or any one or more of the directors is or are accustomed to act.
Relative: Section 2(41) provides that the term ‘relative’ means, with reference to any
person, any one who is related to such person in any of the ways specified in s.6, and no
others.
Section 6 provides that a person shall be deemed to be a relative of another, if, and only if:
(i) They are members of a Hindu undivided family; or
(ii) They are husband and wife; or
(iii) The one is related to the other in the manner indicated in Schedule 1A.
Schedule 1A provides the following list of relatives:

(i) Father, Father’s father, Father’s mother.
(ii) Mother (including step-mother), Mother’s mother, Mother’s father.
(iii) Son (Including step son), Son’s wife, Son’s son, Son’s son’s wife, Son’s daughter,
Son’s daughter’s husband.
(iv) Daughter (including step-daughter), Daughter’s husband, Daughter’s son, Daughter’s

son’s wife, Daughter’s daughter, Daughter’s daughter’s husband.
(v) Brother (including step brother), Brother’s wife.
Public Financial Institutions (S.4 A): The following financial institutions shall be regarded,
for the purposes of the Act, as public financial institutions, namely: (i) The Industrial
Credit and Investment Corporation of India Limited (ICICI), (ii) The Industrial Finance
Corporation of India (IFCI), (iii) The Industrial Development Bank of India (IDBI), (iv) The
Life Insurance Corporation of India (LIC), (v) The Unit Trust of India (UTI).
Also, s.4A empowers the Central Government to specify other institutions, as it may think
fit, to be a public financial institution by issuing a notification in the Official Gazette.
However, no institution shall be so specified unless (i) it has been established or constituted
by or under any Central Act; or (ii) not less than 51 per cent of the paid-up share capital of
such an institution is held or controlled by the Central Government.
The Central Government has specified many other institutions to be public financial
institutions. Some of these are: (i) The Infrastructure Development Finance Company Ltd.,
(ii) National Housing Board, (iii) Rural Electrification Corporation Ltd., (iv) Indian Railways
Finance Corporation Ltd., (v) National Insurance Company Ltd., (vi) Power Finance
Corporation Ltd., (vii) Small Industries Development Bank of India, etc.
Section 4A is relevant in the context of Sections 94A and 224A.
Task “No civil court shall have jurisdiction to entertain any suit or proceeding in respect
of any matter which the Company Law Board is empowered to determine”. Discuss
8
Officer Who is in Default: Section 5 provides that for the purpose of any provision in this
Act which enacts that an officer of the company who is in default shall be liable to any
punishment or penalty, whether by way of imprisonment, fine or otherwise, the expression
‘officer who is in default’ means all the following officers of the company, namely:
(i) The managing director or managing directors;
(ii) The whole time director or directors;
(iii) The manager;
(iv) The secretary;
(v) Any person in accordance with whose directions or instructions the board of directors
of the company is accustomed to act;
(vi) Any person charged by the board of directors with the responsibility of complying
with any provision, provided the person so charged has given his consent in this
behalf to the board of directors;
(vii) Where any company does not have any of the officers specified in clauses (a) to (c),
any director or directors who may be specified by the board of directors in this behalf
or where no director is so specified, all the directors.
(viii) Where the board of directors exercises any power under clause (f) or clause (g), it shall,
within 30 days of the exercise of such powers, file with the Registrar a return in the
prescribed form.
Self Assessment
8. The provisions of the Act relating to the formation of a company are discussed in parts
................................. of the act.
(i) II to IV (ii) III to IV
(iii) Parts I to II (iv) Parts IV to V
9. Property of the company belongs to ....................................

(i) Company (ii) Shareholders
(iii) Members (iv) Promoters
10. In the case of company, audit is ......................................
(i) Compulsory (ii) Optional
(iii) Situational (iv) None of the above
11. The companies which are formed under special Act are called as ..................................
(i) Chartered Companies (ii) Statutory Companies
(iii) Registered Companies (iv) None of these
9
Company Law
Case Study Companies under politics
the the - the
came to be known as “fast track” ones, and were to be given every facility by the government.
Question
Self Assessment
State whether the following statements are true or false:
12. SEBI is a regulatory body to regulate the functioning of stock exchanges.
13. Courts have been replaced by Company Law Board under the Companies Act, 1956.
14. The administration of the Companies Act, 1956 is vested in the Company Law Board.
15. Any person aggrieved by the decision or order of the Company Law Board may file an
appeal in the Supreme Court.
16. No civil court shall have jurisdiction to entertain any suit or proceeding in respect of any
matter which the Company Law Board is empowered to determine.
1.4 Summary
The Companies Act, 1956, has been in force for the last 55 years.
The Act confers a variety of powers on the Central Government and the Company Law
Board to monitor, regulate and control the affairs of the companies.
10
To ensure better management of companies, the Central Government accord approval for the
appointment and reappointment of persons as Managing Directors, Whole-time Directors or
Managers of a public limited or private limited company which is a subsidiary of a public
limited company, under Section 269 read with Section 388 of the CompaniesAct.
In 1988, the Government dispensed with the requirement of the approval for appointment
of managerial personnel in respect of cases which fulfill the conditions as prescribed in
Schedule XIII of the Act.
This Schedule can be modified to suit the changing needs of the time and circumstances in
keeping with this policy of regulation by exception.
1.5 Keywords
CLB: Section 10 E enables the Central Government to constitute the Board of Company Law
Administration (CLB).
Officer: Section 2(30) provides that the term ‘Officer’ includes any director, manager or secretary or
any person in accordance with whose directions or instructions the board of directors or any one
or more of the directors is or are accustomed to act.
SEBI: Section 2(45B) provides that the Central Government may, by notification in the Official
Gazette, establish the Securities and Exchange Board of India (in short - SEBI) for the protection
of investors in securities.
The Central Government: The Central Government is the supreme authority responsible for the
administration of company law.
1.6 Review Questions
1. What is the extent of the Companies Act, 1956?
2. Enumerate the companies to which the Companies Act, 1956 is applicable.
3. Enumerate the associations to which the Companies Act, 1956 is not applicable.
4. Describe the scheme of the Companies Act, 1956.

5. Outline the set up of Company Law Administration.
6. What are the different authorities by which the administration of the Companies Act, 1956
is carried out?
7. Write an explanatory note on Company Law Board.
8. Discuss about “Societies registered under the Societies Registration Act, 1860.”
9. What do you mean by Official Liquidator.
10. Write short on:
(i) Public Financial Institutions
(ii) SEBI
(iii) Advisory Committee
(iv) Meaning of (a) officer, (b) relative, (c) officer who is in default.
11
Company Law
Answers: Self Assessment
1. Company law 2. Companies Act, 1956

3. Part IX
4. Partnership firms which are governed by the Indian Partnership Act, 1932.
5. Company law 6. (c)

7. (a) 8. Parts II to IV
9. Company 10. Optional
11. Statutory Companies 12. True
13. False 14. True

15. False 16. True
1.7 Further Readings
Books Aggarwal, Rohini (2003), “Student’s Guide to Mercantile and Commercial Laws,”
Taxmann’s, New Delhi.
Avtar Singh, Company Law, Eastern Publishers.
Begrail, Ashok K, Company Law, Vikas Publishing House, Delhi.
Kapoor, N.D, Company Law, Sultan Chand & Sons, New Delhi.
M.C. Kucchal ( 2002), Business Law, Vikas Publishing House Pvt. Ltd, Delhi.
P.C. Tulsian (2002), Business Law, Tata Mc. Graw Hill Pvt. Ltd, Delhi.
S. S. Gulshan, Business Law, Excel Books, New Delhi, 2006.
Online links http://www.indialawinfo.com/bareacts/soga.html

www.en.wikipedia.org
www.webopedia.com
12
Unit 2: Meaning and Nature of a Company
Introduction
Separate Property
Perpetual Existence
Objectives
Define a company;
Describe various characteristics of a company;
Explain the corporate veil lifting process.
Introduction
A company, in its ordinary, non-technical sense, means a body of individuals associated for a
common objective, which may be to carry on business for gain or to engage in some human
activity for the benefit of the society. Accordingly, the word ‘company’ is employed to represent
associations formed to carry on some business for profit or to promote art, science, education or
to fulfill some charitable purpose. This body of individuals may be incorporated or
unincorporated.
13
Company Law
2.1 Definition of a Company
The Companies Act, 1956 defines the word ‘company’ as a company formed and registered
under the Act or an existing company formed and registered under any of the previous company
laws (s.3). This definition does not bring out the meaning and nature of the company into a clear
perspective. Also s.12 permits the formation of different types of companies. These may be
(i) companies limited by shares, (ii) companies limited by guarantee and (iii) unlimited companies.
The vast majority of companies in India are with limited liability by shares. Therefore, it is
advisable to define the term ‘company’ keeping in mind this type of company. However, a brief
description of other types of companies will be given later in unit 3.
Lord Lindley has described the company as “an association of many persons who contribute money
or money’s worth to a common stock and employ it in some trade or business; and who share the
profit and loss (as the case may be) arising therefrom”. The common stock so contributed is denoted
in money and is ‘the capital’ of the company. The persons who contribute to it, or to whom it belongs,
are members. The proportion of capital to which each member is entitled is his ‘share’. The
member may sell his share in the company, thus, withdrawing himself and making someone else
a member to whom he transfers shares. Thus, shares in a company are transferable. As a natural
consequence of transferability of shares, the company has what is commonly known as perpetual
succession. With the withdrawal or death of a member of a company, the latter does not come to
an end. The life of the company is independent of the livesof the members of the company. Members
may come and members may go, the company continues until it is dissolved.
Gower, L.C.B. in his book entitled The Principles of Modern Company Law gives an interesting
example. He says, ‘During the war all the members of one private company, while in general meeting,
were killed by a hydrogen bomb. But the company survived, not even a hydrogen bomb could
have destroyed it’.
Section 34(2) gives the effect of registration of a company by identifying the features it acquires
as a consequence thereof. The section provides that:
“From the date of incorporation mentioned in the certificate of incorporation, such of the
subscribers of the memorandum and other persons, as may from time to time be members of the
company, shall be a body corporate by the name contained in the memorandum, capable forthwith
of exercising all the functions of an incorporated company and having perpetual succession and
a common seal, but with such liability on the part of the members to contribute to the assets of
the company in the event of its being wound up as is mentioned in the Act.
Self Assessment
Fill in the blanks:
1. An existing company formed and registered under any of the previous company laws
........................................
2. The persons who contribute to it, or to whom it belongs, are ...................................
3. Members may come and members may go, the company continues until it is
....................................
4.gives the effect of registration of a company by identifying the features

it acquires as a consequence thereof.
14
2.2 Characteristics of Company
On the basis of the above observations, we may spell out the following characteristic features of
a company.
2.2.1 Incorporated Association
A company must be incorporated or registered under the Companies Act. Minimum numbers
required for the purpose is 7, in case of a public company and 2, in case of a private company (s.12).
It may also be mentioned that as per s.11, an association of more than 10 persons, in case of banking
business and 20 in case of any other business, if not registered as a company under the Companies
Act, or under any other law for the time being in force, becomes an illegal association.
2.2.2 Artificial Person
A company is created with the sanction of law and is not itself a human being, it is therefore,
called artificial; and since it is clothed with certain rights and obligations, it is called a person.
A company is accordingly, an artificial person.
2.2.3 Separate Legal Entity
Unlike partnership, company is distinct from the persons who constitute it. Section 34 (2) says
that on registration, the association of persons becomes a body corporate by the name contained
in the memorandum. Lord Macnaghten in the famous case of Salomon v. Salomon & Co. Ltd.
(1897) AC 22 observed that:
A company is at law a different person altogether from the subscribers…..; and though it may be
that after incorporation the business is precisely the same as it was before and the same persons
are managers and the same hands receive the profits, the company is at law not the agent of the
subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form,
except to the extent and in the manner provided by the Act.
The facts of the famous Salomon’s case were as follows:
Salomon carried on business as a leather merchant. He sold his business for a sum of £30,000 to
a company formed by him along with his wife, a daughter and four sons. The purchase consideration
was satisfied by allotment of 20,000 shares of £1 each and issue of debentures worth £10,000
secured by floating charge on the company’s assets in favour of Mr Salomon. All the other
shareholders subscribed for one share of £1 each. Mr Salomon was also the managing director of the
company. The company almost immediately ran into difficulties and eventually became insolvent
and winding up commenced. At the time of winding up, the total assets of the company amounted to
£6,050; its liabilities were £10,000 secured by the debentures issued toMr Salomon and £8,000
owing to unsecured trade creditors. The unsecured sundry creditors claimed the whole of the
company’s assets, viz. £6,050 on the ground that the company was a mere alias or agent for
Salomon.
Held: The contention of the trade creditors could not be maintained because the company being
in law a person quite distinct from its members, could not be regarded as an ‘alias’ or agent or trustee
for Salomon. Also the company’s assets must be applied in payment of the debentures asa secured
creditor is entitled to payment out of the assets on which his debt is secured in priority to unsecured
creditors.
15
Company Law
In Lee v. Lee Air Farming Limited (1960) 3 All ER 429 PC, a company was formed for the purpose
of manufacturing aerial top-dressing. Lee, a qualified pilot, held all but one of the shares in the
company and by the articles was appointed governing director of the company and chief pilot.
Lee was killed while piloting the company’s aircraft and his widow claimed compensation for
his death under the Workmen Compensation Act. The company opposed the claim on the
ground that Lee was not a ‘worker’ as the same person could not be employer and the employee.
Held: There was a valid contract of service between Lee and the company; and Lee was, therefore,
a worker. Mrs. Lee’s contention was upheld.
In Bacha F. Guzdar v. The Commissioner of Income-Tax, Bombay [AIR (1955) SC. 74], the facts of
the case were as follows:
The plaintiff (Mrs. Guzdar) received certain amounts as dividend in respect of shares held by her
in a tea company. Under the Indian Income-tax Act, agricultural income is exempted from
payment of income-tax. As income of a tea company is partly agricultural, only 40 per cent of the
company’s income is treated as income from manufacture and sale and, therefore, liable to tax.
The plaintiff claimed that the dividend income in her hands should be treated as agricultural
income up to 60 per cent, as in the case of a tea company, on the ground that dividends received
by shareholders represented the income of the company.
Held: By the Supreme Court, that though the income in the hands of the company was partly
agricultural yet the same income when received by Mrs. Guzdar as dividend could not be
regarded as agricultural income.
Task A husband and wife who were the only two members of a private ltd., company
were killed in a motor accident. Does the company also die with them?
2.2.4 Limited Liability
The company being a separate person, its members are not as such liable for its debts. Hence, in
the case of a company limited by shares, the liability of members is limited to the nominal value
of shares held by them. Thus, if the shares are fully paid up, their liability will be nil. However,
companies may be formed with unlimited liability of members or members may guarantee a
particular amount. In such cases, liability of the members shall not be limited to the nominal or
face value of the shares held by them. In case of unlimited liability companies, members shall
continue to be liable till each paise has been paid off. In case of companies limited by guarantee,
the liability of each member shall be determined by the guarantee amount, i.e., he shall be liable
to contribute up to the amount guaranteed by him.
Unlimited Liability of a Member of a Limited Liability Company
In the following cases, a shareholder or member shall lose the privilege of limited liability:
1. Where members of the company are reduced below the statutory minimum, viz., 7 in case
of a public company and 2 in case of a private company and the company carries on the
business for more than 6 months while the members are so reduced, every person who is
a member during the time that it so carries on business after those 6 months and is aware
of the fact that it is operating with fewer than the requisite number shall be personallyliable
for the whole of the debts contracted during that time (s.45).
16
2. Where in the course of winding up, it appears that any business of the company has been
carried on with intent to defraud creditors; the Court may declare the persons who were
knowingly parties to the transaction personally liable without limitation of liability for all
or any of the debts or other liabilities of the company (s.542).
2.2.5 Separate Property
Shareholders are not, in the eyes of the law, part owners of the undertaking. In India, this
principle of separate property was best laid down by the Supreme Court in Bacha F. Guzdar v.
The Commissioner of Income Tax, Bombay (Supra). The Supreme Court held that “a shareholder
is not the part owner of the company or its property, he is only given certain rights by law, e.g.,
to vote or attend meetings, to receive dividends” Similarly, in R. F. Perumal v. H. John, it was
observed that “no member can claim himself to be owner of the company’s property during its
existence or on its winding up. In still another case, it was observed that “ even where a shareholder
held almost entire share capital, he did not even have an insurable interest in the property of the
company”. In Macaure v. Northern Assurance Co. Ltd., the facts were as follows:
‘Macaure’ held all except one share of a timber company. He had also advanced substantial
amount to the company. He insured the company’s timber in his personal name. On timber being
destroyed by fire, his claim was rejected for want of insurable interest. The Court applying principle
of separate legal entity held that the insurance company was not liable.
2.2.6 Transferability of Shares
Since business is separate from its members in a company form of organisation, it facilitates the
transfer of member’s interests. The shares of a company are transferable in the manner provided in
the Articles of the company (s.82). However, in a private company, certain restrictions are
placed on such transfer of shares but the right to transfer is not taken away absolutely.
2.2.7 Perpetual Existence
A company being an artificial person cannot be incapacitated by illness and it does not have an
allotted span of life. The death, insolvency or retirement of its members leaves the company
unaffected. Members may come and go but the company can go forever. The saying “King is
dead, long live the King” very aptly applies to the company form of organisation.
2.2.8 Common Seal
A company being an artificial person is not bestowed with a body of natural being. Therefore,
it has to work through its directors, officers and other employees. But, it can be held bound by
only those documents which bear its signature. Common seal is the official signature of a
company.
Seal of company when to be used – The articles of association of the company provide for putting
the seal of the company on documents. Apart from those documents, the company seal is to be
put on power of attorney, deed of lease, share certificates, debentures, debenture trust deed,
deed of mortgage, promissory , negotiable instruments (except cheques), agreement of
hypothecation, loan agreements with banks and financial institutions, contract of employment,
guarantees issued by the company and all formal documents and documents executed on stamp
papers.
17
Company Law
Use of Seal Outside India (s.50)
Where a company has any business or transaction in a place outside India, a facsimile (exact
reproduction) of the common seal may be kept there. The seal should also contain the name of
the place where the seal would be used. For such use, there must be power in the articles. A
person must be properly authorised to use the seal, who shall sign his name and also put the name
of the place and the fact that he has been authorised to do so by the specified resolution.
As per s.48, a company may, by writing under its common seal, empower any person, either
generally or in respect of any specified matters, as its attorney, to execute deeds on its behalf in
any place either in or outside India [s.48(1)].
It further provides that a deed signed by such an attorney on behalf of the company and under
his seal where sealing required, shall bind the company and have the same effect as if it were
under its common seal[s.48(2)].
2.2.9 Company may sue and be sued in its own name
Another fallout of separate legal entity is that the company, if aggrieved by some wrong done to
it may sue or be sued in its own name. In Rajendra Nath Dutta v. Shibendra Nath Mukherjee
(1982) (52 Comp. Cas. 293 Cal.), a lease deed was executed by the directors of the company
without the seal of the company and later a suit was filed by the directors and not the company
to avoid the lease on the ground that a new term had been fraudulently included in the lease
deed by the defendants. Held that a director or managing director could not file a suit, unless it
was by the company in order to avoid any deed which admittedly was executed by one of the
directors and admittedly also the company accepted the rent. The case as made out in the plaint
was not made out by the company but by some of the directors of the company and the company
was not even a plaintiff. If the company was aggrieved, it was the company which was to file the
suit and not the directors. Therefore, the suit was not maintainable.
Self Assessment
5. Consider the following statements:
A statutory auditor of a public limited company claims that he has the following legal
rights in relation to his duties:
(i) Right to refuse to make a report
(ii) Right of access to books of accounts and registers
(iii) Right to seek explanation from directors and officers -
(iv) Right to make statement in the general meeting
Of the above statements:

(a) (i), (ii) and (iii) are correct
(b) (i), (ii) and (iv) are correct
(c) (i), (iii) and (iv) are correct
(d) (ii), (iii) and (iv) are correct
18
6. Match List-I with List-II and select the correct answer using the codes given below in the
lists:
List-I List-II
(Company Issue) (Company Document)
A. Affirmation of compliance with 1. Certificate of incorporation

the registration formalities
B. Classes of shares into which 2. Statutory declaration

shake capital is divided
C. Rules for forfeiture of shares 3. Memorandum of Association
D. Name and address of 4. Articles of association

the company auditor
5. Prospectus
A B C D
(a) 1 4 3 5
(b) 5 4 3 1
(c) 2 3 4 5
(d) 4 1 5 2
2.3 Lifting of the Corporate Veil
A company is distinct from its members. It is a separate legal entity. There is thus, a veil between
a company and its members keeping them both separate from each other. However, sometimes
it becomes necessary to lift this veil, disregard the distinct corporate entity of the company and
find out the realities of the company. The court may investigate the real affairs, ownership, etc.,
of the company. This is called lifting or piercing the corporate veil. In other words, the Court
investigates into the true state of affairs of the company. It has been observed that though a
corporation is a distinct entity, yet in reality, it is an association of persons who are in fact the
beneficial owners of all the corporate property.
The corporate veil is therefore lifted by the court, when it ignores the company and concerns
itself directly with the members or managers. It is largely in the discretion of the Courts and will
depend upon the underlying social, economic and moral factors as they operate in and through
the corporation.
The corporate veil may be lifted in the following instances:
To investigate the relationships between the holding company and subsidiary company;
To investigate the number and names of members of the company;
To investigate the true ownership of shares and controlling power over the company;
To investigate lawful objects of the company;
To investigate mismanagement and oppression by the majority;
To investigate the character of the company where it is trading with an alien enemy or
persons managing the affairs of the company are under the control of enemies or been
residing in enemy country;
To investigate into the affairs where there exists a tendency to create monopoly;
19
Company Law
To investigate the company affairs where it is used for tax evasion or to circumvent tax
obligation;
To investigate if the company is acting as an agent for its shareholders;
To investigate the affairs where it is formed for fraudulent purposes, to defeat and
circumvent the law or to defraud its creditors or to avoid valid obligations.
Bombay High Court in (2004) 121 Comp. Cas 314 has held that the corporate veil may be liftedto
the extent permitted under the statute and no more.
The advantages of incorporation are allowed to be enjoyed only by those who want to make an
honest use of the ‘company’. In case of a dishonest and fraudulent use of the facility of
incorporation, the law lifts the corporate veil and identifies the persons (members) who are
behind the scene and are responsible for the perpetration of fraud.
Following are some such cases:
For the Protection of Revenue: The Court may not recognize the separate existence of
a company where the only purpose for which it appears to have been formed is the tax-
evasion or circumvention of tax obligation. D was a rich man having dividend and interest
income. He wanted to avoid surtax. For this purpose, he formed four private companies,
in all of which he was the majority shareholder. The companies made investments and
whenever interest and dividend incomes were received by the companies, D applied to the
companies for loans which were immediately granted and never repaid. In a legal
proceeding, the corporate veils of all the companies were lifted and the incomes of the
companies treated as if they were of ‘D’ [In re Dinshaw Maneckjee Petit (1927) Bom.371].
Where the company is acting as agent of the shareholders: In such circumstances, the
shareholders will be held liable for its acts. There may be an express agreement to this
effect or such agreement may be implied from the facts of a particular case.
Where a company has been formed by certain persons to avoid their own valid contractual
obligation: In such conditions, the court may proceed on the assumption as if no company
existed.
Example: A sold his business to B and agreed not to compete with him for a given
number of years within reasonable local limits. A, desirous of re-entering business, in violation
of the contractual obligation, formed a private company with majority shareholdings. B filed a
suit against ‘A’ and the private company and the court granted an injunction restraining ‘A’ and
his company with going ahead in the competing business (Gilford Motor Co. v. Horne (1933) 1
Ch. 935).
Where a company has been formed for some fraudulent purpose or is a ‘sham’: The court
will lift the corporate veil in such circumstances to identify the perpetrator of the fraud. In
Delhi Development Authority v. Skipper Construction Company (P) Ltd. [1996] 4 SCALE 202,
the skipper construction company failed to pay the full purchase price of a plot to DDA.
Instead construction was started and space sold to various persons. The two sons of the
directors who had business in their own names claimed that they had separated from the
father and the companies they were running had nothing to do with the properties of their
parents. But no satisfactory proof in support of their claim could be produced. Held, that the
transfer of shareholding between the father and the sons must also be treated as a sham. The
fact that the director and members of his family had created several corporate bodies did not
prevent the court from treating all of them as one entity belonging to and controlled by the
director and his family.
20
Where a company formed is against public interest or public policy: Where for the purpose
of determining the character of the members, the Court may lift the corporate veil.
Example: C company was floated in London for marketing tyres manufactured in

Germany. The majority of C’s shares were held by the German nationals residing in Germany.
During World War I, C company filed a suit against D company for the recovery of trade debt.
The D company contended that C company was an alien enemy company (Germany being at war
with England at that time) and that the payment of the debt would be a trading with the enemy.
The Court agreed with the contention of the defendants [Daimler Co. Ltd. v. Continental Tyre and
Rubber Co., (1916) 2AC 307].
Where device of incorporation is used for some illegal or improper purpose: [PNB Finance
Ltd. v. Shital Prasad Jain (1983) 54 Comp. Cas 66 (Delhi)]. S, the financial advisor of a
financing public limited company was given a loan of 15 lakhs by the company to purchase
immovable properties in Delhi. A pronote with regard to the same was also executed by S.
S diverted the amount of the loan to three public limited companies floatedby him and his
son. These companies, in turn, applied the amount in purchasing immovable properties at
New Delhi. The Delhi High Court refrained the defendants from in any manner alienating,
transferring, disposing of or encumbering the properties in question.
Where the number of members falls below the statutory minimum: (i.e., seven in the case of
a public company and two in the case of a private company) and the company continues to
carry on business for more than six months while the number is so reduced. In such a case,
every person who is a member of the company during the time that it so carries on business
after those six months and has knowledge of that fact, shall be severally liable tothe creditors
for the payment of the company’s debts contracted during that period. Sucha member can
be sued severally (i.e., directly) by the creditors of the company. Both the privileges of limited
liability and that of the separate legal entity are lost. The creditors are permitted to look
behind the company to the shareholders for the satisfaction of their claims (s.45).
Where prospectus includes a fraudulent misrepresentation: In case of a prospectus
containing fraudulent misrepresentation as to a material fact, Ss. 62 and 63 make the
promoters, directors, etc., personally liable not only in damages but they may even be
prosecuted in terms of fine up to 50,000 or imprisonment up to 2 years or both.
Where a negotiable instrument is signed by an officer of a company on behalf of the
company without mentioning the name of the company: Thereon, he is personally liable
to the holder of the instrument, unless the company has already made the payment on the
instrument [s.147 (4) (c)].
Holding and Subsidiary Companies: (Ss. 212-213). In the eyes of law, the holding company
and its subsidiaries are separate legal entities. However, in the following cases, a subsidiary
company may lose its separate identity to a certain extent:
Where at the end of its financial year, a company has subsidiaries, it may lay before
its members in general meeting not only its own accounts, but also a set of group
accounts showing the profit or loss earned or suffered by the holding company and
its subsidiaries collectively and their collective state of affairs at the end of the year;
The Central Government, where it feels desirable, may direct the holding and
subsidiary companies to synchronize their financial years;
The Court may, on the facts of a case, treat a subsidiary company as merely a branch
or department of one large undertaking owned by the holding company.
21
Company Law
Investigation into related companies: Section 239 provides that if it is necessary for the
satisfactory completion of the investigation into the affairs of a company, the Inspector
appointed to investigate may look into the affairs of another related company in the same
management or group.
For investigation of ownership of a company: The separate legal entity may be disregarded
under s.247. This Section authorises the Central Government to appoint one or more
Inspectors to investigate and report on the membership of any company for the purpose
of determining the true persons who are financially interested in the company and who
control or materially influence its policy.
Business intended to defraud creditors: Where in the course of winding up of a company,
it appears that any business of the company has been carried on, with intent to defraud
creditors of the company, or any other persons, or for any fraudulent purpose, the court on
the application of the Liquidator, or any creditor or contributory of the company, may, if
it thinks proper, declare that any persons who are knowingly parties to the carrying on of
the business in the manner aforesaid shall be personally responsible, without any
limitation of liability, for all or any of the debts or other liabilities of the company as the
court may direct (s.542).
Self Assessment
7. The term ‘company’ is defined under which section of the Act?
(a) Sec 3 (1) (b) Sec 4 (2)
(c) Sec 2 (4) (d) Sec 1 (3)
8. Which company shares can be freely transferable

(a) Private Company (b) Public Company
(c) Both a and b (d) None of the above
9. The liability of members if company is limited by guarantee.
(a) Unpaid value of shares (b) Guarantee amount

(c) Unlimited liability (d) None of the above
10. The liability of members if company is limited by shares
(a) Unpaid value of shares (b) Guarantee amount

(c) Unlimited liability (d) None of the above
Task Savoy Ltd. had eight members at the time of incorporation. Within two months, two
of the members transferred their shares to one of the existing members. By the end of the
year, the company went into liquidation. All the shares are fully paid-up. The creditors of
the company sought to recover their dues from the company. The liquidator demanded
money from the shareholders, who refused to accept any liability; their shares being fully
paid-up. Explain the legal position.
22
2.4 Company Distinguished from Partnership
Section 4 of the Indian Partnership Act, 1932 defines a partnership as ‘the relation between
persons who have agreed to share the profits of a business carried on by all or any of them acting
for all’. Persons who enter into a partnership are individually called ‘Partners’ and collectively
a ‘Firm’, and the name under which the business is carried on is called the ‘Firm’s Name’.
The essential characteristics of a partnership organisation are:
1. A partnership is an association of two or more than two persons. However, a limit is placed
by s.11 of the Companies Act, 1956 on the maximum number of partners – at ten in case of
banking business and twenty in case of any other business.
2. A partnership must be the result of an agreement between two or more persons.
3. The agreement must be to carry on some business.
4. The agreement must be to share profits of the firm.
5. The business must be carried on by all or any of them acting for all. The partnership is
based upon the idea of mutual agency. Every partner assumes a dual role – that of a
principal and an agent.
6. The liability of each partner of the firm is unlimited in respect of the firm’s debts.
7. A partnership firm has no independent legal existence apart from the persons who
constitute it.
8. A partnership agreement is based on mutual confidence and trust of the partners.
9. No partner can transfer his share in a partnership to an outsider without the consent of all
the other partners.
10. No change can be made in the nature of the partnership business without the consent of all
the partners.
A partnership firm may be distinguished from a company in the following ways:
1. Legal Status: A partnership firm has no existence apart from its members. A company is
a separate legal entity distinct from its members.
2. Mutual Agency: A partnership is founded on the idea of mutual agency – every partner is
an agent of the rest of the partners. A member of a company is not an agent of the other
members.
3. Liability of Members: The liability of a partner is unlimited, i.e., even his own personal
assets are liable for the debts of the firm. The liability of a member of a limited company
is limited to the extent of the amount remaining unpaid on shares held by him or the
amount of guarantee, as mentioned in the memorandum of association of the company.
4. Transfer of Interest: A partner cannot transfer his interest in the partnership without the
consent of all other partners. A member, subject to the restrictions contained in the articles,
can freely transfer his shares in the company.
5. Duration of Existence: Unless there is a contract to the contrary, the death, retirement, or
insolvency of a partner results in the dissolution of the firm. In contrast, a company enjoys
a perpetual succession. Death or retirement or insolvency of a member of a company does
not affect the existence of the company.
23
Company Law
6. Minimum Membership: The minimum number of persons required to form a partnershipis

two. The minimum number required to form a private company is two and in the case of
a public company the minimum number is seven.
7. Maximum Membership: A partnership cannot be formed by more than twenty persons.
The number is limited to ten in the case of a banking business. In the case of a public
company, there is no limit to the maximum number of members. However, a private
company cannot have more than fifty members.
8. Audit: The audit of the accounts of a firm is not compulsory, whereas the audit of accounts
of a company is mandatory.
9. Use of the Words ‘Limited’ and ‘Private Limited’ not Allowed: Section 631 provides that if
any person or persons trade or carry on business under any name or title of which the
words, “Limited” or “Private Limited” are the last words, that person or each of these persons
shall, unless duly incorporated as a public or a private company, as the case may be, be
punishable with fine which may extend to 500 for every day upon which that name has been
used.
Self Assessment
11. The corporate veil can be lifted where the main object of forming a company is tax evasion.
12. The corporate veil can be lifted where it has been formed by the promoters to avoid their
contractual obligation.
13. An illegal association means a company formed to pursue illegal objects.
14. The corporate veil can be lifted where the company is formed against public policy.
15. A holding company and its subsidiary company are not separate legal entities.
24
£1000 is deposited with the Alliance Bank, Regent Street, shewing our sincerity in the
matter.
During the last epidemic of influenza many thousand carbolic smoke balls were sold as
preventives against this disease, and in no ascertained case was the disease contracted by
those using the carbolic smoke ball.
One carbolic smoke ball will last a family several months, making it the cheapest remedy
in the world at the price, 10s. post free. The ball can be refilled at a cost of 5s. Address:
“Carbolic Smoke Ball Company, “27, Princes Street, Hanover Square, London.”
Mrs. Louisa Elizabeth Carlill saw the advertisement, bought one of the balls and used three
times daily for nearly two months until she contracted the flu on January 17, 1892. She
claimed £100 from the Carbolic Smoke Ball Company. They ignored two letters from her
husband, who had trained as a solicitor. On a third request for her reward, they replied with
an anonymous letter that if it is used properly the company had complete confidence in the
smoke ball’s efficacy, but “to protect themselves against all fraudulent claims” they would
need her to come to their office to use the ball each day and checked by the secretary.
Mrs. Carlill brought a claim to court. The barristers representing her argued that the
advertisement and her reliance on it was a contract between her and the company, and so
they ought to pay. The company argued it was not a serious contract.
Question:
Do you agree to what the company says? Justify. (Hint: summarize this case in your
words).
Practical Exercise
1. Akash and Suman have been carrying on business in partnership as building contractors
in a small town for some years. They carry out most of the work themselves and only
occasionally employ labour. They have no plans to enlarge the area of their operations.
It has been suggested to them that they ought to trade as a company registered under the
Companies Act, 1956. They ask your advice on: what are the alleged advantages of trading
as a company as compared to partnership? Are there any disadvantages of trading as a
company?
2. Two joint Hindu families carry on a business together as joint owners. The first family consists
of three brothers and their respective sons, being twelve in number. The second family
consists of the father, four major sons and two minor sons. Is the business illegal? (Hint: The
business is not illegal. The minors are not to be counted. There are only twenty major persons
– the maximum number of members fixed for an association for carrying on a non-banking
business without being incorporated s.11)
3. The directors of a public limited company accepted a bill of exchange on behalf of their
company. But the word ‘Ltd.,’ was omitted from the name of the company at the time of
acceptance of the bill of exchange. Who can be held liable for the payment of the bill?
(Hint: The directors can be held personally liable, if the company refuses to pay.)
2.5 Summary
The Companies Act empowers the Central Government to inspect the books of accounts
of a company, to direct special audit, to order investigation into the affairs of a company
and to launch prosecution for violation of the Companies Act, 1956.
25
Company Law
Books of accounts and other documents of the companies are inspected by the officers of
the Directorate of Inspection and Investigation authorised for this purpose under Section
209A of the Companies Act and the Registrars of Companies.
These inspections are designed to find out whether the companies conduct their affairs in
accordance with the provisions of the Companies Act, to see whether any unfair practices
prejudicial to the public interest are being resorted to by any company or a group of
companies and to examine whether there is any mismanagement which may adversely
affect interest of the shareholders, creditors, employees and others.
Wherever inspection reports disclose any information that may be of interest to other
Departments or agencies like the Ministry of Commerce, Central Board of Direct Taxes,
Enforcement Directorate, State Government or Provident Fund Authorities, such
information is passed on to them and suitable corrective action is initiated.
When contraventions of the provisions of the Companies Act are detected, action is taken
for filing prosecution for such violations of the provisions of the Companies Act.
2.6 Keywords
Audit: The audit of the accounts of a firm is not compulsory, whereas the audit of accounts of a
company is mandatory.
Company: The Companies Act, 1956 defines the word ‘company’ as a company formed and
registered under the Act or an existing company formed and registered under any of the previous
company laws (s.3).
Mutual Agency: A partnership is founded on the idea of mutual agency – every partner is an agent
of the rest of the partners.
Partnership: Partnership as ‘the relation between persons who have agreed to share the profits
of a business carried on by all or any of them acting for all’.
1. What are the statutory exceptions to the decision in Salomon’s case?
2. “The legal personality of a company is distinct from its members individually and
collectively”. Comment and point out the circumstances when the separate entity of a
company is disregarded by the courts.
3. Explain the meaning of ‘Perpetual Succession’ and ‘Common Seal’ in the case of a company.
4. Enumerate the advantages that a business organisation enjoys through incorporation under
the Companies Act, 1956.
5. What do you understand by the concept of corporate personality?
6. Explain clearly the meaning of ‘lifting of the corporate veil’ of a company. Under what
circumstances may the court lift the veil of a company?
7. Explain the merits and demerits of incorporation of a company.
8. What is the significance of the concept of limited liability?
9. What do you understand by ‘Corporate Veil’? When is this said to be lifted?
10. Distinguish between a company and a partnership firm.
26
1. (s.3) 2. members
3. dissolved 4. Section 34(2).
5. (d) 6. (c)
7. (a) 8. (a)
9. (b) 10. (a)
11. True 12. True
13. False 14. True

15. False
S S. Gulshan, Business Law, Excel Books, New Delhi, 2006.

www.webopedia.com
27
Company Law
Unit 3: Kinds of Companies
CONTENTS
Objectives
Introduction
3.1 Classification on the Basis of Incorporation
3.2 Classification on the Basis of Liability
3.2.1 Companies Limited by Shares
3.2.2 Companies Limited by Guarantee
3.2.3 Hybrid Companies
3.2.4 Companies with Unlimited Liabilities
3.3 Classification on the Basis of Number of Members
3.3.1 Private Company
3.3.2 Public Company
3.4 Classification on the Basis of Control
3.4.1 Holding and Subsidiary Companies
3.5 Classification on the Basis of Ownership
3.5.1 Government Company
3.5.2 Foreign Company
3.6 One Man Company
3.7 Incorporation of Company
3.8 Illegal Association
3.9 Summary
3.10 Keywords
Objectives
Describe various types of company classifications;
Explain private and public company;
Define holding and subsidiary type of companies;
Elaborate upon foreign company;

Explain one man company.
28
Introduction
In the case of a body corporate which is incorporated in a country outside India, a subsidiary or
holding company of the body corporate under the law of such country shall be deemed to be a
subsidiary or holding company of the body corporate within the meaning and for the purposes
of this Act also, whether the requirements of this section (S.4) are fulfilled or not.
A private company, being a subsidiary of a body corporate incorporated outside India, which, if
incorporated in India, would be a public company within the meaning of this Act, shall be deemed
for the purposes of this Act to be a subsidiary of a public company if the entire share capital in
that private company is not held by that body corporate whether alone or together with one or
more other bodies corporate incorporated outside India.
3.1 Classification on the Basis of Incorporation
Companies can be classified into three categories according to the mode of incorporation. If a
company is incorporated by a charter granted by the monarch, it is called a Chartered Company
and is regulated by that charter. For example, the East India Company came into being by the
grant of a Royal Charter. Such types of companies do not exist in India. A company which is
created by a special Act of the Legislature is called a Statutory Company and is governed by the
provisions of that Act. The State Bank of India and the Industrial Finance Corporation of India
are two examples of statutory companies. A company brought into existence by registration of
certain documents under the Companies Act, 1956 is called a Registered Company.
3.2 Classification on the Basis of Liability
The liability of members of a registered company may be limited or unlimited (s.12). It may be
limited by shares, or by guarantee or by both (i.e., shares and guarantee).
3.2.1 Companies Limited by Shares
A company limited by shares is a registered company having the liability of its members limited
by its memorandum of association to the amount, if any, unpaid on the shares respectively held by
them. The amount remaining unpaid on the shares can be called up at any time—during the
lifetime of the company or at the time of winding up. However, a shareholder cannot be called
upon to pay more than the amount remaining unpaid on his shares. His personal assets cannot
be called upon for the payment of the liabilities of the company, if nothing remains to be paid on
the shares purchased by him. Such a company is also known as a ‘Share Company.’
3.2.2 Companies Limited by Guarantee
A company limited by guarantee is one having the liability of its members limited by the
memorandum to such amount as the members may respectively undertake by the memorandum
to contribute to the assets of the company in the event of its being wound up. Such a company is
also known as ‘guarantee company’. The liability of the members of a guarantee company is
limited by a stipulated sum mentioned in the memorandum. The guaranteed amount can be
called up by the company from the members only at the time of winding up if the liabilities of
the company exceed its assets.
A pure ‘guarantee company’ does not have a share capital. The working funds, if required, are raised
from source like fees, donations, subsidy, endowments, grants, subscriptions and the like. Such
a company is generally formed for the purpose of promotion of art, science, culture, charity, sport,
commerce or for some similar purpose.
29
Company Law
3.2.3 Hybrid Companies
A company limited by shares as well as by guarantee is a hybrid form of company which

combines elements of the guarantee and the share company. Such a company raises its initial
capital from its shareholders, while the normal working funds are provided form other sources
such as fees, charges, subscription, etc. Every member of such a company is subject to a two-fold
liability, i.e., the guarantee which may become effective in the winding up of the company and
the liability to pay up to the nominal amount of his share which may become effective during
the lifetime of the company or at the time of winding up.
3.2.4 Companies with Unlimited Liabilities
An unlimited company is a company not having any limit on the liability of its members. The
members of such a company are liable, in the event of its being wound up, to the full extent of
their fortunes to meet the obligations of the company. However, the members are not liable to
the company’s creditors. The company, being a separate legal entity from the persons who
constitute it, is liable to its creditors. If the creditors cannot obtain payment from the company,
they may petition the court for the winding up of the company. The Liquidator will then call
upon the members to contribute to the assets of the company without limitation of their liability
for the payment of the debts of the company.
Self Assessment
Fill in the blanks:
1. If a company is incorporated by a charter granted by the monarch, it is called a

............................................
2. The State Bank of India and the Industrial Finance Corporation of India are two examples
of .......................................... companies.
3. A company limited by guarantee is known as ............................................
4. A pure ‘guarantee company’ does not have a ............................................
3.3 Classification on the Basis of Number of Members
From the point of view of the general public and on the basis of number of members, a company
may be classified as:
1. Private company
2. Public company
3.3.1 Private Company
A private company can be formed by merely two persons by subscribing their names to the
Memorandum of Association. It means a company which has a minimum paid-up capital of one
lakh rupees or such higher paid up capital as may be prescribed; and by its Articles:
1. Restricts the rights of its members to transfer shares;
2. Limits the number of its members to fifty, excluding its employee-members or past employee-
members; provided that where two or more persons hold one or more shares in a company
jointly, they shall, for the purpose of this definition, be treated as a single member;
30
3. Prohibits an invitation to the public to subscribe to its shares and debentures; and
4. Prohibits any invitation or acceptance of deposits from persons other than its members,
directors or their relatives.
3.3.2 Public Company
A public company means a company:
1. Which is not a private company;
2. Has a minimum paid-up capital of 5 lakhs or such higher paid-up capital as may be
prescribed;
3. Is a private company which is a subsidiary of a company which is not a private company.
Section 12 prescribes the minimum number of members as seven who have to subscribe their
names to the memorandum of association but there is no restriction with regard to the maximum
number of members of a public company. A public company may or may not invite public to
subscribe to its share capital. In case, it decides to invite public to subscribe to its share capital,
then it has to issue a prospectus. In case, it decides not to invite public to subscribe to its share
capital and arranges the capital privately then it need not issue a prospectus; it has simply to
submit a statement in lieu of prospectus with the Registrar of Companies at least three days
before it can make allotment of shares. The articles of such a company do not contain provisions
restricting the right of members to transfer their shares. Under the Securities (Contracts) Regulation
Act, 1956, shares and debentures of public companies only are capable of being dealt in on a
stock exchange.
Task Amit and Sunny have been carrying on business in partnership as building
contractors in a small town for some years. They carry on most of the work themselves
and only occasionally employ labour. They have no plans to enlarge the area of their
operations. It has been suggested to them that they ought to trade as a private company
limited by shares. They ask your advice. What are the alleged advantages of trading as a
private company limited by shares? Are there any disadvantages in so trading?
Distinction between Private and Public Company
Following are the main points of distinction between a private and a public company:
In the case of a private company, minimum number of persons to form a company is two
while it is seven in the case of a public company.
In case of a private company the maximum number of members must not exceed fifty
whereas there is no such restriction on the maximum number of members in case of a
public company.
In private company, the right to transfer shares is restricted, whereas in case of public
company the shares are freely transferable.
A private company cannot issue a prospectus, while a public company may, through
prospectus, invite the general public to subscribe for its shares or debentures.
A private company can commence business immediately after receiving the certificate of
incorporation, while a public company can commence business only when it receives a
certificate to commence business from the Registrar.
31
Company Law
A private company need not hold a statutory meeting but a public company must hold a
statutory meeting and file a statutory report with the Registrar.
The directors of a private company are not required to file with the Registrar written consent
to act as directors or sign the memorandum of association or enter into a contractfor their
qualification shares. But the directors of a public company must file with the Registrar their
written consent to act as directors, must sign the memorandum and must enter into a contract
for their qualification shares.
Directors of a private company may be appointed by a single resolution, but it is not so in
case of a public company.
Directors of a private company are not required to retire by rotation, but in case of a public
company, at least two-third of the directors must retire by rotation.
The number of directors in a private company may be increased to any extent without the
permission of the Central Government, but in case of a public company if the number of
directors is to be more than twelve, then the approval of the Central Government is
necessary.
Two members have to be personally present to form the quorum in a private company but
in a public company this number is five members.
In a private company, there are no restrictions on managerial remuneration.
In addition to the above, a private company enjoys some special privileges. A public
company enjoys no such privileges.
A private company cannot issue share warrants.
Special Privileges and Exemptions available to a Private Company
A private company enjoys certain special privileges which are not available to a public company.
It is so because in a private company the money is raised from few people and generally they
belong to the same family or group or are close friends. Therefore, not much public interest is
involved therein. But in case of public companies where the money is raised from general public and
the number is quite large, it is necessary to safeguard their interests, hence, several restrictions are
imposed on public companies.
Following are the special privileges available to a private company:
A private company can be formed with only two members [s.12 (1)].
A private company can proceed to allot shares without waiting for the minimum subscription
(s.69). The reason is that a private company is not required to offer shares to the public.
A private company is not required to issue a prospectus. Therefore, it can allot shares
without issuing a prospectus or delivering to the Registrar a statement in lieu of prospectus
[s.70 (3)].
A private company need not offer further issue of shares to the existing shareholders, i.e.,
a private company is free to allot new issue to outsiders [s.81(3)].
A private company can issue any kind of shares and allow disproportionate voting rights
since Ss. 85 to 89 of the Act are not applicable to it. [s.90(2)].
A private company can commence business immediately after its incorporation [s.149 (7)].
It need not have an index of members [s.151 (1)].
32
A private company is not required to hold a statutory meeting or to file a statutory report
with the Registrar of Companies [s.165 (10)].
Only two members, who are personally present at the meeting, shall form the quorum
unless the articles provide for a larger number [s.174 (1)].
In case of a private company, poll can be demanded by one person present in person or by
proxy, if not more than seven persons are present; if the number present is more than
seven, two members present in person or by proxy can demand a poll [s.179 (1) (b)].
A private company need have a minimum of two directors only [s.252 (2)].
All the directors may be appointed by a single resolution.
The directors of a private company need not file their written consent to act as directors or
to take up their qualification share (Ss.264 & 266).
The directors of a private company need not retire by rotation (s.255).
Section 266 dealing with restrictions on appointment or advertisement of directors is not

applicable to a private company [s.266 (5) (b)].
Where a new director is to be appointed, a special notice of fourteen days is required. This
provision is not applicable to a private company, unless it is a subsidiary of a public
company [s.257 (2)].
Directors of a private company can vote on a contract in which they are interested (s.300).A
private company is exempted from restrictions regarding managerial remuneration.
Loss of Privileges by a Private Company
Section 43 provides that if a private company contravenes any of the three conditions includedin
its Articles as per s.3(1) (iii), then it will be treated as if it is a public company and it will then result
in loss of privileges and exemptions to which it is normally entitled to.
The provision to s.43 states that if the contravention of any of the three restrictions contained in
the articles was accidental, or if the Central Government is satisfied that it is just and equitable
to grant relief, it may relieve the company from these consequences on the application by the
company or any other interested person.
Conversion of a Private Company into a Public Company
Section 44 provides for conversion of a private company into a public company. The procedure
is:
The company in general meeting must pass a special resolution altering its articles in such
a manner that they no longer include the provisions of s.3(1) (iii) which are required to be
included in the articles of a private company. On the date of the passing of the resolution,
the company ceases to be a private company and becomes a public company.
Within thirty days of the passing of the special resolution altering the articles, the company
shall file with the Registrar (i) a printed or type-written copy of the special resolution and
(ii) a prospectus or a statement in lieu of prospectus.
If default is made in filing the resolution and the prospectus or the statement in lieu of
prospectus, the company and every officer in default shall be liable to a fine up to 5,000
for every day of default.
33
Company Law
If the number of members is below seven, steps should be taken to increase it to at least seven
whilst the number of directors should be increased to at least three, if there are only two
directors.
The word ‘Private’ is to be deleted before the word ‘Limited’ in the name.
Conversion of Public Company into a Private Company
There is no direct or express provision in the Act for the conversion of a public company into a
private company except a reference in the proviso to s.31(1). A public company having a share
capital and membership within the limits imposed upon private companies by s.3(1) (iii), may
become a private company by following the procedure as given below:
The company in general meeting has to pass special resolution for altering the articles soas
to include therein the necessary restrictions, limitations and prohibitions and to deleteany
provision inconsistent with the restrictions. For instance, a private company has to put
certain restrictions on the right of members to transfer their shares.
The word ‘Private’ should be added before ‘Limited’.
The approval of the Central Government to the alteration in the articles for converting a
public company into a private company should be obtained.
Within one month of the date of the receipt of the order of approval, a printed copy of the
altered articles must be filed with the Registrar.
With thirty days of the passing of the special resolution, a printed or type-written copy
thereof should be filed with the Registrar.
Self Assessment
5. Match List-I with List-II and select the correct answer using the codes given below the lists:
List-I List-II
A. Duties of auditors 1. Access to Books of company
B. Rights of auditors 2. Penalty for non-compliance with
sections 227 to 229
C. Liabilities of auditors 3. Company in general meeting
D. Removal of auditors 4. To make a report
A B C D
(a) 4 1 2 3
(b) 2 3 1 4
(c) 1 4 3 2
(d) 3 2 4 1
List-I List-II
A. A pure ‘guarantee company’ 1. A company limited by shares
B. Share company 2. A company limited by guarantee
C. Hybrid companies 3. Company limited by share or guarantee
D. Wrong statement 4. Company limited by share and guarantee
34
A B C D
(a) 4 1 2 3
(b) 2 1 4 3
(c) 1 4 3 2
(d) 3 2 4 1
3.4 Classification on the Basis of Control
On the basic of control, companies can be divided into:
1. Holding companies
2. Subsidiary companies
3.4.1 Holding and Subsidiary Companies
Where a company has control over another company, it is known as the Holding Company. The
company over which control is exercised is called the Subsidiary Company. A company is
deemed to be under the control of another if:
That other controls the composition of its Board of Directors.
The other company holds more than half in nominal value of its equity share capital
(where a company had preference shareholders, before commencement of this Act, enjoying
voting rights with that of equity shareholders, for the purpose of control, holding company
should enjoy more than half of the total voting power).
It is a subsidiary of a third company which itself is a subsidiary of the controlling company.
For example, where company ‘B’ is a subsidiary of company ‘A’ and company ‘C’ is a
subsidiary of company ‘B’, then company ‘C’ shall be a subsidiary of company ‘A’.
If company ‘D’ is a subsidiary of company ‘C’, then company ‘D’ shall also be a subsidiary
of company ‘B’ and consequently also of company ‘A’.
Thus, in order to be holding company, a company must either control the composition of the
Board of Directors or hold more than half of the nominal value of the equity share capital of
another company.
Task In a private limited company it is discovered that there are, in fact, fifty four members.
On an enquiry, it is ascertained that six of the members have been employees of the
company in the recent past and that they acquired their shares while they were still
employees of the company. Is it necessary to convert the company into a public limited
company? [Hint: There is no need for conversion. Employee members and ex-employee
members are excluded from the number of fifty - the maximum members of a private
company. See s.3(1) (iii);].
Company Controlling Composition of Board of Directors
The composition of the Board of Directors of a company shall be deemed to be controlled if the latter
has the power, without the consent or concurrence of the other person, to appoint or remove the
holders of all or majority of the directorships.
35
Company Law
A company shall be deemed to have the power to appoint a person as a director in other
company in the following cases:
Where a person cannot be appointed thereto without the exercise in his favour by the
company of such a power of appointment.
Where a person’s appointment or directorship follows necessarily from his appointment

as director, or manager of, or to any other office or employment in the company.
Where a directorship is held by an individual nominated by the company or a subsidiary

thereof.
In determining whether one company is a subsidiary of another, following shall be disregarded:
Any shares held or power exercisable by the other company in a fiduciary capacity shall be
treated as not held or exercisable by it.
Any shares held or power exercisable in a company by any person under provisions of its
debentures or of a trust-deed for securing any issue of such debentures shall be disregarded.
Any shares held or power exercisable by, or by a nominee for a company or its subsidiary,
other than as in clause (2) above, shall be treated as not held or exercisable by it if the
ordinary business of that other company is lending money and the shares are held or
power is exercisable only by way of security in the ordinary course of business.
However, shares held or power exercisable by any person as a nominee of that other company
shall be treated as held or exercisable by the said company. Thus, the shares held or power
exercisable by a subsidiary shall be treated as ‘held’ or ‘exercisable’ by the holding company.
For example, ‘B’ and ‘C’, are subsidiaries of company ‘A’, and both of them hold together more
than half of the equity share capital of company ‘D’ then ‘D’ shall be deemed to be a subsidiary
of ‘A’ although it has not made any direct investment nor ‘B’ or ‘C’ singly hold more than 50%
shares, in the company ‘D’.
Self Assessment
7. Minimum number of members in case of public company is
(a) 1 (b) 2
(c) 5 (d) 7
8. Minimum number of members in case of private company is
(a) 1 (b) 2
(c) 3 (d) 4
9. Maximum number of members in case of private company is
(a) 50 (b) 100

(c) 150 (d) 200
10. Maximum number of members in case of public company is
(a) 0 (b) Unlimited
(c) 50 (d) 100
36
3.5 Classification on the Basis of Ownership
On the basis of ownership, a company may be:
1. Government company
2. Non-government company
3.5.1 Government Company
Section 617 defines a Government Company as “any company in which not less than 51% of the
paid-up share capital is held by the Central Government, or by any State Government or
Governments, or partly by the Central Government and partly by one or more State Governments
[and includes a company which is a subsidiary of a Government Company”].
Government Companies are as much governed by the provisions of the Companies Act as any
other company; but by virtue of s.620, the Central Government may direct that any of the
provisions of the Act will not apply to them or shall apply only with such exceptions, modifications
and adaptations as may be notified by the Government. However, the Central Government
cannot exempt the Government Companies from the provisions of Ss.619 and 619-A which
specifically deal with such companies.
Section 619 provides that the auditor of a Government Company shall be appointed or re-
appointed by the Central Government on the advice of the Comptroller and Auditor-General of
India. The ceilings on the number of audits to be undertaken by an auditor under s.224 are
equally applicable to audit of Government Companies. The Comptroller and Auditor General
of India have the power to direct the manner in which the accounts are to be audited and to give
instructions to the auditor in regard to any matter relating to the performance of his functions.
He is also empowered to get a supplementary test audit of accounts conducted by persons
authorised by him. The auditor of the Government Company has to submit a copy of his audit
report to the controller and auditor general who has the right to comment upon, or supplement
the audit report in such manner as he thinks fit. Such comments or supplementary audit report
must be placed before the annual general meeting of the company at the same time and in the
same manner as the auditor’s report.
Section 619-A provides that the Central Government must place before both Houses of the
Parliament, an annual report on the working and affairs of each Government Company to be
prepared within three months of its annual general meetings, together with a copy of the audit
report and any comments upon or supplement to, such audit report, made by the controller and
auditor general of India. Where a State Government is a participant in a Government Company,
this report has, likewise, to be placed before the State Legislature.
Section 619-B provides that the provisions of s.619 as stated above also apply to a company in
which the Central Government or any State Government or any Government Corporation hold
either singly or jointly not less than 51% of the paid-up share capital.
3.5.2 Foreign Company
Foreign Company is a company incorporated in a country outside India and has a place of
business in India.
However, where not less than 50% of the paid-up share capital (whether equity or preference or
partly equity and partly preference) of a company incorporated outside India and having an
established place of business in India, is held by one or more citizens of India or by one or more
Indian bodies corporate, such company shall comply with such of the provisions of the Act as may
be prescribed with regard to the business carried on by it in India.
37
Company Law
Section 592 requires that every foreign company which establishes a place of business in India, must,
within 30 days of the establishment of such place of business, file with the Registrar of Companies at
New Delhi and also the Registrar of Companies of the State in which such place of business is
situated: (a) A certified copy of the memorandum and articles of the company and if they are not in
English, then a certified translation thereof; (b) the full address of the registered office of the
company; (c) a list of the directors of the company and its secretary with full particulars of their
nationality, address and business or occupation; (d) the names and addresses of one or more
persons resident in India who are authorised to accept service of process or notice or other
documents to be served on the company; and (e) the address of the principal place of business in
India.
Section 593 provides that in case of any alteration in any of the above particulars, the company
has to file with the Registrar of Companies a return of such alteration within the prescribed
time.
Section 594 makes the application of the provisions regarding books of account to be kept by a
company under s.209 to a foreign company so far as it concerns its business in India. The books
of account must be kept at the principal office in India and three copies of balance sheet, profit
and loss account and other documents must be delivered to the Registrar with a list in triplicate
of all places of business in India.
Section 595 requires a foreign company to exhibit conspicuously on the outside of every office
or place of business in India the name of the company and ‘limited’ or ‘private limited,’ if it is a
limited company and the country in which it is incorporated in English as well as in the local
languages in general use in the locality in which the office is situated. Also the prospectus issued
in India must contain this information.
Section 596 provides the procedure for service of any process, notice or other documents on a
foreign company and it shall be deemed to have been served, if addressed to any person whose
name has been delivered to the Registrar of Companies under s.592.
Section 597 provides that the foreign company must also deliver the documents under s.592 to
the Registrar of Companies, New Delhi.
Section 598 provides penalty for default in complying with any of the foregoing requirements. The
company and every officer of the company who is in default shall be punishable with fine up to
10,000 and in the case of a continuing default with an additional fine up to 1000 for every day during
which the default continues.
Section 599 provides that the foreign company which fails to comply with the foregoing provisions
is prohibited from enforcing any contract by way of a suit, set-off or counter-claim, although it
will be liable to be sued in respect of any contract it may have entered into.
Section 600 makes the application of the following Sections to a foreign company: Sections 124- 145;
118; 209; 159-160; 209A; 601-608.
Section 584 provides for the winding up of a foreign company. Where a foreign company, which
has been carrying on business in India, ceases to carry on such business in India, it may be
wound up as an unregistered company under Part X (Ss.582-590), notwithstanding the fact that
the company has been dissolved or ceased to exist under laws of the country in which it was
incorporated.
Task A group of promoters propose to establish a company for charitable purposes without
the addition of the word ‘Limited’ as part of its name. Discuss briefly the procedure to be
followed in addition to the normal procedure for incorporation of a company.
38
3.6 One Man Company
A member may hold virtually the entire share capital of a company. Such a company is known
as a ‘one-man company’. This can happen both in a private company and a public company. The
other member/members of the company may be holding just one share each. Such other members
may be just dummies for the purpose of fulfilling the requirements of law as regards minimum
membership [Salomon v. Salomon & Co. Ltd.].
3.7 Incorporation of Company
Section 12 provides for incorporation of companies which need not have a share capital.
A guarantee company is an example of a company without a share capital. However, with the
introduction of the requirement of minimum paid up share capital for a public company and a private
company, the concept of companies without a share capital has become redundant since 2000.
However, a company registered under section 25 is not required to have minimum paid up share
requirement. [s. 3(6)]
3.8 Illegal Association
Any company association or partnership carrying on banking business with more than ten members
or carrying on any other business with more than twenty members that has for its object the
acquisition of gain, without being registered under the Companies act, shall be considered an illegal
association.
Exceptions:
Joint family carrying on a business as such is not illegal association.
Stock exchange is not considered an illegal association since it is not formed for the
purposes of carrying on any business.
Disabilities of an Illegal Association:
It cannot enter into any contract, nor can it sue any member or outsider.
It cannot contract any debts.

It has no legal existence. However, it can get registered any time and become legal.
Every member shall be personally liable to unlimited extent for all liabilities incurred in
such business.
Every member shall be punishable with fine which may extend to 10,000.
It cannot be wound up under the Act.
Its members have no remedy against each other for contribution or apportionment in
respect of partnership dealings and transactions.
Self Assessment
11. A subsidiary company does not control the composition of the board of directors of its
holding company.
12. A subsidiary company does not hold any shares in its holding company.
39
Company Law
13. A one-mean company is one in which a single person holds virtually all shares of the
company.
14. An association of persons may be incorporated having its objects of promoting commerce,
arts, science, religion or charity.
15. A partnership firm can be a member of s.25 company.
Case Study Customer Contract
explained that it’s his company’s policy was to issue original invoices only when quantities
In this case, the fraudster is pretending to be a US company, but all his registered information
is false. This can be judged easily by calling his company telephone number or by searching
Western Union is a dangerous payment method, it can be picked up anywhere in the

recipient’s country, with no way of tracing the person who picked it up. The criminal remains
anonymous. So it is a commonly used payment method for con-artists. So try to avoid adopting
this payment method and consider other more secure payment methods like escrow.
Questions:
3.9 Summary
No company, association or partnership consisting of more than twenty persons shall be

formed for the purpose of carrying on any other business that has for its object the
acquisition of again by the company, association or partnership, or by the individual
members thereof, unless it is registered as a company under this Act, or is formed in
pursuance of some other Indian law.
This section shall not apply to a joint family as such carrying on a business; and where a
business is carried on by two or more joint families, in computing the number of persons
for the purposes of sub-sections (1) and (2), minor members of such families shall be excluded.
40
Every member of a company, association or partnership carrying on business in

contravention of this section shall be personally liable for all liabilities incurred in such
business.
Every person who is a member of a company, association or partnership formed in

contravention of this section shall be punishable with fine which may extend to one
thousand rupees.
Any seven or more persons, or where the company to be formed will be a private company,
any two or more persons, associated for any lawful purpose may, by subscribing their names
to a memorandum of association and otherwise complying with the requirements of this
Act in respect of registration, form an incorporated company, with or without limited
liability.
3.10 Keywords
Company Limited by Shares: A company limited by shares is a registered company having the
liability of its members limited by its memorandum of association to the amount, if any, unpaid
on the shares respectively held by them.
Government Company: Section 617 defines a Government Company as any company in which
not less than 51% of the paid-up share capital is held by the Central Government, or by any State
Government.
One Man Company: A member may hold virtually the entire share capital of a company. Such
a company is known as a ‘one-man company’.
Private Company: A private company can be formed by merely two persons by subscribing
their names to the Memorandum of Association.
Subsidiary Company: A company over which control is exercised by that other company is
called the Subsidiary Company.
1. State the various classes of companies that can be formed under the Act. Explain the
characteristics of each.
2. Define a ‘Private Company’. State the special privileges and exemptions enjoyed by a
private company.
3. Define a public company. Distinguish between a private company and a public company.
4. What is your opinion on: “There are five members in a public company”?
5. What does a private company have to do in order to become a public company?
6. “A company can be incorporated under the Companies Act without the suffix ‘limited’ or
‘private limited’, as the case may be”. Discuss.
7. “A Government Company is governed by the same legal provisions as any other company
registered under the Companies Act.” Discuss.
8. Explain there may be a company without a share capital.
9. Describe a one-man company is perfectly a valid company.
10. Write explanatory on:
(i) Government Company
41
Company Law
(ii) Holding and subsidiary companies
(iii) Foreign Company
(iv) Non-profit company/section 25 company
(v) Guarantee Company
(vi) Investment Company
11. Explain the consequences and remedy, if any, in respect of the following situations:
(i) A private company has contravened the provisions of s.3(i)(iii) (i.e. definition of a
private company) of the Companies Act, 1956;
(ii) The number of members of a company registered as a public company is reduced to

five.
1. Chartered Company 2. Statutory

3. Guarantee Company 4. Share Capital
5. (a) 6. (b)
7. (d) 8. (b)
9. (a) 10. (b)
11. True 12. True
13. False 14. True

15. True

www.webopedia.com
42
Unit 4: Formation of Company
Introduction
Promotion
Objectives
Floatation
Pre-incorporation or Preliminary Contracts
Objectives
Explain the process of formation of a company;

Describe pre-incorporation of company;
Elaborate upon provisional contracts.
Introduction
A declaration by an advocate of the Supreme Court or of a High Court, an attorney or a pleader

entitled to appear before a High Court or [“a secretary or a chartered accountant, in whole-time
practice in India”] who is engaged in the formation of a company, or by a person named in the articles
as a director, manager or secretary of the company, that all the requirements of this Actand the rules
there under have been complied with in respect of registration and matters precedent and incidental
thereto, shall be filed with the Registrar; and the Registrar may accept such a declaration as sufficient
evidence of such compliance.
4.1 Formation of Company
The whole process of formation of a company may be roughly divided, for convenience, into
three parts i.e., Promotion, Registration and Floatation.
43
Company Law
4.1.1 Promotion
Promotion is a term of wide import denoting the preliminary steps taken for the purpose of
registration and floatation of the company. The persons who assume the task of promotion are
called promoters. The promoter may be an individual, syndicate, association, partnership or
company.
Who is a Promoter?
This term has not been defined under the Act, although the term is used expressly in Ss. 62, 69, 76,
478 and 519.
Perhaps, the true test of whether a person is a promoter is whether he has a desire that the
company be formed and is prepared to take some steps, which may or may not involve other
persons, to implement it. However, persons assisting the promoters by acting in a professional
capacity do not thereby become promoters themselves. The solicitor; who drafts the Articles, or
the accountant who values assets of a business to be purchased, are merely giving professional
assistance to the promoters. If, however, he goes further than this, e.g., by introducing his client
to a person who may be interested in purchasing shares in the proposed company, he would be
regarded as promoter.
Duties and Liabilities of Promoters
Promoters have been described to be in fiduciary relationship (relationship of trust and confidence)
with the company. This relationship of trust and confidence requires the promoter to make a full
disclosure of all material facts relating to the formation of the company. He should not make any
secret profit at the expense of the company he promotes, without the knowledge and consent of the
company and if he does so, the company can compel him to account for it.
A promoter is not forbidden to make profit but to make secret profit. In Gluckstein v. Barnes, a
Syndicate of persons was formed to buy a property called ‘Olympia’ and re-sell this Olympia to a
company to be formed for the purpose. The Syndicate first bought the debentures of the old Olympia
Company at a discount. Then they bought the company itself for £ 1,40,000. Out of this money
provided by themselves the debentures were repaid in full and a profit of £ 20,000 made thereon.
They promoted a new company and sold Olympia to it for £ 1,80,000. The profit £ 40,000 was
revealed in the prospectus but not the profit of £ 20,000.
Held: Profit of £ 20,000 was a secret profit and the promoters of the company were bound to pay
it to the company because the disclosure of this profit by themselves in the capacity of vendors
to themselves in the capacity of directors of the purchasing company was not sufficient.
Disclosure to be made to whom? In Erlanger v. New Sombrera Phosphate Co., it was held that
the disclosure should be made to an independent and competent Board of Directors. This duty is not
discharged if he makes the disclosure to the Board of Directors who are mere nominees of his
own or are in his pay.
Where it is not possible to constitute an independent Board of Directors, the disclosure should
be made to the whole body of persons who are invited to become shareholders and this can bedone
through the prospectus. Thus, the promoters have to ensure that ‘the real truth is disclosed to
those who are induced by the promoters to join the company.’
44
Liabilities of a Promoter for Non-Disclosure
In case a promoter fails to make full disclosure at the time the contract was made, the company
may either:
Rescind the contract and recover the purchase price where he sold his own property to the
company, or
Recover the profit made, even though rescission is not claimed or is impossible, or
Claim damages for breach of his fiduciary duty. The measure of damages will be the
difference between the market value of the property and the contract price.
Liabilities of a Promoter under the Companies Act
Promoter is liable to the original allottee of shares for the mis-statements contained in the
prospectus. It is clear that his liability does not extend to subsequent allottees. He may also
be imprisoned for a term which may extend to 2 years or may be punished with fine up to
50,000 for such untrue statements in the prospectus (Ss.62 and 63).
In the course of winding up of the company, on an application made by official Liquidator,
the court may make a promoter liable for misfeasance or breach of trust (s.543). The court
may also order for the public examination of the promoter (Ss.478 and 519).
Where there are more than one promoter, they are jointly and severally liable and if one of them
is sued and pays damages, he is entitled to claim contribution from other or others. However,
the death of a promoter does not relieve his estate from liability arising out of abuse of his
fiduciary position.
4.1.2 Registration (Ss.12, 33)
Section 12 states that, “any seven or more persons or where the company to be formed will be a
private company, two or more persons, associated for any lawful purpose may, by subscribing their
names to a memorandum of association and otherwise complying with the requirements of this
Act in respect of registration form an incorporated company, with or without limited liability.” Thus,
the promoters will have to get together at least seven persons in the case of a public company,
or two persons in the case of a private company to subscribe to the memorandum of association.
Section 33 states that the following three documents are required to be presented to the Registrar
of Companies of the State in which the registered office of the company is to be situated, for the
purpose of registration of a company:
1. The memorandum of the company;
2. The articles, if any;
3. The agreement, if any, which the company proposes to enter into with any individual for
appointment as its managing or wholetime director or manager.
The documents in (1) and (2) above are required to be signed by seven persons in the case of a
public company and by two persons in the case of a private company. As we shall see later,
certain types of companies need not frame their own Articles of Association; in that case
“Regulations for Management of a Company Limited by shares” (given in Table A of Schedule I
to the Act, 1956) may be adopted.
45
Company Law
Task Shyam forges all the seven signatures on a memorandum of association, and he
obtains a certificate of incorporation. After some time, the registrar comes to know and
wants to revoke the certificate. Can he do so?
Section 33 also requires a declaration to be filed with the Registrar along with the Memorandum and
the Articles. This is known as “Statutory Declaration of Compliance.” It can be made by an advocate
of Supreme Court or of a High Court, an attorney or pleader entitled to appear before a High
Court, or a Company Secretary or a Chartered Accountant in wholetime practice in India, who
is engaged in the formation of the company, or by a person named in the articles as a director,
manager or secretary of the company. The declaration must certify that all requirements of the Act
and Rules made there under in respect of registration have been complied with.
Section 266 requires that if the first directors are appointed by the articles then the following
must be complied with before the registration of articles with the Registrar:
Written consent of those directors to act, signed by themselves, or by an agent duly

authorised in writing; and
An undertaking in writing signed by each such director to take from the company and pay
for his qualification shares (if any), unless he has taken his qualification shares and paid or
agreed to pay for them, or signed the Memorandum for a number of shares not less than
the qualification shares.
Section 266 is applicable only to a public company having a share capital.
4.1.3 Floatation
When a company has been registered and has received its certificate of incorporation, it is ready
for ‘floatation’; that is to say, it can go ahead with raising capital sufficient to commence business and
to carry it on satisfactorily.
We have seen earlier under ‘classification of companies’ that a private company is prohibited
from inviting public to subscribe to its share capital. Therefore, when a private company is
formed, the necessary capital is obtained from friends and relatives by private arrangement.
In the case of a public company also, the promoters may not invite public to subscribe to its share
capital and may arrange the capital privately as in the case of a private company. In such a case,
the intention of the promoters is to take advantages of incorporation not available to a private
company, e.g., to have unlimited number of members, to confer unrestricted right to transfer shares
on the members, etc. However, by far, large numbers of public companies raise their capital in
the very first instance by inviting public to subscribe to its share capital.
Section 70 makes it obligatory for every public company to take either of the following two steps:
(i) Issue a prospectus in case public is to be invited to subscribe to its capital, or (ii) Submit a
‘statement in lieu of prospectus’ in case capital has been arranged privately. It must be done at
least 3 days before allotment.
Self Assessment
Fill in the blanks:
1. ................................. is a term of wide import denoting the preliminary steps taken for the
purpose of registration and floatation of the company.
46
2. Promoters have been described to be in ...................................with the company.
3. A .................................is not forbidden to make profit but to make secret profit.
4. Promoter is liable to the original...................................... of shares for the mis-statements

contained in the prospectus.
4.2 Availability of Company Name
Section 20 states that a company cannot be registered by a name, which in the opinion of the
Central Government is undesirable. Therefore, it is advisable that promoters find out the
availability of the proposed name of the company from the Registrar of Companies. For the
purpose, three names in order of priority should be filed.
The following two documents, though not required to be filed for the purpose of registration,
are usually delivered along with the aforesaid documents.
1. The address of the registered office of the company (s.146).
2. Particulars regarding directors, manager and secretary, if any (s.303).
These two documents are required to be submitted within thirty days of registration of the company.
4.3 Certificate of Incorporation/Consequences of Incorporation
When the aforesaid documents have been filed with the Registrar and the necessary fees paid,the
Registrar will, if he is satisfied, enter the name of the company on the Register of Companies
maintained by him (s.33) and then will issue a Certificate of Incorporation under his signature in
token of registration of the company on the date noted on it (s.34). This certificate serves the same
purpose in the case of a company which a birth certificate does in the case of a natural person.
On registration, the company comes into existence as a legal person distinct from its members
who constitute it from the earliest moment of the day of incorporation stated in the certificate of
incorporation, with rights and liabilities similar to a natural person, competent to enter into
contracts (s.34).
The certificate of incorporation is conclusive evidence that all the requirements of the Companies
Act in respect of registration and of matters precedent and incidental thereto have been complied
with. Accordingly, if memorandum is found to be materially altered after signature but before
registration (Peel’s case), or is signed by only one person for all the seven subscribers or the
signatories be all infants (Moosa Goolam Ariff v. Ebrahim Gulam Ariff), the certificate would be
nevertheless conclusive and would not affect the status and existence of the company as a legal
person although such irregularities might give rise to claim between the subscribers.
This provision prevents the reopening of matters prior and contemporaneous to the registration and
essential to it and it places the existence of the company as a legal person beyond doubt.
In the case of Moosa v. Ebrahim, the memorandum was signed by two adult persons and by a
guardian of the other five members, who were minors. The Registrar, however, registered the
company and issued a certificate of incorporation. The court held the certificate to be conclusive
for all purposes.
In another case of Jubilee Cotton Mills Ltd. v. Lewis, the Registrar issued a certificate of
incorporation on January 8th, but dated it January 6th, which was the date he received the
documents. On January 6th, the company made an allotment of share to Lewis. Held, that the
47
Company Law
certificate was conclusive evidence of incorporation on January 6th and that the allotment was
not void on the ground that it was made before the company was incorporated.
However, if a company has been incorporated with illegal objects, the illegal objects would not
become legal by the issue of the certificate.
Section 36 states that, on registration, memorandum and articles of the company bind the company
and its members to the same extent as if they respectively had been signed by the company and
by the members and contained covenants on its and their part to observe all the provisions
contained in the Memorandum and Articles.
Self Assessment
5. The companies which are formed under special charter granted by the king or queen of
England are called.
(a) Statutory companies (b) Registered companies
(c) Chartered companies (d) None of these
6. The companies which are formed under special Act. Those companies are called as
(a) Chartered companies (b) Statutory companies

(c) Registered companies (d) None of these
7. The companies which are formed under companies Act. 1956. They will be called as
(a) Chartered companies (b) Statutory companies

(c) Registered companies (d) None of these
8. If the guarantee Co. is having no share capital, the liability of shareholders will be
(a) To the extent of guarantee (b) Unpaid value of shares
(c) Unlimited (d) None of the above
4.4 Pre-incorporation or Preliminary Contracts
We have mentioned earlier that a company is an artificial person and is capable of entering into
contracts. The promoters may enter into contracts with third parties on behalf of the proposed
company before obtaining the certificate of incorporation or after obtaining the certificate of
incorporation but before obtaining the certificate to commence business. Thus, in the case of a public
company following are the three situations when contracts may be entered into:
1. Contracts before incorporation
2. Contracts after incorporation but before obtaining the certificate to commence business
3. Contracts after obtaining the certificate to commence business.
However, in the case of a private company, as it is not required to obtain the certificate to commence
business, there are only two situations, i.e., (i) contracts before incorporation; and
(ii) contracts after incorporation.
Those contracts which are entered into by promoters for the intended company before registration
of the company are known as pre-incorporation or preliminary contracts. Very often a company
is formed to purchase an existing business or other property. In such circumstances, the promoters
enter into contracts with the owners of the business or property to be acquired by the proposed
company.
48
A pre-incorporation contract never binds a company since a person cannot contract before his
(or its) existence and a company before incorporation has no legal existence. However, S.15(h) and
19 (e) of the Specific Relief Act, 1963 has provided some relief in this regard. It provides that when
promoters of a company have, before its incorporation entered into a contract for the purpose of the
company and such a contract is warranted by the terms of its incorporation, the contract may be
specifically enforced by or against the company. It is, however, necessary that the company in such
a case must have accepted the contract after its incorporation and communicated such acceptance
to the other party to the contract. Contracts like preparation and printing of the Memorandum,
Articles, etc., renting premises, hiring secretarial staff are envisaged under the Act.
Liability of promoters vis-à-vis pre-incorporation contracts. An important question that needsto
be tackled is what is the position of a promoter vis-à-vis preliminary contracts? If the company does
not execute a fresh contract after incorporation and the contract is not one warranted for the
purpose of incorporation of the company, what will be the legal position of the promoter who brings
about such a contract?
In Phonogram Ltd. v. Lane (1982) Q.B. 938, it was observed that although a contract made before
a company’s incorporation cannot bind the company, it is not wholly devoid of legal effect, even
if all the persons who negotiated the contract are aware that the company has not yet been
incorporated.
The contract takes effect as a personal contract with the persons who purport to contract on the
company’s behalf [Kelner v. Baxter (1866) LR 2 CP 174]. Promoters shall be liable to pay damages
for failure to perform the promises made in the company’s name. This shall be so even where the
contract expressly provides that only the company’s paid up capital shall be answerable for
performance [Scot v. Lord Ebury (1867) LR 2 CP 255].
Task The registrar of companies issued a certificate of incorporation on 8 January, 2006.

However, by mistake, the certificate was dated 5 January, 2006. An allotment of shares had
been made on 7 January, 2006. Can the allotment be declared void on the ground that it was
made before the company was incorporated?
4.5 Provisional Contracts
Those contracts which are entered into by a public company after obtaining the certificate of
incorporation but before getting the certificate to commence business are known as provisional
contracts [s.149(4)]. Such contracts are not binding on the company until the company is entitled
to commence business and on that date they shall become binding, without any need for ratification.
If the company is unable to obtain the certificate to commence business, the provisional contracts
will never become binding on it, and no one can sue in respect of them.
As it shall be explained later, a company can do only such acts as by its memorandum it is
expressly or impliedly authorised to do. Any transaction which is not so authorised is ultra vires
(beyond the powers) and is null and void ab initio. Neither the company, nor the other party to
the contract can enforce it.
49
Company Law
4.6 Form of Contracts made by Companies
Section 46 provides that a company can, in general, contract in the same form as an individual.
Thus, a contract which, if made between private persons, is required to be in writing, may be
made on behalf of the company also in writing. It should be signed by a person acting under the
express or implied authority of the company. Such contracts may also be varied or discharged in
the same manner. Also, a contract which would be valid if made between private persons
although made orally or by parol on behalf of the company by any person acting under express
or implied authority. Such contracts could also be varied or discharged in the same manner.
Some contracts are required to be under seal and, therefore, s.147 requires every company
incorporated under the Act to have a common seal upon which its name should be engraved in legible
characters.
Under s.50, a company may obtain power through its articles to have an official seal, for use
outside India. This is in addition to a common seal.
Self Assessment
9. A promoter stands in a fiduciary relationship with the company he promotes.
10. The validity of a certificate of incorporation cannot be disputed on any grounds whatsoever.
11. After the grant of certificate of incorporation, if all the subscribers to the memorandum
die, the certificate of incorporation automatically gets cancelled.
12. Unlike a private company, a public company cannot commence business immediately
after incorporation.
13. A certificate of incorporation is conclusive evidence that all the requirements of the
Companies Act, as regards registration have been complied with.
50
The company explained that the commission for non-executive directors was upped to
20 lakh a year in 2004, effective for a five-year period starting December 2003.
Shareholders should be part of the good and bad times of the company, said a shareholder
who has been holding a Pfizer share since the beginning, when the multinational sent
letters to shareholders inviting them into their fold.
He, along with some other shareholders, were expressing their unhappiness over the
dividend. The dividend for the year ended 2008 was 12.50 per share, as compared with
the previous year’s 27.50 per share. However, Pfizer’s Chairman, Mr. R.A. Shah, clarified
that there were no motives behind the company’s actions and dividends were generous
when the circumstances warranted it.
On Pfizer Inc’s recently announced plan to raise stake in its Indian subsidiary to 75 per
cent, from the present 41 per cent, he said, that there was no intention to delist, “at this
time”.
Unlike info-tech companies, he said, the applicable milestone for Pfizer for reverse book
building was 75 per cent. Creeping acquisition and buy-back was allowed only till 75 per
cent, he clarified. Also, he said, Pfizer was also evaluating the possibility of merging
Duchem (that has pharma and animal health businesses) with itself.
Detailing Pfizer’s plans to expand its domestic reach, Mr. Handa said that they would
increase the product portfolio and value offerings from the company. The company was
planning to increase its field force by 300 people, including 100 for just retail sales.
Question
Discuss LIC’s role in Pfizer. (Hint: Summarize the LIC responsibilities in Pfizer)
4.7 Summary
The formation of a company, shall state the matters specified in Part I of Schedule II and set
out the reports specified in Part II of that Schedule; and the said Parts I and II shall have
effect subject to the provisions contained in Part III of that Schedule.
A condition requiring or binding an applicant for shares in or debentures of a company to
waive compliance with any of the requirements of this section, or purporting to affect him with
notice of any contract, document or matter not specifically referred to in the prospectus, shall
be void.
Expert to be unconnected with formation or management of company.
4.8 Keywords
Floatation: When a company has been registered and has received its certificate of incorporation,
it is ready for ‘floatation’; that is to say, it can go ahead with raising capital sufficient to commence
business and to carry it on satisfactorily.
Pre-incorporation contract: A pre-incorporation contract never binds a company since a person

cannot contract before his (or its) existence and a company before incorporation has no legal
existence.
Promoters: Promoters have been described to be in fiduciary relationship (relationship of trustand
confidence) with the company.
Promotion: ‘Promotion’ is a term of wide import denoting the preliminary steps taken for the
purpose of registration and floatation of the company.
51
Company Law
1. Who is a promoter of a company? Discuss, citing legal cases, his legal position in relation
to the company he promotes.
2. What are the liabilities of promoters under the Companies Act, 1956?
3. Describe the various stages of incorporation of a public company limited by shares.
4. What documents are required to be filed for incorporation?
5. Discuss the nature and purpose of such documents.
6. What are the conditions; precedent to be complied with by a company for obtaining a
certificate to commence business? Are these conditions applicable to all classes of
companies?
7. Explain certificate of incorporation in detail.
8. Certificate of commencement of business in the case of a public limited company. Discuss.
9. “Promoters have been described to be in fiduciary relationship (relationship of trust and

confidence) with the company”. Discuss.
10. “A pre-incorporation contract never binds a company since a person cannot contract before
his (or its) existence and a company before incorporation has no legal existence”. Discuss.
1. Promotion 2. fiduciary relationship

3. promoter 4. allottee
5. (c) 6. (b)
7. (c) 8. (a)
9. True 10. True
11. False 12. True

13. True
52

www.webopedia.com
53
Company Law
Unit 5: Memorandum of Association
CONTENTS
Objectives
Introduction
5.1 Memorandum of Association – Meaning and Purpose
5.2 Form and Contents
5.2.1 Use of Certain Keywords as Part of the Name
5.2.2 Publication of Name (s.147)
5.2.3 The Registered Office Clause [s.13(1) (b)]
5.2.4 The Objects Clause [s.13 (1) (d)]
5.2.5 The Liability Clause [s.13 (2)]
5.2.6 The Capital Clause [s.13 (4)(c)]
5.2.7 The Association Clause [s.13(4)(c)]
5.3 Alteration of Memorandum
5.3.1 Change of Name
5.3.2 Change of Registered Office
5.3.3 Alteration of Objects Clause
5.3.4 Alteration of Liability Clause (s.38)
5.3.5 Alteration of Capital Clause (S.94)
5.4 Doctrine of Ultra Vires
5.4.1 The Effects and Exceptions of the Doctrine of Ultra vires – An Elaboration
5.5 Summary
5.6 Keywords
Objectives
Define memorandum;
Describe its form and contents;
Explain the alteration of memorandum;
Elaborate upon doctrine of ultra vires.
54
Introduction
‘Memorandum’ means “the memorandum of association of a company as originally framed or

as altered from time to time in pursuance of any previous companies law or of this Act”–S. 2(28).
Any seven or more persons, or where the company to be formed will be a private company, any
two or more persons, associated for any lawful purpose may, by subscribing their names to a
memorandum of association and otherwise complying with the requirements of this Act in
respect of registration, form an incorporated company, with or without limited liability.
5.1 Memorandum of Association – Meaning and Purpose
The Memorandum of Association of a company is its charter which contains the fundamental
conditions upon which alone the company can be incorporated. It tells us the objects of the
company’s formation and the utmost possible scope of its operations beyond which its actions
cannot go. Thus, it defines as well as confines the powers of the company. If anything is done
beyond these powers, that will be ultra vires (beyond powers of) the company and so void.
The memorandum serves a two-fold purpose viz., it enables shareholders, creditors and all
those who deal with the company to know what its powers are and what is the range of its
activities. Thus, the intending shareholder can find out the field in, or the purpose for which his
money is going to be used by the company and what risk he is taking in making the investment.
Also, any one dealing with the company, say, a supplier of goods or money will know whether
the transaction he intends to make with the company is within the objects of the company and
not ultra vires its objects.
5.2 Form and Contents
Section 14 requires that the memorandum of a company shall be in such one of the Forms in
Tables B, C, D and E in Schedule I to the Act, as may be applicable in the case of the company, or
in Forms as near thereto as circumstances admit. Section 15 requires the memorandum to be
printed, divided into paragraphs, numbered consecutively, and signed by at least seven persons
(two in the case of a private company) in the presence of at least one witness, who will attest the
signature. Each of the members must take at least one share and write opposite his name the
number of shares he takes. Section 13 requires the memorandum of a limited company to
contain:
1. The name of the company, with ‘limited’ as the last word of the name in the case of a public
company and ‘private limited’ as the last words in the case of a private company;
2. The name of the state, in which the registered officer of the company is to be situated;
3. The objects of the company, stating separately ‘main objects’ and ‘other objects’;
4. The declaration that the liability of the members is limited;
5. The amount of the authorised share capital, divided into shares of fixed amounts.
These contents of the memorandum are called compulsory clauses.
5.2.1 Use of Certain Keywords as Part of the Name
The Department of Company Affairs has clarified that if a company used any of the following
keywords in its name, it must have a minimum authorised capital mentioned against the
keywords:
55
Company Law
Key words Required Authorised

Capital ( )
1. Corporation 5 crores
2. International, Globe, Universal Continental, Inter-continental, 1 crore
Asiatic, Asia, being the first word of the name.
3. If any of the words in (2) above stated is used within the name 50 lakhs
(with or without brackets)
4. Hindustan, India, Bharat, being the first word of the name 50 lakhs
5. If any of the words at (4) above is used within the name (with 5 lakhs
or without brackets)
6. Industries/Udyog 1 crore
7. Enterprises, Products, Business, Manufacturing 10 lakhs
5.2.2 Publication of Name (s.147)
Every company shall,
(i) paint or affix its name and the address of its registered office and keep the same painted or
affixed, on the outside of every office or place of business in a conspicuous position in
letters easily legible and in the language in general use in the locality.
Department of Company Affairs has clarified that exhibition of its name in English alone,
without at the same time showing it in the local language will not be sufficient compliance
with the requirements of the Section.
The words ‘outside of every office’ do not mean outside the premises in which the office is
situated [Dr. H.L. Batliwala Sons & Co. Ltd. v. Emperor (1941) 11 Comp. Cas. 154 (Bom)].
Where office is situated within a compound, the display outside the office room though
inside the building is sufficient.
(ii) have its name engraven in legible characters on its seal.
(iii) have its name and address of its registered office mentioned in legible characters in all
business letters, bill heads, negotiable instruments, invoices, receipts, etc., of the company.
Penalty: If a company does not paint or affix its name and the address of its registered office in
the prescribed manner, the company and every officer of the company who is in default shall be
punishable with fine.
Also, every officer of a company or any person on its behalf who signs or authorises to be signed
on behalf of the company any bill of exchange, hundi, promissory note or cheque, etc., wherein
the name of the company is not mentioned in the prescribed manner, shall be personally liable
to the holder of such bill of exchange, hundi, promisory note, cheque, etc., for the amount thereof
unless it is paid the company. Personal Liability will, however, be not incurred in the following
cases:
The holder of a negotiable instrument, on which the company’s name has been incorrectly
stated, will not be able to enforce the personal liability under s.147(4) against the officer
concerned if the error was due to the holder’s own act [Durham Fancy Goods Ltd. v.
Michael Jackson (Fancy Goods) Ltd. and Another (1968) 2 Q.B. 839].
The word ‘Limited’ is abbreviated to ‘Ltd.’ (P. Stacey & Co. v. Wallis (1912) 28 T.L.R. 219.
56
There is an accidental omission of the word ’limited’ [Dermatine Co. v. Ashworth (1905)
21 T.L.R. 510]. In this case, a bill of exchange was accepted on behalf of a limited company.
The rubber stamp of the company was longer than the paper. As a result, the word ‘limited’
did not appear on the instrument. Held, the directors who accepted the bill of exchange
were not personally liable because omission was neither deliberate nor of negligent
origin. It was an obvious error of most trifling kind and the mischief aimed at by the Act
did not here exist.
5.2.3 The Registered Office Clause [s.13(1) (b)]
This clause states the name of the State in which the registered office of the company will be
situated. Every company must have registered office which establishes its domicile and it is also
the address at which company’s statutory books must normally be kept and to which notices and
all other communications can be sent. The notice of the exact situation (address) of the registered
office may be given to the Registrar within thirty days from the date of incorporation (s.146).
As in the case of publication of the company’s name, s.147 also makes similar provisions regarding
publication of the Registered Office of the company.
5.2.4 The Objects Clause [s.13 (1) (d)]
The objects clause defines the objects of the company and indicates the sphere of its activities.A
company cannot do anything beyond or outside its objects and any act done beyond them will be
ultra vires and void and cannot be ratified even by the assent of the whole body of shareholders.
However, a company may do anything which is incidental to and consequential upon the objects
specified and such act will not be ultra vires. Thus, a trading company has an implied power to
borrow money, draw and accept bills of exchange.
Task Advise Asiatic Government Security Life Assurance Co. Ltd. whether it can seek
injunction against the New Asiatic Insurance Co. Ltd. which was subsequently formed,
restraining it from having in its name the word ‘Asiatic’ on the ground that it has caused
confusion and can deceive the public. [Hint: Yes, it can seek injunction against the New
Asiatic Insurance Co. Ltd. The two companies are in insurance business, the impression
may be created that both of them are inter-related and the word ‘Asiatic’ is quite an
imaginary word and does not mean anything. Mere addition of the word ‘New’ is not likely
to give an otherwise impression. See s.20.]
Section 13, read along with Tables ‘B’, ‘C’, ‘D’ and ‘E’, in the act requires the company to divide
its objects clause into three parts:
1. Main objects of the company to be pursued by the company on its incorporation;
2. Objects incidental or ancillary to the attainment of the main objects; and
3. Other objects of the company not included in (a) and (b) above.
A company, may on receipt of certificate to commence business, pursue any business given in the
‘main objects’. In the case of companies (other than trading companies) with objects not confined to
one State, the Memorandum must give the name of the State/(s) to whose’ territories the objects
extend’. No business given in ‘other objects’ can, however, be commenced unless prior approval
of shareholders with regard thereto is obtained by way of special resolution passed in general
meeting [s.149 (2A)]. Where special resolution is not passed, the Central Government, may on an
application made by the Board of directors, allow a company to
57
Company Law
commence business in the ‘other objects’, provided the votes cast in favour of the resolution
exceed the votes cast against the resolution, if any [s.149(2B)].
The objects of the company must not be illegal, immoral or opposed to public policy or in
contravention of the Act. For example, s.77 prohibits a company to purchase its own shares.
5.2.5 The Liability Clause [s.13 (2)]
This clause states the nature of liability of the members. In case of a company with limited
liability, it must state that liability of members is limited, whether it be by shares or by guarantee.
This means that in case of a company limited by shares, a member can be called upon at any time
to pay to the company the amount unpaid on the shares held by him. In case of companies
limited by guarantee, this clause will state the amount which every member undertakes to
contribute to the assets of the company in the event of its winding up.
In the case of an unlimited company, this clause need not be given in the memorandum. In fact,
the absence of this clause in the memorandum means that the liability of its members is unlimited.
As per s.45, under certain circumstances the liability of members of a limited company becomes
unlimited.
5.2.6 The Capital Clause [s.13 (4)(c)]
This clause states the amount of share capital with which the company is registered and themode
of its division into shares of fixed value, i.e., the number of shares into which the capitalis
divided and the amount of each share. If there are both equity and preference shares, then the
division of the capital is to be shown under these two heads.
5.2.7 The Association Clause [s.13(4)(c)]
At the end of the memorandum of every company there is an association or subscription clause
or a declaration of association which reads something like this:
“We, the several persons whose names and addresses and occupations are subscribed, are desirous
of being formed into a company in pursuance of this memorandum of association and we
respectively agree to take the number of shares in the capital of the company set opposite our
respective names”.
Then follow the names, addresses, descriptions, occupations of the subscribers and the number
of shares each subscriber has taken and his signature attested by a witness.
Self Assessment
Fill in the blanks:
1. The memorandum serves a .............................. purpose.
2.requires that the memorandum of a company shall be in such one of the

Forms in Tables B, C, D and E in Schedule I to the Act.
3. As in the case of publication of the company’s name, ...............................also makes similar

provisions regarding publication of the Registered Office of the company.
4.states the nature of liability of the members.
5. In the case of an ............................. , liability clause need not be given in the memorandum.
58
5.3 Alteration of Memorandum
Section 16 provides that the company cannot alter the conditions contained in memorandum
except in the cases and in the mode and to the extent express provision has been made in the Act.
These provisions are explained herein below.
5.3.1 Change of Name
Section 21 provides that the name of a company may be changed at any time by passing a special
resolution at a general meeting of the company and with the written approval of the Central
Government. However, no approval of the Central Government is necessary if the change of the
name involves only the addition or deletion of the word ‘private’ (i.e., when public company is
converted into a private company or vice versa).
If through inadvertence or otherwise, a company has been registered with a name which is
identical with or too closely resembles with the name of an existing company, the company may
change its name by passing an ordinary resolution and by obtaining the approval of the Central
Government in writing (s.22).
The change of name must be communicated to the Registrar of Companies within 30 days of the
change. The Registrar shall then enter the new name on the register in the place of the old name
and shall issue a fresh certificate of incorporation with necessary alterations [s.23(1)]. The change
of name becomes effective on the issue of fresh certificate of incorporation. The Registrar will
also make the necessary alteration in the memorandum of association of the company [s.23(2)].
However, change of name shall not affect any rights or obligations of the company or render
defective any legal proceeding which might have been continued or commenced by or against
the company by its former name may be continued by or against the company by its new name
[s.23(3).]
Within 30 days of the passing of the special resolution, a printed or a type written copy of the
resolution should be sent to the Registrar of Companies.
5.3.2 Change of Registered Office
The procedure depends on whether the change is within the jurisdiction of same registrar of
companies (s. 146) or whether the shifting is to the jurisdiction of another registrar of companies
in the same state (s. 146 and s. 17A). This may include:
Change of registered office from one premises to another premises in the same city, town or
village: The company may do so anytime. A resolution passed by the Board of directors shall
be sufficient. However, notice of the change should, within 30 days after the date of the
change, be given to the Registrar who shall record the same (s.146).
Change of registered office from one town or city or village to another town or city or
village in the same state: In this case, the procedure is:
A special resolution is required to be passed at a general meeting of the shareholders;
A confirmation of regional director is to be obtained;
A copy of special resolution and confirmation by regional director is to be filed with

the within 30 days;
Within 30 days of the removal of the registered office, notice of the new location has
to be given to the Registrar who shall record the same. (s.146).
59
Company Law
Change of registered office from one state to another state: Section 17 provides for the
shift of the registered office from one State to another and such shift involves alteration of
memorandum. The change of registered office from one locality to another in the same
city or from one city to another in the same State does not involve alteration of
memorandum.
The shift of the registered office from one State to another can be done by a special resolution
which is required to be confirmed by the Central Government. The Central Government, before
confirming the resolution, will satisfy itself that sufficient notice has been given to every creditor and
all other persons whose interests are likely to be affected by the alteration, including the
Registrar of Companies and the Government of the State in which the registered office is situated.
Also, the Central Government will give an opportunity to members and creditors of the company, the
Registrar and other persons interested in the company to be heard. The Central Governmentmay
confirm the resolution on such terms and conditions as it thinks fit.
It was made clear in Zuari Agro Chemicals Ltd. v. F. S. Wadia and Others (1974) 44 Comp. Cas.
465 that the Company Law Board (now Central government) will not substitute its own wisdom
or judgement for the collective wisdom or judgement of the company expressed in special
resolution. But the bonafides of the company’s application for change can be screened.
Task A company is engaged in jute business. The members unanimously pass a resolution to
start business in rubber. The proposed alteration in the objects clause is submitted to the
Company Law Board for its approval. Advise the Board if the same could be approved or
not. [Hint: It should give the approval. The new business is not inconsistent with the existing
business. See s.17(1)]
Loss of Revenues of State, Whether Relevant Consideration
In Orient Paper Mills Ltd. v. State, AIR (1957) Ori. 232, it was observed that a State whose interests
are affected by the change has a locus standi to oppose shift of registered office of a company.
Accordingly, the Orissa High Court declined to confirm change of registered office from Orissa to
West Bengal, inter alia, on the ground that in a Federal constitution every State has the right to
protect its revenue and, therefore, the interest of the State must be taken into account.
But in Minerva Mills Ltd. v. Govt. of Maharashtra (1975) 45 Comp. Cas 1(Bom.), Justice Ray of the
Bombay High Court held that the Company Law Board (now Central government) cannot refuse
confirmation on the ground that the change would cause loss of revenue to a State or would have
adverse effects on the general economics of the State. The question of loss of revenue to one State
would have to be considered in the prospectus of total revenues for the Republic of India and no
parochial considerations should be allowed to turn the scale in regard to change of registered office
from one State to another within India.
Similar view was expressed in Rank Film Distributors of India Ltd. v. Registrar of Companies,
West Bengal [AIR (1969) Cal. 32]., i.e. that State has no statutory right under s. 17 to oppose the
shifting of the registered office from one State to another.
A printed or a typewritten copy of the special resolution both under s. 146 and s. 17 should be
sent to the Registrar within 30 days of its passing.
A certified copy of the Central Government order of the Central Government should be filed
within three months thereof with the Registrar of each State – the old and the new State. If it is
not filed within the prescribed time, then the alteration shall, at the expiry of such period,
become void and inoperative.
60
A notice of the new location of the registered office must be given to the Registrar of the State to
which the office has been shifted, within thirty days after the change of the office (s.146).
A company is in a position to shift its registered office from one State to another for certain
purposes only. These are discussed in the following paragraph (under ‘Alteration of objects’ –
the grounds being common).
5.3.3 Alteration of Objects Clause
Section 17 empowers a company by a special resolution to alter the objects or to change the place
of its registered office from one State to another if the alteration is sought on any of the following
grounds:
1. To carry on its business more economically and more efficiently: In Dalmia Cement (Bharat)
Ltd., In re (1964) 34 Comp. Cas. 729 (Mad.), the Court observed that whether a company
can carry on its business more economically or more efficiently is a matter for the judgement
of the directors. If the directors consider that under the existing circumstances, it will be
convenient and advantageous to combine the new objects with the existing objects and if it
appears that such a conclusion may be fairly arrived at, the Court (now Central government)
will not go behind it and hold an enquiry as to whether the opinion of the directors is well
founded or is justified.
The true legal position, observed the Delhi High Court, is that the business must remain
substantially the same and the additions, alterations and changes should only be steps-in-
aid to improve the efficiency of the company [Delhi Bharat Grain Merchants Assn. Ltd., In
re (1974) 44 comp. Cas. 214 (Delhi)].
In Re, Scientific Poultry Breeders Association (1933) 3 Comp. Cas. 89 (CA), a company’s
memorandum prohibited payment of remuneration to the members of its governing body.
It wanted for efficient management, amendment in the memorandum to enable it topay
remuneration to its governing body members which was allowed.
2. To attain its main purpose by new or improved means: For the companies registered after
10th October, 1965, there is no difficulty in ascertaining the main purpose because the
Memorandum would state it. But for the companies registered earlier, one has to look not
only to the memorandum but also to what has actually been done.
3. To enlarge or change the local area of its operation: In India Mechanical Gold Extracting
Company, In Re (1891) 3 Ch. 538, the company’s business was confined to the ‘Empire of
India’. It wanted to enlarge its operations by dropping these words. It was allowed to do
so on the condition that the word ‘Indian’ was also dropped from its name.
4. To carry on some business which under existing circumstances may be conveniently or

advantageously combined with the business of the company: In fact, most of the
amendments sought in objects clause are based on this ground. This clause enables a company
to diversify. The working of the clause makes its scope very wide in as much as any activity
which may either conveniently or advantageously be combined with the existing business
may be allowed.
5. To restrict or abandon any of the objects specified in the memorandum: Even for deleting
any portion of the object clause, the procedure laid down in s.17 has to be followed.
6. To sell or dispose of the whole or any part of the undertaking: Where a company wishes
to adopt a cut-back or retrenchment strategy, i.e., where it feels that it has either grown too
61
Company Law
big or diversified in various directions that managing becomes difficult or uneconomical,

it may alter its objects to sell or dispose of any of its undertakings.
7. To amalgamate with any other company or body of persons.
Procedure for Alteration of Objects
A printed or a typewritten copy of the special resolution is required to be filed with the Registrar
within thirty days of the passing thereof.
Also a petition is to be filed with the Central Government for confirmation of the special
resolution. The Central Government, being satisfied that the notice of the resolution was given
to all persons whose interests are likely to be affected by the alteration, including the Registrar
and the State Government and having heard them, may confirm the alteration either wholly or
in part.
A certified copy of the order of the Central Government together with a printed copy of the
altered memorandum must be filed within three months of the date of the order, with the
Registrar. The Registrar will register the documents and issue, within one month a certificate
which will be conclusive evidence that everything required has been done (s.18). If the required
documents are not filed within the prescribed time, the alteration and the order of the Central
Government confirming the alteration, shall, at the expiry of such period, become void and
inoperative (s.19).
5.3.4 Alteration of Liability Clause (s.38)
The liability of a member of a company cannot be increased unless the member agrees in
writing. The consent of the member may, however, be given either before or after the alteration.
Increase in liability may be by way of subscribing for more shares than the number held by him
at the date on which the alteration is made or in any other manner.
In case where the company is a club or any other similar association and the alteration in the
memorandum requires the member to pay recurring or periodical subscription or charges at a
higher rate, although he does not agree in writing to be bound by the alteration, it shall be
binding on him.
In case of unlimited liability company, the liability may be made limited. The alteration will,
however, not affect any debts, liabilities, obligations or contracts entered into by or with the
company before the conversion.
5.3.5 Alteration of Capital Clause (S.94)
This clause deals with alteration of share capital and has been discussed in unit 9.
Task The directors of a company borrow 50,000 from A on a transaction which is ultra vires
the company. Discuss the rights of A against the company and its directors. [Hint: A can
hold directors personally liable. The company can be held liable only if the money has been
used to pay ultra vires debts of the company or in case any assets have been purchased for the
company, these may be attached.
62
Self Assessment
6. Match List-I with List-II and select the correct answer using the codes given below in the
lists:
List-I (Company Issue) List-II (Company Documents)
A. Affirmation of compliance with 1. Certificate of incorporation

the registration formalities
B. Classes of shares into which 2. Statutory declaration

shake capital is divided
C. Rules for forfeiture of shares 3. Memorandum of Association
D. Name and address of 4. Articles of association

the company auditor
5. Prospectus
Codes:
A B C D
(a) 1 4 3 5
(b) 5 4 3 1
(c) 2 3 4 5
(d) 4 1 5 2
7. Which of the following statements are correct?
(i) Minutes are not required to be read at a sub general meeting.
(ii) Confirmation of Minutes is not an item of agenda in general meeting.
(iii) The chairman may disallow any matter which in his opinion is detrimental to the
interests of the company from being included in the minutes.
(iv) Members cannot obtain copies of minutes through they can inspect them during
business hours.

(a) (ii) and (iii) (b) (i), (ii) and (iii)
(c) (i), (iii) and (iv) (d) (ii) and (iv)
5.4 Doctrine of Ultra Vires
Ultra vires means beyond powers, i.e., any act done by the company beyond its legal powers and
authority.
It has been observed that the company has an Independent legal existence and is a separate body
corporate distinct from its members. The company can, therefore, perform acts on its own. The
acts which the company performs are authorized by:
Objects specified in the Memorandum of Association of the company with which it is
registered. Objects include incidental objects also, and
The Companies Act.
63
Company Law
Any act done by the company which is neither authorized by its objects nor by the Companies
Act is ultra vires the powers and authority of the company. An act which is ultra vires the company
is void and cannot bind the company. Since the act is void, it cannot be ratified by the shareholders
either.
In a leading case on the point, it was held that a contract ultra vires the company was void and not
even the subsequent assent of the whole body of the shareholders could ratify it. An ultra vires
contract being void ab initio cannot become intra vires by reasons of estoppel, lapse of time,
ratification, acquiescence, or delay. In this case, the objects of the company provided to makeand
sell, or lend or hire railway carriage and wagons and all kinds of railways plants, to carry on the
business of mechanical engineers and general contractors, etc. The company contracted with Riche
to finance the construction of railway line in Belgium. On repudiation of contract by the company,
Riche claimed damages contending that the contract fell within the scope of the words “general
contractors” and further contended that the contract was ratified by a majority of shareholders. It
was observed in the case that the Memorandum of Association had two fold effects – an affirmative
that it states the ambit and extent of powers of the company and negative that nothing shall be done
beyond that ambit. It is specific and the term ‘general contractors’, therefore, cannot be so widely
interpreted. The contract of the company to finance the construction of railway line was ultra vires
the objects of the company. Since the act was ultra vires, the power and scope of objects of
Memorandum could not be ratified either.
The directors though authorized to make payments towards any charitable or any benevolent
object, the payment was held to be ultra vires. It was held that the directors could spend for the
promotion of only such charitable objects as would be useful for the attainment of the company’s
objects. Earlier it has been held in Eastern Countries Rly that “no company can devote any part
of its funds to an object which is neither essential; nor incidental to the fulfillment of its object
howsoever beneficial that object might be”.
Act Ultra vires the Powers of Directors and Ultra vires the Articles but Intra vires the
Memorandum: The directors of the company may act beyond the powers and authority assigned
to them. The directors derive their powers through:
1. Articles of Association
2. Specific authority through resolutions.
3. Companies Act.
An act ultra vires the powers of directors but not ultra vires the company can be ratified by the
share holders. Similarly an act ultra vires the articles of company but within the powers of the
Memorandum (intra vires the memorandum) can be ratified by altering the articles. In short, an
act ultra vires the company is void and cannot be ratified. An act ultra vires the powers of directors
and ultra vires the articles but intra vires the Memorandum can be ratified as such an act is only
irregular.
The aggrieved party has the following relief:
Directors can be made liable to outsiders for breach of an implied warranty of authority.
Any member of the company can get an injunction restraining the company from performing
an ultra vires act or from proceeding with it.
If a director makes an ultra vires payment, he can be compelled to refund the money to the
company.
It has been mentioned earlier that a company cannot go beyond its objects mentioned in its
memorandum. The company’s activities are confined strictly to the objects mentioned in its
memorandum and if they go beyond these objects, then such acts will be ultra vires. The object of
64
declaring such act as ultra vires is to protect the interests of shareholders and all others who deal
with the company. Some points worth noting as regards doctrine of ultra vires are:
A company exists only for the objects which are expressly stated in its objects clause or
which are incidental to or consequential upon these specified objects.
Any act done outside the express or implied objects is ultra vires.
The ultra vires acts are null and void ab initio. The company is not bound by these acts; and
neither the company nor the other contracting party can sue upon it.
Example: (1) A company with the objects, namely (i) to make and sell or lend on hire railway
carriages and wagons and all kinds of railway plant, fittings, machinery and rolling stock; (ii) to
carry on the business of mechanical engineers and general contractors; (iii) to purchase, lease, work
and sell, mines, minerals, land and buildings; (iv) to purchase and sell as merchants timber, coal,
metals or other materials. The company contracted to finance the construction of a railway bridge
in Belgium and there was evidence that the agreement had been ratified by all the members. Later,
the company repudiated the agreement and was sued for breach of contract. In its defence, the
company repudiated its lack of capacity to enter into a contract which was outside the scope of its
objects clause. The other party brought an action for damages for breach of contract. His contentions
were that the contract in question came wellwithin the meaning of the words ‘general contractors’
and, was, therefore, within the powers of the company and secondly, that the contract was ratified
by the majority of the shareholders.
Held: That the term ‘general contractors’ must be taken to indicate the making generally, of such
contracts as were connected with the business of mechanical engineers. If the term ‘general
contractors’ was so interpreted it would authorise the making of contracts of any and every
description, such as, for instance, of fire and marine insurance and the memorandum in place of
specifying the particular kind of business, would virtually point to the carrying on of business
of any kind whatsoever and would, therefore, be altogether not meaningful. Hence, the contract
was entirely beyond the objects in the memorandum of association. [Ashbury Railway Carriage
and Iron Co. v. Riche (1875) LR 7 HL 653].
(2) The objects clause of a company included making of costumes, gowns and similar things
within the clothing trade. However, it extended its activities to the manufacture of veneered
panels and became indebted to three parties (a) builders of the veneered panels factory,
(b) suppliers of veneers and (c) fuel merchants. In the meantime the company went into liquidation
and rejected the claim of the three creditors. The creditors filed suits for the recovery of money.
Held: the contention of the liquidator was correct as all the three contracts were clearly ultra
vires.
In case a company is about to undertake an ultra vires act, the members of a company (even
a single member) can get an order of injunction from the court restraining the company from
going ahead with the ultra vires act.
If the directors have exceeded their authority and done something then such matter can be
ratified by the general body of the shareholders, provided the company has the capacity to
do so by its memorandum of association.
Example: Company has the power to borrow money, but the Articles of the company provide
that in case the directors borrow more than 50,000, they should get prior approval by the company
in general meeting. However, the directors can issue debentures to the extent of
75,000 without getting the approval from the shareholders.
65
Company Law
The company in general meeting may ratify the act of directors as it is intra vires the company,
though ultra vires the powers of the directors of the company:
Any property acquired by a company under an ultra vires transaction may be protected by
the company against damage by third persons.
Directors and other officers can be held liable to compensate the company for any loss
occasioned to it by an ultra vires act.
Directors and other officers shall be personally accountable to the third parties
Money or property gained through an ultra vires transaction available in specie or capable
of being identified shall be restituted (restored) to the other party.
In case, an ultra vires loan, taken by a company is used for payment of its intra vires debts, the
lender of the ultra vires loan is substituted in place of the creditor who has been paid off and
as such can recover the money.
Self Assessment
8. Which of the following need not have MOA
(a) Public company (b) Private company
(c) Government company (d) Statutory Corporation
9. A company can change its name by passing
(a) Ordinary resolution
(b) Special resolution
(c) Either by special resolution or by ordinary resolution
(d) None of the above
10. Ultra vires means
(a) Beyond the power (b) with in the power
(c) Both (d) None of the above
11. Ultra vires loans granted by the company are
(a) Void (b) Voidable
(c) Valid (d) None of the above
5.4.1 The Effects and Exceptions of the Doctrine of Ultra vires – An

Elaboration
Doctrine of ultra vires has been developed to protect the investors and creditors of the company.
The doctrine of ultra vires could not be established firmly until 1875 when the Directors, & C., of
the Ashbury Railway Carriage and Iron Company (Limited) v Hector Riche, (1874-75) L.R. 7 H.L.
653 (discussed above also) was decided by the House of Lords. A company called “The Ashbury
Railway Carriage and Iron Company,” was incorporated under the Companies Act, 1862. Its
objects, as stated in the Memorandum of Association, were “to make, and sell, or lend on hire,
railway carriages and wagons, and all kinds of railway plant, fittings, machinery, and rolling-
stock; to carry on the business of mechanical engineers and general contractors; to purchase,
lease, work, and sell mines, minerals, land, and buildings; to purchase and sell, as merchants,
66
timber, coal, metals, or other materials, and to buy and sell any such materials on commission
or as agents.” The directors agreed to purchase a concession for making a railway in a foreign
country, and afterwards (on account of difficulties existing by the law of that country), agreed to
assign the concession to a Société Anonyme formed in that country, which société was to supply
the materials for the construction of the railway, and to receive periodical payments from the
English company.
The objects of this company, as stated in the Memorandum of Association, were to supply and
sell the materials required to construct railways, but not to undertake their construction. The
contract here was to construct a railway. That was contrary to the memorandum of association;
what was done by the directors in entering into that contract was therefore, in direct contravention
of the provisions of the Company Act, 1862.
It was held that this contract, being of a nature not included in the Memorandum of Association,
was ultra vires not only of the directors but of the whole company, so that even the subsequent
assent of the whole body of shareholders would have no power to ratify it. The shareholders
might have passed a resolution sanctioning the release, or altering the terms in the articles of
association upon which releases might be granted. If they had sanctioned what had been done
without the formality of a resolution, that would have been perfectly sufficient. Thus, the contract
entered into by the company was not a voidable contract merely, but being in violation of the
prohibition contained in the Companies Act, was absolutely void. It is exactly in the same
condition as if no contract at all had been made, and therefore, a ratification of it is not possible.
If there had been an actual ratification, it could not have given life to a contract which had no
existence in itself; but at the utmost it would have amounted to a sanction by the shareholders to the
act of the directors, which, if given before the contract was entered into, would not have made it
valid, as it does not relate to an object within the scope of the memorandum of association.
Later on, in the case of Attorney General v. Great Eastern Railway Co., this doctrine was made
clearer. In this case the House of Lords affirmed the principle laid down in Ashbury Railway
Carriage and Iron Company Ltd v. Riche but held that the doctrine of ultra vires “ought to be
reasonable, and not unreasonable understood and applied and whatever may fairly be regarded
as incidental to, or consequential upon, those things which the legislature has authorized, ought
not to be held, by judicial construction, to be ultra vires.”
The doctrine of ultra vires was recognised in Indian the case of Jahangir R. Modi v. Shamji Ladha
and has been well established and explained by the Supreme Court in the case of A.
Lakshmanaswami Mudaliar v. Life Insurance Corporation of India . Even in India it has been held
that the company has power to carry out the objects as set out in the objects clause of its
memorandum, and also everything, which is reasonably necessary to carry out those objects.
For example, a company which has been authorized by its memorandum to purchase land had
implied authority to let it and if necessary, to sell it. However, it has been made clear by the
Supreme Court that the company has, no doubt, the power to carry out the objects stated in the
objects clause of its memorandum and also what is conclusive to or incidental to those objects,
but it has no power to travel beyond the objects or to do any act which has not a reasonable
proximate connection with the object or object which would only bring an indirect or remote
benefit to the company.
To ascertain whether a particular act is ultra vires or not, the main purpose must first be ascertained,
then special powers for effecting that purpose must be looked for, if the act is neither within the main
purpose nor the special powers expressly given by the statute, the inquiry should be made whether
the act is incidental to or consequential upon. An act is not ultra vires if it is found:
Within the main purpose, or
Within the special powers expressly given by the statute to effectuate the main purpose, or
67
Company Law
Neither within the main purpose nor the special powers expressly given by the statute but
incidental to or consequential upon the main purpose and a thing reasonably done for
effectuating the main purpose.
The doctrine of ultra vires played an important role in the development of corporate powers.
Though largely obsolete in modern private corporation law, the doctrine remains in full force
for government entities. An ultra vires act is one beyond the purposes or powers of a corporation.
The earliest legal view was that such acts were void. Under this approach a corporation was
formed only for limited purposes and could do only what it was authorized to do in its corporate
charter.
This early view proved unworkable and unfair. It permitted a corporation to accept the benefits
of a contract and then refuse to perform its obligations on the ground that the contract was ultra
vires. The doctrine also impaired the security of title to property in fully executed transactions in
which a corporation participated. Therefore, the courts adopted the view that such acts were
voidable rather than void and that the facts should dictate whether a corporate act should have
effect.
Over time a body of principles developed that prevented the application of the ultra vires doctrine.
These principles included the ability of shareholders to ratify an ultra vires transaction; the
application of the doctrine of estoppel, which prevented the defense of ultra vires when the
transaction was fully performed by one party; and the prohibition against asserting ultra vires when
both parties had fully performed the contract. The law also held that if an agent of a corporation
committed a tort within the scope of the agent’s employment, the corporation couldnot defend on
the ground that the act was ultra vires.
Despite these principles the ultra vires doctrine was applied inconsistently and erratically.
Accordingly, modern corporation law has sought to remove the possibility that ultra vires acts
may occur. Most importantly, multiple purposes clauses and general clauses that permit
corporations to engage in any lawful business are now included in the articles of incorporation.
In addition, purposes clauses can now be easily amended if the corporation seeks to do business
in new areas. For example, under traditional ultra vires doctrine, a corporation that had as its
purpose the manufacturing of shoes could not, under its charter, manufacture motorcycles.
Under modern corporate law, the purposes clause would either be so general as to allow the
corporation to go into the motorcycle business, or the corporation would amend its purposes
clause to reflect the new venture.
State laws in almost every jurisdiction have also sharply reduced the importance of the ultra vires
doctrine. For example, section 3.04(a) of the Revised Model Business Corporation Act, drafted in
1984, states that “the validity of corporate action may not be challenged on the ground that the
corporation lacks or lacked power to act.” There are three exceptions to this prohibition: it may be
asserted by the corporation or its shareholders against the present or former officers or directors
of the corporation for exceeding their authority, by the attorney general of the state in a proceeding
to dissolve the corporation or to enjoin it from the transaction of unauthorized business, or by
shareholders against the corporation to enjoin the commission of an ultra vires act or the ultra
vires transfer of real or personal property.
Government entities created by a state are public corporations governed by municipal charters
and other statutorily imposed grants of power. These grants of authority are analogous to a
private corporation’s articles of incorporation. Historically, the ultra vires concept has been
used to construe the powers of a government entity narrowly. Failure to observe the statutory
limits has been characterized as ultra vires.
In the case of a private business entity, the act of an employee who is not authorized to act on the
entity’s behalf may, nevertheless, bind the entity contractually if such an employee would
68
normally be expected to have that authority. With a government entity, however, to prevent a
contract from being voided as ultra vires, it is normally necessary to prove that the employee
actually had authority to act. Where a government employee exceeds her authority, the
government entity may seek to rescind the contract based on an ultra vires claim.
Critique of the Ultra vires Doctrine
Creditors’ Interests: The existence of the doctrine does not entitle a creditor dealing with a company
to assume that it will only act intra vires and, if he neglects to enquire or, having enquired, draws
the wrong conclusion, he may risk loss from which other creditors may fortuitously benefit. The
doctrine could be more in the nature of a trap than a protection for the creditor. Indeed, there are
instances where the doctrine had adverse effects even for a diligent creditor or third party dealing
with a company, as he may spend considerable time and effort to ensure that a proposed transaction
is intra vires.
In theory, no doubt the doctrine of ultra vires may provide protection by limiting the business
and thus, preventing unauthorized operations, which may damage the solvency of a company
and its ability to repay. In practice this is not a consideration, which weighs with creditors at all.
The prolixity of memoranda of association, and the power of a company to alter its objects, and
the ability of a company to operate through subsidiaries, makes it impractical to rely on the
objects to impose any limitation on the businesses which the company may carry on. Such
limitations may be, however, and in many cases imposed by creditors by including the necessary
restrictions in their contracts with the company.
In practicality, a creditor lending funds on a long-term basis will normally impose conditions to
ensure that the loan is applied for a particular purpose, and will check the object clause of the
company. A creditor advancing short-term funds, or advances repayable on demand, is less
likely to scrutinize the object clause of the company and be more ready to assume that, if it is a
trading company, the borrowing is within its powers. Normally, the creditor lending funds on
any significant scale will ascertain whether or not there are in the articles any restrictions on the
directors’ borrowing powers, but these articles normally expressly provide that any breach of
the borrowing limit will not invalidate the borrowing.
Frequently, there will be a lending agreement, which will contain such restrictions on the
activities of the company, which the lender considers prudent.
Consideration of the object clauses as a protection where such commercial instruments are
issued is theoretical rather than practical, because most modern memoranda of association
authorize widely diverse objects and in any event, the company can alter its objects or operate
through subsidiaries.
One important and pertinent question in this regard is: what is the standing of a creditor regarding
challenging of the alteration by the company.
This is a question which assumes a lot of importance since the creditors seem to be one class which
has been most affected by the whole jumble of law. The researcher’s view in this regard is that
a creditor per se has no right and all his rights are merely contractual in nature which is a notion
further affirmed by the fact that if the ultra vires doctrine is abolished, then the contractual capacity
of the company will be more like that of a natural person. Further, the intervention of a creditor
regarding the company entering into an ultra vires transaction is not practical since it is very
difficult for a creditor to know of the transactions being entered into by the company. Thus, as
such, the creditor has no practical means of knowing that what the company is doing and since his
relationship with the company is more in the nature of a contract, there seems no justification to the
researcher to allow the creditor to object to the alteration of the object clause of the company. In
view of some commentators, even if such a right is created; that will be
69
Company Law
totally ineffectual for the reasons mentioned above by the researcher. In fact, to prove their
point, the commentators cite the example of existence of such a right and subsequent withdrawal
in December 1947, indicating that experience showed that such a right was unnecessary and
ineffective. A very pertinent question in this regard is that can the creditors contractually bind
the company so as not to alter the objects of the company in future? In view of the researcher the
answer to this question will be no, since, first of all, this will be a matter which will ideally be
regulated by the articles of association of the company since those will regulate the extent to
which the directors of the company can enter into the agreement with the creditors. Further, the
company cannot bind itself not to exercise its right conferred by the statute without shareholders
approval.
Shareholders’ Interests: No doubt shareholders interests are well protected in theory, by the law as
well. However, in practicality, memoranda of association are excessively prolix, being designed to
include every conceivable business. This defeats the object of having an object clause and confers
no protection on members. It also fails to guide investors as to what is the real business of a
company. One more important query in this regard can be that, what is the remedy available to the
shareholder? In this regard, the researcher’s view is that since the law has provided enough
protection to the shareholders in this regard – approval by the CLB, there should ideallybe no need
for such a protection. In view of the researcher, perhaps this remedy is too far fetched and this point
will be dealt with by the researcher while dealing with the practical aspects of the whole process of
alteration.
The assumption that the entire public has access to the MoA is based on archaic thinking.
Consequent to industrial growth and wide dispersal of shareholding vis-a-vis the vastness of
India, those who deal with the company are generally confined to the place over which the
Registrar of the Companies has jurisdiction. They may have a right to receive the required
information by post; but such exercise will involve time and it may frustrate conclusions of
dealing with a company.
The aforesaid concept of law is perhaps justified in England since that is a small country as
compared to India. The assumption as to the possibility of automatic inspection at public registry,
therefore, needs review.
It is not being canvassed that a company need not spell out in advance what it proposes to do.
Of course, it is essential that the lines of the business are spelled out somewhere, but it is
pointless to insist on the demarcation between the main objects and the ancillary objects; especially
when the main objects embrace a score of activities.
Self Assessment
12. The doctrine of ultra vires is an illusory protection to the shareholders and a pitfall to the
outsiders.
13. An ultra vires act, even if endorsed by all the members of the company, is void.
14. A company cannot alter the conditions contained in its memorandum except in cases, in
the mode and to the extent for which express provision is made in the Act.
15. The intention of the legislature is to prevent too easy an alteration of the conditions
contained in MOA.
16. A company can shift its registered office to another state by passing an ordinary resolution
and with the permission of CLB.
70
Case Study Insurance Sector and Law
O
ver the years, it has been almost a standard practice for the agents of Life Insurance
Corporation to give their customers a part of their commission. They usually pay
the first quarter’s premium on behalf of the customer. That this practice is
illegal is a fact; and therefore, not a matter of opinion. However, there are two views over
whether the law should prohibit this ‘rebating’, or not.
Most life insurance companies support banning of rebating, although they all agree that
monitoring this is almost impossible. “There has to be a change in awareness level for all
customers to refrain from rebating,” says Ms Suniti Ghoshal, Head-Corporate
Communications, Aviva Life Insurance (formerly, Dabur CGU Life Insurance).
“This industry has been with a monopoly player, hence, certain things have only been
done without being questioned much,” Ms Ghoshal said, in an e-mail to Business Line.
Other insurance companies agree. “An agent rebates in order to shorten his sales cycle.
This shortening of process often leads to misrepresentation resulting in poor service quality,”
says a spokesman of Max New York Life Insurance. However, another point ofview of the
same issue is that there is no point in prohibiting rebating by agents, which is any way
extremely difficult to monitor. Advocates of this view point out that in most countries;
insurance companies are even allowed to extend credit to their customers for premiums. In
India, a claim is payable if and only if the premium has been received in full. Rebating is in a
way an informal credit extended to the customer by the agent.
After all, the agent is paying out of his pocket. Why prohibit rebating only in the insurance
industry, when discount is a way of life in all other industries?
But insurance companies do not like it. Mr Dilip Gazaaro, Head-Retail Sales, HDFC Standard
Life, says that his company actually dismissed an agent for rebating.
At Aviva, the Financial Planning Advisers are trained to handle such demands, says Ms
Ghoshal. “They can explain the customer as to why he needs to pay the agent for his
service. If the customer can pay substantial amounts for premium, he also needs to ensure
that the advice he receives and the service he avails of for his policy are the best in terms
of quality and integrity.” Max New York Life’s spokesman echoes similar views. “We as
an industry are also establishing a code of conduct against such practices. At the Life
Insurance Executive Council, we have recommended that the penalty for rebating be
increased from 500 to 10,000.” There are others who believe that rebating should continueto
be illegal, no matter how difficult it is to monitor. Says Mr N. Raveendran, Director, Alegion
Risk Management Services (which proposes to become a general insurance broker),
“Legalising rebating would drive away the serious agents who do not usually give rebates”.
He says that there would come a time, when the society matures enough to be willing to
pay for a service, that rebating will automatically go away.
After all, you don’t necessarily go to the doctor who charges the least. But legalising
rebating would push back the arrival of such a time.
Question
Discuss the financial planning advisor role in insurance industry. ( Hint: Basically financial
advisor is a main person who involve more and more in the planning of insurance sector).
71
Company Law
5.5 Summary
The memorandum serves a two-fold purpose. It enables shareholders, creditors and all
those who deal with the company to know what its powers are and what is the range of its
activities.
Section 15 requires the memorandum to be printed, divided into paragraphs, numbered

consecutively, and signed by at least seven persons (two in the case of a private company)
in the presence of at least one witness, who will attest the signature.
The objects of the company must not be illegal, immoral or opposed to public policy or in
contravention of the Act.
The change of name must be communicated to the Registrar of Companies within 30 days
of the change.
Section 17 provides for the shift of the registered office from one State to another and such
shift involves alteration of memorandum.
5.6 Keywords
Liability Clause: Liability clause states the nature of liability of the members.
Memorandum of Association: The Memorandum of Association of a company is its charter

which contains the fundamental conditions upon which alone the company can be incorporated.
The Capital Clause: Capital clause states the amount of share capital with which the company is
registered and the mode of its division into shares of fixed value, i.e., the number of shares into which
the capital is divided and the amount of each share.
The Object Clause: The objects clause defines the objects of the company and indicates the sphere
of it activities.
1. Explain memorandum of association and state its contents.
2. State the rule laid down in ‘Ashbury Railway Carriage Co. vs. Riche’s case.
3. Discuss the legal significance of the different clauses in the memorandum of association.
4. Describe the circumstances under which the alteration of objects clause is permissible.
5. Describe the formalities to be complied with for changing the objects clause.
6. How are alterations made in a memorandum of association?
7. Write explanatory on “Doctrine of ultra vires and its implications”.
8. Write explanatory on “Change of name clause”.
9. Describe the steps to be taken by a company to effect changes in the location of its registered
office from:
(a) One place to another place in the same city;
(b) One city to another city in the same state;
(c) One state to another state.
72
10. Explain the various clauses included in the memorandum of:
(a) A limited company and
(b) An unlimited company.
1. two-fold 2. Section 14
3. s.147 4. Liability clause
5. unlimited company 6. (c)
7. (b) 8. (d)
9. (c) 10. (a)
11. (a) 12. True
13. True 14. True

15. True 16. False

www.webopedia.com
73
Company Law
Unit 6: Articles of Association
CONTENTS
Objectives
Introduction
6.1 Articles of Association – Meaning and Purpose
6.2 Registration of Articles
6.3 Subject Matter of Articles
6.4 Inspection of Copies of the Articles
6.5 Alteration of Articles
6.6 Doctrine of Indoor Management
6.7 Constructive Notice of Memorandum and Articles
6.8 Articles and Memorandum: Their Relation and Distinction
6.8.1 Members bound to Company
6.8.2 Company bound to Members
6.9 Legal Effect of Memorandum and Articles
6.10 Summary
6.11 Keywords
Objectives

Define articles of association;
Describe registration of articles;
Explain subject matter of articles;
Know alteration of articles;

Elaborate upon doctrine of indoor management.
Introduction
There may in the case of a public company limited by shares, and there shall in the case of an
unlimited company or a company limited by guarantee or a private company limited by shares,
be registered with the memorandum, articles of association signed by the subscribers of the
memorandum, prescribing regulations for the company.
The articles of association of a company limited by shares may adopt all or any of the regulations
contained in Table A in Schedule I.
74
In the case of any such company which is registered after the commencement of this Act, if
articles are not registered, or if articles are registered, in so far as the articles do not exclude or
modify the regulations contained in Table A aforesaid, those regulations shall, so far as applicable,
be the regulations of the company in the same manner and to the same extent as if they were
contained in duly registered articles.
6.1 Articles of Association – Meaning and Purpose
The articles of association of a company and its bye laws are regulations which govern the
management of its internal affairs and the conduct of its business. They define the duties, rights,
powers and authority of the shareholders and the directors in their respective capacities and of
the company and the mode and form in which the business of the company is to be carried out.
The Articles of association of a company have a contractual force between company and its members
as also between the members inter se in relation to their rights as such members. They are
subordinate to and are controlled by memorandum. Articles cannot supersede the objects as set
out in the memorandum of association [Birds Investments Ltd. v. C.I.T. (1965) 35 Comp. Cas.147
Cal.] The memorandum, as we have seen earlier, lays down the scope and powers of the company,
whereas the articles govern the ways in which the objects of the company are to be carried out. Also
the alteration of memorandum involves elaborate procedure, whereas the articles can be framed
and altered by the members by passing special resolution. The memorandum is the area beyond
which the actions of the company cannot go inside that area the shareholders may make such
regulations for their own governance as they think fit. However, the articles must not be inconsistent
with the memorandum. Also, as in the case of memorandum, the articles of the company must not
contain anything which is against or repugnant to the provisions of the Companies Act (s.9).
6.2 Registration of Articles
Section 26 states that a public company limited by shares may register articles of association
signed by the subscribers to the memorandum. If, however, it does not register its own articles,
then the articles given in Table A of Schedule I automatically becomes applicable. Further, even
if it does register articles of its own, Table A will still apply automatically unless it has been
excluded or modified. There are actually three possible alternatives in which such company may
adopt articles: (i) it may adopt Table A in full or, (ii) it may wholly exclude Table A and set out
its own regulations in full, or (iii) it may set out its own articles and adopt part of Table A. The
alternatives (ii) and (iii) are often employed; and partial adoption of Table A has particular
advantage for small companies, because of economy in printing and also because any provision
of Table A is legally beyond any doubt.
As regards a company limited by guarantee and unlimited liability company and, a private
company limited by shares, s.26 provides for compulsory registration of articles prescribing
regulations for the company. However, they may adopt any of the appropriate regulations of
Table A.
In any case, the articles of a company must be: (i) printed, (ii) divided into paragraphs, numbered
consecutively, (iii) signed by subscribers to the memorandum in the presence of at least one
witness who shall attest the signatures. Also, articles are to be stamped with requisite stamp and
filed along with the memorandum (s.3).
75
Company Law
6.3 Subject Matter of Articles
The articles of a company usually deal with the following matters:
1. The business of the company;
2. The amount of capital issued and the classes of shares into which the capital is divided; the
increase and reduction of share capital;
3. The rights of each class of shareholders and the procedure for variation of their rights;
4. The execution or adoption of a preliminary agreement, if any;
5. The allotment of shares; calls and forfeiture of shares for non-payment of calls;
6. Transfer and transmission of shares;
7. Company’s lien on shares;
8. Exercise of borrowing powers including issue of debentures;
9. General meetings, notices, quorum, proxy, poll, voting, resolution, minutes;
10. Number, appointment and powers of directors;
11. Dividends – interim and final – and general reserves;
12. Accounts and audit;
13. Keeping of books – both statutory and others.
Self Assessment
Fill in the blanks:
1. The articles of association of a company limited by shares may adopt all or any of the
regulations contained in Table A in ............................
2. The ........................ of a company have a contractual force between company and its members
as also between the members inter se in relation to their rights as such members.
3. Articles cannot supersede the objects as set out in the .............................
4.states that a public company limited by shares may register articles of

association signed by the subscribers to the memorandum.
6.4 Inspection of Copies of the Articles
A company shall, on being so required by a member, send to him within seven days of the
requirement, on payment of one rupee, a copy of the articles. If a company makes default, the
company and every officer of the company, who is in default, shall be punishable with fine up
to 50 (s.39).
Task A company, in which the directors hold majority of the shares, altered its articles so
as to give power to directors to require any shareholder, who competed with the company’s
business, to transfer his shares, at their full value, to any nominee of the directors. S had
some shares in the company. Is S bound by the alteration? [Hint: S shall be bound by the
alteration. The alternation is in the general interest of the company.]
76
6.5 Alteration of Articles
Section 31 provides that subject to the provisions of the Act and to the conditions contained in its
memorandum, a company may, by special resolution alter or add to its articles. A printed or type
written copy of every special resolution altering the articles must be filed with the Registrar within
30 days of the passing of the special resolution.
The right to alter just by passing special resolution is so important that a company cannot in any
manner deprive itself of the power to alter its articles. Also, the power to reduce or increase the
number of members in the case of a company limited by guarantee without share capital, from
time to time, as given in the articles can be done by a special resolution of the general body of
members. However, in spite of the power to alter its articles, a company can exercise this power
subject to certain limitations.
Limitations on Power to alter Articles and these are:
The alteration must not exceed the powers given by the memorandum or conflict with the
other provisions of the memorandum.
The alteration must not be inconsistent with any provision of the Companies Act or any other
statute. For example, no company can purchase its own shares (s.77) and if the articles of a
company are altered so as to have the power to purchase its own shares, then such power will
be void.
The altered articles must not include anything which is illegal, or opposed to public policy
or unlawful.
The alteration must be bona fide for the benefit of the company as a whole. The alteration
will not, however, be bad merely because it inflicts hardship on an individual shareholder.
Example: (i) A company had a lien on all shares “not fully paid” for calls due to the company.
There was only one shareholder A, who owned fully paid-up shares. He also held partly-paid shares
in the company. A died. The company altered its articles striking out the words “not fully paid up”
and thus, gave itself a lien on all shares – whether fully paid up or not. The legal representative of A
challenged the alteration on the ground that the alteration had retrospective effect.
Held: The alteration was good, as it was done bona fide for the benefit of the company as a whole,
even though the alteration had a retrospective effect [Allen v. Gold Reefs of West Africa Ltd. (1900)
1 Ch. 656].
(ii) By an alteration in the articles, a company was empowered to expropriate shares held by any
member who was in business in competition with the company. At the time of alteration, there
was only one member doing business in competition with the company. He challenged the
alteration.
Held: The alteration was valid, although only one member was at that time within the ambit of
alteration, as the alteration was bona fide and for the benefit of the company [Sidebottom v.
Kershaw Leese & Co. (1920) Ch. 154 (C.A.)].
The alteration must not constitute a fraud on the minority by the majority. If the alteration
is not for the benefit of the company as a whole, but for majority of the shareholders, then
the alteration would be bad. In other words, an alteration to the articles must not discriminate
between the majority shareholders and the minority shareholders so as togive the former
an advantage of which the latter have been deprived.
77
Company Law
Example: In Brown v. British Abrasive Wheel Co. (1919) 1 Ch. 290, the majority which
held 98 per cent of the shares passed a special resolution that upon the request of holders of
9/10th of the issues shares, a shareholder shall be bound to sell and transfer his shares to the
nominee of such holders at a fair value. The alteration was held to be invalid since it amounted to
an oppression of minority.
There cannot be alteration of the articles so as to compel the existing members to take or
subscribe for more shares or in any way to contribute to the share capital, unless they give
their consent in writing (s.38).
An alteration of articles to effect a conversion of a public company into a private company

cannot be made without the approval of the Central Government (s.31).
A company cannot justify breach of contract with third parties or avoid a contractual liability
by altering articles.
The amended regulation in the Articles of Association cannot operate retrospectively, but
only from the date of amendment [Pyare Lal Sharma v. Managing Director, J & K Industries
Ltd.].
6.6 Doctrine of Indoor Management
The doctrine of constructive notice throws a burden on people entering into contracts with the
company that they are presumed to have read the documents, though in fact, they might not
have read them. On the other hand, the doctrine of indoor management allows all those who
deal with the company to assume that the provisions of the articles have been observed by the
officers of the company. In other words, they are not bound to enquire into the regularity of
internal proceedings. An outsider is not expected to see that the company carries out its internal
regulations.
Example: The directors of a company were authorised by the articles to borrow on bond
such sums of money as should from time to time, by a resolution of the company in general
meeting, be authorised to be borrowed. The directors gave a bond to T without the authority of
any such resolution. The question arose whether the company was liable on the bond.
Held: The company was liable on the bond, as T was entitled to assume that the resolution of the
company in general meeting had been passed [The Royal British Bank v. Turquand (1856) 6 E &
B 327].
Exceptions: The doctrine of indoor management is subject to the following exceptions:
1. Knowledge of Irregularity: The rule does not protect any person who has actual or
constructive notice of the want of authority of the person acting on behalf of the company.
Example: The articles of a company empowered the directors to borrow up to 1,000.

They could exceed the limit of 1,000 with the consent of the company in general meeting.
Without such consent, they borrowed 3,500 from themselves and took debentures. The company
refused to pay the amount. Held: Their debentures were good to the extent of 1,000 only as they had
notice of the internal irregularity [Howard v. Patent Ivory Co., (38 Ch. D. 156)].
2. No Knowledge of Articles: The rule cannot be invoked in favour of a person who did not
consult the memorandum and articles and thus, did not rely on them.
78
Example: T was a director in the investment company. He, purporting to act on behalf of the
company, entered into a contract with the Rama Corporation and took a cheque from the latter.
The articles of the company did provide that the Directors could delegate their powers to one of
them. But Rama Corporation never read the articles. Later, it was found that the directorsof the
company did not delegate their powers to T. Plaintiffs relied on the rule of Indoor Management.
Held: They could not, because they did not know the existence of the power to delegate. [Rama
Corporation v. Proved Tin and General Investment Co. (1952) 1 All ER 554].
3. Void or illegal transaction: The rule does not apply to transactions which are void or illegal
ab initio, e.g., forgery.
Example: The secretary of a company forged signature of two of the directors required
under the articles on a share certificate and issued the certificate without authority. The applicants
claimed to be entitled to be registered as members of the company. Held: The certificate was a
nullity and the holder of the share certificate could not take advantage of the doctrine of indoor
management [Ruben v. Great Fingal Consolidated (1906) A.C 439].
4. Negligence: If an officer of a company does something which would not ordinarily be
within his powers, the person dealing with him must make proper enquiries and satisfy
himself as to the officer’s authority. If he fails to make inquiry, he cannot rely on the rule.
Example: A person who was sole director and principal shareholder of a company paid
into his own account cheques drawn in favour of the company. The bank should have made
enquiries as to the power of the director. The bank was put upon inquiry and was accordingly,
not entitled to rely upon the ostensible authority of director [A. L. Underwood v. Bank of
Liverpool (1924) 1 K. B. 775].
6.7 Constructive Notice of Memorandum and Articles
Section 610 provides that the memorandum and articles, when registered, become public
documents and then they can be inspected by anyone on payment of a nominal fee. Therefore,
any person who contemplates entering into a contract with the company has the means of
ascertaining and is thus, presumed to know the powers of the company and the extent to which
they have been delegated to the directors. In other words, every person dealing with the company
is presumed to have read these documents and understood them in their true perspective. This
is known as ‘Doctrine of Constructive Notice’. Even if the party dealing with the company does
not have actual notice of the contents, it is presumed that he has “constructive notice” of them.
Examples:
(i) One of the articles of a company provides that a bill of exchange to be effective must
be signed by two directors. A bill of exchange is signed only by one of the directors.
The payee cannot claim under the bill.
(ii) In Kotla Venkataswamy v. Ram Murthy AIR (1934) Mad. 579, the articles provided
that all deeds and documents of the company shall be signed by the managing
director, secretary and working director. A mortgage deed was accepted with
secretary and working director’s signature only. Held, the deed was invalid.
(iii) Similarly, if a person enters into a contract which is beyond the powers of the
company, he cannot acquire any right under the contract against the company.
79
Company Law
Self Assessment
5. Signature of memorandum and articles should be done by how many number of persons
in case of public company.
(a) 7 (b) 5
(c) 4 (d) None of the above
6. Signature of memorandum and articles should be done by how many number of persons
in case of private company.
(a) 3 (b) 4
(c) 2 (d) None of the above
7. Address of the registered office is situated in
(a) MOA (b) AOA
(c) Prospectus (d) None of these
8. Alteration of articles must be done only by passing

(a) Special resolution (b) Ordinary resolution
(c) Both (d) None of the above
6.8 Articles and Memorandum: Their Relation and Distinction
Section 36 provides that the memorandum and articles, when registered, bind the company and
its members to the same extent as if they had been signed and sealed by each member and contained
convenants on the part of each member to observe and be bound by all the provisions of the
memorandum and articles. Thus, the company is bound to the members; the members are bound to
the company; and the members are bound to the other members by whatever is contained in these
documents. But neither a company nor its members are bound to outsiders. These relationships are
discussed herein below:
6.8.1 Members bound to Company
Each member must observe the provisions of the articles and memorandum. For instance, a
company has a right of lien on members’ shares, or to forfeit the shares on non-payment of calls.
Every member is bound by whatever is contained in the memorandum and articles.
Example: The articles of a company contained a clause that on the bankruptcy of a member,
his shares should be sold to other person and at a price fixed by the Directors. ‘B’, a shareholder was
adjudicated bankrupt. His trustee in bankruptcy claimed that he was not bound by these provisions
and should be at liberty to sell the shares at the true value. Held, that the trustee was bound by the
articles, as shares were purchased by ‘B’ in terms of the articles. [Borland Trustees v. Steel bros.
Co. Ltd. (1901) 1 Ch. 279].
Each member is not only bound by the covenants of memorandum and articles as originally
framed but as altered form time to time in accordance with the provisions of the Companies Act.
The articles of associations are the regulations of the company binding on the company and on
its shareholders. Further, the shareholders cannot among themselves enter into an agreement
which is contrary to or inconsistent with the articles of association of the company.
80
6.8.2 Company bound to Members
Similarly, a company is bound to members by whatever is contained in its memorandum and articles
of association. The company is bound not only to the “members as a body” but also to the
individual members as to their individual rights. The members can restrain a company from
spending money on ultra vires transactions. An individual member can make the company fulfill
its obligations to him, such as to send the notice for the meetings, to allow him to cast his vote in
the meetings.
Members bound to member. The articles bind the members inter se, i.e., one to another so far as
rights and duties arising from the articles are concerned.
It is well settled that the articles of association will have a contractual force between the company
and its members as also between the members inter se in relation to their rights as such members.
Example: The articles of a company provided that whenever any member wished to transfer
his shares, he was under an obligation to inform the directors of his intention and the directors were
under an obligation to take the said shares equally between them at a fair value. The directors
refused to take the shares of a particular member on the ground that the Articlesdid not impose
an enforceable liability upon them.
Held: The directors were under an obligation to purchase the shares, as members of the company, in
terms of the provisions of the Articles. There was a personal liability of members inter se
[Rayfield v. Hand (1960) Ch.1].
Whether Company or Members bound to Outsiders?
No, the memorandum or articles do not confer any contractual rights to outsiders against the
company or its members, even though the name of the outsiders is mentioned in the articles.
Example: The articles of a company provided that Eley should be solicitor for life to the
company and should not be removed from office except for misconduct. Later on he also became
a member of the company. But after employing him as a solicitor for a number of years, the
company discontinued his services. He, being a member, sued the company for damages for
breach of the contract contained in the articles of association.
Held: His suit was dismissed on the ground that, he, as a solicitor, was no party to the articles. He
must prove a contract independent of the articles. There was no infringement of his right as a
member. The breach of contract was there but in his capacity as a non-member [Eley v. Positive
Government Security Life Assurance Co., (1876) 1 Ex. D. 88].
Whether Directors are bound by whatever is contained in the Articles?
Yes, the directors of the company derive their powers from the articles and be subject to
limitations, if any, placed on their powers by the articles. If they contravene any provisions of
articles, two parties may be affected: (1) the company itself and (2) the outsiders.
In case of contravention of the provisions of the articles, the directors render themselves liable
to an action at the instance of the members. However, members may ratify the act of the
director, if they so desire. But if as a result of the breach of duty any loss has resulted to the
company, the directors are liable to refund to the company any damage so suffered.
Further, where the directors contravene the provisions of the articles, it may affect outsiders’
interest also. This is explained below with the help of a case, viz., Royal British Bank v. Turquand
(1856) 119 ER 886.
81
Company Law
The plaintiffs contracted with a director of the defendant company, and gave him a cheque under the
contract. The director could have been authorised under the company’s articles, but was notin
fact so authorised. The plaintiff had not seen the articles. The director misappropriated the
cheque and the plaintiff sued the company. Is the company liable?
6.9 Legal Effect of Memorandum and Articles
The legal effect of articles may be summed up as follows:
1. The articles constitute a contract between the company and its members.
2. The articles bind the members to the company.
3. The articles bind the company to members as members.
4. The articles bind members to members.
5. The articles do not bind the company to outsiders.
6. The articles do not bind the company to any member in a capacity other than that of a
member.
Self Assessment
State whether statement is true or false:
9. Every member is bound to the company by whatever is contained in the memorandum

and articles.
10. The members of a company can restrain a company from spending money on ultra vires
transactions.
11. The company is not bound to the individual members as to their non-corporate or
individual rights.
12. The members of a company are bound to each other in relation to their rights as such
members.
13. The memorandum or articles do not confer any contractual rights to an outsider against
the company, even though his name is mentioned in the articles.
82
fundamental levels in the WTO regime. At the government level, at the revenue authorities
level and at the business unit level.” China was surprised. “Wow! These CA students are
so analytical,” he told himself. “You mean to say, accounting firms will have opportunities
at the international level,” queried Muskan, Wafer’s niece. She was in Class X.
“Yeah,” said Wafers. And added, “Actually, the opportunities are not just in the industry.
They are in practice as well.” China remarked, “But that comes with a huge price. If the
pink papers are to be believed, accounting firms in the US have millions of dollars worth
of legal suits pending against them.” Muskan asked, “So?” “So,” replied China, “the
liberalised trade scenario which offers potential to provide services across international
borders will augment greater liability to firms in case of default.” Muskan looked definitely
confused.
Wafers explained. “Legally, accounting firms in India are allowed to function as sole
proprietary concerns or as partnership firms. A partnership is the relationship between
persons who have agreed to share the profits of a business carried on by all or anyone of
them acting for all.” This set Muskan thinking. “So will I be liable for my partners’
shortcomings even if I have been honest in conducting my duties,” she asked. “That’s the
general idea,” said China impressed by the kid asking the right questions.
“This traditional model is not equipped to meet the multi-competency, multi-disciplinary
and multi-locational requirements of today’s global and domestic clients,” said China.
Wafers added, “Moreover, the major chunk of all benefits is drawn by the creamy layer of
large firms.” She had read a research report on “Who are India’s top auditors and how
much do they charge,” which had, among others, documented the great divide in the
accounting profession. “This is why the accounting fraternity is in favour of limited liability
partnership,” (LLP) she added. “But what is LLP?” asked China. Ha, that’s why she loved
China. The walking encyclopaedia had no inhibitions about seeking a clarification on a
doubt, if he had one.
“A limited liability partnership is a form of organisation which shields a partner’s assets
from limitless liabilities that may accrue from the omissions and commissions of other
partners,” answered Wafers. Not for nothing was Wafers considered strong in law. “In
LLP, every partner will be an agent of the partnership and not of the other partners,” she
added. “Isn’t this a merger of the partnership form of organisation and the company
form?” remarked China.
“Exactly,” said Wafers. “It promises perpetual succession and a distinct legal identity were
it to become law. Further, it requires only a minimum of two partners, having no cap on
the maximum number of partners a firm can have,” she added. “Section 11,” said China
hurriedly, “of the Companies Act bars the formation of a partnership consisting of more
than 20 persons. Won’t the firm have to register itself as a company?” “Yes and No.” said Wafers
“If LLP becomes law, Section 11 will have to be amended. The idea is to make LLPa vehicle
for business expansion.
“How?” asked Muskan. Replied Wafers, “Because of the legal stipulation of unlimited
liability among partners, Indian partnerships are mostly restricted to family members and
persons who know each other thoroughly.” She added, “LLP being a form of partnership
having characteristics of a company will limit liability in the case of business failure or
professional negligence litigation to the partner responsible.” “You mean, only the
negligent partner will be penalised and not the whole firm,” asked China. “Yes,” said
Wafers.
Contd...
83
Company Law
China played the devil’s advocate. “Is it possible to prove that only a particular partner
was negligent and not the others?” Wafers replied, “They will have to divide work amongst
themselves appropriately. This could create disputes between partners, but crystal clear
division of duties between partners will go a long way in reducing the same.”
“Excellent,” said Muskan. “The LLP form of organisation would help the small and medium
practitioners by encouraging networking and specialisation of functions.”
Wafers had a word of caution, “The decision to go for LLP will be based on the interplay
of costs and benefits.” China continued his black hat thinking, “Other forms of organisation are
tried and tested. Why then should one go for something new?” Wafers answered this
question philosophically quoting John Rockefeller, “If you want to succeed, you should
strike out new paths rather than travel the worn out paths of accepted success.” China
smiled.
Question
Comment on “A partnership is the relationship between persons who have agreed to share
the profits of a business carried on by all or anyone of them acting for all”. ( Hint: Refer
partnership act)
6.10 Summary
The articles of association of a company and its bye laws are regulations which govern the
management of its internal affairs and the conduct of its business.
Section 26 states that a public company limited by shares may register articles of association
signed by the subscribers to the memorandum.
Section 31 provides that subject to the provisions of the Act and to the conditions contained in
its memorandum, a company may, by special resolution alter or add to its articles.
The company altered its articles striking out the words “not fully paid up” and thus, gave
itself a lien on all shares whether fully paid up or not.
The doctrine of constructive notice throws a burden on people entering into contracts with
the company that they are presumed to have read the documents, though in fact, they
might not have read them.
6.11 Keywords
Alteration of Articles: Section 31 provides that subject to the provisions of the Act and to the
conditions contained in its memorandum, a company may, by special resolution alter or add to
its articles.
Article of Association: The articles of association of a company and its bye laws are regulations
which govern the management of its internal affairs and the conduct of its business.
Doctrine of Indoor Management: Doctrine of indoor management allows all those who deal
with the company to assume that the provisions of the articles have been observed by the
officers of the company.
84
1. What are articles of association? Enumerate some of the items included therein.
2. Discuss whether it is legally compulsory for a company to have its own articles of
association.
3. What restrictions should the articles provide to give a company the status of a private
company?
4. Distinguish between articles and memorandum.
5. Explain the procedure laid down in the Companies Act, 1956 to alter the articles of a
company.
6. Discuss the limits upon the powers of a company to alter its articles.
7. Discuss the binding effect of memorandum and articles, when registered, on the members
and outsiders.
8. Explain the doctrine of constructive notice. Are there any exceptions to the said doctrine?
9. Explain and illustrate the ‘Doctrine of Indoor Management’. What are the exceptions to
this rule?
10. Explain the rule laid down in the Royal British Bank vs. Turquand and state the exceptions
to the rule.
11. State the inter-relationship of Doctrine of Indoor Management with the Doctrine of
Constructive Notice.
12. Examine the legal effect of the articles. How far is a provision depriving the company of
the power to alter the articles valid?
1. Schedule I 2. Articles of Association

3. Memorandum of Association 4. Section 26
5. (a) 6. (c)
7. (b) 8. (a)
9. True 10. True
11. False 12. True

13. True
85
Company Law

www.webopedia.com
86
Unit 7: Prospectus
Unit 7: Prospectus
Introduction
Objectives

Define prospectus;
Know content of prospectus;
Describe information memorandum;
Explain abridged prospectus;

Explain statement in lieu of prospectus.
Introduction
Prospectus or statement in lieu of prospectus to be filed by private company on ceasing to be private

company. Every prospectus filed under sub-section (1) shall state the matters specified in Part I of
Schedule II and set out the reports specified in Part II of that Schedule, and the said PartsI and II
shall have effect subject to the provisions contained in Part III of that Schedule.
Every statement in lieu of prospectus filed under sub-section (1) shall be in the form and contain the
particulars set out in Part I of Schedule IV, and in the cases mentioned in Part II of the Schedule,
shall set out the reports specified therein, and the said Parts I and II shall have effect subject to the
provisions contained in Part III of that Schedule.
87
Company Law
7.1 Prospectus – Definition and Meaning
A prospectus, as per s.2 (36), means “any document described or issued as prospectus and includes
any notice, circular, advertisement or other document, inviting deposits from the public or inviting
offers from the public for the subscription or purchase of, any shares in or debentures of a body
corporate”. Thus, a prospectus is not merely an advertisement; it may be a circular or even a notice.
A document shall be called a prospectus if it satisfies two things:
1. It invites subscriptions to shares or debentures or invites deposits.
2. The aforesaid invitation is made to the public.
What constitutes an offer to the public?
The following criteria is laid down as to what shall constitute an offer to the public:
An invitation to the public, shall include an invitation to any section of the public, whether
selected as members or debenture holders of the company concerned, or as clients of the person
issuing the prospectus or in any other manner.
In Rattan Singh vs. Moga Transport Co. Ltd. (1959) 20 Comp. Cas. 165, the learned judge held
that, in all cases, the determination of the question of an offer being made to the public depends upon
the facts and language of the notice, and the particular circumstances of each case.
In Nash vs Lynde (1929, A.C. 1585), Justice Viscount Summer observed: “The ‘public’ is of course
a general word. No particular numbers are prescribed. Anything from two to infinity may serve;
perhaps even one, if he is intended to be the first of a series of subscribers, but makes further
proceeding needless by himself subscribing the whole. The point is that the offer is as such to
be open to anyone, who brings his money and applies in due form, whether the prospectus was
addressed to him on behalf of the company or not.”
In this context it is relevant to discuss the concept of deemed prospectus.
7.1.1 Prospectus by Implication (Deemed Prospectus)
Section 64 has been designed to check the bypassing of the provisions of s.56 as given above, by
making an offer of sale of shares or debentures through the medium of Issue Houses. The
process involves allotment of shares to an Issue House who, in turn, will issue advertisement
offering shares for sale. Since the advertisement is not issued by the company, it does not
amount to a prospectus and thereby liability of non-compliance of s.56 provisions cannot be
invoked. To check this malady, s.64 provides that all documents containing offer of shares or
debentures for sale shall be included within the definition of the term ‘prospectus’ and, shall be
deemed as prospectus by implication of law. All enactments and rules of law as to the contents
of prospectuses and as to the liability in respect of statements and omissions from prospectuses
shall apply in respect of such documents.
Further, s.64 provides that unless the contrary is proved, an allotment of, or an agreement to allot
shares or debentures shall be deemed to have been made with a view to the shares or debentures
being offered for sale to the public, if it is shown:
that the offer of the shares or debentures for sale to the public was made within 6 months after
the allotment or agreement to allot; or
that at the date when the offer was made, the whole consideration to be received by the
company in respect of the shares or debentures had not been received by it.
88
Unit 7: Prospectus
In case a document is deemed as prospectus, then it must contain the following information in
addition to the information required to be stated in prospectus under s.56:
1. The net amount of consideration received or to be received, by the company in respect of

the shares or debentures to which the offer relates; and
2. The place and time at which the contract under which the said shares or debentures have been
or are to be allotted may be inspected.
For purposes of registration of a prospectus under s.60, the persons making the offer of sale to
the public are to be deemed as directors of the company.
Where the person making the offer is a company or a firm, the documents (i.e., deemed prospectus)
must be signed by at least two directors or one-half of the partners as the case may be.
Circumstance under which a Document containing an offer for Sale of Shares or

Debentures be not deemed to be a Prospectus
Whether a document containing an offer for sale of shares or debentures is a prospectus or not,
depends upon whether it extends an invitation to the public to subscribe or not. The prima facie
test of ‘public offer’ or ‘public invitation’ is whether the terms of the offer or invitation are such
that despite its limited circulation, it is open to any person who so chooses to bring his money
and apply for shares in response to the invitation. If the offer or invitation is so open, then it
constitutes a ‘public offer’. If, on the other hand, an offer or invitation can be accepted only by the
person to whom it is made and none other, then it will not be deemed to be an offer or invitation
to the public.
The word ‘public’ includes any section of the public (s.67). It may, thus, include all registered
medical practitioners in Delhi, all advocates of High Court of Delhi, all Englishmen living in India.
What does not constitute an offer to the Public or Circumstances under which a
Document containing an offer for Sale of Shares or Debentures be not deemed to be
a Prospectus
However, in the following cases, the document inviting subscription to shares or debentures of
a company shall not be deemed as invitation to the public and hence, shall not be a prospectus:
A document issued by a company by way of invitation to existing members or debenture

holders, to subscribe to shares or debentures by way of ‘right’ is not a prospectus [s.56(5)].
An invitation shall not be an invitation to the public if it cannot be calculated to result,

directly or indirectly in the shares or debentures becoming available for subscription or
purchase by persons other than those receiving the invitation. Thus, it will not be an
invitation to public where A receives the invitation, but B who is a friend of A does not
receive the invitation but desires to subscribe, but the company does not accept his offer,
as he (B) was not invited to make the offer. It was A, and A only for whom the invitation
to subscribe to the shares was meant; no one else (whether B or not) could not have
responded to the invitation extended to A only. On the other hand, it will become an
invitation to the public where his (B’s) or anyone’s offer shall be accepted by the company.
Thus, offering of shares to a director of Kith and Kins is not an invitation to the public to
buy shares [Rattan Singh vs. Moga Transport Co. Ltd., supra].
89
Company Law
An offer to shareholders of an existing company (say ‘A’) of shares in a new company (say
‘B’) in exchange for existing shares of A, is not an offer to the public. (Government Stock
and Other Securities Investment Co. vs. Manila Rail CO. [1897] AC 81).
Where an invitation is made by the management of a company to selected persons for
subscription or purchase by the persons receiving the offer or invitation, the shares or
debentures and such invitation or offer is not calculated directly or indirectly to be availedof
by other persons, such invitation or offer shall not be deemed as prospectus [s.67(3)]. In
Nash vs. Lynd (1929) AC 158, a document marked ‘strictly confidential’ containing
particulars of a proposed issue of shares was sent by the managing director to a co-director
and through him passed on privately to a small circle of friends of the director. The House
of Lords held that it was not a prospectus, as there had been no issue to the public.
However, an invitation to subscribe to its shares by a company (other than a non-banking
finance company or a public financial institution) even though meant for subscription/purchase
only by those who receive it, shall be considered as invitation to public if it is made to fifty
persons or more. Thus, a private placement of its shares by such a company comes under the
purview of ‘public issue’ if invitation is made to fifty or more persons.
Self Assessment
Fill in the blanks:
1. A prospectus, as per ................................. , means any document described or issued as

prospectus and includes any notice, circular, advertisement.
2. The process involves .................................... to an Issue House who, in turn, will issue
advertisement offering shares for sale.
3. In case a document is deemed as prospectus, then it must contain the following information
in addition to the information required to be stated in prospectus ..................................
4. The word .................................includes any section of the public (s.67).
7.2 Contents of Prospectus
Section 56 lays down that the matters and reports stated in Schedule II to the Act must be
included in a prospectus. The format of a prospectus is divided into three parts.
In the first part, brief particulars are to be given about matters mentioned below:
1. General Information: Under this head, information is given about:
(i) Name and address of registered office of the company.
(ii) Name (s) of stock exchange (s) where application for listing is made.
(iii) Declaration about refund of the issue, if minimum subscription of 90 per cent is not
received within 90 days from closure of the issue.
(iv) Declaration about the issue of allotment letters/refunds within a period of 10 weeks
and, interest in case of any delay in refund, at the prescribed rate, under s.73.
(v) Date of opening of the issue.
(vi) Date of closing of the issue.
(vii) Name and address of auditors and lead managers.
90
Unit 7: Prospectus
(viii) Whether rating from CRISIL or any rating agency has been obtained for the proposed
debentures/preference shares issue. If no rating has been obtained, this should be answered
as ‘No’. However, if ‘Yes’, the rating should be indicated.
(ix) Names and addresses of the underwriters and the amount underwritten by them together
with declaration by the Board of directors that the underwriters have sufficient resources
to meet their respective obligations.
(x) Consent of the Central Government about the present issue as also particulars of letter of
intent/industrial licence making clear in the statement that the Central Government does
not undertake any responsibility for financial soundness or correctness of the statement(s).
(xi) Punishment if application for shares is made in a fictitious name (under s. 68A).
(xii) Names and addresses of trustees of the debenture trust deed, in case of issue of debentures.
Task A company issued a prospectus advertising that the company has a great Potential
with “turnover of a million bags of cement in a year”. It is discovered later that while the
company has the installed capacity of one million bags, it had never produced more than
6 lac bags of cement in a year. A buyer of shares seeks remedy against the misleading
statement. Would he succeed? [Hint: Yes, he would succeed.]
2. Capital Structure of the Company:
(i) Authorised, issued, subscribed or paid-up capital.
(ii) Size of the present issue, giving separately reservation for preferential allotment to
promoters and others.
3. Terms of the Present Issue:
(i) Terms of Payment.
(ii) How to apply i.e., making use of the application form, on the basis of study of
prospectus and mode of payment.
(iii) Any special tax benefits for the company and its shareholders.
(iv) Rights of the instrument holders, such as they will get dividends for the whole year
or for the period of holding only.
4. Particulars of the Issue:
(i) Object(s) of the issue.
(ii) Project cost.
(iii) Means of Financing (including contribution of promoters).
5. Company Management and Project:
(i) History and main objects and present business of the company, as also name and
address of subsidiary, if any.
(ii) Promoters and their background.
(iii) Location of the project.
(iv) Collaborations, if any, with details of any performance guarantee or assistance in
marketing.
(v) Nature of the product(s) export possibilities, export guarantee.
91
Company Law
(vi) Stock market data for shares/debentures of the company including high and low price
in each of the last three years and, monthly high and low during the last six months,
if applicable.
(vii) Names, addresses and occupation of managing directors, whole-time directors, other
directors including nominee directors and manager, mentioning any directorship
held in other company, in each case.
(viii) Plant and machinery, technology, process, etc.
(ix) Infrastructure facilities for raw materials and utility like water and electricity.
(x) Schedule of implementation of the project and the progress made so far, giving
relevant details like land acquisition, civil construction, installation of plant and
machinery, trial production, date of commercial production, etc.
(xi) Approach to marketing and proposed marketing setup.
(xii) Future prospects, expected capacity utilisation during the first three years from the
date of commencement of commercial production, and the expected year from which
the company would be earning cash profits and net profits.
Part II of Schedule II requires the company to give detailed information. This part is further sub-
divided into three parts viz., General Information, Financial Information and Statutory and Other
Information.
1. General Information: It shall include information on matters like:
(i) Consent of directors, auditors, solicitors, managers to the issue, registrars to the
issue, bankers of the company, bankers to the issue and experts. If an expert’s opinion
was obtained, the same should be given.
(ii) Change, if any, in directors and auditors during the last 3 years and reasons therefor.
(iii) Procedure and time schedule for allotment and issue of certificates.
(iv) Names and addresses of company secretary, legal advisor, lead managers, co-
managers, auditors and bankers to the issue and brokers to the issue.
(v) Authority for the issue and details of resolution passed therefor.
2. Financial Information: It includes:
(i) A report by the auditors of the company with respect to (a) its profits and losses
(distinguishing items of non-recurring nature), and assets and liabilities, and (b) the
rate of dividend paid by the company during the preceding five financial years.
If, however, no accounts have been made up in respect of any part of the period of
five years ending on a date three months before the issue of the prospectus, the
report shall contain a statement of that fact. If the company has subsidiaries, the
report shall, in addition, deal with either the combined profits and losses and assets
and liabilities of its subsidiaries or each of the subsidiary, so far as they concern the
members of the company.
(ii) A report by the accountants (who shall be qualified under the Act for the appointment
as auditor of a company and who shall be named in the prospectus) on the profits
and losses of the business for the preceding five financial years and on the assets and
liabilities of the business on a date which shall not be more than 120 days before the
date of the issue of the prospectus. This report is required to be given if the proceeds
of the issue of the shares or debentures are to be applied directly in the purchase of
any business.
92
Unit 7: Prospectus
A similar report on the accounts of a body corporate by an accountant (who shall be

named in the prospectus) if the proceeds of the issue are to be applied in the purchase
of shares of the body corporate so that, that body corporate becomes a subsidiary of the
acquiring company.
(iii) Principal terms of loans, and assets charged as security.
3. Statutory and Other Information: It includes information about:
(i) Minimum subscription.
(ii) Expenses of the issue i.e. fee payable to advisors, registrars to the issue, managers to the
issue and trustees for the debenture holders.
(iii) Underwriting commission and brokerage.
(iv) Previous issue for cash.
(v) Previous public or rights issue; if any, during the last five years, along-with prescribed
particulars.
(vi) Issue of shares otherwise than for cash.
(vii) Commission or brokerage on previous issues.
(viii) Revaluation of assets, if any, during the last five years.
(ix) Material contracts and, time and place where such documents may be inspected.
(x) Debentures and redeemable preference shares or other instruments issued but,
remaining outstanding on the date of the prospectus and terms of their issue.
(xi) Purchase of any property with prescribed details.
(a) Details of directors, proposed directors, whole-time directors, their

remuneration, appointment, remuneration and of manager or managing
director, interests of directors, their borrowing powers and qualification
shares.
Any amount or benefit paid or given within the preceding two years or
intended to be paid or given to any promoter or officer, and consideration for
payment of giving the benefit.
(b) Full particulars of the nature and extent of the interest, if any, of every director or
promoter.
(xii) Restrictions, if any, on transfer and transmission of shares/debentures, and on their

consolidation or splitting.
(xiii) Outstanding litigations relating to financial matters or criminal proceedings against

the company or directors under schedule XIII.
(xiv) Any material development subsequent to the date of the latest balance sheet and its
impact on performance and prospects of the company.
(xv) Management perception of risk factors (e.g. sensitivity to foreign exchange rate
fluctuations, difficulty in availability of raw materials or in marketing of products,
cost/time over-run, etc.).
Part III of the Schedule gives explanations of certain terms and expressions used under Part-I and
Part - II of the Schedule.
93
Company Law
It also requires a declaration that all relevant provisions of the Act and the guidelines issued by
the government have been complied with and nothing has been stated in the prospectus that is
contrary to the provisions of the Act. Further, in clause 19 it has been stated that a company
which has not been in existence for five years, then the period of actual life shall be substituted
for five years.
7.3 Shelf Prospectus and Information Memorandum
Section 60A makes provisions for a shelf-prospectus in certain situations. A ‘shelf-prospectus’

means “a prospectus issued by any financial institution or bank, for one or more issues of the
securities or class of securities specified in that prospectus”.
Any public financial institution, public sector bank or scheduled bank whose main object is
financing, shall file a shelf prospectus with the registrar before issue of securities. In such a
situation, such a company need not file a prospectus afresh at every stage of offer of securities by
it within a period of validity not exceeding one year.
But a company, filing a shelf prospectus is required to file an Information Memorandum (as
given in s. 60B below), on all material facts relating to new charges created, changes in the
financial position as have occurred between the first offer of securities and previous offer of
securities within such period as may be prescribed by the Central Government, prior to making
of a second or subsequent offer of securities under the shelf prospectus.
An information memorandum shall be issued to the public, along with shelf prospectus filed at
the stage of the first offer of securities and, such prospectus shall be valid for a period of one
year, from the date of opening of the first issue of securities.
Where an update of information memorandum is filed every time an offer of securities is made,
such memorandum together with the shelf prospectus shall constitute the prospectus.
Section 60B provides as follows as regards information memorandum:
A public company making an issue of securities may circulate information memorandum

to the public prior to filing of a prospectus.
A company inviting subscription by an information memorandum is bound to file a

prospectus, prior to the opening of the subscription lists and the offer as a red-herring
prospectus, at least three days before the opening of the offer.
The information memorandum and red-herring prospectus shall carry same obligations
as are applicable in the case of a prospectus.
Any variation between the information memorandum and the red-herring prospectus
shall be highlighted as variations by the issuing company.
Every variation as made and highlighted under (iv) is to be individually intimated to the
persons invited to subscribe to the issue of securities.
In the event of the issuing company or the underwriters to the issue who have invited or
received advance subscription by way of cash or post-dated cheques or stock-invest, the
company or such underwriters or bankers to the issue shall not encash such subscription
moneys or post-dated cheques or stock invests before the date of opening of the issue,
without having individually intimated the prospective subscribers of the variation and,
without having offered an opportunity to such prospective subscribers to withdraw their
application and cancel their post-dated cheques or stock-invest or return of subscription
paid.
94
Unit 7: Prospectus
The applicant or proposed subscriber can exercise his right to withdraw from the
application, on any intimation of variation within seven days from the date of such
intimation and, shall indicate such withdrawal in writing to the company and the
underwriters.
Any application for subscription, which is acted upon by the company or underwriters or
bankers to the issue, without having given enough information of any variations, or the
particulars of withdrawing the offer or an opportunity for cancelling the post-dated cheques
or stock-invest or stop payments for such payments shall be void. Further, the applicants
shall be entitled to receive a refund or return of its post-dated cheques or stock-invest or
subscription moneys on cancellation of its application, as if the said application had never
been made and, the applicants are entitled to receive back their original application and
interest at 15%, from the date of encashment till payment of realisation.
Upon the closing of the offer of securities, a final prospectus stating therein the total
capital raised, whether by way of debt or share capital and, the closing price of the securities
and any other details as were not complete in the red-herring prospectus, shall be filed in
the case of listed public company with SEBI and registrar and in any other case with the
registrar only.
Self Assessment
5. are required to file prior to making second and subsequent issue of

securities in case shelf prospectus are filed:
(a) Information memorandum (b) Information articles
(c) Form 13 (d) None of the above
6. Information memorandum + shelf prospectus together constitutes ............................
(a) Memorandum (b) Articles
(c) Prospectus (d) None of the above
7. Validity period of information memorandum is ..........................
(a) 1 year (b) 2 years
(c) 3 years d. 4 years
8. prospectus were issued in order to test the market before finalizing

issue size/ price.
(a) Deemed (b) Shelf
(c) Red herring (d) None of the above
9. If there is any variation in case of R.H.P ................................. days should be given for
withdrawal of application
(a) 1 (b) 3
(c) 5 (d) 7
10. In case of redherring prospectus, the refund is made with an interest @
(a) 12 (b) 13
(c) 15 (d) 16
95
Company Law
7.4 Red Herring Prospectus
The ‘red-herring’ prospectus means “a prospectus which does not have the complete particulars
on the price of the securities offered and the quantum of securities offered”.
Task X and Co., Ltd., intended to buy a rubber estate in Peru. Its prospectus contained extracts
from an expert’s report giving the number of rubber trees in the estate. The report was
inaccurate. Will any shareholder buying the shares of the company on the basis of the above
representation have any remedy against the company? Can the person authorizing the issue
of the prospectus escape from the liability?
7.5 Abridged Prospectus
Section 56(3) requires that no one shall issue any form of application for shares or debentures of
a company unless, the same is accompanied by a memorandum, (known as ‘Abridged Prospectus’)
containing such salient features of prospectus as may be prescribed. Thus, instead of appending
full prospectus, an ‘abridged prospectus’ need only be appended to the application form.
In order to provide for greater disclosure of information to prospective investors so as to enable
them to take an informed decision regarding investment in shares and debentures, Form 2-A
has been prescribed as a format of abridged prospectus. It is further required that the abridged
prospectus and the share application form should bear the same printed number and the two
should be separated by a perforated line. Accordingly, the investor may detach the application
form before submitting the same to the company or the designated bankers.
7.5.1 When ‘Abridged Prospectus’ is not Necessary
In the following circumstances, an ‘abridged prospectus’ containing the prescribed particulars

as per Form 2A, need not accompany the application forms:
In the case of a bona fide invitation to a person, to enter into an underwriting agreement
with respect to the shares or debentures.
When shares or debentures are not offered to the public.
Where offer is made only to existing members/debenture holders of the company by way
of rights, whether with or without the right of renunciation.
In the case of issue of shares or debentures which are, in all respects similar to those
previously issued and dealt in, and quoted on a recognised stock exchange.
Penalty: Non-compliance of the aforesaid provisions by any person shall attract punishment in
terms of fine which may extend to 5,000.
Besides, the omission from a prospectus of a matter required to be included by s.56, may give
rise to an action for damages, at the instance of a subscriber for share or debentures who has suffered
loss thereby. It should be noted that the Act does not say that directors shall be liable,but this
seems to be implied from s.56 (4).
Self Assessment
11. When there is a untrue statement in a prospectus who can sue

(a) Subscribed in primary market (b) Subscribed in secondary market
(c) Rights issue (d) None of the above
96
Unit 7: Prospectus
12. Definition of prospectus was given under which sec.
(a) 2 (30) (b) 2 (32)

(c) 2 (34) (d) 2 (36)
13. Which of the following are not required to issue prospectus?
(a) Private company (b) Incase of right issue

(c) Sweat equity issue (d) All the above
14. Which one of the following has a right to claim compensation for any loss due to
misstatement in prospectus
(a) Purchasing shares in Primary Market
(b) Secondary Market
(c) Subscribers to memo.
(d) All the above
7.6 Misstatements in Prospectus and their Consequences
According to s.65 (1): (a) A statement included in a prospectus shall be deemed to be untrue, if the
statement is misleading in the form and context in which it is included; and (b) Where the omission
from a prospectus of any matter is calculated to mislead, the prospectus shall be deemed in respect
of such omission, to be a prospectus in which an untrue statement is included. The expression
‘included’ with reference to a prospectus means, included in the prospectus itself or contained in
any report or memorandum appearing on the face thereof or by reference incorporated therein or
issued therewith.
Example: A company issued a prospectus. All the statements included therein were
literally true. One of the statements disclosed the rates of dividends paid for a number of years.
But dividends had been paid not out of trading profits but out of realised capital profits. This
material fact was not disclosed. Held: The prospectus was false in material particulars and Lord
Kylsant, the managing director and chairman, who knew that it was false, was held guilty of
fraud [Rex vs. Kylsant, (1932) 1 K. B. 442].
A person who has applied for shares in the company and, who has been allotted shares, has
certain remedies against the company and the persons issuing the prospectus. But a buyer of
shares in the open market or a subscriber to the memorandum has no such right. If, however, a
prospectus is issued with the object of inducing persons to buy shares in the open market, any
person who buys shares even in the open market on the basis of the statements made in it, has
a right of action if the statements are untrue or there is material omission from the prospectus.
A false statement or omission of material facts gives rise to civil as well as criminal liability.
7.7 Statement in Lieu of Prospectus
If a public company makes a private arrangement for raising its capital then it must file a
statement in lieu of prospectus with the Registrar, at least three days before any allotment of
shares or debentures can be made. Schedule III contains a model form of a Statement in Lieu of
Prospectus in pursuance of s.70; Schedule IV contains a model form of a Statement in Lieu of
Prospectus when a private company is converted into a public company in pursuance of s.44. If
allotment of shares or debenture is made without filing the Statement in lieu of Prospectus, the
97
Company Law
allottee may avoid it within two months after the statutory meeting, or where no such meeting
is to be held, within two months of the allotment. Contravention also renders the company and
every director liable to a fine up to 10,000.
A prospectus issued by a company contained a promise of subscription of a substantial amount
by some persons so as to induce the public to subscribe. The plaintiff who was allotted 10 shares
alleges material misrepresentation. Decide upon the case. [Hint: Those responsible for making such
a statement in the prospectus shall be held liable. See Ss.62, 63, 68 and 69 of the Companies Act,
1956.]
7.8 Underwriting Commission and Brokerage
In the event of the issuing company or the underwriters to the issue who have invited or received
advance subscription by way of cash or post-dated cheques or stock-invest, the company or such
underwriters or bankers to the issue shall not encash such subscription moneys or post-dated
cheques or stock invests before the date of opening of the issue, without having individually
intimated the prospective subscribers of the variation and, without having offered an opportunity
to such prospective subscribers to withdraw their application and cancel their post-dated cheques
or stock-invest or return of subscription paid.
The applicant or proposed subscriber can exercise his right to withdraw from the application, on any
intimation of variation within seven days from the date of such intimation and, shall indicate
such withdrawal in writing to the company and the underwriters.
Any application for subscription, which is acted upon by the company or underwriters or
bankers to the issue, without having given enough information of any variations, or the
particulars of withdrawing the offer or an opportunity for cancelling the post-dated cheques or
stock-invest or stop payments for such payments shall be void. Further, the applicants shall be
entitled to receive a refund or return of its post-dated cheques or stock-invest or subscription
moneys on cancellation of its application, as if the said application had never been made and, the
applicants are entitled to receive back their original application and interest at 15%, from the
date of encashment till payment of realisation.
Brokerage Contracts: In addition to underwriters, a company may also enter into brokerage
contracts with brokers. A broker is a person who undertakes to ‘place’ shares, i.e., find persons
who will buy shares, in consideration of an agreed brokerage and if he fails to place any of the
shares, he is not personally liable to take them, nor is he entitled to any brokerage in respect of
shares not placed. The underwriter, on the other hand, is bound to take up the shares, which the
public has not taken and is entitled to the whole of the agreed commission.
It may be noted that there must be authority in the articles to pay brokerage, and the brokerage
must be disclosed in the prospectus, or statement in lieu of prospectus, as the case may be and it
should pay a reasonable brokerage (s.76).
Self Assessment
15. A person can avoid the contract to purchase shares in the company even if he has purchased
shares in the open market and has not gone through the prospectus containing untrue
statements.
16. An allottee of shares can retain the shares and can sue the company for damages in case he
finds that the prospectus contained untrue statements.
98
Unit 7: Prospectus
17. A director can avoid liability for misstatements in the prospectus if he proves that he has
reasonable ground to believe that the statement alleged to be untrue is true.
18. An expert is not criminally liable in respect of misstatements in the prospectus.
19. Where a prospectus contains untrue statements, the persons who authorized its issue are
punishable with fine up to 5,000.
Case Study Contract Termination
I
n the recent decision of Olivaylle Pty Ltd v Flottweg GMBH & Co KGAA (No 4) (2009) 255
ALR 632, a single judge of the Federal Court held that a purported termination of a
contract for the sale of goods by the purchaser for an alleged breach of that contract
was invalid. The judge also made an important observation about the acceptance of
agreements in the age of email communications.
Briefly, the facts of the case are as follows. The director and controlling mind of Olivaylle
sought to establish a large olive grove and olive oil manufacturing plant in central western
Victoria. While waiting for the first stage of the grove to reach maturity, the director of
Olivaylle tendered for a number of international producers of equipment for the processing of
olives and, on 8th February 2005, entered into a written contract with Flottweg, a large
international manufacturer of such equipment. Prior to entering into the contract, Olivaylle
paid a deposit of approximately [euro] 140. It was a term of the contract that Flottweg
would guarantee that the equipment supplied would be in accordance with certain design
and quality specifications, and that Olivaylle would be entitled to exercise a right to a
reduction in the purchase price or a “withdrawal” from the contract on the expiry of a
“reasonable period of grace” after notice in writing of a failure to meet such specifications.
Such a notice was delivered on 21 st February 2006 alleging purported defects in the
production line process and requiring those defects to be remedied by 30 th June 2006,
failing which Olivaylle asserted that it would withdraw from the contract and demand the
return of its deposit. On the passing of 30th June 2006, Olivaylle did just that - to which
Flottweg took issue and proceedings were commenced.
Essentially, Olivaylle’s case was that the requisite “reasonable period of grace” had expired,
entitling it to terminate or “withdraw” from the contract. Further, in order to give business
efficacy to the contract, it was an implied term of the contract that Olivaylle was, upon its
withdrawal from the contract, entitled to its deposit back and was not required to make
any further payments under the contract.
Logan J also expressed the view (which in the end wasn’t necessary for his decision) that
the instantaneous communication rule applies when considering when and where the
acceptance of an offer by email occurs. His Honour suggested that he would employ an
analogy to telexes - the place where the message is received is where the contract is
accepted, rather than the postal acceptance rule which states that acceptance occurs at the
time and place where the letter was posted. In this case, Flottweg’s acceptance was
communicated by email (sent in Germany) to Olivaylle at its olive grove in Victoria. Thus,
if the Federal Court position in this regard is to be followed, it appears that a contract will
be deemed to be made, and therefore, the law that applies will be, where the email
acceptance was received.
Contd...
99
Company Law
Question
Is it right on the part of Olivaylle to nominate 30th June 2006 as the reasonable period of
grace? Why? (Hint: Refer para 2 in the case)
7.9 Summary
A prospectus, as per s.2 (36), means any document described or issued as prospectus and
includes any notice, circular, advertisement.
Section 64 has been designed to check the bypassing of the provisions of s.56 as given above,
by making an offer of sale of shares or debentures through the medium of Issue Houses.
Whether a document containing an offer for sale of shares or debentures is a prospectus or

not, depends upon whether it extends an invitation to the public to subscribe or not.
Section 56 lays down that the matters and reports stated in Schedule II to the Act must be
included in a prospectus.
Section 60A makes provisions for a shelf-prospectus in certain situations.
Section 56(3) requires that no one shall issue any form of application for shares or debentures
of a company unless, the same is accompanied by a memorandum, (known as ‘Abridged
Prospectus’).
7.10 Keywords
Abridge Prospectus: An ‘abridged prospectus’ need only be appended to the application form.
Prospectus: A prospectus, as per s.2 (36), means any document described or issued as prospectus
and includes any notice, circular, advertisement.
Red Herring Prospectus: The ‘red-herring’ prospectus means, a prospectus which does not have the
complete particulars on the price of the securities offered and the quantum of securities offered.
Shelf Prospectus: A ‘shelf-prospectus’ means, a prospectus issued by any financial institution or
bank, for one or more issues of the securities or class of securities specified in that prospectus.
1. Define a prospectus. Detail out its contents.
2. Explain the provisions of the Companies Act, 1956 with regard to the registration of a
prospectus of a public company going for public issue of equity shares. What are the
documents required to be submitted by the company to the Registrar for this purpose?
3. Explain the remedies available to an allottee who has subscribed for the shares on the faith
of a false and misleading prospectus.
4. Describe the defences available to a director in case of a suit against him for misstatements
made in the prospectus.
5. Enumerate cases in which a prospectus is not required to be issued by a public company.
6. State the consequences of non-disclosure of matters, which ought to be included in the

prospectus.
100
Unit 7: Prospectus
7. State the circumstances when the Registrar must refuse the registration of a prospectus.
8. Explain the nature and extent of liability of an expert in respect of a prospectus containing
a misstatement.
9. Explain the extent of civil and criminal liability for misstatements in the prospectus.
10. Who are liable for misstatements in a prospectus?
11. How does a prospectus differ from a statement in lieu of prospectus?
12. Explain the terms ‘underwriting’ and ‘underwriting commission’. State the conditions
which are to be fulfilled for the payment of underwriting commission.
1. s.2 (36) 2. allotment of shares

3. under s.56 4. ‘public’
5. (a) 6. (c)
7. (a) 8. (c)
9. (d) 10. (c)
11. (a) 12. (d)
13. (d) 14. (a)
15. False 16. False
17. False 18. True
19. False
M.C. Kucchal ( 2002), “ Business Law”, Vikas Publishing House Pvt. Ltd, Delhi.
P.C. Tulsian (2002), “ Business Law”, Tata Mc. Graw Hill Pvt. Ltd, Delhi.

www.webopedia.com
101
Company Law
Unit 8: Membership in a Company
CONTENTS
Objectives
Introduction
8.1 Member — Definition and Meaning
8.2 Member and Shareholder
8.3 Modes of Becoming Member
8.4 Who may become a Member
8.4.1 Minor
8.4.2 Company
8.4.3 A Partnership Firm
8.4.4 A Foreigner
8.4.5 President of India/Governor of a State
8.4.6 Society registered under the Societies Registration Act, 1860
8.4.7 Trade Union
8.5 Cessation of Membership
8.6 Rights of Members
8.7 Liability of Members
8.8 Register of Members (Sec. 150)
8.8.1 Index of Members
8.8.2 Rectification of Register of Members
8.9 Annual Return

8.10 Summary
8.11 Keywords
Objectives
Define member;
Describe shareholder;
Explain modes of becoming member;
Know partnership firm;

Describe cessation of membership.
102
Introduction
A firm may be a member of any association or company licensed under this section, but on the
dissolution of the firm, its membership of the association or company shall cease.
A licence may be granted by the Central Government under section 25 on such conditions and
subject to such regulations as it thinks fit, and those conditions and regulations shall be binding
on the body to which the licence is granted, and where the grant is under sub-section (1), shall,
if the Central Government so directs, be inserted in the memorandum, or in the articles, or partly
in the one and partly in the other.
It shall not be necessary for a body to which a licence is so granted to use the word “Limited” or
the words “Private Limited” as any part of its name and, unless its articles otherwise provide,
such body shall, if the Central Government by general or special order so directs and to the
extent specified in the direction, be exempt from such of the provisions of this Act as may be
specified therein.
8.1 Member — Definition and Meaning
Section 41 provides that:
1. The subscribers of the memorandum of a company shall be deemed to have agreed to

become members of the company and on its registration, shall be entered as members in
its register of members.
2. Every other person who agrees in writing to become a member of a company and whose
name is entered in its register of members, shall be a member of the company.
3. Every person holding equity share capital of a company, and whose name is entered as
beneficial owner in the records of the depository, shall be deemed to be a member of the
concerned company (vide Depository Act, 1996).
On this basis, there are two pre-requisites for a person to become a member of a company:
1. The agreement in writing to take shares of the company; and
2. The registration of his name in its register of members.
Besides, a person may also become a member of a company through the depository system.
Thus, a person can agree to take shares of a company either as the subscriber at the initial stage
of its formation or in any of the following manner:
1. By subscribing to its further or new shares;
2. On transfer of its shares from an existing member;
3. On acquisition or purchase of its shares (for example, take-over bid, renunciation of rights
shares by an existing member); and
4. On acquisition of its shares by devolution (for example, transmission of shares to legal

heirs of a deceased member, on insolvency, upon merger/amalgamation through court’s
order);
5. On conversion of convertible debentures or loans pursuant to the terms of issue of such
debenture or loan agreement respectively.
The fundamental difference between the subscribers who agree to take shares at the time of
formation of the company, and persons who agree to take shares later is that the former become
103
Company Law
members immediately on incorporation of the company, that is, they automatically become
members. The latter, though having agreed to take shares, become members only after their
names are registered in the register of members of the company.
8.2 Member and Shareholder
In the case of a company limited by shares, the persons whose names are put on the register of
members are the members of the company. They may also be called shareholders of the company
as they have been allotted shares and are holding them in their own right. In such a situation, the
terms ‘member’ and ‘shareholder’ are interchangeably used to mean the same person. In Srikanta
Data vs. Venkateshwara Real Estate Enterprises (P) Ltd. (1990) 68 Comp. Cas. 216 (Kar), it was
held that unless the context otherwise requires, the word ‘member’ under s.2(27) means a
‘shareholder’ excepting a person, who is a bearer of a share warrant of the company. But in the
case of an unlimited company or a company limited by guarantee, a member may not be a
shareholder, for such a company may not have a share capital. However, sometimes a distinction is
maintained between a member and a shareholder in the case of a company having a share
capital. In other words, as regards the same set of shares one person may be a member and
another be the shareholder of the company. This distinction arises in the following situations:
1. X is a member of a company limited by shares. His name is placed on the register of
members as he is holding shares in his own right and, therefore, whether we call him a
member or a shareholder, it is immaterial. In such a situation, the terms ‘member’ and
‘shareholder’ may be used interchangeably. Now, in the following three situations he will
cease to be a shareholder, though he continues to be the member of the company:
(i) On Sale: X sells the shares to Y. He fills in a share transfer form and hands it over to
Y. He also gives the share certificate representing the shares to Y. In return for sale
of shares, he receives consideration from Y. X is no longer a shareholder as he has
sold the shares and property in the shares has passed to Y. But the name of X continues
to be on the register of members till the transfer of shares is registered by the company
in favour of Y. Thus, a person who acquires the shares in the open market may be a
shareholder but he does not become the member immediately. It is only when his name
is entered in the register of members that he becomes a member of the company.
(ii) On Death: X dies and his property, including shares, is inherited by Y, his legal
representative. X is no longer the shareholder. He is not in existence to hold the shares.
Y is holding the shares in his own right and, therefore, can rightly be called the
shareholder. But X continues to be the member as his name still appears on the register
of members. However, as soon as Y gets his own name registered in the register of
members, then X will cease to be a member.
(iii) On Becoming Insolvent: X becomes insolvent and his property, including shares, vests
in the Official Receiver or Official Assignee. The Official Receiver or Assignee is
holding the shares in his own right. Therefore, X is no longer the shareholder,
though he continues to be the member of the company.
2. A person who is holding a share warrant is a shareholder but he is not a member of the
company as his name is struck off the register of members (s.115).
3. A person who subscribes to the memorandum of association immediately becomes a

member, even though no shares are allotted to him. Till shares are allotted to the subscriber,
he is a member but not a shareholder of the company.
104
4. In the case of a company limited by guarantee having no share capital or an unlimited

company having no share capital, there will be only ‘members’ but not ‘shareholders’.
Self Assessment
Fill in the blanks:
1. A ................................... may also become a member of a company through the depository

system.
2. A person can agree to take shares of a company either as the .......................... at the initial
stage of its formation.
3. In the case of a company limited by shares, the persons whose names are put on the
register of members, are ....................................
4. Sometimes a distinction is maintained between a member and a............................ in the

case of a company having a share capital.
8.3 Modes of Becoming Member
A person may become a member or a shareholder of a company by any of the following ways:
1. By Subscribing to the Memorandum of Association: The subscribers of the memorandum of

a company are deemed to have agreed to become members of the company only by reason
of their having signed the memorandum. A subscriber to the memorandum becomes a
member, the moment the company is registered and it is not necessary that their names
must have been entered in the register of members.
Further, by subscribing the memorandum every one of the subscribers is deemed to have
contracted to become a shareholder in respect of the shares he subscribed for.
Task M Company Limited issued 2,00,000 equity shares of 10 each. You are allotted 100
shares. Explain any ten rights you have as a member of the company.
2. By Agreement and Registration: Section 41(2) provides that, apart from the subscribers of
the memorandum, ‘every other person who agrees in writing to become a member and whose
name is entered in its register of members shall be a member of the company’. It follows
that except in the case of the subscribers to the memorandum, a person does not become a
member of the company until his name is duly recorded in the register of members.
Registration of the name of a person as a member of a company may arise:
(i) Upon application and allotment.
(ii) By transfer. The member may acquire shares from an existing member by sale, gift
or some other transaction.
(iii) By transmission. Here a person becomes a shareholder by transmission of shares to him

through death, lunacy or insolvency of the member of a company.
(iv) By estoppel. This arises when a person holds himself out as a member, or knowingly
allows his name to remain on the register, when he has actually parted with his
shares. In the event of winding up, he will be liable, like other genuine members, as
105
Company Law
a contributory. However, he may escape liability by applying for removal of his

name under s.155.
(v) By agreeing to purchase qualification shares. A person who signs and delivers to the
registrar a written undertaking, to take from the company and pay for qualification
shares, is in the same position as if he had subscribed to the memorandum for a similar
number. As such, he is also deemed to have become a member automatically on
incorporation of the company.
8.4 Who may become a Member
Subject to the provisions of law, the memorandum and the articles, any person sui juris can
become a member of a company. The position of certain persons in this regard is given below:
8.4.1 Minor
The position of a minor as a member of a company is as follows:
As a minor is wholly incompetent to enter into a contract [Mohiri Bibi vs. Dharmodas
Ghose, (1903) 30 Cal. 539 (P.C)], an agreement by a minor to take shares is void and hence, he
cannot be a member of a company.
If shares are allotted to a minor in response to his application and his name entered on the
register of members, in ignorance of the fact of minority, the company can repudiate the
allotment and remove his name from the register on coming to know of the minority of
the member. The company must repay all money received from him in respect of the
allotted shares.
The minor can also repudiate the allotment during his minority and he shall be returned
the amount he paid towards the allotment of shares.
If the name of the minor continues on the register of members and neither party repudiates
the allotment, the minor does not incur any liability on the shares during minority and he
cannot be held a contributory at the time of winding up [Fazalbhoy Jaffar vs. The Credit Bank
of India (1914) 39 Bom. 331].
If an application for shares is made by a father as guardian of his minor child and the company
registers the shares in the name of the child describing him as a minor, neither the minor
nor the guardian can be placed on the list of contributories at the time of winding up
[Palaniappa vs. Official Liquidator, Pasupati Bank Ltd., AIR 1942 Mad. 470 and 875].
If somehow the name of a minor appears on a register of members and in the meantime he
attains majority and if he does not want to continue to be a member, then he must repudiate
his liability on the shares on the grounds of minority. The company cannot take defence
on the principle of estoppel that, the minor had fraudulently misrepresented his age or,
had received dividends and other privileges as a member. However, if he had received
dividends and exercised his rights as a member of the company after attaining majority,
then he cannot repudiate his liability on shares.
In case of transfer of partly-paid shares to a minor, the company may refuse to register
him as a member. In case, the company, in ignorance of the minority, has permitted the
transfer, then the company may remove the name of the minor and replace it by that of
transferor, even though the latter may have been ignorant of the minority.
106
In case of fully paid shares, a minor’s name may be admitted in the register of members,
if he happens to acquire the same by way of transfer or transmission. In Devan Singh vs.
Minerva Films Ltd. (AIR 1956 Punjab 106), the court held that there is no legal bar to a
minor becoming a member of a company by acquiring shares (by way of transfer) provided
the shares are fully paid-up and no further obligation or liability is attached to them.
8.4.2 Company
A company, being an artificial person and a separate legal entity may become a member of
another company, if it is so authorised by its memorandum to purchase shares. This is, however,
subject to the provisions of s.42. Under this section, a subsidiary company cannot be member of
its holding company and any allotment or transfer of shares in a holding company to its
subsidiary, or even to a nominee for such subsidiary, is void, except that a subsidiary company
may:
Hold shares in the holding company in the capacity of a personal representative of a deceased
shareholder, or
Hold such shares as trustees, (except where the holding company or another subsidiary is
beneficially interested under the trust otherwise than merely by way of the holding
company’s business), or
Remain a member of its holding company, if it was a member before April 1, 1956, but
may not vote at meetings of a holding company or any class of its members.
As has been mentioned earlier, a company cannot purchase its own shares (s.77) and, therefore,
cannot become a member of itself. However, a company may acquire a beneficial interest in its
own shares, as by the exercise of its paramount lien on the shares of a member as security for
moneys owed by him to the company, or by forfeiture of shares for non-payment of calls.
8.4.3 A Partnership Firm
A partnership firm being an unincorporated association and therefore, not having a separate
legal entity distinct from the partners, cannot be registered as a member in the register of
members of a company. However, partners, either individually or in their joint names (as joint
members) may hold shares in a company as a part of the partnership property. But a partnership
firm may become a member of a company registered under s.25 of the Companies Act, 1956 (i.e.,
associations not for profit).
8.4.4 A Foreigner
As per the Law of Contract, a foreigner can enter into contracts and therefore, can purchase
shares in a company but this is subject to the provisions of Foreign Exchange Management Act,
1999 (FEMA).
When the country, of which the foreigner is resident, is at war with India, then the foreigner
becomes an alien enemy and therefore, his power of voting at company meetings and his right
to receive notices for meetings, etc., are suspended during the war-period.
8.4.5 President of India/Governor of a State
In the case of a government company, the shares can be held in the name of the President of
India/Governor of a State.
107
Company Law
8.4.6 Society registered under the Societies Registration Act, 1860
A society registered under the Societies Registration Act, 1860 is treated as a ‘person’ having a
separate legal entity distinct from the members constituting it. Therefore, such a society can become
member of a company under s.41 (2) of the Companies Act, 1956.
8.4.7 Trade Union
A trade union registered under the Trade Union Act 1926, is a body corporate and thus, can sue
and be sued, and can enter into contracts in its own name. Thus, a registered union can become
a member under s.41 of the Companies Act, 1956.
Task Mr. P who is a member of A Ltd., has been declared insolvent. However, his name
appears in the register of members of A Ltd. Can he attend the AGM of A Ltd., and receive
the 20 percent dividend declared by it? [Hint: He can attend the meeting and also receive
the dividend declared by the company. However, he has to hand over the dividend to the
official receiver or assignee.]
8.5 Cessation of Membership
A person may cease to be a member of a company when:
He transfers his shares to another person and the shares are registered in the name of the
transferee;
His shares are forfeited by the company for non-payment of calls;
He surrenders his shares to the company and the latter accepts the surrender;
His shares are sold by the company to enforce its lien and the buyer of these shares is
registered as a member;
He dies and his legal heir gets his own name registered in the register of members or sells
shares to a party who gets his name registered with the company;
He is adjudged insolvent and the official receiver/official assignee either transfers the
shares to a third party who gets registered as a member or disclaims shares;
He was holder of redeemable preference shares which have now been redeemed by the
company;
He rescinds the contract of membership on the ground of fraud or misrepresentation;
His shares are purchased either by another member of the company or by the company
itself by an order of a court under s.402;
He has got share warrants issued in exchange for share certificates of fully paid-up shares;
and
On the commencement of winding up (but he will be liable as a contributory and is also

entitled to a share in the surplus assets, if any).
As mentioned earlier, a company may be member of another company. In such a situation if the
shareholding company is being wound up, then the membership will come to an end if the
liquidator disclaims the shares.
108
8.6 Rights of Members
A member of a company has a number of rights vis-à-vis the company. These are conferred on
him either by the Act or, by the articles of the company. Some of the most important rights of a
member are:
To have the certificate of shares held ready for delivery to him within three months from
the date of allotment;
To have his name entered in the register of members if it had not been entered or has been
wrongly removed;
To transfer shares subject to the provisions of the Act and the articles;
To receive notices of meetings, to attend meetings and to vote thereat (either in person or
by proxy);
To inspect the register of members and register of debenture holders and get extracts
therefrom (s.163);
To obtain copies of memorandum and articles on request and payment of the prescribed
fees;
To have the first option to buy any new shares on a further issue of shares by the company
(s.81);
To participate in the election of directors and appointment of auditors;
To get a copy of the balance sheet and profit and loss account at least 21 days before the
annual general meeting;
To apply to the court to have any “variation of shareholders’ rights” set aside (s.106);
To nominate a person to whom his shares in the company shall vest in the event of his
death (s.109 A);
To obtain, on request, minutes of proceedings at general meetings (s.196);
To participate in the removal of directors by passing an ordinary resolution (s.284);
To petition to the court for prevention of mismanagement and oppression (s.399);
To petition to the court for an order of injunction restraining the directors from going
ahead with an ultra vires act;
To petition for compulsory winding up;
To participate in passing a special resolution for voluntary or compulsory winding up;
To participate in the surplus assets, if any, on the liquidation of the company.

To inspect the following registers: (a) of investments not held in company’s name (s. 49);
(b) of charges and copies of instruments creating charges (s. 144); (c) of members and index
thereof (s. 150 and s. 151); (d) of debenture holders and index thereof (s. 152); (e) of foreign
members (s. 158); (f) of contracts in which directors are interested (s. 301); (g) of directors
shareholdings (s. 307); of directors, managing director, manager, secretary (s. 303); of
loans and investments (s. 372A).
109
Company Law
8.7 Liability of Members
A member is also subject to certain liabilities and obligations either by the Act or by the articles.
Some of the important ones are:
If shares are not allotted for a consideration other than cash, then a member must pay the
whole nominal value of his shares in cash.
If a member is holding partly paid-up shares, and the company goes into liquidation, then
he becomes liable as contributory to pay, if called upon to do so, towards the assets of the
company (s.429).
A person may be included in the ‘B’ list of contributories, as a past member and required
to pay to the extent of the amount remaining unpaid on the shares, which he held within
one year prior to the commencement of winding up, if (i) on the commencement of winding
up, debts exist which were incurred while he was a member; and (ii) the contributories of the
‘A’ list (i.e., present members) are not able to satisfy the contribution required from them in
respect of their shares.
As mentioned earlier, the liability of members becomes unlimited and several, even in the
case of a limited liability company (s.45).
A member is bound to the company by all the covenants of the articles; e.g., a company
may have a paramount lien on a member’s shares for any amount due from him to the
company.
In the case of a company limited by guarantee, the member may be asked to contribute to
the extent of his guarantee at the time of winding up.
8.8 Register of Members (Sec. 150)
Section 150 read with s.168 requires every company to keep a register of members ordinarily at its
registered office. The register must contain the following particulars:
The name, address and occupation of each member;
The number of shares held by each member, distinguishing each share by its number and
amount paid-up;
The date of entry in the register;

The date on which a person ceased to be a member.
Where fully paid-up shares have been converted into stock, the fact that stock has been issued is
to be entered against the name of the member in the register of members.
It is the duty of the company to maintain the register of members. A company cannot take advantage
of its failure to maintain the prescribed register of members. Thus, in N. Satyaprasad Rao and
others vs. V.L.N Sastry & Others [(1988)64 Comp. Cas. 492], it was held that, where register
does not incorporate name of all shareholders as members, those shareholders who have been
issued share certificates can exercise their rights as members.
8.8.1 Index of Members
Section 151 requires every company with more than 50 members, to keep an index of names of
members, unless the register itself is in the form of an index. The index of members is required
to be kept at the same place as the register of members. The register of members is open to
110
inspection by members free of charge and by non-members on payment of one rupee for two
hours a day during business hours.
A company may close the register at any time, by giving seven days’ previous notice, by an
advertisement in a newspaper circulating in the district in which the registered office of the company
is situated. However, the aggregate number of days for which it can be closed in a year cannot exceed
45 days. Also, it cannot be closed for more than 30 days at a time.
Section 157 provides that a company with a share capital may, if authorised by its Articles, keep
in any country outside India a branch register of members resident there, called a Foreign
Register. The registrar must be informed of the place where this register is kept. The foreign
register is deemed part of the company’s principal register and must be maintained in the same
manner as the principal register.
Task The majority of the shareholders of a company passed a resolution to alter its
articles, and authorised the directors to require any shareholder to compulsorily transfer
shares of such shareholder competed with the company’s business. The plaintiff shareholder
who competed with the company’s business challenged the validity of the resolution.
Decide. [Hint: The resolution is valid; it being in the general interest of the company.]
8.8.2 Rectification of Register of Members
Section 111 provides for the rectification of the register of members by the CLB on an application by
any person aggrieved such as member, transferor, transferee, the company. The CLB may order
for rectification of the register: (i) where the name of any person is, without sufficient cause,
entered in or omitted from the register of members of a company; (ii) where default or unnecessary
delay occurs in entering on the register the fact that a person has ceased to be a member of the
company.
Where the CLB has ordered the rectification of the register, the rectification should be made and
notice of rectification must be filed with the Registrar within 30 days of the order of the CLB.
Self Assessment
5. Which of the given below members are not shareholders
(a) Minors (b) Insolvent

(c) Share warrant holders (d) All of the above
6. Which of the following is a right of the members of a company
(a) Right to have share (b) Right to Appoint Auditor

(c) Right to Appoint Director (d) All of the above
7. Which of the following is not a member of a company?
(a) Partnership firm (b) Foreigner

(c) Government (d) HUF
8. For quorum, the Joint holders will be collectively counted as how many members.
(a) 1 (b) 2
(c) 3 (d) 4
111
Company Law
8.9 Annual Return
Section 159 provides that every company having a share capital must prepare and file within
60 days from the date on which its annual general meeting is held, or if no annual general meeting
is held, from the date when the meeting ought to have been held, with the registrar an Annual Return
in accordance with Part I of Schedule V, which prescribes the contents as follows:
1. The address of the registered office of the company;
2. The name and address of the country where foreign register of members is kept;
3. A summary of share capital and debentures:
(i) The number of shares issued for cash;
(ii) The number of shares issued for consideration other than in cash;
(iii) The nominal amount of capital in respect of each class of shares;
(iv) The number of shares into which nominal capital is divided;
(v) The number of shares taken up to the last annual general meeting;
(vi) The amount called up;
(vii) The total amount of commission paid;
(viii) The discount allowed on any shares or debentures;
(ix) The shares forfeited and the amount paid-up thereon;
(x) The share warrants issued and surrendered.
4. The total indebtedness of the company in respect of all charges (including mortgages) which
are required to be registered with the registrar under s.125.
5. A list of present members and debenture-holders and also of past members who have ceased
to be members or debenture-holders since the date of the last annual general meeting, giving
full particulars of the number of shares or debentures held and details of transfer, if any.
6. A list of its directors, managing directors, and managers, past and present.
With a view to avoid repetition of cumbersome particulars, appended to the annual return in
Schedule V, it is provided that, where any of the five preceding returns has given full particulars as
to past and present members and the shares held and transferred by them, the return in question
may contain only such of the particulars as relate to, persons ceasing to be or becoming members
and, to shares transferred or to changes in the number of shares held since the date of one of
these returns.
Where any of the company’s shares are converted into stock, notice regarding which has been
given to the registrar, the list must state the amount of stock held by each member instead of
shares so converted previously held by him.
Signing of the annual return (s.161). The copy of the annual return to be filed with the registrar shall
be signed both by a director and by the manager or secretary of the company or wherethere
is no manager or secretary, by two directors of the company, one of whom shall be the managing
director where there is one.
In case of a company whose shares are listed on a recognised stock exchange, the copy of such
annual return shall also be signed by a secretary in whole-time practice.
112
If default is made in filing the annual return, the company and every officer in default is liable
to be fined up to 500 per day during the period of default.
Self Assessment

9. It is not mandatory for a company to maintain a register of members.
10. A register of members remain open for inspection by its members for at least two hours
every day except when the register is closed.
11. A company cannot close its register of members for more than 45 days in a year.
12. At any one time, the company cannot close its register of members for more than 30 days.
13. A company cannot transfer shares during the period when the register of members is
closed.
Case Study Client and Company Relations
Questions
1.
2.
8.10 Summary
Every other person who agrees in writing to become a member of a company and whose
name is entered in its register of members, shall be a member of the company.
113
Company Law
In the case of a company limited by shares, the persons whose names are put on the
register of members, are the members of the company.
A subscriber to the memorandum becomes a member, the moment the company is

registered and it is not necessary that their names must have been entered in the register
of members.
The minor can also repudiate the allotment during his minority and he shall be returned
the amount he paid towards the allotment of shares.
A company, being an artificial person and a separate legal entity may become a member
of another company, if it is so authorised by its memorandum to purchase shares.
8.11 Keywords
Company: A company, being an artificial person and a separate legal entity may become a
member of another company, if it is so authorised by its memorandum to purchase shares.
Member: Person who agrees in writing to become a member of a company and whose name is
entered in its register of members, shall be a member of the company.
Partnership Firm: A partnership firm being an unincorporated association and therefore, not
having a separate legal entity distinct from the partners, cannot be registered as a member in the
register of members of a company.
Shareholders: Members may also be called shareholders of the company as they have been
allotted shares and are holding them in their own right.
Trade Union: A trade union registered under the Trade Union Act 1926, is a body corporate and
thus, can sue and be sued, and can enter into contracts in its own name.
1. Define the term ‘members’.
2. Explain the ways of acquiring membership in a company.
3. Under what circumstances does a person cease to be a member of a company?
4. State the provisions of the Companies Act, 1956 relating to maintenance of the register of
members and Index of Members of a company.
5. To what extent is it possible for a minor to become a member of a company, under the
provisions of the Companies Act, 1956? Explain.
6. What is the reporting obligation of the shareholder in case he is not the beneficial owner
of the shares (BENAMI shareholding)?
7. What are the particulars entered in the register of members? How many years should the
register of members be preserved?
8. Comment on the following statements:
(i) In a company, all shareholders are members but all members need not be shareholders.
(ii) Every shareholder of a company is known as a member, while every member may
not be known as a shareholder.
(iii) A minor cannot become member of a company.
114
9. Distinguish between:
(i) A member and a shareholder in a company.
(ii) Forfeiture and surrender of shares.
10. Write with reasons whether the following can become members of a company:
(i) Minor
(ii) Foreigner
(iii) A company.
1. person 2. subscriber
3. the members of the company 4. shareholder
5. (d) 6. (d)
7. (a) 8. (a)
9. False 10. True
11. True 12. True

13. True
Taxmann’s, New Delhi
Avtar Singh, Company Law, Eastern Publishers
Begrail, Ashok K, Company Law, Vikas Publishing House, Delhi
Kapoor, N.D, Company Law, Sultan Chand & Sons, New Delhi
M.C. Kucchal ( 2002), “ Business Law”, Vikas Publishing House Pvt. Ltd, Delhi
P.C. Tulsian (2002), “ Business Law”, Tata Mc.Graw Hill Pvt. Ltd, Delhi
S S. Gulshan, Business Law, Excel Books, New Delhi, 2006

www.webopedia.com
115
Company Law
Unit 9: Share and Share Capital
CONTENTS
Objectives
Introduction
9.1 Shares
9.1.1 Share vs. Share Certificate
9.1.2 Share vs. Stock
9.2 Kinds of Shares
9.2.1 Preference Share
9.2.2 Participating and Non-participating Shares
9.2.3 Cumulative and Non-cumulative Preference Shares
9.2.4 Redeemable and Irredeemable Shares
9.2.5 Irredeemable Preference Shares
9.2.6 Equity Share
9.2.7 Cumulative Convertible Preference Shares (CCPS)
9.2.8 Deferred or Founders’ Shares
9.2.9 Non-voting Shares
9.2.10 Sweat Equity Shares
9.2.11 Bonus Shares
9.3 Alteration of Capital
9.3.1 Why alteration is required?
9.3.2 How it is done?

9.4 Share Capital
9.4.1 Alteration of Share Capital
9.5 Reduction of Share Capital
9.5.1 Procedure for Reduction of Capital
9.5.2 Reduction of Share Capital without the Sanction of the Court
9.5.3 Reduction of Capital vs. Diminution of Capital
9.6 Reorganisation of Capital
9.6.1 Issue of Shares to existing Shareholders
9.6.2 Public Issue of Shares
9.7 Voting Rights
9.8 Rights Shares
Contd...
116
9.9 Summary
9.10 Keywords
Objectives
Define shares;
Explain the various kinds of shares;
Describe the equity share;

Know the share capital;
Describe share capital alteration;
Know reduction of share capital.
Introduction
In the case of an unlimited company, the articles shall state the number of members with which
the company is to be registered and, if the company has a share capital, the amount of share capital
with which the Company is to be registered.
In the case of a company limited by guarantee, the articles shall state the number of members with
which the company is to be registered.
In the case of a private company having a share capital, the articles shall contain provisions relating
to the matters specified in sub-clauses (a), (b) and (c) of clause (iii) of sub-section (1) of section 3;
and in the case of any other private company, the articles shall contain provisions relating to the
matters specified in the said sub-clauses (b) and (c). [S. 27]
9.1 Shares
Section 2(46) defines a share as “a share in the share capital of a company and includes stock
except where a distinction between stock and share is expressed or implied”.
This definition does not bring out the meaning of a share in its true perspective.
A share signifies the following:
The interest of a shareholder in the company; the right to receive dividend, attend meetings,
vote at the meeting and share in the surplus assets of the company, if any, in the event of
the company being wound up [Bacha F. Guzdar vs. Commissioner of Income Tax, Bombay,
L. R. 617 SC];
The liability of the shareholder in the company to pay calls on shares until fully paid up;
The right of the shareholder to transfer the shares subject to the articles of association (For
this purpose s.82 classifies shares as movable property, transferable in the manner provided
in the articles);
Binding covenants on the part of the company as well as the shareholder, as given in the
articles of the company.
117
Company Law
Thus, a share of a company in the hands of a shareholder signifies a bundle of rights and
obligations [Viswanath vs. East India Distilleries (1957) 27 Comp. Cas. 175]. But a share is not a
negotiable instrument. [C.I.T. vs. Associated Industrial Dev. Co. (1969) 2 Comp. L.J. 19]
Section 83 requires that each share in a company having a share capital must be distinguished by its
distinctive number.
[The Companies (Amendment) Act, 1999 amended s.82 to the effect that for the word ‘shares’, the
words ‘shares and debentures’ shall be substituted.]
9.1.1 Share vs. Share Certificate
A common man uses ‘share’ and ‘share certificate’ to mean the same. It is, therefore, important to
note the exact differences between the two. Section 82, in this regard describes a share as “a
movable property, transferable in the manner provided by the articles of the company”. Section
84, on the other hand, describes a ‘share certificate’ to mean “a certificate, under the common seal of
the company, specifying any shares held by any member”. Section 84 further suggests that a share
certificate shall be prima facie evidence of title of the member to such shares. Thus, whereas ‘share’
represents property, ‘share certificate’ is an evidence of the title of the member to such property.
Each share bears a distinctive number and it is not the same as share certificate number, the two are
different. In fact, a share certificate may be an evidence of many shares, say 50, 100 or even 1
lakh. Thus, whereas there will be only one number as the share certificate number for one certificate,
there will be as many distinctive numbers in respect of shares as are evidenced by the share
certificate.
Thus, the share certificate, being prima facie evidence of title, it gives the shareholder the facility
of dealing more easily with his shares in the market. It enables him to sell his shares by showing
at once marketable title.
Also, a share certificate serves as an estoppel, as to payment against a bona fide purchaser of the
shares from alleging that, the amount stated as being paid on shares has not been paid. However,
a person who knows that, statements in a certificate are not true, cannot claim an estoppel against
the company.
9.1.2 Share vs. Stock
The share capital of a company is divided into a number of indivisible units of specified amount.
Each of such unit is called a ‘share’. Thus, if the share capital of the company is 5,00,000 divided into
50,000 units of 10 each, unit of 10 shall be called a share of the company.
The term ‘stock’ may be defined as the aggregate of fully paid-up shares of a member merged
into one fund of equal value. It is a set of shares put together in a bundle. The ‘stock’ is expressed
in terms of money and not as so many shares. Stock can be divided into fractions of any amount
and such fractions may be transferred like share. Such fractions, unlike the shares, bear no
distinctive numbers.
A company cannot make an original issue of the stock. A company limited by shares may, if
authorised by its articles by a resolution passed in the general meeting, convert all or any of its
fully paid-up shares into stock [s.94 (1) (c)]. On conversion into stock, the register of members
must show the amount of stock held by each member instead of the number of shares. The
conversion does not affect the rights of the members in any way.
118
The main difference between shares and stocks are:
Share Stock
1. A share has a nominal value. A stock has no nominal value.
2. A share has a distinctive number that A stock bears no such number.
distinguishes it from other shares. (Except
where it is held under Depository mode.)
3. Shares can be issued originally to the A company cannot make an original issue
public. of stock. Stock can be issued by existing
company by converting its fully paid-up
shares.
4. A share may either be fully paid-up or A stock can never be partly paid-up. It is
partly paid-up. always fully paid-up.
5. A share cannot be transferred in fractions. A stock may be transferred in any
It is transferred as a whole. fractions.
6. All the shares are of equal denomination. Stock may be of different denominations.
7. Shares can be i ssued by any company, Stock can be issued only by a public
public or private. company limited by shares.
Self Assessment
Fill in the blanks:
1. Share is define in section ...................................
2. Section 83 requires that each share in a company having a share capital must be distinguished
by its ......................................
3. A common man uses ‘share’ and ‘share certificate’ to mean the ...............................
4. The share capital of a company is divided into a number of indivisible units of specified
amount. Each of such unit is called a ..............................
5. The term ................................may be defined as the aggregate of fully paid-up shares of a

member merged into one fund of equal value.
9.2 Kinds of Shares
As mentioned above, a share carries certain rights and is subject to some obligations. A company
may issue all shares with same rights and obligations. However, it may issue different types of
shares with different rights and liabilities attached to them so as to satisfy the needs of different
types of investors. In such a case, the rights attached to the different classes of shares are called
“class rights”. The class rights normally relate to voting, dividends, return of capital or share in
the surplus assets of the company (the last two rights being available at the time of winding up)
and are invariably set out in the articles of the company.
The most common classes of shares are:
1. Preference;
2. Equity or Ordinary;
3. Deferred or Founders’.
119
Company Law
A public company and a private company which is a subsidiary of a public company may not
issue shares other than equity, preference and Cumulative Convertible Preference Shares (CCPS).
Further, SEBI has allowed companies to issue other financial instruments subject to its guidelines.
Consequently, many companies have issued to their promoters and directors convertible
warrants which can be converted into shares by them at their convenience at any time within 18
months from the date of their issue.
9.2.1 Preference Share
A preference share is one which carries the following two rights, over holders of equity shares:
1. A preferential right in respect of dividends at a fixed amount or at a fixed rate,
2. A preferential right in regard to repayment of capital on winding up.
The preference or priority of the preference shareholders is in relation to the rights of equity
shareholders [s.85].
9.2.2 Participating and Non-participating Shares
If a preference share carries either one or both of the following rights then it is known as a
participating share:
1. To participate further in the profits either along with, or after payment of a certain rate of
dividends on equity shares,
2. To participate in the surplus assets at the time of winding up [s.85].
Thus, if a preference share does not carry either of these rights, then it will be known as a non-
participating share. It should be remembered that, preference shares are always presumed to be
non-participating unless, expressly described as participating.
9.2.3 Cumulative and Non-cumulative Preference Shares
If a preference share carries the right for payment of arrears of dividend from future profits, then
such a share is known as cumulative preference share. Thus, dividends not paid in any year or
years accumulate and are paid out whenever profits are available.
If a preference share does not carry the right to dividend in arrears, then such a preference share
is known as non-cumulative or simple share. Thus, if no profits are available in a year, the
holders get nothing nor can they claim unpaid dividend in subsequent years. It should be
remembered that preference shares are always presumed to be cumulative unless expressly
described as non-cumulative.
9.2.4 Redeemable and Irredeemable Shares
A preference share which can be redeemed upon the resolution of the board of directors, if the
articles so provide, is known as redeemable preference share (s.80). A company can issue
redeemable preference shares if it complies with the following requirements:
1. Such shares are to be issued as redeemable preference shares; shares issued earlier cannot be
converted into redeemable preference shares;
2. There must be authority in the articles to issue redeemable preference shares;
3. The shares can be redeemed only when they are fully paid up;
120
4. The shares may only be redeemed: (a) out of profits of the company which would otherwise
be available for dividend, or (b) out of the proceeds of a new issue of shares - not necessarily
of redeemable preference shares made for the purpose of redemption;
5. If there is a premium payable on redemption, it must have been provided out of profits or
out of the securities premium account before the shares are redeemed;
6. Where the shares are redeemed out of profits, a sum equal to the nominal amount of the
shares redeemed is to be transferred out of profits to the “Capital Redemption Reserve
Account.”
The redeemable preference shares can be redeemed by the company either at a fixed date, or
after a certain period of time, or at the option of the company. But redemption of such shares
shall not be taken as reducing the nominal capital of the company.
9.2.5 Irredeemable Preference Shares
No company limited by shares can issue any preference shares which are irredeemable or are
redeemable after the expiry of ten years from the date of issue. Also, once the company hasredeemed
the shares, or it is about to redeem them, it may issue new shares up to the same nominal
amount and it will be presumed that the preference shares were never redeemed. In such a
situation, the company’s capital is not deemed to be increased and, therefore, no stamp duty is to be
paid. This privilege is available only if the redemption takes place within one month after the
making of the fresh issue [s.80 (4)].
Non-compliance with the provisions of s.80 will render the company and every officer of the
company who is in default liable to a fine up to 10,000.
9.2.6 Equity Share
‘Equity share’ means a share which is not a preference share (s.85). The rate of dividend is not
fixed. The Board of directors recommends the rate of dividend which is then declared by the
members at the AGM. Before recommending dividend on equity shares, the BOD have to comply
with the provisions of law as regards depreciation, transfer of a minimum amount to reserves,
etc.
The holders of equity shares have voting rights in proportion to the paid-up equity capital of the
company [s.87(1)].
The Companies (Amendment) Act, 2000, substituted a new section for s.86. It provides that the
share capital of a company limited by shares shall be of two kinds only, namely:
1. Equity Share Capital
(i) With voting rights or
(ii) With differential rights as to dividend, voting or otherwise in accordance with such
rules and subject to such conditions as may be prescribed; and
2. Preference Share Capital.
Prior to the amendment to the Companies Act in 2000, public companies were not allowed to
issue equity shares with differential rights.
Thus, companies are now allowed to issue non-voting equity shares. However, these shares can
be issued subject to the rules and conditions prescribed by the Department of Companies Affairs.
121
Company Law
The Department of Companies Affairs has notified the rules, “The Companies (Issue of Share
Capital with Differential Voting Rights) Rules, 2001” which, inter alia, provide for the following:
1. Share with differential voting rights, including non-voting shares, cannot exceed 25 per
cent of the total issued share capital.
2. The company issuing such shares must have distributable profits in the three years
preceding such issues.
3. Companies will not be allowed to convert its equity capital with regular voting rights
into shares with differential voting rights and vice versa.
4. Issue of such shares must be approved by the shareholders by way of a resolution in a

general meeting:
The notice of the general meeting to shareholders shall carry an explanatory statement
detailing, inter alia, the following:
(i) Voting rights which shares with differential rights will carry;
(ii) Scale or proportion to which the voting rights of such shares will vary;
(iii) That the members holding equity shares with differential rights will be entitled to
bonus and rights shares of the same class.
5. Listed companies must obtain the shareholders’ approval through postal ballot.
6. Companies which have defaulted in filing annual returns during the preceding three years
or have failed to repay their deposits or interest thereon on due date or redeem
debentures on due date or pay dividend after becoming due, will not be eligible to issue
shares with differential rights.
7. Companies which have defaulted in addressing investors’ grievances will not be allowed
to issue such shares.
8. Issue of such shares must be authorized by articles of the company.
9. The company should not have been convicted of any offence under SEBI Act, 1992, Securities
Contract (Regulation) Act, 1956 and FEMA, 1999.
10. Members holding equity shares with differential rights shall be entitled to bonus and
rights issue of the same class.
The holders of equity shares carrying voting rights shall have voting rights in proportion to the
paid-up equity capital of the company, in case the voting is by poll [s.87(1)].
Rights/Powers of Equity Shareholders
In particular, the equity shareholders have the following rights/powers:
He can ask for a copy of memorandum and articles (s.39).

He is entitled to receive offer to subscribe to further issue of capital on rights basis (s.81).
The shareholders holding not less than 10 per cent of the issued shares, having not consented
to in favour of resolution for variation of rights may apply to the court for cancellation of the
variation of the rights of shareholders (s.107).
He has a right to apply to the CLB for rectification of register of members (s.111).
He has a right to inspect documents and registers to be kept by the company and ask
extracts therefrom (s.163).
122
He can apply to the CLB to call AGM if default is made in calling the same by a company
(s.167).
A corporate body, being member of a company, can appoint a representative to attend

general meeting of the company (s.187).
He has a right to inspect minutes of general meetings and ask for extracts therefrom
(s.196).
He is entitled to receive fully paid-up bonus shares as and when issued (s.205).
A shareholder, also being a director, can inspect books of account of the company during
business hours (s.209).
He is entitled to have copies of account and auditor’s report or statement of salient features
(s.219).
Two hundred shareholders or shareholders having one-tenth voting power may ask the
Central Government for investigation of the affairs of the company (s.235).
He can send a notice to the company signifying his candidature or that of any other person
to the office of director to be elected at the AGM (s.257).
He can give a special notice of a resolution for removal of a director (s.284).
Shareholders having substantial holding can present the case to CLB for removal of any
incompetent managerial personnel. The Central Government has the power to remove
managerial personnel on recommendation of the CLB (s.388).
He can apply to the CLB for relief in case of oppression or mismanagement of the affairs
of the company (s.397 and s. 398).
He can complain for the non-compliance of any of the provisions of the Companies Act,
1956, to the registrar and CLB.
9.2.7 Cumulative Convertible Preference Shares (CCPS)
The Government vide its guidelines dated 19th August, 1985 permitted issue of another class of
shares by public limited companies, called cumulative convertible preference shares.
The guidelines issued by the Ministry of Finance in this regard are as follows:
1. Applicability: The guidelines will apply to the issue of CCPS by public limited companies
which propose to raise finance.
2. Objects of the Issue: The objects of the issue of the above instrument should be for any of
the following purposes: (a) Setting-up of new projects; (b) Expansion or diversification of
existing projects; (c) Normal capital expenditure for modernisation; and (d) Working capital
requirements.
3. Quantum of Issue: The amount of CCPS cannot exceed the equity shares offered to the
public for subscription. However, in case of projects assisted by financial institutions, the
quantum of issue would be approved by the financial institutions/banks.
4. Terms of Issue: Following are the terms of issue of CCPS:
(i) CCPSs would be deemed to be equity issue for the purpose of calculation of debt
equity ratio as may be applicable.
(ii) The entire issue of CCPSs would be convertible into equity shares between the end
of 3 years and 5 years as may be decided by the company and approved by SEBI.
123
Company Law
(iii) The conversion of the CCP shares into equity would be deemed as being one resulting from
the process of redemption of the preference shares out of the proceeds of a fresh
issue of shares made for the purposes of redemption.
(iv) The rate of preference dividend payable on CCP shares would be 10%.
(v) The guidelines in respect of preference shares regarding ratio of 1:3 as between
preference shares and equity shares would not be applicable to this new instrument.
(vi) On conversion of the preference shares into equity shares, the right to receive arrears
of the dividend, if any, on the preference shares up to the date of conversion shall
devolve on the holder of the equity shares on such conversion. The holder of the
equity shares shall be entitled to receive the arrears of dividend as and when the
company makes profit and is able to declare such dividend.
(vii) The aforesaid CCP share would have voting rights as applicable to preference share
under the Companies Act.
(viii) The conversion of aforesaid preference shares into equity shares would be compulsory
at the end of 5 years; and the aforesaid preference shares would not be redeemable
at any stage.
5. Denomination: The face value of CCP share will ordinarily be 100 each.
6. Listing: CCP shares shall be listed on one or more stock exchange in the country.
7. Articles of Association of the Company and Resolution of the General Body: The articles
of association of the company proposing to issue CCPSs should contain a provision for
issue of such shares. Further, the company must submit with the application to SEBI a
certified copy of a special resolution in this regard under s.81 (1A) of the Companies Act,
duly passed in the general meeting of the company. This resolution must approve the issue
of CCP shares and provide for compulsory conversion of the preference shares between
the 3rd to 5th year, as the case may be.
Task A buys from B 400 shares in a company on the faith of a share certificate issued by
the company. A tenders to the company a transfer deed duly executed together with B’s
share certificate. The company discovers that the certificate in the name of B has been
fraudulently obtained and refuses to register the transfer. Advise A. [Hint: A has a right to
be registered as a shareholder or receive compensation from the company to the extent of
the value of the shares at the time of refusal to register the transfer as a share certificate
works as an estoppel against the company.
9.2.8 Deferred or Founders’ Shares
A pure private company can issue shares of a type other than those discussed above (s.90). Thus,
it may issue what are known as deferred shares. As deferred shares are normally held by
promoters and directors of the company, they are usually called founders’ shares. They are
usually of a smaller denomination, say one rupee each. However, they are generally given equal
voting rights with equity shares, which may be of higher denomination, say 10 each. As
regards payment of dividend to holders of such shares, the articles usually provide that these
shares will carry a dividend fixed in relation to the profits available after dividends have been
declared on the preference and equity shares. Thus, the promoters, founders and directors have
a very direct interest in the success of such a company: the greater the profits of the company, the
higher their dividends.
124
It is to be remembered, however, that as and when the private company converts itself into a
public company, it will have to alter its capital structure and retain only equity share capital and
preference share capital (including CCPs), if any.
9.2.9 Non-voting Shares
‘Non-voting shares’ as the term suggests, are shares which carry no voting rights. These are
contemplated as altogether a different class of shares which may carry additional dividends in
lieu of the voting rights. The Companies (Amendment) Act, 2000 provided for issue of such type
of equity shares under s.86.
9.2.10 Sweat Equity Shares
The Companies (Amendment) Act, 1999, allowed issue of sweat equity shares subject to fulfillment
of certain conditions. A new Section - 79A was inserted for this purpose. The provisions are:
Notwithstanding anything contained in s.79, a company may issue sweat equity shares of a
class of shares already issued if the following conditions are satisfied: (a) the issue of sweat
equity shares is authorised by a special resolution passed by the company in the general meeting;
(b) the resolution specifies the number of shares, current market price, consideration, if any, and the
class or classes of directors or employees to whom such equity shares are to be issued; (c) atleast
one year has, at the date of the issue, elapsed since the date on which the company was entitled
to commence business; (d) the sweat equity shares of a company whose equity shares are listed
on a recognised stock exchange are issued in accordance with the regulations of SEBI.In case of
a company whose shares are not listed on any recognised stock exchange, the sweat equity
shares may be issued in accordance with the guidelines as may be prescribed. For purposes of this
section, the expression ‘a company’ means company incorporated, formed and registered under this
Act and includes its subsidiary company incorporated in a country outside India.
The expression “sweat equity shares” means equity shares issued by the company to employees
or directors at a discount or for consideration other than cash for providing know-how or
making available rights in the nature of intellectual property rights or value additions, by
whatever name called.
However, all the limitations, restrictions and provisions relating to equity shares shall be
applicable to such sweat equity shares.
9.2.11 Bonus Shares
A company may, if the articles so provide, capitalise profits by issuing fully paid-up shares to
the members thereby transferring, the sums capitalised from the profit and loss account or
Reserve Account to the Share Capital [s.205 (3)]. Such shares are known as bonus shares and are
issued to the existing members of the company free of charge.
The issue of bonus shares is regulated, not only by the Companies Act, 1956 but also by the
guidelines issued by SEBI in this regard.
SEBI guidelines for the issue of Bonus shares, 2000 provide as follows:
No bonus issue shall be made within 12 months of any public/right issue.
The bonus issue shall only be made out of free reserves built out of the genuine profits or
share premium collected in cash only.
The reserves created by revaluation of fixed assets cannot be capitalised.
125
Company Law
The declaration of bonus issue, in lieu of dividend, cannot be made.
The bonus issue is not made unless the partly-paid share, if any, existing, are made fully
paid up.
The company (a) has not defaulted in payment of interest or principal in respect of fixed
deposits, and interest on existing debentures or principal or redemption thereof, and
(b) has sufficient reason to believe that it has not defaulted in respect of the payment of
statutory dues of the employees such as contribution to provident fund, gratuity, bonus,
etc.
A company which announces its bonus issue after the approval of the BOD must implement
the proposals within a period of 6 months from the date of such approval and shall not
have the option of changing the decision.
There should be a provision in the articles of the company for capitalisation of reserves;
etc. and, if not, the company shall pass a resolution at its general body meeting making
provisions in its articles for capitalisation of reserves, etc.
Consequent to the issue of bonus shares if the subscribed and paid-up capital exceed the
authorised share capital, a resolution shall be passed by the company at its general body
meeting for increasing the authorised share capital.
No company shall, pending conversion of FCDs/PCDs, issue any shares by way of bonus, unless
similar benefit is extended to the holders of such FCDs/PCDs. Through reservation of shares
in proportion to such convertible part of FCDs/PCDs. The shares so reservedmay be issued
at the time of conversion of such debentures on the same terms on whichthe bonus issues
were made.
Self Assessment
6. Consider the following functions of a stock exchange:
(i) Providing a ready market for securities
(ii) Helping capital formation
(iii) Regulating the capital structure of a company
(iv) Regulating the public deposits with companies
Of the above functions:

(a) (i), (ii), (iii) and (iv) are correct (b) (i), (ii), and (iii) are correct
(c) (i) and (ii) are correct (d) none is correct
List-I List-II
A. Minimum issued capital for being listed 1. One crore
on a stock exchange
B. Exemption from the consent of controller 2. Three crores
of capital issues for issue of shares
C. Amount payable on shares to be called 3. Issued capital of less than 3
only in installments and not in one stroke crores
D. Listing in OTC exchange 4. Issued capital of 50 crores and

above
126
A B C D
(a) 2 1 4 3
(b) 1 3 4 2
(c) 2 1 3 4
(d) 4 3 1 2
9.3 Alteration of Capital
Alteration is making changes whether by way of addition, deletion or modification to the

existing thing. Similarly, in case of alteration of Capital Clause it means making changes to the
existing Capital Structure of the company, which may be required at several times and on
several occasions like if company goes for capital restructuring or if it is looking for some extra
funds and the Authorised Share Capital of the Company don’t permit it to do so because of the
limited Capital stated there.
9.3.1 Why alteration is required?
At various instances and occasions there arises a need to alter its various parts in various forms
like increase, subdivision, reclassification, consolidation, conversion, cancellation, reduction and
many more. Generally the people have a misconception that alteration of capital is alteration of
Authorised Share capital but it’s not true at all as alteration can be made at various stages like by
just increasing the paid up capital.
9.3.2 How it is done?
If the alteration is made to any clause other than Authorised Capital then one need not modify
the Charter of the Company i.e., Memorandum of Association of Company and/or Articles of
Association of the Company, as it can just be done either by according the Board Consent or
shareholders Consent as the situation demands. However, if the Authorised Share Capital is to
be altered, a detailed procedure as outlined below has to be followed:
1. Prior Stage: At this stage, the in-house consent i.e., of management is accorded by passing
a Board Resolution by simple majority at a duly convened Board Meeting or either by
circulation. When such consent is attained, then a proper notice is sent to all the shareholders
of the company to intimate them about the ensuing General Meeting for the said purpose.
The Notice is to be attached with the relevant Explanatory Statement.
2. Conduction of Meeting and according the consent of Shareholders: When a proper notice is
sent then comes the stage of convening the meeting, which can be convened only if there is
a proper Quorum. At the meeting one needs to accord the consent of shareholders of the
company by passing an ordinary resolution/or special resolution as the situation demands
like if it’s the case of increase, consolidation, sub-division, conversion or cancellation of
Share Capital under section 94 of the Companies Act, 1956; then ordinary resolution is
required however, in case of reduction of Share Capital under Section 100 of the Companies
Act, 1956, then consent is to be accorded by way of Special Resolution and not only this
along with the special resolution, the consent of court is also required.
3. Proceedings on the consent accorded: Once the consent of the shareholders is accorded and
in case of reduction of share capital, the approval of court is also obtained then the necessary
changes are to be made to the Memorandum of Association of the Company and if required
then to the Articles of Association of the company as well and an intimation to the Registrar
127
Company Law
of Companies is made by way of filing the E-form 5, E-form 23 and E-form 21 as may be
required according to the alteration made. Stamp duty is also to be paid in case of increase
which is to be paid as per the relevant State Stamp Act. The said E-Forms are to be filed with
the concerned Registrar of Companies.
4. Approval of the said Change: Mere intimation to the Registrar of Companies is not sufficient
if alteration is to be made. The form needs to be approved by the concerned Registrar of
Companies. Hence, it is always advisable to keep a check on the status of the E-form filed.
Task The capital of X Ltd., is 50 lakhs, consisting of equity share capital of 40 lakhs and
redeemable preference share capital of 10 lakhs. The preference share capital is to be
redeemed before 31st December, 2005. The company is running in losses and its accumulated
losses aggregated to 15 lakhs. The company wants to borrow 20 lakh from a financial
institution to improve its working and also to redeem the preference share capital. Advise.
[Hint: Refer to s. 80. The preference shares can be redeemed out of only two sources and no
other. The borrowing from financial institution for redemption of preference shares is not
provided for. The amount may, however, be borrowed for improving its working capital.]
9.4 Share Capital
It means the capital of a company, or the figure in terms of so many rupees divided into shares
of a fixed amount, or the money raised by the issue of shares by a company.
As mentioned above, a public company and its subsidiary can issue only two kinds of shares,
viz., preference and equity. Therefore, such a company can have only two kinds of share capital
by issue of preference shares and equity shares, viz., preference share capital and equity share
capital. The expression “Preference Share Capital” and “Equity Share Capital” are used in the
following five different senses:
1. Nominal, Authorised or Registered Capital: This is the sum stated in the memorandum as
the share capital of a company, with which it is proposed to be registered. This is the
maximum amount of capital which it is authorised to raise, by issuing shares and upon
which it pays stamp duty. As we shall see later, when the original amount of the authorised
capital is exhausted by issue of shares, it can be increased by passing an ordinary resolution.
2. Issued Capital: It is that part of the authorised capital which, the company has issued for
subscription. The amount of issued capital is either equal to or less than the authorised
capital.
3. Subscribed Capital: It is that portion of the issued capital which has been subscribed for by
the purchasers of the company’s shares. The amount of subscribed capital is either equal to
or less than the issued capital.
4. Called-up Capital: The company may not call up full amount of the face value of the
shares. Thus, the called-up capital represents the total amount called-up on the shares
subscribed. The total amount of called-up capital can be either equal to or less than the
subscribed capital.
Thus, uncalled capital represents the total amount not called-up on shares subscribed, and the
shareholders continue to be liable to pay the amounts as and when called. However,the
company may reserve all or part of the uncalled capital, which can then be called in the event
of the company being wound up. For this purpose, a special resolution is
128
required to be passed and then the uncalled capital is known as Reserve Capital or Reserve
Liability (s.99).
5. Paid-up Capital: Paid-up capital is the amount of money paid-up on the shares subscribed.
9.4.1 Alteration of Share Capital
Section 94 provides that if the articles authorise, a company limited by share capital may, by an
ordinary resolution passed in general meeting, alter the conditions of its memorandum in
regard to capital so as:
1. To increase its authorised share capital by such an amount as it thinks expedient by issuing
fresh shares;
2. To consolidate and divide all or any of its shares into shares of larger amount than its
existing shares;
3. To convert all or any of its fully paid-up shares into stock and reconvert the stock into fully
paid-up shares of any denomination;
4. To sub-divide its shares, or any of them, into shares of smaller amount than fixed by the
memorandum, but the proportion paid and unpaid on each share must remain the same;
5. To cancel shares which, at the date of the passing of the resolution in this behalf, have not
been taken or agreed to be taken by any person.
These clauses are now explained in detail:
1. Increase of Authorised Share Capital: A company, limited by shares, if the articles authorise,
can increase its authorised share capital by passing an ordinary resolution. Within 30 days
of the passing of the resolution, a notice of increase in the share capital must be filed with
the Registrar. On receipt of the notice, the Registrar shall record the increase and also
make any alterations which may be necessary in the company’s memorandum or articles
or both. If default is made in filing the notice, the company and every officer of the
company who is in default shall be punishable with fine up to 500 per day during which
the default continues (s.97).
2. Consolidation and Sub-division of Shares: Consolidation is the process of combining
shares of smaller denomination. For instance, 10 shares of 10 each are consolidated into
one share of 100. Sub-division of shares is just the opposite of consolidation, i.e., one share
of 100 is divided into 10 shares of 10 each. Once a resolution has been passed, a copy of
the resolution is required to be sent within thirty days to the Registrar.
3. Conversion of Shares into Stock and vice versa: Stock is simply a set of fully paid-up
shares put together, and is transferable in any denomination or fraction. On the other
hand, a share is transferable as a whole; it cannot be split into parts. For example, a share
of 10 can be transferred as a whole; it cannot be transferred in parts. But if 10 shares of
10 each fully paid are converted into stock of 100, then the stockholder can transfer stock,
say, worth 17 also.
Section 94 empowers a company to convert its fully paid-up shares into stock by passing
a resolution in general meeting, if its articles authorise such conversion. A notice is to be
filed with the Registrar within thirty days of the passing of the resolution specifying the
shares so converted.
It is to be noted that stock cannot be issued in the first instance. It is necessary to first issue
shares and have them fully paid-up and then convert them into stock. Also, stock can be
reconverted into fully paid-up shares by passing a resolution in general meeting.
129
Company Law
When shares are converted into stock, the shareholders are issued stock certificates. In the
Register of members, the amount of stock is written against the name of a particular
member in place of number of shares. The stockholder is as much a member of the company
as a shareholder.
4. Diminution of Share Capital: Sometimes, it so happens that shares are issued, but are not
taken up by the members of the public and, therefore, not allotted. Section 94 provides
that a company may, if its articles authorise, by resolution in general meeting, cancel
shares which on the date of the passing of the resolution in this behalf have not been taken
or agreed to be taken by any person, and diminish the amount of the share capital by the
amount of the shares so cancelled. This constitutes diminution of capital and should be
distinguished from reduction of capital.
Authorised Share Capital stands increased under certain Circumstances
Section 94A empowers the Central Government to administratively increase the authorised
capital of a company when an order is made under s. 81(4).
Section 81(4) provides that where any debentures have been issued to, or loans have been
obtained from the government by a company, the Central Government may, if in its opinion it
is necessary in the public interest to do so, by order, direct that such debentures or loans or any
part thereof shall be converted into shares in that company. Such an order can be made even if
the terms of issue of such debentures or the terms of such loans do not include a term, providing
for an option for such conversion. Consequently, the Central Government can administratively
increase the nominal capital of the company.
Also the nominal share capital of a company shall stand increased, when any public financial
institution proposes to convert debentures or loans (having an option of conversion) issued to,
or given to the company, when an application is made by the financial institution to the Central
Government to pass orders for the increase of the authorised share capital of the company.
The consequence of the order of the Central Government will be that the conditions contained
in the memorandum of the company shall stand altered and, the nominal share capital of such
company shall stand increased by an amount equal to the amount of the value of the shares into
which such debentures or loans or part thereof has been converted.
Where the memorandum of a company becomes altered as above, the Central Government shall
send a copy of such an order to the Registrar and also to the company. On receipt of such order,
the company shall file in the prescribed form, within 30 days from the date of such receipt, a return
to the Registrar with regard to the increase of share capital and the Registrar shall on receipt of
such order and return, carry out the necessary alteration in the memorandum of the company.
9.5 Reduction of Share Capital
Sections 100-105 provide for the reduction of share capital. A company limited by shares, if so
authorised by its articles, may, by special resolution, which is to be confirmed by the court
reduce its share capital:
1. By reducing or extinguishing the liability of members for uncalled capital, e.g., where a
share of 10 on which 5 are paid, is treated as a share of 5 fully paid-up. In this way, the
shareholder is relieved from liability on the uncalled capital;
2. By paying off or returning capital which is in excess of the wants of the company, e.g.,
where there is a share of 10 fully paid-up, reduce it to 5 and pay back 5 to the shareholder.
130
3. Pay off paid-up capital on the understanding that it may be called up again, e.g., a share of
10 is fully paid-up, on which 2.50 may be returned to the shareholder on the condition
that when necessary, the company may call it up again. Thus, the difference between
method (1) and this method is that the uncalled liability is not extinguished in the latter;
4. A combination of the preceding methods.
5. Write off or cancel capital which has been lost or is not represented by available assets,
e.g., a share of 10 fully paid-up is represented by 7.50 worth of assets. In such a situation,
reality can be re-introduced into the balance sheet of the company by writing off 2.50 per
share. This is the most common method of reduction of capital. The assets side of the
balance sheet may include useless assets, fictitious goodwill, preliminary expenses, discount
on issue of shares and debentures, etc. These assets are either cancelled or their values are
reduced to the extent they are useful. Correspondingly, share capital on the liability side
is reduced.
9.5.1 Procedure for Reduction of Capital
After passing the special resolution for the reduction of capital, the company has to apply to the court
by way of petition to confirm the resolution under s.101. The creditors are entitled to object where
the proposed reduction of share capital involves either: (i) the diminution of liability in respect of
unpaid capital; or (ii) the payment to any shareholder of any paid-up share capital, or in any other
case, if the court so directs.
To enable the creditors to object, the court selects a list of such people. If any creditor objects,
either his consent to the proposed reduction should be obtained or he should be paid off or his
payment secured. However, the court may dispense with the consent of a creditor on the company
securing payment of the debt or claim, by appropriating the full amount or that fixed by the
court.
Section 102 states that if the court is satisfied that either the creditors entitled to object have
consented to the reduction, or that their debts have been paid or secured, it may confirm the
reduction. It may also direct that the words “and reduced” be added to the company’s name for
a specified period and that the company must publish the reasons for the reduction and the
causes which led to it.
Section 103 provides for registration of the court’s order with the Registrar. The company has
also to send the minutes, giving details of the share capital as altered. The reduction of share
capital takes effect only on registration of the court’s order with the Registrar and not before.
The Registrar will issue a Certificate of Registration, which will be a conclusive evidence that,
both the requirements of the Act have been complied with and that the share capital is now as set
out in the minutes. The registered minutes are deemed to be substituted for the corresponding
capital clause in the memorandum, thereby altering the memorandum within the meaning of
s. 40. The copies of the memorandum which will be issued subsequently must, therefore, be in
accordance with the articles.
Section 104 provides that after the reduction of capital, the members cease to be liable for calls
as regards to the amount, by which the nominal amount of their shares has been reduced.
If, however, any creditor entitled to object to the reduction of share capital is not entered on the
list of creditors, then every member at the time of the registration of the court order and minutes
is liable to contribute for the payment of that debt.
131
Company Law
Section 105 provides for punishment with imprisonment extending to one year or with fine or both,
if any officer of the company knowingly conceals the name of any creditor entitled to object to
the reduction or misrepresents the nature or amount of claim or debt or abets such concealment or
misrepresentation.
9.5.2 Reduction of Share Capital without the Sanction of the Court
There are some cases in which there is reduction of share capital and no confirmation by the court
is necessary. These are:
1. Forfeiture of Shares: A company may, in pursuance of its articles, forfeit shares for non-
payment of calls.
2. Surrender of Shares: It is a short-cut to forfeiture. It may be accepted by the company under

circumstances where its forfeiture is justified. It has the effect of releasing the shareholder
whose surrender is accepted from liability on shares.
3. Diminution of Capital: This has already been explained in Para 8.6. Section 94 clearly states
that diminution of capital does not amount to reduction of capital.
4. Redemption of Redeemable Preference Shares: This has already been explained in Para
8.2.4 as provided by s.80.
5. Purchase of Shares of a Member by the Company under s.402: The court may order the
purchase of shares of any member of the company by the company, under certain
circumstances.
9.5.3 Reduction of Capital vs. Diminution of Capital
Reduction of capital involves, working off past losses against capital, cancellation of the uncalled
capital or repayment of surplus capital. It may involve reduction of issued capital, subscribed or
paid up share capital. Diminution of capital de cancellation of the authorised or issued capital
(but not subscribed). Diminution of capital does not constitute a reduction of capital within the
meaning of the Companies Act. The distinction between reduction and diminution ofcapital is as
follows:
1. Diminution of capital is the reduction of the issued capital. Reduction of capital involves
reduction of subscribed or paid-up capital; there is no reduction of issued capital.
2. Both require authorisation by articles but whereas ‘diminution’ can be effected by an

ordinary resolution (if so authorised by articles), reduction of capital cannot be effected
without passing a special resolution.
3. ‘Reduction’ requires confirmation by court (s.100) but ‘diminution’ needs no confirmation
by the court (s.94).
4. In case of ‘reduction’, court may order the company to add the words ‘and reduced’ after its
name [s.102 (3) but no such order can be passed in case of ‘diminution’ s.94].
5. In case of ‘diminution’, notice is to be given to Registrar within 30 days from the date of
cancellation whereupon, the Registrar shall record the notice and make the necessary
alteration in the memorandum and articles. In case of ‘reduction’, a more detailed procedure
has been prescribed though there is no time limit as in case of ‘diminution’.
132
9.6 Reorganisation of Capital
The companies limited by shares have to issue shares to raise the necessary capital for their
operations. Issue of shares may be made in three ways:
1. By private placement of shares.
2. By allotting entire shares to an issue-house, which in turn, offers the shares for sale to the
public.
3. By inviting the public to subscribe for shares in the company through a prospectus.
1. Private Placement of Shares: A private company limited by shares is prohibited by the

Act and the articles from inviting the public to subscribe in shares or debentures. It also
need not file statement in lieu of prospectus. Its shares are issued privately, to a small
number of persons known to the promoters or related to them by family connections.
A public company can also raise its capital by placing the shares privately and, without
inviting the public to subscribe to its shares or debentures. In this kind of arrangement, an
underwriter or broker finds persons, normally his clients who wish to buy the shares. He
acts merely as an agent and his function is simply to procure buyer for the shares, i.e., to
place them. Since no public offer is made for shares, there is no need to issue any prospectus.
However, under s.70, such a company is required to file with the Registrar a statement in
lieu of prospectus, at least 3 days before making allotment of any shares or debentures.
As per the guidelines issued by SEBI in June, 1992, private placement of shares should not
be made by subscription of shares from unrelated investors through any kind of market
intermediaries. This means a promoters’ share should not be contributed by subscription
of those shares, by unrelated investors through brokers, merchant bankers, etc. However,
subscription of such shares by friends, relatives and associates is allowed.
2. By an Offer for Sale: Under this arrangement, the company allots or agrees to allot shares
or debentures at a price to a financial institution or an issue-house for sale to the public.
The issue-house publishes a document called an offer for sale, with an application form
attached, offering to the public shares or debentures for sale at a price higher than what is
paid by it or at par. This document is deemed to be a prospectus [s.64(1)]. On receipt of
applications from the public, the issue-house renounces the allotment of the number of
shares mentioned in the application in favour of the applicant purchaser who becomes a
direct allottee of the shares.
3. By Inviting Public through Prospectus: This is the most common method by which a
company seeks to raise capital from the public. The company invites offers from members
of the public to subscribe for the shares or debentures through prospectus. An investor is
expected to study the prospectus and if convinced about the prospects of the company,
apply for shares.
133
Company Law
9.6.1 Issue of Shares to existing Shareholders
The capital is also raised by issue of rights shares to the existing shareholders (s.81). In this case
the shares are allotted to the existing equity shareholders in proportion to their original
shareholding, e.g., one share against every two shares held by a member.
9.6.2 Public Issue of Shares
Public issue of shares means the selling or marketing of shares for subscription by the public by
issue of prospectus. For raising capital from the public by the issue of shares or debentures, a
public company has to comply with the provisions of the Companies Act, the Securities Contracts
(Regulations) Act including the Rules made thereunder and the Guidelines and instructions
issued by the concerned Government authorities, the Stock Exchange and SEBI, etc. Management
of public issue involves coordination of activities and cooperation of a number of agencies such
as managers to the issue, underwriters, brokers, registrars to the issue, solicitors/legal advisors,
printers, publicity and advertising agents, financial institutions, auditors and other Government/
Statutory agencies such as Registrar of Companies, Reserve Bank of India, stock exchange, SEBI,
etc.
It is advisable to keep in mind the guidelines issued by SEBI with regard to issue of shares
termed as “Guidelines for Disclosure and Investor Protection” before issuing shares to the
public.
Share application form to seek permanent account number. In respect of applications for value
of 50,000 or more, the applicant or in case of applications in joint names, each of the applicant,
shall mention his/her permanent account number/GIR number and income-tax circle, ward,
district or the fact of non-allotment of PAN/GIR number, as the case may be and applications
not complying with the provisions are liable to be rejected.
Self Assessment
8. A company must inform the registrar about redemption of preference shares within
(a) 21 days (b) 15 days
(c) 30 days (d) None of the above
9. The capital which is part of the uncalled capital of the company which can be called up
only in the event of its winding up is called
(a) Issued capital (b) Nominal capital

(c) Authorised Capital (d) Reserve capital
10. XYZ Co. is a holding of XZ Pvt. Company. XZ Co. issued deferred shares. The issue is valid
or void
(a) Valid (b) Void
(c) Situation does not arise (d) None of the above
11. What is the maximum period for redemption in case of preference shares issued by the
company
(a) 10 years (b) 15 years
(c) 20 years (d) None of these
134
9.7 Voting Rights
Voting Rights of Preference Shareholders
The preference shareholders will vote only on matters directly relating to preference shares.
Section 87 (2) mentions the following matters which relate to preference shares and preference
shareholders can vote on them: (i) any resolution for winding up of the company; (ii) any
resolution for the reduction or repayment of share capital; (iii) any resolution at any meeting, if
dividend on cumulative preference shares remains unpaid for at least two years. Holders of non-
cumulative preference shares shall have a right to vote on all resolutions, if their dividendsare in
arrear for the two financial years during a period of six years ending with the financial year
preceding the meeting. [s.87(2)].
9.8 Rights Shares
The existing members of the company have a right to be offered shares, when the company wants
to increase its subscribed capital. Such shares are known as “rights shares” but they are not
issued free of charge.
Section 81 provides that where at any time after the expiration of two years from the date of
incorporation of the company, or after one year from the date of the first allotment of shares,
whichever is earlier, a public company limited by shares issues further shares within the limits
of the authorised capital, its directors must first offer these shares to the existing holders of
equity shares in proportion, as nearly as circumstances admit, to the capital paid up on their
shares at the time of the further issue. The company must give notice to each of the equity
shareholders, giving him the option to buy the shares offered to him by the company. The
shareholders must be informed of the number of shares he has the option to buy. He must be
given at least fifteen days to decide whether he would exercise his option or not. If the shareholder
does not inform the company of his decision, he shall be deemed to have declined the offer.
Unless the articles of the company otherwise provide, the directors must state in the notice of
offer the fact that the shareholder has also the right to renounce the offer, in whole or part, in
favour of some other person who need not be member of the company. If the shareholder
declines or, is deemed to have declined or, if the person in whose favour the renunciation is
made declines to buy the shares, the company’s directors may dispose of those shares in such
manner as they may think fit.
Task DJA Co. Ltd., is holding 40% of total equity shares in MR Co. Ltd. MR Co. Ltd.
(incorporated on 1.1.2003) decided to raise the paid-up equity share capital by issuing
further shares and also decided not to offer any shares to DJA Co. Ltd., on the ground that
it was already holding a high percentage of shares in MR Co. Ltd. Articles of MR Co. Ltd.,
provides that the new shares be offered to the existing shareholders of the company. On
1.3.2006. new shares are issued to all the shareholders excepting DJA Co. Ltd. Examine the
validity of decision of Board of directors of MR Co. Ltd., of not offering any further shares
to DJA Co. Ltd.
Exception: However, the company may, by special resolution in general meeting, decide that
the directors need not offer the shares in the further issue to the existing equity shareholders
and, that they may dispose of them in any manner whatsoever. But where it has been possible to
muster ordinary majority only, the directors may not offer the shares to the existing equity
shareholders, if permission is obtained from the Central Government. Further, s.81 does not
135
Company Law
apply to a private company. Thus, a private company need not offer its further issue first to existing
shareholders and therefore its directors are free to offer them in the manner they deem fit. Further,
s.81 is not applicable in the case of issue of shares against conversion of loans or debentures.
SEBI has issued following Guidelines regarding Rights Issues, 2000:
Applicability: These guidelines apply to rights issues made by existing listed companies
whose equity share capital is listed. These guidelines are not applicable to the rights issues
where the aggregate value of securities offered does not exceed 50 lacs.
Appointment of Registrar: Appointment of Registrars to the Issue shall be compulsory.
Withdrawal of a Rights Issue after Announcement: Where any company has withdrawn the
rights issue after announcing the record date, such a company shall not be permitted to make
application for listing of any of its securities for a minimum period of twelve months from
the announced record date.
Underwriting: Underwriting of rights issue is not mandatory. But, where it is underwritten,
the lead manager, if any, should make a statement in the letter of offer that, in their
opinion, assets of the underwriters are adequate to meet their obligation.
Appointment of Merchant Banker: For rights issues of listed companies exceeding 50 lakhs,
the issue should be managed by a category-1 merchant banker, holding a valid certification of
registration issued by SEBI.
Partly Paid Shares to be Made Fully paid: Partly paid shares, if any must either be made
fully paid or forfeited.
Disclosure in Letter of Offer: It shall be the duty of the merchant banker, acting as the lead
manager, to ensure that the letter of offer contains all the matters specified by SEBI in this
regard and otherwise provides a true, correct and fair view of the state of affairs of the
company which are adequate for the investors to arrive at a well-informed decision.
Agreement with Depository: A company cannot make a right issue unless:
It enters into an agreement with a depository for dematerialisation of securities already

issued or proposed to be issued to the existing shareholders; and
The company gives an option to the subscribers/shareholders to receive the certificate

or hold securities in dematerialised form with a depository.
Filing Letter of Offer: The Merchant Banker, in case of rights issue exceeding 50 lakhs,
shall file the letter of offer with SEBI at least 21 days prior to the filing of the letter of offer
with Regional Stock Exchange. However, if within 21 days from the date of filing of draft
letter of offer, SEBI specifies any changes therein, the Issuer or the Lead Merchant Banker
shall carry out such changes before filing the draft letter of offer with Regional Stock
Exchange.
Closure of Rights Issue: A rights issue shall be kept open for at least 30 days but not more
than 60 days.
Minimum Subscription: SEBI requires the following clause in respect of minimum

subscription to be stated in the letter of offer.
“If the company does not receive the minimum subscription of 90% of the issue, the entire
subscription will be refunded to the applicants within 42 days from the date of closure of
the issue. If there is delay in the refund of the application money by more than 8 days after the
company becomes liable to pay the amount, i.e., forty-two days after closure of the
136
issue, the company will pay interest for the delayed period. @ 15% per annum as prescribed
in sub-section (2) and (2A) of Section 73 of the Companies Act, 1956.”
In case of composite issue, the Lead Merchant Banker shall ensure that the requirements of
minimum subscription is satisfied both jointly and severally, i.e., independently for both
rights and public issues.
No Reservation in Rights Issues: SEBI guidelines prohibit any preferential allotment in

favour of the issuing companies, permanent employees and financial institutions. If a
company desires to make any preferential allotment to the employees or any identified
persons it may do so independent of rights issue by complying with the guidelines in that
regard.
Promoters’ Contribution and Lock-in-Period: The requirement of promoters contribution
shall not be applicable in case of rights issues.
Rights of FCD/PCD Holders: No company shall, pending conversion of FCDs/PCDs, issueany
shares by way of rights unless similar benefit is extended to the holders of such FCDs or
PCDs. The benefits shall be extended by making a reservation of shares in proportion to
the convertible part of FCDs/PCDs. The shares so reserved may be issued at the time of
conversion of such debentures on the same terms on which the rights issue was made.
Restriction on Further Capital Issues: No company shall make any further issue of capital
in any manner whether by way of issue or otherwise, during the period commencing from
the submission of offer document to SEBI on behalf of the company for rights issues, till the
securities referred to in the said offer document have been listed or application money
refunded on account of non-listing or under-subscription, etc.
Over- subscription not to be Retained: Over-subscription shall not be retained under any
circumstances.
Issue to be made Fully-Paid Up: The issue shall have to be made fully-paid up within 12
months, except where the issue size exceeds 500 crore.
Additional Facility for Applying: The Lead Merchant Banker shall ensure that an
advertisement giving the date of completion of dispatch of letters of offer, is released in at least
one English National Daily circulated at the place where registered office of the issuer
company is situated. The advertisement must be published at least 7 days before the date of
opening of the issue.
Self Assessment
12. A company can issue shares at a discount within six months of the date on which it became
entitled to commence business.
13. Share premium amount can be treated as free reserves.
14. Share premium amount can be utilised for issuing fully paid bonus shares to members.
15. The maximum rate of discount on shares must not exceed 10 percent or such higher rate as
the central government may permit in any special case.
16. The Companies Act 1956, does not prescribe the maximum rate of premium on shares.
137
Company Law
Case Study Federal Government Responsibilities against

Food Industry
G
overnmental responsibility for food in Canada is divided among the federal, 10
provincial, three territorial, and thousands of municipal governments. Some 77
pieces of legislation govern food inspection among three levels of government.
Federal responsibility centres on export and inter-provincial trade: protecting and
expanding export markets for Canadian food products, and facilitating interprovincial
trade. In addition, the federal government sets food safety, quality and grading standards
for products sold interprovincially and internationally and administers regulations aimed
at preventing the production or sale in Canada of dangerous, adulterated or misbranded
products.
Provinces and municipalities are responsible for:
The intraprovincial aspects of the food industry, including local food processing, the food
service industry, and the food retail industry.
They decide whether and how to inspect local operations, including restaurants and grocery
stores, as well as dairies and meat plants whose products are sold within the province.
(Moore and Skogstad, p. 130) The federal government of Canada faced a number of food
security problems in the early 1990s, which facilitated adoption of innovative reform
measures:
1. Canada’s reputation for high quality food had been damaged by the “tainted tuna”
scandal.
2. Resources for additional inspection of fish products were not available; resources
were not only scarce but shrinking.
3. The Government wanted to reform its public service along the lines achieved in the
United Kingdom and New Zealand, where separate agencies were spun off from
government.
4. Developments in international trade and potential developments in interprovincial
trade:
(a) Industry and governments favoured harmonized standards and streamlined
inspection to ensure the competitiveness of the Canadian food industry
domestically & internationally.
(b) Canadian producers/processors were vulnerable to trade challenges in a
fragmented system.
(c) Gaps resulting from non-inspection or non-rigorous inspection were perceived by
processors as a weak link, despite the small percentage of overall production
represented and assurances outlined in the Auditor General of Canada’s 1994
Report.
(d) Closer integration of the US and Canadian markets under free trade agreements
made the industry anxious to reduce the costs and inefficiencies resulting
from differing provincial standards e.g. fluid milk.
5. The “national treatment” principle in the North American Free Trade Agreement
could be interpreted to mean that imports must meet the provincial standard of the
Contd...
138
province they enter rather than the standard required for inter-provincial or
international trade. This could drag down Canadian food standards to the lowest
common denominator.
(a) Canadian exporters were concerned about being denied access to external
markets on the grounds that Canadian food safety standards and inspection
systems were not equivalent to those of the markets into which they were
shipping.
(b) The 1994 SPS Agreement required that countries use their food safety and
animal, plant and health regulations only to the extent necessary to protect
human, animal life or health, not for trade protection purposes.
6. Emergence of alternatives to high-cost prescriptive regulation: New scientific and
technological tools furnished the Government with opportunities to shift additional
costs and a significant degree of responsibility for food safety to the food industry
itself. Risk assessment methods allowed the allocation of food inspection resources
on a risk basis. One such risk-based tool, the Hazard Analysis Critical Control Point
(HACCP) system, developed for the US space program, was deemed more effective
than existing systems in ensuring food safety. Canada was the first government to
adopt this system, for its fish inspection program. It was so well accepted
internationally that Canadian meat packing plants were subsequently required to
conform to US regulations requiring large American meat packing plants to
implement a HACCP plan by January 1998.
7. National unity was threatened, and solutions suggested in the winning Liberal
platforms in the 1993 and 1997 elections were renewal of the federation, including
better coordination of services and reduction in overlap and duplication among
governments.
The Government of Canada consolidated all of its food inspection and quarantine
services from Health Canada, Fisheries and Oceans, and Agriculture and Agri-Food
Canada into one self-standing Agency effective April 1, 1997. The Agency reports
not to a deputy minister but directly to the Minister of Agriculture and Agri-Food.
The Agency has separate employer status, and so can hire and fire its own employees,
rather than working through the Public Service Commission. It also has a number
of financial flexibilities not available to government departments, most notably the
capacity to retain revenues.
Protecting the public interest is a major concern in creating alternate Service Delivery
Agencies (ASDs) in Canada. Employing the Auditor General of Canada’s definition of
the public interest when assessing ASDs, the CFIA addressed whether there was an
appropriate focus on public objectives, maintenance of public service values and
adequate control over public funds and assets. On all counts the CFIA’s self- assessment
concluded it was serving the public interest.
The Auditor General of Canada was appointed as an external auditor under the CFIA
Act, with duties to audit the CFIA’s financial statements and assess the fairnessand
reliability of the performance information provided in the Agency’s Annual Report
to Parliament. The Auditor General also has authority to conduct periodic value-for-
money audits of the Agency.
Contd...
139
Company Law
Clarification of food-related roles and responsibilities of federal government

departments has led to:
(a) A more integrated and comprehensive approach (gate-to-plate) to trichinosis

in swine, tuberculosis in cattle and zoonotic diseases such as salmonella
enteritidis in poultry.
(b) Improved capacity to respond to outbreaks of food-borne illness and threats

to the food system presented by medicated feeds and antibiotic residues.
(c) Separation of health and safety standard setting from inspection, permitting
new flexibilities for inspection.
(d) Separation of health risk analysis from risk management, thereby fulfilling a
World Health Organization principle
(e) Reduced criticism of conflict of interest because the same department was
responsible for promoting and regulating an industry (fisheries).
8. A more integrated and comprehensive approach (gate-to-plate) to trichinosis in

swine, tuberculosis in cattle and zoonotic diseases such as salmonella enteritidis in
poultry.
9. Improved capacity to respond to outbreaks of food-borne illness and threats to the
food system presented by medicated feeds and antibiotic residues.
10. Separation of health and safety standard setting from inspection, permitting new
flexibilities for inspection.
11. Separation of health risk analysis from risk management, thereby fulfilling a World
Health Organization principle
12. Reduced criticism of conflict of interest because the same department was responsible
for promoting and regulating an industry (fisheries).
Question
Analyse the kind of agency it is. (Hint: Summarize this case)
9.9 Summary
The right of the shareholder to transfer the shares are subject to the articles of association
(For this purpose s.82 classifies shares as movable property, transferable in the manner
provided in the articles).
Section 83 requires that each share in a company having a share capital must be distinguished
by its distinctive number.
A common man uses ‘share’ and ‘share certificate’ to mean the same. It is, therefore,
important to note the exact differences between the two.
The share capital of a company is divided into a number of indivisible units of specified
amount.
If a preference share carries the right for payment of arrears of dividend from future profits,
then such a share is known as cumulative preference share.
The Companies (Amendment) Act, 1999, allowed issue of sweat equity shares subject to
fulfillment of certain conditions.
140
9.10 Keywords
Cumulative Preference Share: If a preference share carries the right for payment of arrears of
dividend from future profits, then such a share is known as cumulative preference share.
Equity Share: ‘Equity share’ means a share which is not a preference share (s.85). The rate of
dividend is not fixed.
Non-voting Share: ‘Non-voting shares’ as the term suggests, are shares which carry no voting
rights. These are contemplated as altogether a different class of shares which may carry additional
dividends in lieu of the voting rights.
Redeemable Share: A preference share which can be redeemed upon the resolution of the board
of directors, if the articles so provide, is known as redeemable preference share.
Share: A share is the share capital of a company and includes stock except where a distinction
between stock and share is expressed or implied.
Stock: The term ‘stock’ may be defined as the aggregate of fully paid-up shares of a member
merged into one fund of equal value.
1. Define a share.
2. What are the different types of shares which a company can issue?
3. How and subject to what conditions can loans and debentures be converted into shares?
4. How and for what purposes can a company alter its share capital?
5. Discuss the procedure for reduction of share capital.
6. A company limited by shares intends to buy some of its own shares. Advise.
7. Explain the three different ways through which issue of shares may be made by a public
company.
8. Explain the provisions as regards increase of subscribed capital by a public company by

allotment of further shares.
9. In what way does the Companies, Act, 1956 regulate the issue of shares at a premium?
State the purpose for which the share premium so charged can be utilized. To what extent
it is possible for a company to issue shares at a premium for consideration other than cash?
10. State the circumstances wherein shares of a company can be issued at a discount. What is
the liability of directors for improper issue of shares at discount?
11. Explain the meaning of ‘Sweat equity shares’. State the conditions a company has to fulfill
for issuing such shares.
12. Comment on the following:
(i) A company is prohibited from buying its own shares or financing the purchase
thereof.
(ii) A company cannot reduce its share capital without the sanction of the court.
(iii) Section 81 is intended to prevent the directors from offering shares to outsiders
before an offer is made of further issue of capital as a right to the existing
shareholders.
141
Company Law
(iv) Under certain situations, a company can reduce its share capital without the sanction
of the court.
(v) Under certain circumstances, the authorised capital can be increased by the Central
Government.
1. 2(46) 2. distinctive number
3. same 4. ‘share’
5. ‘stock’ 6. (c)
7. (a) 8. (c)
9. (d) 10. (b)
11. (c) 12. False
13. False 14. True

15. True 16. True

www.webopedia.com
142
Unit 10: Management of Company
CONTENTS
Objectives
Introduction
10.1 Directors – Definition and Meaning
10.1.1 Deemed Director (s. 7).
10.1.2 Small Shareholders’ Director
10.2 Legal Position of Directors
10.2.1 Directors as Agents
10.2.2 Directors as Trustees
10.2.3 Directors as Managing Partners
10.2.4 Directors as Employees of the Company

10.2.5 Director as Officers of the Company
10.3 Qualifications and Disqualifications of Directors
10.3.1 Other Disqualifications
10.3.2 Minor as a Director
10.3.3 Validity of acts of Directors (s. 290)
10.4 Appointment of Directors
10.4.1 Appointment of First Directors
10.4.2 Appointment of Subsequent Directors
10.4.3 Restrictions on Appointment of Directors
10.5 Modes of Appointments
10.6 Director Remuneration
10.6.1 What is included in Remuneration?
10.6.2 Increase in Remuneration
10.7 Remuneration Payable to a Manager
10.7.1 Managerial Remuneration vis-à-vis Schedule XIII
10.8 Disclosure
10.8.1 Interested Directors not to Participate or Vote in Board’s Proceedings
10.8.2 Register of Contracts in which Directors are Interested
10.8.3 Disclosure of Director’s Interest in Contract Appointing Manager, or

Managing Director
10.9 Service Contract
Contd...
143
Company Law
10.10 Removal of Directors
10.10.1 Removal by Shareholders
10.10.2 Removal by the Central Government
10.10.3 Removal by Company Law Board
10.11 Retirement of Director
10.12 Appointment of a Director other than a Retiring Director
10.13 Power and Fiduciary Duties
10.13.1 Powers of the Board of Directors
10.13.2 The Mode or Manner of Exercise of Board’s Powers
10.13.3 Restrictions on Powers of Directors
10.14 Duties of Director in Relation to Good Corporate Governance
10.15 Summary
10.16 Keywords
Objectives
Describe the legal position of director;
Outline the qualifications and disqualifications of director;
Explain the director remuneration;

Elaborate upon principles of disclosure.
Introduction
A company, being an artificial person, acts through human agency. Accordingly, under the Act,
it is necessary for every company to have a Board of directors. In addition to this, the following
categories of managerial personnel may be appointed (s.197-A):
1. Managing Director; or
2. Manager.
Section 197A does not prohibit the employment of other managerial personnel, such as executive or
whole-time directors, which do not come within the term “managing director” or “manager”.
Thus, it is possible for a company to make simultaneously the appointment of (i) managing
director and whole time director; or (ii) manager and whole time director. Section 197A prohibits
the simultaneous appointment of managing director and manager in the same company.
144
10.1 Directors – Definition and Meaning
Section 2 (13) defines a Director as including “any person occupying the position of director, by
whatever name called.” This is a definition based purely on function; a person is a director if he
does whatever a director normally does. But the Act gives no further guidance on the function,
duties and position of a director. In reality, directors are the persons who direct, conduct, manage or
superintend a company’s affairs. Section 291 has entrusted the management of the affairs of the
company in their hands. They chalk out the general policy of the company within the framework
of the memorandum of the company. They appoint the company’s officers and recommend the
rate of dividend. The directors of company are collectively referred to as the ‘Board of Directors’
[s. 2(6)].
Thus, it is not the name by which a person is called but the position he occupies and the functions
and duties which he performs that determine whether he is a director of a company or not.
In Forest of Dean Coal Mining Co. Re (1878) 10 Ch D 450, it was stated that function is everything;
name matters nothing. So long as a person is duly appointed by the company to control its
business and authorised by its articles to contract in its name and on its behalf, he is a director,
whether named as such or not.
The articles of a company, sometimes, designate its directors as governors, members of the
governing council or the board of management or may give them any other title, but so far as
the law is concerned they are simply directors. For example, in the case of associations registered
as companies under s. 25, the members of the executive committee or governing council or
management board are directors for purpose of the Act, even when they are not designated as
directors.
10.1.1 Deemed Director (s. 7).
For certain purposes, a person even when he is not a director may be deemed to be a director of
a company. The Act treats as director a person in accordance with whose directions or instructions
the Board of directors of a company is accustomed to act. This provision has the effect of widening
the definition of the term ‘director’. However, this provision merely operates to impose liabilities
or prohibition on such a person who is deemed to be a director. However, a deemed director
does not acquire any right or power in connection with the management of the company. He
may be made liable but he cannot demand to participate in the meetings of the Board of directors
or to manage the affairs of the company in any way. But for the purpose of treating a person as
a deemed director and invoking his liability, it is necessary to establish that the Board of
directors is accustomed to act according to his directions and instructions. Acting casually or
once in a while on certain instructions by a person would not be a ‘deemed director’.
A deemed director need not necessarily be an individual. The person may even be a body corporate
say, a holding company.
It must be noted that the expression ‘deemed director’ does not include persons advising the
Board of directors of a company in their professional capacity. Thus, a lawyer, accountant or
other professional advisor will not come within the expression ‘deemed director’ when he gives
professional advice or instructions and the Board is accustomed to act according to his advice or
instructions, then he will not be a ‘deemed director’.
Section 303(1) provides that any person with whose directions or instructions the Board of directors
of a company is accustomed to act is also deemed to be a director.
A manager or any other managerial personnel is, however, not a director [Deen Dayalu v. Sri B.
P. Reddy A.P. (1984) 2 Comp LJ 396].
A ‘deemed director’ is called as ‘shadow director’ under English Law.
145
Company Law
10.1.2 Small Shareholders’ Director
A public company having (a) a paid up capital of five crore rupees or more, and (b) one thousand
or more small shareholders may have a director elected by such small shareholders in the
manner as may be prescribed. For this purpose, “small shareholder” means a shareholder
holding shares of nominal value of twenty thousand rupees or less (i.e. up to 20,000) in a public
company to which this section applies. The Department of Company Affairs, has prescribed the
Companies (Appointment of the Small Shareholders’ Director) Rules, 2001. Such a director will
be elected by the majority of the small shareholders. The tenure of such director shall be a
maximum of three years and he need not retire by rotation. However, he can be re-elected for a
period of three years on the expiry of his tenure. Such a director can be removed in pursuance of
s. 284. A person cannot hold office as small shareholders’ director in more than 2 companies.
Further, the person proposed to be elected must be a small shareholder of the company.
Furthermore, such a director is not eligible for appointment as whole time or managing director
of the company. If he ceases to be a small shareholder, he is deemed to have vacated his office as
‘small shareholders director’.
Example: The Board of directors of ABC Ltd., an unlisted company, having a paid up share
capital of 6 crores consisting of equity share capital of 5 crores and preference share capital of 1
crore and also having 11,000 small shareholders holding equity shares propose to appoint a director
to represent the small shareholders.
Under s. 252, a public company, if it has a paid up capital of 5 crores or more, and one thousand
or more small shareholders may have a director elected by such small shareholders. It is obvious,
that the appointment of such a director is not mandatory; it is discretionary for the company.
Example: In a company, there are more than one thousand small shareholders, and it has
a paid up capital of more than five crore rupees. The small shareholders have exercised their
right to appoint a director on the board of the company. The company wants to remove him before
the expiry of his period of appointment. The company can do so under s. 284 without the consent of
the small shareholders.
10.2 Legal Position of Directors
The exact position of ‘Director’ is hard to define, as no formal definition, either statutory or
judicial, of the term has been given. However, judicial pronouncements have described them as
(i) agents, (ii) trustees, or (iii) managing partners. But each of these expressions is used not as
exhaustive of their power and responsibilities but as indicating points of view from which they may
for the moment and for the particular purpose be considered.
10.2.1 Directors as Agents
The directors act as agents of the company and the ordinary rules of agency apply. They exercise the
powers that are subject to the duties within the framework of the company’s articles, and the Act.
For instance, they may make contracts on behalf of the company and they will not be personally
liable as long as they act within the scope of their authority. But if they contract in their own name,
or fail to exclude personal liability, they also will be liable. If the directors exceed their authority,
the same act may be ratified by the company. But if they do something beyond the objects clause of
the company, then the act is ultra vires and the company cannot ratify the same. But directors are
not agents for the individual shareholders; they are the agents of the company – the artificial
person.
146
10.2.2 Directors as Trustees
The directors have also been described as trustees. But they are not trustees in the full sense of
the term, in as much as no proprietary rights of the company’s property are transferred to them and,
therefore, they enter into contracts on behalf of the company and in the name of the company. On
the other hand, in the case of a trust, the legal ownership of the trust property is transferred to the
trustee and therefore, he can enter into contract in his own name, but whatever he does, he does for
the benefit of the beneficiaries.
Although directors are not trustees in the real sense of the term, they occupy an office of trust
and are in certain respects in the position of trustees for the company. Such cases are:
They are trustees of money which comes to their hands or which is actually under their
control. If they mis-apply company’s money, they have to make good the same as if they
were trustees.
They are trustees for exercising powers conferred on them for the benefit of the company. For
instance, powers to allot shares, to make calls, or to forfeit shares should be exercised bona
fide in the interests of the company.
They stand in a fiduciary relationship to the company and, therefore, whenever there is
clash of his personal interests with that of the company, he should keep in mind the
company’s interests.
A director is in no way a trustee for individual shareholders except when the former induces the
latter by mis-representation to sell the shares to him.
10.2.3 Directors as Managing Partners
The directors are also sometimes described as managing partners. In this sense, a company is
considered a partnership firm. As one or more partners may manage the affairs of the firm on
behalf of all the partners, similarly a few shareholders, who are elected directors by the
shareholders, manage the affairs of the company. They manage the affairs of the company on
their own behalf and on behalf of other shareholders who elect them.
10.2.4 Directors as Employees of the Company
The directors are not employees of the company or employed by the company, nor are they servants
of the company, or members of the “company’s staff”. A director can, however, hold a salaried
employment or an office in addition to that of his directorship which may, for these purposes, make
him an employee or servant and in such a case, he would enjoy rights given to employees as such;
but his directorship and his rights through that directorship are quite separate from his rights as
employee. Thus, he is then entitled to remuneration and other benefits admissible to him as an
employee in addition to his remuneration as director under the Act. TheAct recognises situations
of this nature. Sections 314 and 318, for instance, provide for a director holding an office or place of
profit under a company.
10.2.5 Director as Officers of the Company
Directors are treated as officers of the company [s. 2(30)]. Also, directors are ‘officers in default’
(s. 5) and may become liable to certain penalties for failure to comply with certain provisions of
the Act.
147
Company Law
Self Assessment
Fill in the blanks:
1. defines a Director as including “any person occupying the position of

director, by whatever name called.”
2. A ................................ need not necessarily be an individual.
3. A ‘deemed director’ is called as ‘shadow director’ under .................................
4. The directors act as agents of the company and the ordinary rules of .................................
apply.
5. In partnership firm, the directors are also sometimes described as .................................
10.3 Qualifications and Disqualifications of Directors
The Act has not prescribed any academic or professional qualifications for the directors. Also,
the Act imposes no share qualification on the directors. So, unless the company’s articles contain a
provision to that effect, a director need not be a shareholder unless he wishes to be one
voluntarily. But the articles usually provide for a minimum share qualification. Thus, Regulation
66 of Table A provides that a director must hold at least one share in a company. Where a share
qualification is fixed by the articles of a company, the Act provides (s. 270) that:
It must be disclosed in the prospectus;
Each director must take his qualification shares within two months after his appointment;
The nominal value of the qualification shares must not exceed 5,000 or the nominal value of
one share where it exceeds 5,000;
Share warrants will not count for purposes of share qualification.
If a director fails to obtain his share qualification within two months, he vacates office
automatically on the expiry of two months from the date of his appointment and if he acts as
director after the expiry of two months without taking the qualification shares, he is liable to a
fine up to 5,000 for every day until he stops acting as such (s. 272).
However, the articles of a company can neither compel a person to hold qualification shares
before he is elected a director nor can they require him to obtain qualification shares within a
shorter period than two months after his appointment and if any provisions to this effect is
made in the articles, it shall be void.
The effect of this provision is that if the company is wound up during this period of two months,
the director cannot be placed in the list of contributories, in as much as there is no express or implied
contract under which he would be bound to take the qualification shares, since his name cannot be
put on the register of members unless he has applied for shares and these are allotted to him [Zamir
Ahmed Raz. vs. D.R. Banaji (1957) 27 Comp. Cas. 634].
Task X Co. Ltd. wants to make a contract with a partnership firm. Four of the five directors
of the company are partners of such partnership. How can the contract be executed? [Hint: The
contract may be executed by the general body of shareholders by passing an ordinary
resolution to that effect. Also see s.299.]
148
However, the mere acting as a director does not import any agreement to take the shares from
the company; but, if in such circumstances he is put on the register by the officers of the company
after the time limit for qualifying has expired (i.e. 2 months after his appointment) and he continues
to act as a director, he is estopped by his conduct from repudiating the shares and willbe liable to
pay for them.
The appointment of a director commences from the date on which the result of poll taken to elect
is announced, and the two months are calculated from that date, and not the one on which the
poll was actually taken.
It may be noted that:
The qualification shares can be held by a director even as a trustee, if that fact does not
appear on the register of members, and if the company can deal with the shares as his own.
Also, shares held jointly with any other person is sufficient share qualification. It was held
in Grundy v. Briggs [1910]1 Ch. 444, that unless articles provide otherwise, shares in joint
names entitles any of the joint holders to be appointed as a director. But not more than one
joint holder can be appointed.
The mortgaging of shares does not disqualify a person to be appointed as a director,
unless the articles provide otherwise.
A person who holds requisite qualification shares at the time of his appointment, a subsequent
increase in the amount of share qualification cannot be made applicable to him
[International Cable Co. Re, (1892) 66 LT 253].
Where a director acts without acquiring his qualification shares after the expiry of two months
from the date of his appointment, the company will be bound to third parties for acts of such a
director until the defect in appointment or disqualification is disclosed, and acts done by him
after the disclosure by the company will not bind it. Thus a de facto director is as good a director
as a de jure director so far as persons having no notice of the defect are concerned (s. 290).
As the provisions of s. 270 and s. 272 do not apply to a private company (s. 273), it may or may
not provide in its articles any requirement of share qualification. The articles may thus provide
for share qualification and the amount may be more than 5000.
Further, a private company which is not a subsidiary of a public company may, by its articles,
provide additional qualifications for a director, such as, a person must be a B. Com., or holding
a fixed deposit receipt in his own name issued by the company.
Section 274 has laid down certain disqualifications and therefore, the following persons are
incapable of being appointed directors of any company:
1. A person found by a court to be of unsound mind;
2. An un-discharged insolvent;
3. A person who has applied to be adjudged an insolvent;
4. A person who has been convicted by a court for an offence involving moral turpitude and
sentenced in respect thereof to imprisonment for not less than six months and a period of
five years has not elapsed from the date of the expiry of the sentence;
5. A person who has failed to pay calls on shares held by him whether alone or jointly with
others for six months from the date fixed for the payment;
6. A person who has been disqualified by court under s. 203 which empowers the court to
restrain fraudulent persons from managing companies, unless the leave of the court has
been obtained for his appointment;
149
Company Law
7. Such person is already a director of a public company which, (a) has not filed the annual
accounts and annual returns for any continuous three financial years; or
8. Has failed to repay its deposit or interest thereon on due date or redeem its debentures on due
date or pay dividend, and such failure continues for one year or more. Further, such person
shall not be eligible to be appointed as a director of any other public company for a period
of 5 years from the date on which such public company, in which he is a director, failed to file
annual accounts and annual returns under (a) above or has failed to repay its deposits or
interest or redeem its debentures on due date or pay dividend referred to in (b).
The disqualifications mentioned under (iv) and (v) above may be removed by the Central
Government by a notification in the official gazette. On the other hand, a private company may
provide in its articles that a person shall be disqualified for appointment as director on any
other additional ground. However, a subsidiary private company or a public company cannot,
by its articles, provide for any additional disqualifications.
10.3.1 Other Disqualifications
The following two provisions also provide for disqualifications of directors:

(i) Where a director has been convicted of an offence under s. 209A, he shall, on and from the
date on which he is so convicted, be deemed to have vacated his office as such. On such a
vacation of office, he shall be disqualified for holding the office of a director in any
company for a period of five years from such date.
(ii) A director who has been removed from any managerial position by the Central Government
shall not be a director of a company, for a period of five years from the date of the order of
removal unless the said Government has reduced the period with the concurrence of the
Company Law Board [s, 388 E].
10.3.2 Minor as a Director
In the case of a minor, though there is no provision in the Act, expressly disqualifying him, as he
is not competent to contract, he cannot file either with the company or with the registrar any
valid consent to act as director, as required by s.264. But as s.264 applies only to public companies;
there is nothing prohibiting a minor being a director of a private company. However, from a
practical point of view a minor can be an ornamental director as he can neither be party to any
transaction which requires competency to contract – nor, for the same reason, can he be delegated
any powers of the board. He may possibly vote on all resolutions at board meetings.
Example: Mr. Ram is a director of ABC Ltd. XYZ Ltd. and PQR Ltd. ABC Ltd. was regular
in filing annual returns, but did not file annual accounts for the year ended March 31, 2007.
Further ABC Ltd. failed to pay interest on loans taken from a public financial institution from 1st
January, 2007 onwards and also failed to repay the matured deposits on due date from1st
April, 2007 onwards.
Mr. Ram is proposed to be appointed as additional director of MN Ltd. on 1st June, 2008.
Also Mr. Ram wants to continue as a director of XYZ Ltd. and PQR Ltd. Further, he seeks
reappointment when he retires by rotation at the AGM, of respective companies to be held in
September, 2008.
150
As regards failure of ABC Ltd. to pay interest on term loans taken from a public financial
institution, the disqualification does not apply under s. 274(1)(g)(B).
As regards failure to repay its deposits on due date and the failure continues for more than one
year, Mr. Ram is disqualified. In the light of this disqualification, he is not eligible to be appointed
on additional director in MN Ltd. From 1st June, 2008 onwards.
The disqualification would come into operation only at the time of appointment or
reappointment of Mr. Ram as director of any public company after the default has become
effective. Till such time, he can continue to hold office of director in all public companies in
which he is a director. Therefore, he need not vacate the office of director in XYZ Ltd. and PQR
Ltd. (either under s. 274(1)(g) or s. 283).
However, Mr. Ram cannot seek reappointment in XYZ Ltd. and PQR Ltd. when he retires by
rotation at the AGMs to be held in September, 2008.
Example: Mr. A is a director of ABC Ltd. which failed to repay matured deposits from
1st April, 2007 onwards and the default continues. But ABC Ltd. is regular in filing annual
accounts and annual returns. Mr. A is also a director of PQR Ltd. and XYZ Ltd.
ABC Ltd. has committed default under s. 274 (1)(g)(B) and Mr. A, being a director of ABC Ltd.
becomes disqualified for his appointment or reappointment as a director in any other public
company. However, he need not vacate his office of directors in PQR Ltd. and XYZ Ltd. as it is not
required either by s. 274 or s. 283.
In case DEF Ltd. wants to appoint Mr. A as an additional director at the Board meeting to be held
on 15 May, 2008, it cannot be done [Proviso to s. 274(1)(g)].
Further, if Mr. A had ceased to be a director of ABC Ltd. by resignation on 1 st March, 2008, then the
proviso to s. 274(1)(g) would not be attracted, and therefore he could be appointed as a director
in DEF Ltd.
Example: The articles of association of MKP Ltd. incorporated with an authorised share
capital of 50 crores divided into 5 crore equity shares of 10 each contained the following clause:
“The qualification of a director shall be the holding of at least 1,000 equity shares in the company
and such a director, if not already so qualified shall have to obtain his qualification within a
period of 30 days from the date of his appointment as a director.”
A person appointed as a director may acquire shares for qualification within 2 months after his
appointment. Therefore, the clause requiring him to obtain his qualification shares within a
period of 30 days from the date of his appointment is void.
In this case, the disqualification specified in s. 274(1)(g)(A) does not apply as ABC Ltd., has not
committed defaults in respect of both the matters (i.e. annual returns and annual accounts for
three consecutive financial years).
Also, the clause requires him to hold at least 1,000 equity shares of 10 each. This amounts to
10,000 whereas s. 270(3) restricts the nominal value of the qualification shares to 5000 or
nominal value of one share where it exceeds 5000.
Example: Mr. A, who has huge personal liabilities far in excess of his assets and properties,
has applied to the court for adjudicating him as an insolvent and such application is pending. He
cannot be appointed as a director of a company [s. 274(1)(c)].
151
Company Law
Example: Mr. B was caught red handed in a shop lifting case two years ago and for
embezzlement of funds and sentenced to imprisonment for a period of eight weeks. He can be
appointed as a director of a company, as the disqualification given in s. 274(1)(d) is not attracted.
Example: Mr. C, a former bank executive, was convicted by a court eight years ago for
embezzlement of funds and sentenced to imprisonment for a period of one year. He can be
appointed as a director of a company as disqualification under s. 274(1)(d) is not attracted.
Example: Mr. D is a director of DLT Ltd. which has not filed its annual returns pertaining
to the AGMs held in the calendar years 2005, 2006 and 2007. He can be appointed as a director in
any other company under s. 274(1)(g), as the failure on the part of DLT Ltd. is on account of
annual returns, and not in respect of filing of annual accounts.
The provisions of s. 274 regarding disqualifications of directors do not apply in the following
cases:
(i) The special directors appointed on the board of a company under the Sick Industrial
Companies (Special Provision) Act, 1985;
(ii) The nominee directors appointed on the board of a company by public financial institutions
and companies established by the Special Acts of Parliament, like I.D.B.I., L.I.C., U.T.I.
(iii) The nominee directors appointed by the Central or State Government on a banking
company.
10.3.3 Validity of acts of Directors (s. 290)
Section 290 provides that the acts done by a director shall be valid even if his appointment is
discovered to be invalid because of any defect or disqualification or where his appointment had
terminated by virtue of any provisions contained in the Act or in the articles. Section 290 is
designed to protect persons dealing with the company such as lenders, vendors and purchasers
of shares and debentures. Thus, a party entering into a contract with a company through its
director may assume that the acts of the director are valid if he does not know the irregularity,
if any, in the appointment of the director.
However, the acts will not be valid (or the provisions of s. 290 shall not operate) where:
(i) His appointment is illegal, or there is no appointment at all.
(ii) He continues in his office knowing that his term has expired.
(iii) He knew from the beginning that his appointment was defective.
(iv) He acted in the capacity of a managing director, manager [subject, however, to the
provisions of s. 269(12)] or secretary.
(v) His acts are ultra vires the company.
(vi) Where requirement as to minimum number of directors is not satisfied.
(vii) The third party was aware of the defect in his appointment.
152
10.4 Appointment of Directors
The appointment of directors rests in the following hands:
1. Subscribers to the memorandum – s.254; Clause 64 (Table A);
2. Company in general meeting – Ss.255-57; 263-265;
3. Board of directors – Ss.260, 262, 313;
4. Central Government – s.408; (e) Third parties – s.255.
10.4.1 Appointment of First Directors
The first directors are usually named in the articles of a company. The articles may, however, instead
of naming the first directors confer power on the subscribers, or majority of them, to appoint the
directors. Where the appointment is to be made by the majority of subscribers, the majority of them
(and not only the quorum fixed by the articles) should be present if the appointment is to be valid.
Where there are no articles or the articles neither name them nor confer any such power on the
subscribers, then Clause 64 of Table A in Schedule I to the Act confers powers on the subscribers or
a majority of them to make the appointment of first directors. Furthermore, if the articles neither
name them, nor do they contain a provision for their appointment by the subscribers and Table
A is excluded, then the subscribers to the memorandum who are individuals are deemed to be the
first directors of the company until the directors are duly appointed at a general meeting of the
company in accordance with the provisions of s.255.
10.4.2 Appointment of Subsequent Directors
Sections 255 and 265 provide for three alternate schemes for the constitution of the Board of
directors of a public company or a private company which is subsidiary of a public company. These
schemes are: (i) all the directors retire at every annual general meeting [s.255]; or (ii) at least
two-thirds of the total number of directors must be persons whose period of office is liable to
determination by retirement by rotation (s.255); or (iii) at least two-thirds of the directors may be
appointed by the principle of proportional representation, by a single transferable voteby a system
of cumulative voting or otherwise and shall be directors for a period of three yearsat a time
(s.265). The remaining directors in (ii) and (iii) and the directors generally of a pure private
company, unless otherwise provided in the articles, must also be appointed by the company in
general meeting.
Thus, a company may have two types of directors, retiring and non-retiring. The directors may
retire by rotation as given in s. 256 or after a period of 3 years as given in s. 265.
Thus, every company should have a duly constituted board appointed in accordance with the
provisions of s.255. A general meeting is called by the ‘first’ directors after the allotment of
shares in the case of a company limited by shares and in the case of any other company, after its
incorporation, for the specific purpose of appointment of directors.
10.4.3 Restrictions on Appointment of Directors
Section 266 states that a person cannot be appointed a director by the articles, or named as a director
in the prospectus or statement in lieu of prospectus unless, before registration of the articles,
publication of the prospectus, or filing of the statement in lieu of prospectus, he has:
153
Company Law
Signed and filed with the registrar a consent in writing to act as such director; and either:
(i) Signed the memorandum for his qualification shares, if any; or
(ii) Taken his qualification shares, if any, from the company and paid or agreed to pay for
them; or
(iii) Signed and filed with the registrar a written undertaking to take from the company his
qualification shares, if any, and pay for them; or
(iv) Made and filed with the registrar an affidavit to the effect that his qualification shares are
registered in his name.
This section does not apply to:
A company not having a share capital;
A private company;
A public company which was formed as a private company;
A prospectus issued by a company after the expiry of one year from the date on which the
company was entitled to commence business.
Self Assessment
6. The agenda of the first Board Meeting of a limited company generally consists of the
following items:
(i) Election of chairman
(ii) Approval of draft prospectus
(iii) Appointment of officers, viz., The secretary, the manager and the accountant
(iv) Incorporation of the company and the legal advisor to report on the same
The correct order in which the above items of the agenda usually appear is:
(a) (i), (ii), (iii), (iv) (b) (iv), (iii), (ii), (i)
(c) (iii), (iv), (i), (ii) (d) (iv), (i), (iii), (ii)
7. Which one the following statements relating to a company secretary are not correct?
(a) He is not likely to perform duties towards shareholders
(b) He is the mouthpiece of the Board of directors
(c) He may be considered to be the head of the administrative section of a company
(d) He is to arrange for Board meetings.
10.5 Modes of Appointments
The Companies Act does not prescribe how directors are appointed; this is left to the companies’
articles of association. Typically, directors are elected by the members at the annual general
meeting of the company.
Table A which contains default articles makes provision for the appointment of directors. Thus,
the present position is that the company’s articles will provide for the appointment of directors,
or the default position in Table A will apply unless Table A is excluded by the company’s articles.
154
Having an express provision in the Companies Act will simplify matters as a company will not
have to provide for the appointment of directors in its articles or rely on Table A, unless the
company wishes to provide for a different mode of appointment. The Steering Committee
received industry feedback that in practice, Table A is often excluded by the companies’ articles
as it is not found to be useful.
The current Singapore approach of not prescribing in legislation how directors are appointed is
consistent with the position in the UK and Hong Kong. The Steering Committee considered
whether the Companies Act should expressly provide for the mode of appointing directors,
following the position in Australia and New Zealand.
For reasons of simplicity and greater clarity, the Steering Committee recommends that the
Companies Act should provide expressly that unless the articles provide otherwise, a company
may appoint a director by ordinary resolution passed at a general meeting. The mode of
appointment is subject to the company’s articles to give flexibility to companies.
This approach is consistent with that in Australia where the statutory provisions in the Australia
Corporations Act 20017 on the mode of appointing directors are replaceable rules. It is also
consistent with the approach in the New Zealand Companies Act 1993 where section 153(2)
provides for the appointment of subsequent directors by ordinary resolution, unless the
constitution of the company otherwise provides.
During the focus group consultation, the majority of the respondents expressed support for
having such an express provision on the appointment of directors in the Companies Act. It was
felt that notwithstanding that there is little dispute in practice on how directors are appointed,
it would be good to clearly provide that the general meeting has power to appoint directors,
subject to contrary provision in the articles.
10.6 Director Remuneration
Section 198 provides that the total managerial remuneration payable by a public company or a
private company which to its directors or manager in respect of any financial year must notexceed
11 per cent of the net profit of that company for that financial year, in computing the above ceiling
of 11 per cent computed in the manner laid down in section 349 and 359. The fees payable to
directors for attending Board meetings is not included.
10.6.1 What is included in Remuneration?
Explanation to s.198 describes the term ‘remuneration’. According to it, for the purposes of Ss.
309, 310, 311, 381 and 387, ‘remuneration’ includes the following:
1. Any expenditure incurred by the company in providing rent-free accommodation, or any

other benefit or amenity in respect of accommodation free of charge, to any of its directors
or manager;
2. Any expenditure incurred by the company in providing any other benefit or amenity free of
charge or at a concessional rate to any of the persons aforesaid;
3. Any expenditure incurred by the company in respect of any obligation or service, which,
but for such expenditure by the company, would have been incurred by any of the persons
aforesaid; and
4. Any expenditure incurred by the company to effect any insurance on the life of, or to
provide any pension, annuity or gratuity for, any of the persons aforesaid or his spouse or
child.
155
Company Law
Section 309 contemplates three kinds of directors, i.e., (i) Managing Director; (ii) Whole-time
director; (iii) Director pure and simple. Further, s.309 provides that subject to the general
provisions of s.198, dealing with the total managerial remuneration, the remuneration be
determined by the articles, or by a resolution or, if the articles so require, by a special resolution,
passed by the company in general meeting. Any remuneration paid for services in any other
capacity shall not be included if: (a) the services rendered are of a professional nature; and (b) in the
opinion of the Central Government, the director possesses the requisite qualifications for the
practice of the profession.
A director who is neither in the whole-time employment of the company nor a managing
director may be paid remuneration. (a) by way of a monthly, quarterly or annual payment with
the approval of the Central Government; or (b) by way of commission, if the company by special
resolution authorises such payment; or (c) by both.
Task X holds shares and directorship in a number of companies. X is proposed to be a Director

of a company named Asian Ltd. State the requirements of law necessary to be complied with
by him before and after he joins the Board of Asian Ltd. [ Hint: (i) X should resign one of the
directorships, if he is already a director of more than 15 companies,
(ii) He should give his consent in writing before joining the Board of Asian Ltd. (s.264)
(iii) He should file his consent with the Registrar within 30 days of the date of joining.
(iv) He should disclose the nature and extent of his interest in other companies (s.299).
(v) He should acquire the qualification shares, if any prescribed by the Articles of Asian
Ltd. in case he does not own the same already.]
However, in either of the above cases, the remuneration paid to such director, or where there is more
than one such director, shall not exceed: (i) one per cent of the net profit of the company,if the
company has managing or whole-time director or manager; (ii) three per cent of the net profits of
the company in any other case. The company in general meeting may, however, with the approval
of the Central Government, authorise the payment of a commission at a rate higher than one per
cent, or as the case may be, three per cent of its net profits.
Each director is entitled to receive a sitting fee for each meeting of the Board or a committee thereof,
provided the same is authorised by the articles.
A whole-time director or a managing director may be paid remuneration either by way of a 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 per cent of the net profits for one such director and if thereis more
than one such director, 10 per cent for all of them together. Furthermore, a managing or whole-time
director who is in receipt of any commission from the company cannot receive any remuneration
from any subsidiary of the company.
If any director draws or receives, directly or indirectly, by way of remuneration any sum in
excess of the limits stated above, without the sanction of the Central Government, where it is
required, he shall have to refund such sums to the company and until the refund is made the
money will be held by him in trust for the company. The company cannot waive the recovery of
any sum refundable to it, unless permitted by the Central Government.
The provisions of s.309 will not apply to a private company unless it is a subsidiary of a public
company.
156
10.6.2 Increase in Remuneration
Section 310 provides that every increase in the remuneration of any director including a managing
or whole-time director granted or provided by any amendment in his term of appointment which
has the effect of increasing, whether directly or indirectly, the amount payable to him would not
be operative unless the same has been approved by the Central Government. But no approval of the
Central Government would be required if the increase in remuneration made is in accordance
with the conditions specified in Schedule XIII. Also no approval of the Central Government is
necessary, if the increase in the remuneration is only by way of fee for each meeting of the Board
or a committee of the Board attended by any such director and the amountof the fee after such
increase does not exceed such sum as may be prescribed. The Central Government has laid down
differential scale of sitting fee according to the paid-up capital of the companies.
10.7 Remuneration Payable to a Manager
Section 387 provides that he may receive remuneration either by way of a monthly payment or
by way of a specified percentage of the ‘net profits’ of the company, or partly by one way and
partly by the other. Such remuneration, however, must not exceed in the aggregate 5 per cent of
the net profits except with the approval of the Central Government.
10.7.1 Managerial Remuneration vis-à-vis Schedule XIII
A public company is entitled to appoint its managerial personnel and fix their remuneration so
long as the same is in accordance with the conditions laid down in Schedule XIII without seeking the
prior approval of the Central Government. Schedule XIII, provides as follows:
1. Remuneration Payable by Companies Having Profits: Subject to the provisions of s.198
and s.309, a company having profits in a financial year may pay any remuneration, by way
of salary, dearness allowance, perquisites, commission and other allowances, which shall
not exceed 5 per cent of its net profits for one such managerial person and if there are more
than one such managerial persons, 10 per cent for all of them together.
2. Remuneration payable by companies having no profits or inadequate profits: Where in
any financial year during the currency of tenure of the managerial person, a company has
no profits or its profits are inadequate, it may pay remuneration to a managerial person,
by way of salary, dearness allowance, perquisites and other allowance, not exceeding ceiling
limit of 24,00,000 per annum or 2,00,000 per month calculated on the following scale:
Where the effective capital of the company is Monthly remuneration payable

shall not exceed ( )
Less than 1 crore 75,000
1 crore or more but less than 5 crores 1,00,000
100 crores or more 2,00,000
In addition to the above, certain perquisites like contribution to provident fund, gratuity, leave
encashment may be paid. Non-resident Indians may also be paid children education allowance,
157
Company Law
holiday passage for children studying outside India or family staying abroad, leave travel
concession. These additional benefits shall be subject to the limits laid down in Schedule XIII.
The expression ‘effective capital’ shall mean the aggregate of the paid-up share capital (excluding
share application money or advances against shares); amount, if any, for the time being standing to
the credit of share premium account, reserves and surplus (excluding revaluation reserve); long
term loans and deposits repayable after one year (excluding working capital loans, overdrafts,
interest due on loans unless funded, bank guarantee, etc. and other short term arrangements) as
reduced by the aggregate of any investments (except in case of investments by an investment
company whose principal business is acquisition of shares, stock, debentures or other securities),
accumulated losses and preliminary expenses not written off.
Sitting Fee (s.310)
The sitting fee payable to a director for each meeting of the Board of Directors or a committee
thereof shall not exceed ceiling prescribed by the Central Government (presently, 5,000). Any
increase in the sitting fee payable to a director shall not require the prior approval of the Central
Govt. if it falls within the prescribed limits.
10.8 Disclosure
Disclosure of interest by directors, Section 299 provides as follows:
1. A director of a company who is in any way concerned or interested in a contract or

arrangement by or on behalf of the company must disclose such concern or interest at the
board meeting at which the contract is discussed. However if the director was not interested
in the contract at the date of the meeting, then he must disclose his interest at the next
board meeting held after he became interested.
2. However, if a director gives a general notice to the board that he is a director or member
of a specified company or firm and is to be regarded as interested in any contract which is
made with, it then this is a sufficient declaration or disclosure of interest. Such a general
notice must, however, be given once every financial year and that too at the board meeting.
3. Non-compliance by a director with the aforesaid requirements will render him liable to a
fine up to 50,000.
4. However, there is an exclusion clause. All contracts and arrangements between two
companies where the interest of a director or director of one company in the other does not
exceed a shareholding of two percent of the paid-up share capital of the other are excluded
from the provisions of s.299.
Section 299 is in accordance with the principle of law that an agent cannot put himself into a position
where his duty and his interest conflict.
10.8.1 Interested Directors not to Participate or Vote in Board’s

Proceedings
Section 300 provides as follows:
“An interested director must not participate in the discussions or exercise his vote on the particular
contract or arrangement in which he is interested. If he does vote, his vote shall be void, nor his
presence count for the purposes of quorum”.
158
However, these restrictions do not apply to:
1. A private company which is neither a subsidiary nor a holding company of a public

company;
2. A private subsidiary company in respect of contracts or arrangements entered into by it

with the holding company;
3. Any contract of indemnity against any loss which any director(s) may suffer by reason of
becoming or being a surety or sureties for the company;
4. A company in which the director had only his qualification shares and he was nominated
as a director by the other company with which the contract is entered into;
5. A company in which the director is a member holding not more than two per cent of the
paid-up share capital of the company.
A director who knowingly contravenes the provisions of s.300 is liable to be fined up to

50,000.
10.8.2 Register of Contracts in which Directors are Interested
To ensure that the provisions of sections 297-300 are complied with, s.301 provides as follows:
1. Every company must keep one or more registers in which must be entered separately
particulars of all contracts or arrangements in which directors and their relatives are
interested, and also particulars of firms and companies in which directors are interested as
partners, members or directors. The particulars to be entered in the register are:
(i) The date of the contract or arrangement;
(ii) The names of the parties thereto;
(iii) The principal terms and conditions thereof;
(iv) The date on which the contract was placed before the board, where it is required to
be placed;
(v) The names of the directors voting for and against the contract or arrangement; and
(vi) The names of directors who remained neutral.
2. The aforementioned particulars must be entered in the register within seven days of the
approval of the board, where approval is required.
In case of any other contract or arrangement, the particulars must be entered in the register
within seven days of the receipt at the registered office of the company of the particulars
of such other contract or arrangement or within 30 days of the date of such contracts or
arrangements whichever is later.
The register is required to be placed before the next meeting of the board and is then to be
signed by all the directors present at the meeting.
3. The register aforesaid shall also specify, in relation to each director of the company, the
names of the firms and bodies corporate of which notice has been given by him under
s.299.
4. Exemption has been granted to contracts for the sale or purchase or supply of goods, etc. not
exceeding 1000 in value in any year, and also to contracts by banking companies for collection
of bills in the ordinary course of business, and transactions of banking and insurance
companies in the ordinary course of business with any director, relative, partner, etc.
159
Company Law
5. If default is made in complying with the above provisions of s.301, then the company, and
every officer of the company who is in default, shall, in respect of each default, be punishable
with fine which may extend to 5000.
6. The above register shall be kept at the registered office of the company, and it shall be open
to inspection. Extracts may be taken from the register and any member of the company may
demand copies thereof. The provisions of s.163 which apply to the register of members shall
apply to the register in which directors are interested.
Task The total strength of the Board of directors of a company is ten. How many directors
are liable to retire by rotation at the next annual general meeting? [Hint: Three] (s. 255,256)
10.8.3 Disclosure of Director’s Interest in Contract Appointing Manager,

or Managing Director
Section 302 states that where a company appoints or varies the terms of appointment of a
manager, managing director, or whole-time director, and any director is directly or indirectly
interested or concerned in the matter, then an abstract of the matter and of the director’s interest
therein should be circulated by the company to its members within 21 days of the date of the
contract or its variation. These contracts must be kept at the registered office of the company,
and must be available for inspection by the members. If the appointment or variation is made
by a resolution of the board, the above provisions will apply to the same.
If default is made in complying with these provisions, then the company, and every officer of the
company who is in default, shall be punishable with fine which may extend to 10,000.
Further, all contracts entered into by a company for the appointment of a manager, managing
director shall be kept at the registered office of the company and shall be open to the inspection
of the members of the company. Extracts may be taken from the register and copies thereof may
be demanded by any member. The provisions of s.163, which applies to the register of members
become applicable here also.
Summary of provision of Section 297 with respect to interested directors:
Particulars Persons in which director is said to Approvals required

be interested
Contracts with 1. Director or relative 1. Approval of the board.
the company 2. A firm in which a director or his 2. In case the PUC of the
relative is a partner. company is 1 crore or more,
3. Any other partner in such a firm then approval of the board and
4. A private company of which the prior approval of the central
director is a director or a government.
member.
Example: R is the managing director of a public company with a paid up capital of

200 lac. He is also a partner of the firm in which the other partners are his wife and two sons.
The company proposes to enter into a contract with the firm for the sale of its products of the value
of 5 lac on credit.
As per s.297 such a contract can be entered only if (i) the consent of board of directors is obtained,
and (ii) the previous approval of the central government is obtained (since the paid up capital is
more than 1 crore).
160
Example: P is the managing director of a public company with a paid up capital of

150 lac. The company proposes to enter into a contract for the sale of its products of the value
of 5 lakhs on credit with a private company in which the wife of P and his two sons S and T are
members.
The facts of this case do not attract the restriction for entering into contract with an interested
director. P is neither a director nor a member of the private company.
Example: The articles of a company states that a director shall not vote in respect of a
contract in which he is interested. In a resolution put up for approval of the shareholders, a
shareholder (even if he is a director), may vote as he pleases even when his interests are different
from or opposed to those of the company. As a shareholder, he is not a trustee for the company
or for any one else. Hence, the director can exercise his voting rights at a general meeting in
favour of a contract in which he is interested.
Example: Company Y with a paid-up capital of 50 lakhs entered into a contract with company
Z which has paid up capital of 5 lakhs. A director of a company Y is holding equity shares of the
nominal value of 50,000 in Z company. The director does not disclose his interest at the board
meeting under s. 299. The holding of the director is less than two percent of 5 lakhs. Therefore, the
director is not liable to disclose his interest under s. 299(6).
10.9 Service Contract
Directors not to Hold Office or Place of Profit
Section 314 imposes certain restrictions on the holding of office or place of profit in a company
by the directors and their associates. Following is the summary of restrictions so provided:
1. Section 314 (1) (a): No director of a company shall hold any office or place of profit (carrying
any remuneration) under the company or its subsidiary except with the consent of the
company by a special resolution. It shall, however, be sufficient if the special resolution is
passed at the first general meeting held after such appointment.
2. Section 314 (1) (b): Except by passing a special resolution, and the approval of the central
government the following persons shall not hold any office or place of profit carrying a total
monthly remuneration of such sum as may be prescribed (presently 10,000 per month):
A partner or relative of a director or manager;
A firm in which such director or manager, or relative of either, is a partner;
A private company of which such a director or manager, or relative of either, is a
director or member.
Again, special resolution may be passed at the first general meeting after the appointment
made. Where, however, the aforesaid appointment is made without the knowledge of the
director, the consent of the company may be obtained either in the general meeting
aforesaid or within three months from the date of the appointment, whichever is later.
However, a director or any of his associates may be appointed as managing director,
manager, banker or trustee for the debenture-holders of the company without sanction of
special resolution, if the remuneration received from such subsidiary in respect of such
office or place of profit is paid over to the company or its holding company.
161
Company Law
For the aforesaid appointment of a director or his associates, special resolution shall not
only be necessary at the time of first appointment but also for every subsequent appointment
on a higher remuneration not covered by the special resolution except where an appointment
on a time-scale has already been approved by the special resolution.
It may be noted that the aforesaid restrictions do not apply where a relative of a director
or a firm in which such relative is a partner holds any office or place of profit under the
company or a subsidiary thereof having been appointed to such office or place before such
director became a director of this company [s. 314(1A)].
3. Section 314(1)(B): (i) no partner or relative of a director or manager; (ii) no firm in which
such director or manager, or relative of either is a partner; (iii) no private company of which
such a director or manager, or relative of either, is a director or member, shall hold an office
or place of profit in the company carrying a total monthly remuneration of not less than such
sum as may be prescribed (presently, 50,000 per month) except by passing a special
resolution and the approval of the Central Government.
4. Section 314(2)(C): If any director or his associate holds an office or place of profit in
contravention of the aforesaid provisions, then: (i) he shall be deemed to have vacatedsuch
office or place of profits as such on and from the date next following the date of the general
meeting; (ii) he shall be liable to refund to the company any remuneration received or the
monetary equivalent of the perquisites or advantage enjoyed by him. The company cannot
waive the recovery of any sum refundable to it as above unless, permitted to do so by the
Central Government.
These provisions will neither affect the director’s office as such nor shall he be liable to refund
remuneration received in the capacity of a director, e.g; if some commission or monthly
remuneration is payable to all the directors, the same will not be refundable, but if a director
receives something in addition to other directors that he will be bound to pay to the company.
Thus, for the purposes of this section, an office and place of profit is to be deemed to be one of
profit if in case it is held by a director, such director over and above his remuneration as a
director, and in case it is held by any other person, firm or private company or a body corporate,
obtains anything from the company by way of remuneration, whether as salary, fees,
commission, or perquisites, right to occupy any premises rent-free as a place of residence or
otherwise.
Section 629 (A) also provides for a fine of 5,000 and a further fine of 500 for every day during the
period in which contravention continues.
Section 314 (2A) makes it obligatory for every individual, firm, private company, or other body
corporate proposed to be appointed to any office or place of profit to which this section applies
to declare in writing before or at the time of appointment, whether he or it is or is not connected
with any director of the company in any of the ways referred to in s.314 (1).
The aforesaid restrictions do not apply to a person who being the holder of any office of profit
in the company is appointed by the Central Government, under s.408, as a director of the
company. [s. 314(4)].
10.10 Removal of Directors
A director may be removed by:
1. Shareholders
2. Central Government
3. CLB
162
10.10.1 Removal by Shareholders
Section 284 provides that a company may, by ordinary resolution passed in general meeting after
special notice, remove a director before the expiry of his term of office. On receipt of the special
notice, the company must forthwith send a copy thereof to the director concerned to enable him to
make a representation. If he makes a representation in writing and requests the company to notify
it to the members, the company must, unless it is received by it too late for it to send to the
members, state the fact of the representation in any notice of the resolution given to the members.
It should also send a copy of the representation to every member of the company to whom notice
of the meeting is sent. If the representation is not sent as aforesaid, the company must at the instance
of the director concerned read it out at the meeting. The director is also entitled to be heard on
the resolution at the meeting.
The special notice given by the member(s) must specify the reasons for removal of the director.
However, the copy of the representation of the director sought to be removed, need not be circulated
nor the concerned director be allowed the right to have the representation read out in the general
meeting (where the same was not circulated earlier because of late receipt), if the company or any
other person claiming to be aggrieved, has made an application to CLB to prevent such circulation
or reading out on the ground that such circulation or reading out would amount to abuse of the right
on the part of the concerned director to secure needless publicity for defamatory matters, and CLB,
being satisfied, orders accordingly.
The vacancy caused by the removal of a director may be filled at the same meeting and if so
filled, the person appointed thereto will only hold office for the residual period of the removed
director. If the vacancy is not filled by the company in general meeting, the Board of directors
may fill it as if it were a casual vacancy in accordance with s.262, but the board cannot appoint the
removed director.
A removed director may claim compensation for loss of office as a director, or claim damages
for the termination of any other office on account of the removal, or may continue to hold the
additional office.
But the following directors cannot be removed by the company in general meeting:
A director appointed by the Central Government under s.408.

A director of a private company holding office for life on April 1, 1952.
A director elected by the principle of proportional representation under s.265.
A director appointed by the Central Government under Industries (Development and

Regulation) Act, 1951.
A director appointed under Sick Industrial Companies (Special Provisions) Act, 1985.
A director appointed by financial institutions under their statutory powers.

A nominee director.
A director appointed by CLB (s. 402).
It is to be noted that s.284 is not exhaustive as it is stated therein that nothing in s.284 shall be
taken as derogating from any power to remove a director which may exist apart from the
section. The articles of a company may provide for the removal of a director.
Thus it is to be noted that the power to remove a director is not an absolute or unrestricted one.
163
Company Law
Example: The shareholders of X Co. Ltd. sought to remove a director at a meeting. The
concerned director alleged that this could not be done as no special notice was given to pass a
resolution to remove him. As such he was deprived of his right to make a representation. The
shareholders’ contention that the sending of the special notice and the right of the director to make
a representation were only a formality was not tenable. [Queen Kuries and Loans (P) Ltd.
v. Sheena Jose, (1993) 76 Comp. Cas 821 Ker]. The contention of the director was held to be correct.
Example: If in the above example, one shareholder holding ten equity shares of 10 each fully
paid up had given a special notice for the removal of the director, but did not state anyreasons for
the removal. Even in such a case, the director cannot be removed, as the disclosure of the ground for
removal is a matter of substance and not of form because the director concerned is entitled to
make a representation in writing against his removal. How can he make the representation, if he
does not know the reasons of his removal.
10.10.2 Removal by the Central Government
The provisions of s. 203 and s. 204 prohibit certain persons from acting or being appointed as
directors, and provide for their removal only if they were convicted for offences involving moral
turpitude. In all those cases, conviction or finding of guilt by the court is the prerequisite for
bringing about vacation of office. Strict proof of guilt in a criminal case is essential and very often
such persons may go scot-free in spite of malpractices. The findings of the CLB will enablethe
Central Government to take quick action against persons involved in cases of fraud, etc. For this
purpose, s.388B to 388E have been inserted in the Act.
Under s.388B, the Central Government has the power to make a reference to the CLB against any
managerial personnel. The power can be exercised where, in the opinion of the Central Government,
there are circumstances suggesting:
1. At the personal level, 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 of
default in carrying out his obligations and functions under the law, or breach of trust in
connection therewith; or
2. At the company level. that the business of the company is not or has not been conducted
and managed by such person in accordance with sound business principles or prudent
commercial practices; or
3. At the industry level, that the business of the company is or has been conducted or managed
by such person in a manner which is likely to cause or has in fact caused, serious injury or
damage to the interest of trade, industry or business to which such company pertains; or
4. At the community level, that the business of the company is or has been conducted and
managed by such person with an intent to defraud its creditors, members, or any other
person or otherwise for a fraudulent or unlawful purpose or in a manner prejudicial to
public interest.
The reference may be made by stating a case against the person aforesaid, with a request that, the
CLB may inquire into the case, record finding as to whether or not such person is a fit and proper
person to hold the office of director or any other office connected with the conduct and management
of any company.
The statement of the case by the Central Government should be in the form of an application
presented to the CLB and the person against whom such case is stated and referred should be
164
joined as a respondent to the application. The application should contain a concise statement of such
circumstances and materials as the Central Government may consider necessary for purpose of
inquiry to be made by the CLB. The application must be signed and verified in the same manner
as a complaint in a suit by the Central Government under the Code of Civil Procedure.
Thereafter, the CLB will hear the case against the respondent. At any stage of the proceedings,
the CLB may allow the Central Government to alter or amend the application in such a manner
and on such terms as may be just and all such alterations and amendments shall be made as may
be necessary for the purpose of determining the real question in the inquiry (s.388B).
If during the pendency of the case the CLB 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. This person, who is temporarily appointed to discharge the duties in place of the
respondent will be regarded as a public servant within the meaning of s.21 of the Indian Penal
Code (s.388C).
At the conclusion of the hearing of the case, the CLB shall record its findings, stating therein
specifically as to whether or not respondent is a fit and proper person to hold the office of
director or any other office connected with the conduct and management of any company
(s.388-D).
On the basis of the aforesaid findings, the Central Government may, by order, notwithstanding
any other provisions contained in the Act, remove the delinquent respondent from his office
(s.388E(1)).
An order under s.388E must not be passed against any person unless he has been given a
reasonable opportunity to show cause against the order. However, no matter can be raised by
such a person before the Central Government, which has already been decided by the CLB
(s.388E(2) and proviso thereto).
After the delinquent person has been, by order, removed, he shall neither hold any office for a
period of 5 years from the date of the order of removal nor will he be paid any compensation for
loss of office as a result of removal. The time-limit may, however, be relaxed by the Central
Government with the previous concurrence of the CLB, and the Central Government may
accordingly permit such person to hold the office of a director or any other office connected with the
conduct and management of the affairs of the company even before the expiry of the period of 5
years. On the removal of the person, the company may, with previous approval of the Central
Government, appoint another person to that office in accordance with the provisions of the Act.
10.10.3 Removal by Company Law Board
Section 402(b) empowers the CLB to remove some managerial personnel when an application to
it is made for prevention of oppression and mismanagement under Ss. 397 and 398. Under this
section, if the CLB finds that, the relief ought to be granted, it may terminate, set aside or modify
any agreement between the company and the managing director or any other director or the
manager. When appointment of a managerial personnel is so terminated or set aside, he can
neither sue the company for damages or compensation for the loss of office, nor can he be
appointed, except with the leave of the CLB, in any managerial capacity in the company for a
period of 5 years from the date of the order terminating or setting aside his contract with the
company. Also the removed director shall not be entitled to claim any compensation from the
company for loss of his office.
165
Company Law
A Director of a private company is appointed as its managing director on a monthly salary of

10,000. There is an objection to this on the ground that a director cannot be appointed to an
office of profit. Advise.
10.11 Retirement of Director
The directors due to retire by rotation vacate office at the latest on the last day on which an
annual general meeting could have been held under s. 166, and therefore, if this meeting is not held,
the directors cannot claim to continue after the date on which the meeting should have been
held. The reasons for not allowing directors to continue after the date on which the AGM should have
been held is that as it is the duty of the directors to call the AGM within the prescribed time, they
cannot be allowed to take advantage of their own default and by that means to continue in office
for the extended period [B.R. Kundra v. Motion Pictures Assn. (1976)46 Comp Cas. 339 Del].
10.12 Appointment of a Director other than a Retiring Director
Section 257 provides for the procedure of appointment of a person other than the retiring director.
If any person, (whether a member of the company or not) other than the retiring director wishes
to stand for directorship, he must signify his intention to do so by giving 14 days’ notice to
the company before the meeting and the company must inform the members not later than seven
days before the meeting either by individual notices or by advertisement of this fact in at least two
newspapers circulating in the place where its registered office is situated,of which one must be in
English and the other in the regional language of the place. Also, the candidate or the member who
intends to propose him as director has to deposit a sum or 500 which shall be refunded to such
person or as the case may be, to such other member, if the candidate succeeds in being elected. In
case such person is not elected as director, he or the member, as the case may be, will not be entitled
to the refund of 500 and the amount deposited shall stand forfeited to the company. Also s.264
requires every person proposed as a candidate for the office of a director to sign and file first with
the company his consent to act as a director, if appointed and then with registrar within 30 days
of his appointment.
Example: The BOD of XYZ Ltd. appoints Mr. A as a director in the vacancy caused by
resignation of Mr. B. Now at the ensuing AGM, Mr. A is to vacate his office. The company is
contemplating to reappoint him as a director, treating him as a retiring director.
The company cannot treat A as a retiring director under s. 257. Therefore, he cannot be deemed
to have been reappointed. The procedure given in s. 257 will have to be followed for his
appointment.
10.13 Power and Fiduciary Duties
10.13.1 Powers of the Board of Directors
Section 291 provides for general powers of the Board of directors.
“Subject to the provisions of the Act, the Board of directors of a company shall be entitled to
exercise all such powers and to do all such acts and things, as the company is authorised to
exercise and do”
166
However, the Board cannot exercise any power or do any act or thing which is directed or
required, whether by this or any other Act or by the memorandum or articles of the company or
otherwise, to be exercised or done by the company in general meeting. In exercising any such
power or doing any such act or thing, the board will be subject to the provisions contained in
that behalf in this or any other Act, or in the memorandum or articles of the company, or in any
regulations not inconsistent therewith and duly made thereunder, including regulations made
by the company in general meeting.
Thus, the Board may exercise all powers of the company and can do all such acts and things that
the company can do. But the exercise of such powers of the Board shall be in conformity with the
provisions of the Companies Act or any other Act and memorandum, articles and resolutions of
the company in general meetings. Thus, a general meeting may, by amending the articles,
restrict the powers of the board. But the meeting cannot invalidate any act validly done by the
board except in the following cases: (1) where the directors are either unable or unwilling to act
[Barron vs. Potter (1914) 1 Ch. 895]; (2) when the directors act for their own personal interests in
complete disregard to the company [Marshall’s Value Gear Co. Ltd. vs. Manning Wardle & Co.
Ltd (1909) Ch. 267]; (3) when the Board has become incompetent to act e.g. where all the directors
constituting the Board are interested in a dealing or where none of the directors was validly
appointed [B.N. Vishwanathan vs. Tiffins B.A. and Ltd. AIR (1953) Mad 510].
10.13.2 The Mode or Manner of Exercise of Board’s Powers
Section 292 provides that the Board of directors of a company shall exercise the following powers
on behalf of the company and it shall do so only by means of resolutions passed at meeting of the
Board:
(i) The power to make calls on shareholders in respect of money unpaid on their shares;
(ii) The power to buyback its shares under s. 77A;
(iii) The power to issue debentures;
(iv) The power to borrow money otherwise than on debentures;
(v) The power to invest funds of the company (subject to sections 293 and 372A); and
(vi) The power to make loans. (subject to sections 293 and 372 A).
The Board may, however, by a resolution passed at a meeting delegate to any committee of
directors, the managing director, the manager or any other principal officer of the company, the
powers specified in clauses (iv), (v) and (vi) on such conditions as the Board may prescribe.
Besides the powers specified in s.292, there are certain other powers also which can be exercised
only at the meeting of the Board. These are:
1. The power of filling casual vacancies in the Board (s.262);
2. Sanctioning of a contract in which a director is interested [s.297];
3. The power to recommend the rate of dividend to be declared by the company at the
Annual General Meeting, subject to the approval by the shareholders.
In the following cases, not only that the powers be exercised at the Board’s meeting but also that
every director present and entitled to vote must consent thereto:
1. The power to appoint a person as managing director or manager, who is already managing
director or manager of another company (Ss.316 and 386).
2. The power to invest in any shares and debentures of any other body corporate (s.372).
167
Company Law
10.13.3 Restrictions on Powers of Directors
Section 293 provides that, the Board of directors of a public company or a private company which
is a subsidiary of a public company cannot exercise the following powers without the consent of the
shareholders in general meeting:
1. Sell, lease or otherwise dispose of the whole, substantially the whole, of the undertaking
of the company, or where the company owns more than one undertaking, of the whole or
substantially the whole, of any such undertaking.
However, this restriction does not apply to the case of a company whose ordinary business
is to sell or lease property.
2. Remit or give time for the re-payment of any debt due by a director except in the case of
renewal or of continuance of an advance made by a banking company to its director in the
ordinary course of business.
3. Invest, otherwise than in trust securities, the amount of compensation received by the
company in respect of compulsory acquisition of any fixed assets of the company.
4. Borrow money exceeding the aggregate of the paid-up capital of the company and its free
reserves. ‘Borrowing’ does not include temporary loans obtained from the company’s
bankers in the ordinary course of business.
The expression ‘free reserves’ mean reserves not set apart for any specific purpose.
Further, every resolution passed by the company in general meeting shall specify the total
amount up to which moneys may be borrowed by the board. Furthermore, the expression
‘temporary loans’ means loans repayable on demand or within six months from the date
of the loan such as short term, cash credit arrangement, the discounting of bills and the
issue of other short term loans of a seasonal character, but does not include loans raised
for the purpose of financing expenditure of a capital nature.
5. Contribute in any year, to charitable and other funds not directly relating to the business
of the company or the welfare of its employees, any amount exceeding 50,000 or 5% of its
average net profit for the last three financial years, whichever is greater.
However, contributions to National Defence Fund or any other fund approved by the Central
Government for the purpose of national defence are exempted from the above provisions. Any
amount may be contributed without obtaining the sanction of the company in general meeting.
However, the amount contributed to these funds must be disclosed in the profit and loss account
of the company for the year in which the contribution was made.
The Companies Act does not expressly empower companies to borrow money. Therefore, most
of the companies expressly provide for such borrowing powers in the memorandum. In such a
case, where memorandum authorises the company to borrow, the articles provide as to how and
by whom these powers shall be exercised. It may also fix up the maximum which can be borrowed
by the company.
Example: The paid up share capital and free reserves of XYZ Ltd. is 100 crore as on April1,
2008. The shareholders of the company at their general meeting held on April 4, 2008, by a resolution
authorised the board of the company to borrow money ‘exceeding the paid-up share capital and free
reserves of the company, to the extent required by the board of directors.” The board, as a result,
borrowed money to the extent of 130 crore, including 20 crore as short term loan and 25 crore as a
temporary loan for financing the construction of a building of the company.
168
The borrowing made by the board violates the provisions of the Act because (i) it exceeds the paid
up capital and free reserves even after excluding short term loan of 20 crore assuming that the loan
is obtained from the companies bankers in the ordinary course of business. (ii) the resolution passed
in the general meeting enabling the board to borrow in excess of its paid up capital and free reserves
without specifying the total amount up to which money may be borrowed by the board.
Example: The position would be different in case the company’s paid up share capital and
free reserves increased to 150 crore and the board borrow money to the extent of 140 crore
which neither include any short-term loan nor temporary loan for financing of the construction of a
building for the company. As the board could raise up to 150 crores, but in fact has raised 140 crore
only, there is no contravention of the provision of the Act.
Self Assessment
8. Minimum no. of Directors in case of a public company is
(a) 1 (b) 2
(c) 3 (d) 4
9. Minimum no. of Directors in case of private company is
(a) 1 (b) 2
(c) 3 (d) 4
10. Age limit of Directors in case of public company is
(a) 65 (b) 70
(c) 60 (d) 55
11. Age limit of Directors in case of private company is
(a) 65 (b) 70
(c) 75 (d) No limit
10.14 Duties of Director in Relation to Good Corporate Governance
Duties of directors may be divided under two heads: (1) Statutory duties; and (2) Duties of a
general nature. The statutory duties are the duties and obligations imposed by the Companies
Act. These have been discussed at appropriate places. Important among them are:
1. To file Return of Allotments: Section 75 charges a company to file with the Registrar,
within a period of 30 days, a return of the allotments stating the specified particulars.
Failure to file such return shall make directors liable as ‘officer in default’. A fine up to
500 per day till the default continues may be levied.
2. Not to Issue Irredeemable Preferences Shares or Shares Redeemable after 10 years: Section
80 forbids a company to issue irredeemable preference shares or preference shares
redeemable beyond 10 years. Directors making any such issue may be held liable as ‘officer
in default’ and may be subject to fine up to 1,000.
3. To Disclose Interest [Ss.299-300]: A director who is interested in a transaction of the
company must disclose his interest to the Board. The disclosure must be made at the first
meeting of the Board held after he has become interested. This is because a director stands
169
Company Law
in a fiduciary capacity with the company and therefore, he must not place himself in a position
in which his personal interest conflicts with his duty. Interest should be such which avoids
conflicts with the duties of the director towards the company.
Notice, however, that the Companies Act does not debar a company from entering into a
contract in which a director is interested. It only requires that such interest be disclosed.
An interested director should not take part in the discussion on the matter of his interest.
His presence shall not be counted for the purpose of quorum. He shall not vote on that
matter. If he does vote, his vote shall be void. Non-disclosure of interest makes the contract
voidable and not void. Where the whole Board of directors is aware of the facts, a formal
disclosure is not necessary (Venkatachalapathi vs. Guntur Mills AIR 1929 Mad 353). In this
case, a loan was advanced by the wife of a director creating a mortgage on the property of
the company. The director did not disclose his interest and he even voted on the matter.
The company later sued to have mortgage set aside.
Held: the fact was known to all directors and a formal disclosure was not necessary. As
regards voting by the interested director, it was held that the voting would not render the
contract void or voidable unless in the absence of that vote, there would have been no
quorum qualified to contract.
4. To disclose receipt from transferee of property: Section 319 provides that any money
received by the directors from the transferee in connection with the transfer of the company’s
property or undertaking must be disclosed to the members of the company and approved
by the company in general meeting. Otherwise the amount shall be held by the directors
in trust for the company. This money may be in the name of compensation for loss of office
but in essence may be on account of transfer of control of the company. But if it is bona
fide payment of damages for a breach of contract, then it is protected by s.321(3).
5. To disclose receipt of compensation from transferee of shares: If the loss of office results
from the transfer (under certain conditions) of all of the shares of the company, its directors
would not receive any compensation from the transferee unless the same has been approved
by the company in general meeting before the transfer takes place (s.320). If the approval
is not sought or the proposal is not approved, any money received by the directors shall
be held in a trust for the shareholders who have sold their shares.
Section 320 further provides that in pursuance of any agreement relating to any of the above
transfers, if the directors receive any payment from the transferee within one year before or
within 2 years after the transfer, it shall be accounted for to the company unless the director
proves that it is not by way of compensation for loss of office.
Section 321 further provides that, if the price paid to a retiring director for his shares in the company
is in excess of the price paid to other shareholders or any other valuable consideration has been
given to him, it shall also be regarded as compensation and should be disclosed to the shareholders.
Some other statutory duties are: to attend the Board meetings; to convene and hold general
meetings; to prepare and place before AGM financial accounts; to make declaration of solvency.
The general duties of directors are as follows:
1. Duty of good faith: The directors must act in the best interest of the company. Interest of
the company implies the interests of present and future members of the company on the
footing that the company would be continued as a going concern.
A director should not make any secret profits. He should also not exploit to his own use
the corporate opportunities. In Cook vs. Deeks (1916) AC 554, it was observed that “Men
who assume complete control of a company’s business must remember that they are not
170
at liberty to sacrifice the interest which they are bound to protect and while ostensibly
acting for the company, direct in their own favour business which should properly belong
to the company they represent.” In this case, there was an offer of a contract to the company.
Directors who were the holders of shares of 3/4 of the votes resolved that the company
had no interest in the contract and later entered the contract by themselves.
Held: The benefit of the contract belonged in equity to the company.
2. Duty of Care: A director must display care in performance of the work assigned to him. He
is, however, not expected to display an extraordinary care but that much care only which
an ordinary prudent man would take in his own case. Justice Romer in Re City Equitable
Fire Insurance Company [1925 Ch. 407] observed, “His (director’s) duties will depend upon
the nature of the company’s business, the manner in which the work of the company is
distributed between the directors and other officials of the company. In discharging these
duties a director must exercise some degree of skill and diligence. But he does notowe to his
company the duty to take all possible care or to act with best care. Indeed, he need not
exhibit in the performance of his duties a greater degree of skill than may reasonably be
expected from a person of his knowledge and experience. It is, therefore, perhaps, another way
of stating the same proposition that directors are not liable for mere errors of judgement.”
Similar view was expressed in Langunas Nitrate Co. vs. Lagunas Nitrate Syndicate (1899)
2 Chi. 392, in the following words: “If directors act within their powers, if they act with such
care as is to be reasonably expected of them having regard to their knowledge and experience
and if they act honestly for the benefit of the company they discharge boththeir equitable
as well as legal duty to the company.”
Section 201 states that, a provision in the company’s articles or in any agreement that excludes
the liability of the directors for negligence, default, misfeasance, breach of duty or breach
of trust, is void. The company cannot even indemnify the directors against such liability. But if
a director has been acquitted from such charges, the company may indemnify him against costs
incurred in defense. Section 633 further states that, where a director may be liable in respect
of the negligence, default, breach of duty, misfeasance or breach of trust but if he has acted
honestly and reasonably and having regard to all the circumstances of the case, he ought fairly
to be excused, the court may relieve him either wholly or partly from his liability on such
terms as it may think fit.
3. Duty to attend Board Meetings: A number of powers of the company are exercised by the
Board of directors in their meetings held from time to time. Although a director is not
expected to attend all the meetings but if he fails to attend three consecutive meetings or
all meetings for a period of three months, whichever is longer, without permission, his
office shall automatically fall vacant.
4. Duty not to Delegate: Director, being an agent, is bound by maxim ‘delegatus non protest
delegare’ which means a delegate cannot further delegate. Thus, a director must perform
his functions personally. A director may, however, delegate in the following cases:
(a) where permitted by the Companies Act or articles of the company; (b) having regard to
the exigencies of business certain functions may be delegated to other officials of the
company.
Some other duties are to convene statutory; annual general meeting and also extraordinary general
meeting when required by the shareholders of the company; to prepare and place at the AGM along
with the balance sheet and profit and loss account, a report on the company’s affairs; to make a
declaration of solvency in the case of a member’s voluntary winding up.
171
Company Law
The duties of the directors are usually regulated by the company’s Articles. While performing
their duties, they must display reasonable care, honesty, good faith, skill and diligence. As they
stand in a fiduciary relationship to the company and they are agents and trustees in certain
respects, they are bound to exercise in the performance of their duties a reasonable degree of
skill and care.
Self Assessment
12. The board of directors can make political contribution by passing a resolution at its
meeting only.
13. The board of directors can fill a casual vacancy in the office of a director by passing a
resolution by circulation.
14. The board of directors can appoint an additional director by passing a resolution either at
a meeting or by circulation.
15. The board of directors can enter into a joint venture agreement by passing a resolution
either at a meeting or by circulation.
16. The board of directors can invest in another body corporate by passing a resolution at its
meeting.
Case Study Reliance Industries
R
eliance Industries, the largest shareholder in Reliance Energy, has voted in favour
of entrusting itself with the power to appoint the majority of directors on the REL
board.
Earlier these powers were vested with Mr. Anil Ambani, REL Chairman and Managing
Director.
According to sources, RIL was among the 97.24-per cent REL shareholders who voted in
favour of the changes to its Articles of Association, a set of rules that govern day-to-day
workings of a company, through a postal ballot. The result of which was announced.
The altered Article envisages that so long as the Reliance Group of Companies holds
26 per cent or more of REL’s paidup voting equity share capital, it will have the right to
appoint majority of REL’s directors on the board of the company.
Reliance Industries had earlier said that it had not sought in any withdrawal of powers
conferred on Mr. Anil Ambani. It had also said that RIL had not been consulted by REL
before the proposed re-amendment of the relevant articles of association. The move to
alter the articles of association was seen as part of the ongoing differences between the
Ambani brothers over control of the 99,000-crore Reliance Group, of which REL is a
subsidiary.
REL had, by way of a special resolution, asked shareholders to mail their votes through
postal ballot for a change in its Articles of Association.
The company had sought permission to change Article 131 (a), 131 (a) (ii) and 131 (aa),
which allowed Mr. Anil Ambani the power to appoint one-third or majority of the total
Contd...
172
directors on REL’s board, choose the Vice-Chairman of the company and even decide the
tenure of the Chairman, Vice-Chairman and the directors appointed by him.
REL sought to vest these powers with its prime shareholder, Reliance Industries.
Question
Why does Reliance want alteration in Reliance Energy’s articles? ( Hint: due to the conflict
between the Ambani brothers)
10.15 Summary
Section 2 (13) defines a Director as including “any person occupying the position of director,
by whatever name called.”
The articles of a company, sometimes, designate its directors as governors, members of

the governing council or the board of management or may give them any other title, but
so far as the law is concerned, they are simply directors.
A deemed director need not necessarily be an individual. The person may even be a body
corporate say, a holding company.
The directors act as agents of the company and the ordinary rules of agency apply.
The directors are also sometimes described as managing partners.

Directors are treated as officers of the company [s. 2(30)].
10.16 Keywords
Deemed Director: For certain purposes, a person even when he is not a director may be deemed
to be a director of a company.
Director: Any person occupying the position of director, by whatever name called director.
Legal Position of Director: The exact position of ‘Director’ is hard to define, as no formal definition,
either statutory or judicial, of the term has been given. However, judicial pronouncements have
described them as (i) agents, (ii) trustees, or (iii) managing partners.
Statutory Duties: The statutory duties are the duties and obligations imposed by the Companies
Act.
1. Define ‘Director’. What is his legal position in a company?
2. To what extent can the directors of a company be considered as trustees, agents or managing
partners of the company? Explain your answer with reasons.
3. Who can be a director? What qualifications, if any, must a person possess in order to
become a director of a company?
4. How are the directors of a company appointed?
5. What are the disqualifications of a director?
6. Can the directors of a company be appointed by the Board of directors?
7. State the powers of the Board of directors which can be exercised only with the approval
of the members in a general meeting of the company.
173
Company Law
8. Enumerate the powers which can be exercised by the Board of directors only at its meetings.
9. What do you understand by an office or place of profit held by a director under the
company? In this regard, discuss the restrictions placed by the Companies Act, 1956.
10. State in relation to a public company:
(a) When additional directors can be appointed and for what period?
(b) When an alternate director can be appointed and for what period?
(c) How is the office of a director filled in case of a casual vacancy, and for what period?
(d) When can directors be appointed by the principle of proportional representation

and for what period?
1. Section 2 (13) 2. deemed director

3. English Law 4. agency
5. managing partners 6. (d)

7. (a) 8. (c)
9. (b) 10. (a)

11. (d) 12. True
13. False 14. True

15. True 16. True

www.webopedia.com
174
Unit 11: Corporate Governance
Introduction
Corporate Managers as Trustees
Corporate Managers as Protectors of Interests
Objectives
Define corporate governance;

Describe corporate manager as trustee;
Explain corporate governance in the Indian scenario.
Introduction
Corporate governance became a dominant business topic in the wake of the spate of corporate
scandals of midyear 2002-Enron, Worldcom and Tyco, to name a few. Interest in corporate
governance is not new, but the severity of the financial impact of these scandals undermined the
confidence of both the institutional and the individual investor and heightened concerns about
the ability and resolve of private enterprises to protect their stakeholders. The crisis in confidence
in the corporate sector contributed to the downward pressure on stock prices worldwide and
particularly in the United States. In the first six months of 2002, the S&P 500 fell 16 percent, the
technology heavy NASDAQ fell 36 percent. The U.S. government intervened, and new legislation
required CEOs to personally attest to the accuracy of their firms’ accounts and report results
more quickly. Simultaneously, corporate America increased the level of self-regulation.
11.1 Corporate Governance
Corporate governance consists of the set of processes, customs, policies, laws and institutions
affecting the way people direct, administer or control a corporation. Corporate governance also
175
Company Law
includes the relationships among the many players involved (the stakeholders) and the corporate
goals. The principal players include the shareholders, management, and the board of directors. Other
stakeholders include employees, suppliers, customers, banks and other lenders, regulators, the
environment and the community at large.
‘Corporate governance’ is a term that refers to the set of processes, customs, policies, laws and
institutions affecting the way a corporation is directed, administered or controlled. The term
may also describe the company’s compliance with applicable codes (corporate governance
guidelines), its investment technique based on active ownership (as in corporate governance
funds) or a field in economics, which studies the many issues arising from the separation of
ownership and control.
Corporate governance is also inclusive of the relationships of the stakeholders, and the goals for
which the corporation is governed. Corporate governance is an international business issue.
In the US, corporate governance became a high profile issue as a result of corporate scandals and
business failures, such as Enron and WorldCom. However, internationally, similar scandals have
made corporate governance an issue that all organizations have made a business priority.
A key component of corporate governance is accountability, to shareholders, customers,
employees and others. Corporations must not only comply with federal regulations and exercise
fiscal responsibility but governance must extend to ethical responsibilities as well. In its simplest
view, corporations should seek to comply with codes to the overall good of all constituents.
Corporate governance is used to monitor whether outcomes are in accordance with plans; and
to motivate the organization to be more fully informed in order to maintain or alter
organizational activity. Primarily though, corporate governance is the mechanism by which
individuals are motivated to align their actual behaviors with the overall corporate good (i.e.
maximum aggregate value generated by the organization and shared fairly amongst all
participants).
Corporate governance in the broadest sense, defines the operating rules of a company. Those
rules will encompass the laws of the land, fiduciary or economic responsibility, ethical behavior,
fraud prevention, risk mitigation and in general good corporate citizenry. Everyone in a
corporation from the boardroom to the front line has a role in corporate governance.
11.1.1 Need of Corporate Governance
The success of modern enterprises depends on the adoption and implementation of good
management practices to protect the interests of stakeholders. Sound corporate governance
practices help companies to improve their performance and attract investment while enabling
them to realize their corporate objectives, protect shareholder rights, meet legal requirements,
and demonstrate to a wider public how they are conducting their business. These practices have
become critical to worldwide efforts to stabilize and strengthen global capital markets and
protect investors.
Good corporate governance helps an organisation to achieve its outcomes and obligations
through sound planning and risk management. It provides a means to assist in decision making
and to improve accountability. It also helps to provide a framework for establishing responsibility to
the organisation’s members, the people served by the organisation and other stakeholders.
11.1.2 Features of Good Corporate Governance
There are some key features of good governance that you need to consider when assessing the
governance of your organisation. These features should be central to an organisation’s corporate
governance framework and should be included in governance related documentation which
176
may include organisational plans, business plans, marketing plans, policy and procedures
manuals, risk management reviews and/or quality assurance manuals. The features are:
Strategy setting and planning
Risk management
Consultation
Roles and responsibilities
Skills, independence and resources
Conduct and ethics
Performance
Succession planning
Financial and operational reporting
Audit committees.
Good corporate governance is important to professional investors. Major institutions rank

corporate governance on par with the firm’s financial indicators when evaluating investment
decisions. A McKinsey study found that professional investors are even prepared to pay large
premiums for investments in firms with high governance standards. Premiums ranged from an
average of 13 percent in North America and even Western Europe to 20 or 25 percent in Asia and
Latin America and even higher in Easter Europe and Africa. On average when moving from
poorest to best on corporate governance, firms could expect an increase of 10 to 12 percent in
market value.
A number of bodies have published guidelines for good corporate governance. One found very
useful was the organization for Economic Co-operation and Development’s 1999 publication
“OECD Principles for Corporate Governance,” which defined corporate governance as “providing
the structure for determining organizational objectives and monitoring to ensure that objectives are
attained”. The OECD emphasized that “there is no single model of good corporate governance,”
but it noted that in many countries corporate governance is vested in a supervisory board that is
responsible for protecting the rights of shareholders and other stakeholders (employees,
customer, creditors, and so on). The board, in turn, works with a senior management team to
implement governance principles that ensure the effectiveness of organizational processes.
Corporate and Key Asset Governance
A framework for linking corporate and IT governance is proposed. The top of the framework
(Figure 11.1) depicts the board’s relationships. The senior executive team, as the board’s agent,
articulates strategies and desirable behaviors to fulfill board mandates.
Strategy is viewed as a set of choices. Who are the targeted customers? What are the products and
service offerings? What is the unique and valuable position targeted by the firm? What core
processes embody the firm’s unique market position?
177
Company Law
Desirable behaviors embody the beliefs and culture of the organization as defined and enacted
through not only strategy but also corporate value statements, mission statements, business
principles, rituals, and structures. Desirable behaviors are different in every enterprise. Behaviors,
not strategies, create value. For example, Johnson & Johnson relied on autonomous business
units to create shareholder value for nearly a hundred years. Eventually, however, customers
insisted that they wanted to deal with J&J not a set of individual J&J operating companies.
Accordingly, J&J’s well-known corporate credo has evolved to specify desirable behaviors such
as lowering the cost of its products to customers, creating mechanisms for better understanding
the unique needs of individual customers, and transferring employees across J&J companies to
enhance individual careers and help them identify with the corporation.
The lower half of Figure 11.1 identifies the six key assets through which enterprises accomplish
their strategies and generate business value. Senior executive teams create mechanisms to govern
the management and use of each of these assets both independently and together. The key
elements of each asset include the following:
Human Assets: People, skills, career paths, training, reporting, mentoring, competencies,
and so on.
Financial Assets: Cash, investments, liabilities, cash flow, receivables, and so on.
Physical Assets: Buildings, plant, equipment, maintenance, security, utilization, and so on.
IP Assets: Intellectual Property (IP), including product, services, and process know-how
formally patented, copy righted, or embedded in the enterprises people and systems.
178
Information and IT Assets: Digitized data, information, and knowledge about customers,
processes performance, finances, information systems, and so on.
Relationship Assets: Relationships within the enterprises as well as relationships, brand,

and reputation with customers, suppliers, business units, regulators, competitors, channel
partners, and so on.
Governance of the key assets occurs via a large number of organizational mechanisms. Some
mechanisms are unique to a particular asset (for example, the IT architecture committee) and
others cross and integrate multiple asset types ensuring synergies between key assets. Maturity
across the governance of the six key assets varies significantly in most enterprises today with
financial and physical assets typically the best governed and information assets among the
worst.
At the bottom of figure 11.1 are the mechanisms used to govern each of the six key assets. It is
contended that enterprises with common mechanisms across multiple assets perform better.
For example, if the same executive committee governs both financial and IT assets, a firm can
achieve better integration and create more value. Some mechanisms will always be unique to
each asset the audit committee for financial assets and the IT architecture committee for example,
but some common mechanisms lead to better coordination of the six assets.
As a sobering exercise, quickly jot down the list of mechanisms used in your enterprise to govern
each of the six assets. Could you complete the lists? How many of the mechanisms were common
across more than one asset more than two assets? Coordinating the six key assets of anenterprise
is not easy. The average assessment of a group of forty-two CIOs on how well their enterprises
integrated IT governance with the governance of the other key assets was less than three on a
five point scale. Creating common governance mechanisms across the assets will notincrease
integration but the resulting smaller number of mechanisms will be simpler to communicate
and implement. Education of the senior management team about how governance mechanisms
combine to work for the enterprise is an essential and ongoing task for effective governance.
We contend that many tangible benefits await better IT governance.
Self Assessment
Fill in the blanks:
1. Corporate governance includes the relationships among the many players involved and
the .......................................
2.is used to monitor whether outcomes are in accordance with plans;

and to motivate the organization to be more fully informed in order to maintain or alter
organizational activity.
3. A McKinsey study found that .......................................... are even prepared to pay large
premiums for investments in firms with high governance standards.
4.are different in every enterprise.
11.2 Corporations as Social Entity
A corporation, though producing and distributing goods and services, is not just an economic
and legal entity. No doubt, society is dependent upon corporations for the supply of goods and
services but they cannot ignore the social consequences of their overall activities. In fact, a
corporation, in addition to being an economic entity, is also a social entity. This fact is nowadays
recognized beyond doubt and social implications of working of corporations are studied with
keen interest. Every business corporation operates within a certain kind of social environment.
179
Company Law
No business corporations however humble, is purely a private or personal office of its promoters
and/or its managerial personal; it has to function with a certain kind of social control imposed both
from within and without.
No business corporation can be regarded as a purely profit making organization. The establishment
of any business corporation is attended with not only legal and economic consequences but with
many social consequences. Therefore, the corporate managers have to treat the corporations not
only as important economic institutions but also as a major force for bringing about and managing
social change.
11.3 Corporate Managers as Trustees
The corporate managerial personnel stand in a fiduciary relationship towards the corporation
for which they are working. This relationship is based on the premise that they have a privilege
to control the resources of the corporation. They have powers – both financial and non-financial.
They are vested with discretionary powers in a number of situations. They are vested with
discretion, in relation to management and superintendence of the corporation’s affairs. They are
not mere employees of the corporation. They can no longer conform themselves to the employee-
employer relationship. They are not only employees but also agents and trustees for the
corporation.
As an agent, a manager firstly, should not make use of the corporate opportunities for his
personal gain. Secondly, he should carry out his duties with as much skills as possible.
A manager should also realize that he is a trustee for the corporation for which he is working.
He is however, not a trustee in the strict sense of the term in as much as no ownership or
property is vested in him in his capacity as a manager. Nevertheless, in certain respects, he is in
the position of trustee for the corporation. Firstly, he is a trustee of resources, which come into
his hands or which are actually under his control, he will be held liable to make good money. In
the second place, a manager is in the position of a trustee for the corporation as regards the
exercise of all powers which he is authorized to exercise, on behalf of the corporation. In the
third place, a manager’s position partakes of the fiduciary character of trusteeship, so that he is
precluded from allowing the interest of the corporation to clash with his own interest.
11.4 Corporate Managers as Protectors of Interests
The fact that a manager occupies a fiduciary position in relation to his corporation raises a few more
questions. Is a manager not in a position of trust in relation to consumers of the products of his
corporation? Is he not in a position of trust in relation to the employees of the corporation? What is
his position vis-à-vis suppliers, dealers competitors, etc? How does he stand in relationship to the
community in which the corporation exists? These questions are a subject of considerable debate
and the consensus is in favour of answering these questions in the affirmative. The managers owe
responsibilities to employees, consumers and the community at large. As a corporation has social
implications, it may be called a ‘public’ institution. In this sense, managers are public trustees.
Therefore, the managers have to keep in mind all interests whether internal or external which are
affected by the operations of the corporation.
Consequently, social consciousness and duty to the society must become an integral part of the norm
of manager’s responsibilities. All this carries the manager much beyond the scope of a mere
commercial manager. He has to manage the corporation to include social good. The managers are
the administrators of a community system and the wealth of the country is controlled by them. This
gives the managers the economic power to affect the lives of the masses with every position of
power, law implies certain responsibilities. Therefore, the managers
180
have responsibilities to the various segments of the society. The responsibilities of the managers are
co-extensive with the sphere of corporate influence. They owe a duty to the employees in the
corporation in that their conditions of service are proper. They owe duty to the consumers in
providing quantity goods and services at reasonable prices. They owe a duty to society, to keepthe
environment free of pollution. The managers have to accept these realities of life and fulfill the
obligations to the various sections of the society.
Once the corporations are considered public institutions, their managers become public trustees.
From the point of view of both the general public and the government, the standards of duties
of managers have changed. New ethical standards have come up in which the interests of the
various segments of the society are given due consideration.
11.5 Corporate Governance in the Indian Scenario
Many factors in the Indian socio-economic environment have added significance to the concept
of corporate governance. Firstly, the Indian government is committed to remove poverty and
bring about a socialist society in which private interest will be subordinated to the national
considerations. The constitution of India provides for economic and social justice for all. Our
country, being welfare state, has therefore, enacted many laws in order to make corporations
feel responsible to the various segments of the society. Many amendments have been carried
out in the recent past to the Companies Act, 1756, the Consumer Protection Act, 1986 and other
laws which suggest a fresh look at the economic and social values implicit in the existing legal
provisions.
One could safely hope and predict that the new concept of the company formally projected in the
Indian Corporate Legislation will be the dominant factor in the shaping of corporate policy in
the years ahead of us.
Secondly, the financial institutions and banks are contributing a great deal towards the financial
needs of the corporate sector. The financial institutions and the banks require the borrowing
corporations to conform to the declared social and economic policy of the government. This is
ensured by nominating representatives on the Board of Directors of the borrowing companies.
Thirdly, the ethical aspect of business relates back to some of our ancient teaching, and is deeply
enshrined in the thoughts and workings of some of our great national leaders. In the modern
context, one has to refer to Mahatma Gandhi, who aimed at throughout his life, the promotion
and development of the concept of trusteeship in almost every field-political, social, and economic.
According to Gandhi, all life is trust and all power carries with it obligations.
Corporate governance may thus, be defined as a conscious effort by the corporate management
to balance judiciously the interests of its different stakeholders. Some of the stakeholders are
shareholders, employees, consumers, society, government, suppliers, creditors, etc.
In 1999, the Securities and Exchange Board of India (SEBI) appointed a committee to promote and
raise the standards of corporate governance of India. It was headed by Mr. Kumara Mangalam
Birla, and, as such the committee came to be known as Kumara Manglam Committee on corporate
governance. The agenda of the committee was three-fold, i.e.,
1. (a) To suggest suitable amendments to the Listing Agreement executed by the stock
exchanges with the companies
181
Company Law
(b) To suggest any other measures to improve the standard of corporate governance in the
listed companies, in areas such as continuous disclosure of material information, both
financial and non-financial, manner and frequency of such disclosures, responsibilities
of non-executive directors.
2. To draft a code of Corporate Best Practices.
3. To suggest safeguards that be installed within the companies to deal with inside trading.
The committee identified three constituents which have a key role to play in improving the
standard of corporate governance. These are the shareholders, the board of directors, and the
managerial personnel of the company. The responsibilities of these constituents were identified
to ensure effective corporate governance. Some of the recommendations of the committee are:
1. The Board of directors should have at least 50% non-executive directors. Further, the
Board should have at least 1/3 of the members as independent directors where the chairman
is non-executive, and at least 1/2 of the Board should be independent in case the chairman
is an executive.
2. The Board should constitute (a) an ‘Audit Committee’; and (b) a ‘remuneration Committee’
to determine remuneration package for executive directors.
3. The Board meetings should be held at least four times in a year, with a maximum gap of
four months between any two meetings.
4. The corporate governance section of the Annual Report should make disclosures on
remuneration paid to directors in all forms.
5. There should be a separate section on corporate governance in the Annual Report, with
details on the levels of compliance by the company of the mandatory recommendations of
the committee.
6. A separate section on compliance with the mandatory recommendations of clause 49 of
the Listing Agreement should form part of the report and the details of non-compliance
should be highlighted.
Self Assessment
5. Society is dependent upon corporations for the supply of goods and services but they
cannot ignore the social consequences of their overall activities.
6. Business corporations can be regarded as a purely profit making organization.
7. Social consciousness and duty to the society must become an integral part of the norm of
manager’s responsibilities.
8. The Indian government is committed to remove poverty and bring about a socialist
society in which private interest will be subordinated to the national considerations.
9. The financial institutions and banks are not contributing a great part of the financial needs
of the corporate sector.
182
Case Study Why Intervention is effective in Emerging Markets
O
n 2nd and 3rd December 2004, the BIS hosted a meeting of Deputy Governors of
central banks from major emerging market economies to discuss foreign exchange
market intervention. While few developed countries have actively intervened
within the last decade, the outstanding exception being Japan, intervention has been
commonplace in the emerging market community.
There are several reasons why developed countries no longer actively intervene. One is
that research and experience suggest that the instrument is only effective (at least beyond
the very short term) if seen as foreshadowing interest rate or other policy adjustments.
Without a durable and independent impact on the nominal exchange rate, intervention is
seen as having no lasting power to influence the real exchange rate and thus. competitive
conditions for the tradable sector. A second reason is that large-scale intervention can
undermine the stance of monetary policy. A third reason is that private financial markets
have enough capacity to absorb and manage shocks - so that there is no need to “guide”
the exchange rate.
Yet emerging market countries do intervene - presumably because they believe the
instrument to be an effective tool in the circumstances and for the situations they face. The
difference in view is brought home by the unprecedented scale of foreign exchange reserve
accumulation by the emerging market group in recent years. Between the end of 2001 and
the end of 2004, global foreign exchange reserves grew by over US$ 1600 billion, reflecting
reserve accumulation by emerging market economies in Asia. Many observers from
developed economies have publicly attributed the comparatively weak appreciation of
Asian currencies against a rapidly depreciating US dollar to such intervention. Hence there
does seem to be a common belief that intervention by emerging market economies has
significantly altered the path of the real exchange rate for long enough to matter – even if
such a view runs counter to received wisdom about intervention in the markets formajor
currencies.
This meeting threw some new light on these issues. Some flavour of the discussion can be
gleaned from the central bank papers reproduced in this volume, along with overview
papers prepared by BIS staff. Four central questions are outlined below; it will be clear
that many important issues remain to be resolved.
Is intervention more effective in emerging markets?
The wide range of different objectives behind intervention in practice makes assessment
difficult - especially empirical assessment that uses data from different episodes and
different countries where policy objectives may vary. In flexible exchange rate cases, the
objectives of intervention are particularly varied, a point which emerges clearly from the
Moreno paper and the individual country papers in this volume. Reasons for intervention
cited by central banks that do not target the exchange rate include: to slow the rate of
change of the exchange rate; to dampen exchange rate volatility (in some cases to satisfy
an inflation target); to supply liquidity to the forex market; or to influence the level of
foreign reserves. The paper from South Africa provides an example of objectives that are
both subsidiary to the main objective and conditional on prevailing circumstances (in this
case, the process of reserve accumulation being used to help dampen volatility when that
is convenient). Other country papers show that varying mixtures of objectives are quite
commonplace.
Contd...
183
Company Law
Many central banks would argue that their main aim is to limit exchange rate volatility
rather than to meet a specific target for the level of the exchange rate. Yet others would
counter that it is better to abstain from intervention in the foreign exchange market: such
a stance would, they contend, make investors more aware of the need to hedge their own
exposures, and this would help the market in hedging instruments to develop. The papers
from Israel, Mexico, Poland and Thailand are particularly relevant in this regard. There is
indeed some evidence that exchange rate volatility has fallen a lot in some countries
where the central bank has not intervened in recent years. The papers from Korea and
Peru highlight the existence of a policy trade-off where there are reasons to intervene to
dampen volatility yet intervention may involve moral hazard with respect to market
development.
The survey reported in Mihaljek’s paper shows that many emerging market central banks view
intervention as effective in influencing the exchange rate consistent with their objectives. Part
of this may be attributable to cases in which fixed or targeted exchange rate regimes are
in place: under such a regime, monetary policy actions are primarily dictated by what is
needed to achieve and maintain the exchange rate target, intervention in the foreign
exchange market is automatic or nearly so, and the exchange rate peg has proved reasonably
durable. The papers from Hong Kong SAR and Saudi Arabia illustrate the point.
Formal econometric research has usually thrown doubt on the conclusion of effectiveness
of intervention in flexible exchange rate cases although, as noted, such research often
conflates interventions for different purposes. In addition, the effectiveness of intervention
is likely to depend on the specific circumstances - studies of effectiveness on average do
not answer the question of when intervention is likely to be successful.
Disyatat and Galati’s paper surveys the available empirical evidence, and presents new
evidence for the Czech koruna (the methodology requires detailed daily data on intervention
and option prices, which were only available for the Czech Republic). The authors’ new
estimates tentatively suggest the existence of a cumulative effect from repeated intervention
(although the mechanism is not clear). In the group of countries surveyed, there are several
examples of repeated interventions over lengthy periods. In this connection, the paper from
Venezuela makes the interesting point that intervention might have diminishing power with
repetition.
It remains possible that greater apparent effectiveness of intervention in emerging market
cases simply reflects different structural characteristics. Emerging market economies tend
to have less substitutability of assets across currency boundaries, and the authorities tend
to have greater financial - and certainly regulatory - weight relative to their private
markets. Mihaljek’s paper shows clearly that emerging market economies typically hold
very large reserves compared with market turnover, even if interventions are not in
general large relative to turnover. And several of the country papers describe the application
of regulatory measures to obtain influence over the exchange rate.
Questions
1. What do you think intervention is effective for emerging market. (Hint: Yes)
2. What is the effect of intervention on global economy. (Hint: It provides more

opportunities)
Source: BIS paper no 24
184
11.6 Summary
A corporation, though producing and distributing goods and services, is not just an
economic and legal entity.
A manager should also realize that he is a trustee for the corporation for which he is
working.
As a corporation has social implications, it may be called a ‘public’ institution.
The responsibilities of the managers are co-extensive with the sphere of corporate influence.
The financial institutions and the banks require the borrowing corporations to conform to the
declared social and economic policy of the government.
Corporate governance may be defined as a conscious effort by the corporate management

to balance judiciously the interests of its different stakeholders.
A reasonable or rational purpose of governance might aim to assure, (sometimes on

behalf of others) that an organization produces a worthwhile pattern of good results while
avoiding an undesirable pattern of bad circumstances.
11.7 Keywords
Complaint: Any allegation in writing by a complainant with a view to obtaining any relief
under the Act.
Consumer: Any person who buys any goods for consideration which has been paid or promised
or partly paid and partly promised.
Corporate Governance: A conscious effort by the corporate management to balance judiciously

the interests of its different stakeholders.
1. Explain the concept of corporate governance and its relevance in the present day corporate
world.
2. What disclosures are required to be made under the provisions of clause 49 of the Listing
Agreement?
3. What is the role of Audit Committee in relation to corporate governance?
4. Explain the different provisions of the Companies Act, 1956 concerning corporate
governance.
5. “Corporate governance is an international business issue.” Discuss.
6. “Corporate governance is used to monitor whether outcomes are in accordance with

plans; and to motivate the organization to be more fully informed in order to maintain or
alter organizational activity.” Explain.
7. How corporate governance means to assist in decision making and to improve
accountability? Explain.
8. Describe the features of good corporate governance.
185
Company Law
9. “Society is dependent upon corporations for the supply of goods and services but they
cannot ignore the social consequences of their overall activities.” Explain.
10. “The managers are the administrators of a community system and the wealth of the
country is controlled by corporate governance”. Explain.
1. corporate goals 2. Corporate governance
3. professional investors 4. Desirable behaviors
5. True 6. False
7. True 8. True
9. False

www.webopedia.com
186
Unit 12: Company Meetings and Proceedings
Introduction
Statutory Meeting (S.165)
Extraordinary Meeting (EGM) (S.169)
Ordinary Resolution [s.189(1)]
Special Resolution [s.189 (2)]
Objectives
Describe provisions relating to statutory meetings;
Explain provisions relating to annual general meetings;
Explain extraordinary meeting;

Describe voting and poll.
187
Company Law
Introduction
A company is an artificial person and therefore, cannot act itself. It must act through some
human intermediary. The various provisions of law empower shareholders to do certain things.
They are specifically reserved for them to be done in company’s general meetings. Section 291
empowers the Board of directors to manage the affairs of the company. In this context meetings
of shareholders and of directors become necessary. The Act has made provisions for the following
different types of meetings of shareholders: (i) Statutory Meeting; (ii) Annual General Meeting;
(iii) Extraordinary General Meeting; and (iv) Class Meetings.
12.1 Statutory Meeting (S.165)
Some of the most important legal provisions regarding the statutory meetings are:
1. It is required to be held only by a public company having a share capital. A private

company or a public company registered without share capital is under no obligation to
hold such a meeting.
2. It must be held within a period of not less than one month and not more than six months
from the date at which the company is entitled to commence business.
3. At least 21 days before the day of meeting, a notice of the meeting is to be sent to every member
stating it to be a statutory meeting.
4. The Board of directors should also get a report, called the statutory report, sent to each
member along with the notice of the meeting. If the statutory report is forwarded later,
it shall be deemed to have been duly forwarded if it is so agreed to by all the members
entitled to attend and vote at the meeting. A copy of the statutory report should also be
sent to the Registrar after the same is sent to the members.
The statutory report contains (a) the total number of shares allotted – fully paid-up and
partly paid-up; allotted for cash and for consideration other than cash; (b) the total cash
received by the company in respect of all allotments; (c) an abstract of receipts and payments
up to a date within seven days of the date of the report and the balance of cash in hand;
(d) any commission or discount paid on the issue of shares or debentures; (e) the names,
addresses and occupations of directors, auditors, managers and the secretary of the
company; (f) the extent to which any underwriting contract has not been carried out;
(g) the arrears due on calls from every director; (h) the particulars of any commission or
brokerage paid to any director or manager on the issue of shares and debentures.
The statutory report is required to be certified as correct by at least two directors, one of
whom shall be the managing director, where there is one. Also, the auditors of the company
shall certify that part of the statutory report which relates to the shares allotted, cash received
thereon and the receipts and payments and the balance of cash in hand.
5. The members present at the meeting may discuss any matter relating to the formation of
the company or arising out of the statutory report without previous notice having been
given.
6. The meeting may adjourn and the adjourned meeting has the same powers as the original
meeting. The adjourned meeting, therefore, may do anything which could have been done
by the original meeting.
7. If default is made in complying with the provisions of s.165, the following consequences may
follow: (a) Every director or other officer of the company who is in default shall be punishable
with fine up to 5,000. (b) The Registrar or a contributory may apply to the
188
court for the winding up of the company [s.439]. However, the court may, instead of
passing an order for winding up, give directions for the holding of the meeting for filing of
the statutory report.
8. It should be remembered that this meeting is required to be held only once in the life time
of a public company, having a share capital.
12.2 Annual General Meeting (AGM) (SS.166-168)
As the name signifies, this is an annual meeting of a company. The provisions relating to this
meeting are:
1. Every company, whether public or private, having a share capital or not, limited or
unlimited must hold this meeting.
2. The meeting must be held in each calendar year and not more than fifteen months shall elapse
between two meetings. However, the first AGM may be held within eighteen months from
the date of its incorporation and if such general meeting is held within that period, it need not
hold any such meeting in the year of its incorporation or in the following year. The maximum
gap between two such meetings may be extended by three months by taking permission of
the Registrar, who may so allow for any special reason.
The Company Law Department has expressed the view that the Registrar can grant
extension of time, for special reasons, up to a maximum period of 3 months, even if such
extension allows the company to hold its AGM beyond the calendar year. However, the
said extension shall be granted only if the application therefor is made to the Registrar
before the expiry of the period as per s.166 (1).
3. The meeting must be held (i) on a day which is not a public holiday, (ii) during business hours,
(iii) at the registered office of the company or at some other place within the city, town or
village in which the registered office is situated. [s.166(2)].
4. The business to be transacted at such a meeting may comprise of (s.173):
(i) Ordinary business which relates to the following matters: (a) consideration of accounts,
balance sheet and the reports of the Board of directors and auditors;
(b) declaration of dividend; (c) appointment of directors in the place of those retiring;
and (d) appointment of auditors and fixation of their remuneration.
(ii) Any business other than ordinary business transacted at the meeting will be deemed
to be special business. With regard to all special business, an Explanatory Statement
is required to be annexed to the notice.
5. What about a situation where annual accounts are not ready for being placed before the AGM?
In case annual accounts are not ready for laying at the appropriate AGM, it is opento the
company concerned to adjourn the said AGM to a subsequent date when the annual accounts
are expected to be ready for approval in the AGM. Since consideration of annual accounts is
only one of the matters to be dealt with at an AGM, directors are under a statutory obligation
to hold the meeting. The proper course shall be to hold the meeting and then adjourn it to a
suitable date for considering the accounts. The adjourned meeting must, however, be held
within the maximum time limit allowed under s.166.
6. The combined reading of Ss.166 and 210 requires compliance with the following: (a) There
must be one meeting held in each calendar year. (b) Not more than 15 months must elapse
between one general meeting and another. (c) The period of 15 months may be extended
to 18 months by the Registrar. (d) Except in the case of the first AGM, the accounts must
relate to a period beginning with the day immediately after the period for which they
189
Company Law
were submitted and ending with a day which must not precede the day of the meeting by
more than 6 months; or 6 months and the extension granted by the Registrar, i.e., a
maximum period of 9 months.
7. The company must give twenty-one days notice to all the members of the company and
the auditor. A shorter notice may be held valid if consent is accorded to, by all the members
entitled to vote at the meeting (s.171). Such a consent may be given before the meeting is
held or after the resolutions are passed. A copy of Directors’ report on the company’s
position for the year together with copy of the audited accounts and auditors’ report must
accompany the notice. Also a proxy form must be attached with the notice, on which it
shall be specifically mentioned that a member entitled to vote is entitled to appoint proxy,
and such proxy need not be a member of the company.
The notice must specify the place and the day and hour of the meeting and shall contain a
statement of the business to be transacted thereat [s.172(1)].
If the time of holding the meeting and other essential particulars required by the section
are not specified in the notice, the meeting will be invalid and all resolutions passed
thereat will be of no effect.
The notice must be given to every member, legal representative of a deceased member or
assignee of an insolvent member and to auditor or auditors [s.172(2)].
8. If default is made in holding the meeting, the Central Government may, on the application
of any member of the company, call or direct the calling of the meeting. If the company
fails to hold the meeting either originally or when directed to do so by the Central
Government, then the company and every officer of the company who is in default shall
be punishable with fine up to 50,000; and in the case of a continuing default, with a further
fine of 2500 per day during the continuance of default (s.168).
12.2.1 Certain Typical Issues in Respect of AGM
1. Whether AGM can be called on a Public Holiday: Section 166(2), inter alia, provided that,
every AGM shall be called on a day that is not a public holiday. The Department of
Company Affairs has opined that, it is a mandatory provision.
However, Bank holidays (for purposes of closing) though declared as public holidays under
the Negotiable Instruments Act, 1881 shall not be treated as public holidays for the aforesaid
purpose. Thus, 31st March and 30th Sept. shall not be considered as public holidays.
In the following cases, however, AGM may be held on a public holiday: (i) Section 2(38)
provides that, if any day is declared by the Central Government to be a public holiday after
the issue of the notice convening such a meeting, it shall not be deemed to be a public
holiday in relation to the meeting. (ii) Where a public company or its subsidiary has by its
Articles fixed the time of its AGM and the day turns out to be a public holiday [Proviso (a)
to s.166(2)]. (iii) Where a public company or its subsidiary has, by a resolution passed in
one AGM fixed the time for its subsequent AGM and the day turns out to be a public holiday
[Proviso (a) to s.166(2)]. (iv) A private company which is not a subsidiary of a public
company may also [like a public company or its subsidiary under (ii) and (iii) above] by a
resolution agreed to all the members thereof fix the time as well as the place of its AGM
and the same shall be valid if the day happens to be a public holiday [Proviso
(b) to s.166(2)]. (v) A company to whom a license is granted under s. 25 is exempted from
the provisions of s.166(2). (vi) Where the AGM is adjourned because of lack of quorum, it
is to be held on the same day in the next week at the same time and place (s.174). In case the
day comes to be accidentally a public holiday, it shall not amount to contravention of s.166(2).
190
2. Whether it is not obligatory to advertise notice of meetings in the newspapers: However,

as an abundant precaution, the company may advertise in the newspapers to avoid objection
from such of the shareholders as reside outside India and who incidentally may not receive
the notices served through post.
3. Voting Rights of Members: It shall be determined as at the date of the meeting and not as
they would have been if the meeting had been held within the prescribed time.
4. Meeting Beyond Statutory Time: It cannot be said to be void or illegal. If the central
government does not extend the date of holding the AGM u/s 167, the directors shall be
subjected to increasing penalty but the meeting shall be a valid meeting. Otherwise, the
position in law would become impossible.
5. Power to Cancel or Postpone: The Board of directors has the power to cancel or postpone
a meeting convened, though it cannot be exercised except for bona fide and proper reasons.
Task A company served a notice of a general meeting to its members. The notice stated
that a resolution to increase the share capital of the company would be considered at such
meeting. A shareholder complains that the amount of the proposed increase was not specified
in the notice. Is the notice valid?
Self Assessment
Fill in the blanks:
1. is required to be held only by a public company having a share capital.
2. In statutory meeting the Board of directors should also get a report, called the
................................
3. The statutory report is required to be certified as correct by at least two directors, one of
whom shall be the managing director, and other ..................................
4. meeting must be held in each calendar year and not more than fifteen
months shall elapse between two meetings.
12.3 Extraordinary Meeting (EGM) (S.169)
Every general meeting (i.e. meeting of members of the company) other than the statutory meeting
and the annual general meeting or any adjournment thereof, is an extraordinary general meeting.
Such meeting is usually called by the Board of Directors for some urgent business which cannot
wait to be decided till the next AGM. Every business transacted at such a meeting is special
business. An explanatory statement of the special business must also accompany the notice calling
the meeting. The notice should also give the nature and extent of the interest of the directors or
manager in the special business, as also the extent of the shareholding interest in the company of
every such person. In case approval of any document has to be done by the members at the meeting,
the notice must also state that the document would be available for inspection at the Registered
Office of the company during the specified dates and timings.
The Articles of Association of a Company may contain provisions for convening an extraordinary
general meeting. E.g., it may provide that “the board may, whenever it thinks fit, call an
extraordinary general meeting” or it may provide that “if at any time there are not within India,
directors capable of acting who are sufficient in number to form a quorum, any director or any
two members of the company may call an extraordinary general meeting”.
191
Company Law
12.3.1 Extraordinary General Meeting on Requisition
The members of a company have the right to require the calling of an extraordinary general
meeting by the directors. The board of directors of a company must call an extraordinary
general meeting if required to do so by the following number of members:
Members of the company holding at the date of making the demand for an EGM not less
than one-tenth of such of the voting rights in regard to the matter to be discussed at the
meeting.
If the company has no share capital, the members representing not less than one-tenth of the
total voting rights at that date in regard to the said matter.
The requisition must state the objects of the meetings and must be signed by the requisitioning
members. The requisition must be deposited at the company’s registered office. When the
requisition is deposited at the registered office of the company, the directors should within 21
days, move to call a meeting and the meeting should be actually be held within 45 days from the
date of the lodgement of the requisition. If the directors fail to call and hold the meeting as aforesaid,
the requisitionists or any of them meeting the requirements at (a) or (b) above, as the case may be,
may themselves proceed to call meeting within 3 months from the date of the requisition, and claim
the necessary expenses from the company. The company can make goodthis sum from the directors
in default. At such an EGM, any business which is not covered by the agenda mentioned in the notice
of the meeting cannot be voted upon.
Clause 47 of Table A (Schedule I) provides that, all general meetings other than AGMs shall be
called the EGMs. The legal provisions as regards such meetings are:
1. EGM is convened for transacting some special or urgent business that may arise in between
two AGMs, for instance, change in the objects or shift of registered office or alteration of
capital. All business transacted at such meetings is called special business. Therefore,
every item on the agenda must be accompanied by an ‘Explanatory Statement’.
2. An EGM may be called: (i) by the directors on their own accord; (ii) by the directors on
requisition; (iii) by the requisitionists themselves; (iv) by the Company Law Board. The board
of directors may call a general meeting of the members at any time by giving not less than
21 days notice. A shorter notice may, however, be held valid if consent is accorded thereto by
members of the company holding 95% or more of the voting rights (s.171). The board of
directors must convene a general meeting upon request or requisition if the following
conditions are satisfied (s.169):
The requisitionists must be such number of members who, at the date of the deposit of the
requisition, are the holders of 1/10th of total voting power. Thus, in case of a company having
a share-capital they should hold at least 1/10th of such of the paid-up capital that carries right
to vote in regard to that matter. Preference shareholders have voting power only as regards
matters relating to the preference shareholders. They have no voting right and therefore, no
right to requisition in respect of other matters. If the company does not have a share capital,
they should at least hold 1/10th of the total voting power of the company in regard to that
matter. The requisition must state the objects of the meeting, i.e., it must set out the matters
for the consideration of which the meeting is to be called. Further, requisition must have been
deposited at the registered office of the company. The requisition must be signed by the
requisitionists. In case all the aforesaid conditions are satisfied, the board of directors must
within 21 days of the receipt of the requisition call the meeting giving at least 21 days notice
fixing the meeting within 45 days of the receipt of the requisition.
Where the resolution proposed is a special resolution then the requirements of s.189(2) must be
complied with, viz., it should be so described and explanatory statement be annexed.
192
If the board of directors does not/fails to call the meeting as aforesaid (i.e., at least 21 days notice
fixing the date of the meeting within 45 days of the deposit of a valid requisition), the meeting
may be called by the requisitionists themselves: (a) In case of a company having share capital, by one
or more requisitionists as represent: (i) a majority in value of the paid-up share capital held by all
the requisitionists; or (ii) at least 1/10th of the paid-up share capital carrying voting rights in
respect of that matter, whichever is less; or (b) in case of a company not having a share capital, by
one or more requisitionists who represent at least 1/10th of the total voting power of the company
in regard to the matter of the requisition.
Where the Articles, in accordance with the provisions of s.180, provide that members who have
not paid calls on their shares would not be entitled to vote, then they cannot requisition a
meeting, nor vote at it and if they do so, the proceedings would be invalid.
The requisitioned meeting must be held within 3 months of the date of the deposit of the requisition.
Further, where two or more persons hold any shares or interest in a company jointly, a
requisition, or a notice calling a meeting, signed by one or only some of them shall, for the
purposes of this section, have the same force and effect as if it had been signed by all of them.
Any reasonable expenses incurred by the requisitionists, as aforesaid, shall be repaid to them by
the company and the same shall be recouped from directors at fault.
A meeting by the requisitionists must be held in the same manner as nearly as possible, in which the
meetings are to be called by the board of directors. However, where the registered office is not
made available to them for holding the meeting, they may hold the meeting elsewhere [R.
Chettair vs. M. Chettair (1951) 21 Comp. Cas. 93].
Powers of the Company Law Board (s.186).
If for any reason it is impracticable to call a meeting of the company, other than an AGM, the Company
Law Board may direct the calling of the meeting: (a) on its own motion; (b) on an application of any
director; (c) on an application of any member entitled to vote at that meeting.
For the aforesaid meeting, the Company Law Board may give directions in respect of the place,
date and the manner in which the meeting be held and conducted. It may also give such ancillary
or consequential directions as it thinks expedient, including a direction that one member present
in person or proxy shall be deemed to constitute a meeting.
Example: Superclean Industries Pvt. Ltd. is a company in which there are three
shareholders and all of them are directors of the company. Mr. Superman holds 60 percent of the
paid up share capital while the balance 40 percent of shares is held equally by the remaining two
directors. Because of some rift among them, the two directors holding 40 percent share capital
have aligned and started preventing the holding of any meetings of the company. The articles of
the company provide for a minimum of two directors/members as quorum for board meetings
as well as general meetings.
Mr. Superman is a majority shareholder, but he is helpless, as no meeting can be held because of
no quorum. He would apply to CLB under s. 186 for convening of the general meeting. The CLB,
if satisfied, will order a meeting to be held with the presence of one member as sufficient
quorum. Mr. Superman, being the majority shareholder is entitled to exercise his statutory right
to participate in the decision-making process, which cannot be frustrated by the quorum
requirement. [Opera Photography Ltd. Re, 1989 B CLC 763 CLD]
193
Company Law
Self Assessment
5. Which of the following are included in the ‘Statutory Books’ for the purpose of company
audit?
(i) Register of charges
(ii) Minutes Books for the Board meetings
(iii) Articles of Association
(iv) Minutes Book for the shareholder’s meeting
(v) Register of members
(vi) Memorandum of Association
Codes
(a) (i), (ii), (iv) and (v) (b) (ii), (iii), (iv) and (vi)
(c) (i), (iii), (v) and (vi) (d) (ii), (iii), (v) and (vi)
6. Consider the following statements: A statutory auditor of a public limited company claims
that he has the following legal rights in relation to his duties:
(i) Right to refuse to make a report
(ii) Right of access to books of accounts and registers
(iii) Right to seek explanation from directors and officers
(iv) Right to make statement in the general meeting.
Of the above statements:
(a) (i), (ii) and (iii) are correct (b) (i), (ii) and (iv) are correct
(c) (i), (iii) and (iv) are correct (d) (ii), (iii) and (iv) are correct
12.4 General Meeting for Shareholders
When it is proposed to alter, vary or affect the rights of a particular class of shareholders (e.g.,
where accumulated dividends on cumulative preference shares are to be cancelled) and it is not
possible to obtain the consent in writing, of the holders of 3/4th of the issued shares of that class, a
meeting of the holders of those shares may be called. Such a meeting is commonly known as a
‘class meeting’. It should be noted that all resolutions in a class meeting must be passed as special
resolutions.
The holders of at least 10% of the issued shares of that class who did not consent in favour of the
resolution may apply to the court within 21 days to have the resolution cancelled and where
such application is made, the resolution shall not have effect unless and until it is confirmed by
the court.
Task A meeting was properly convened and was subsequently adjourned by the chairman.
No fresh notice is given for the adjourned meeting which is held subsequently. State
whether the adjourned meeting is valid. [Hint: The adjourned meeting in question is valid
as per s.174.]
194
12.5 Requisites of a Valid Meeting
12.5.1 Notice of Meeting
Every member of the company is entitled to a notice of every general meeting. A notice of not
less than 21 days must be given in writing to every member. However, a shorter notice for AGM
will be valid if all members entitled to vote give their consent. In case of other meetings, a shorter
notice will be valid if consent is given by members holding at least 95% of the paid-up capital
carrying voting rights, or representing at least 95% of the voting power.
The notice may be given to members either personally, or sending by post to him at his registered
address. A notice of a meeting may also be given by advertising the same in a newspaper
circulating in the neighbourhood of the registered office of the company.
The secretary should see that proper notice of meeting must be given to all persons who are
entitled to receive it. An improper or insufficient notice, as well as absence of notice, may affect
the validity of a meeting and render the resolutions passed at the meeting ineffective. Also the
notice should make a full and frank disclosure to the members of the fact on which they would
be expected to vote.
12.5.2 Agenda of the Meeting
The word ‘agenda’ indicates the business to be transacted at a meeting. It is prepared for all kinds of
meetings in order that the meeting may be conducted systematically. The agenda is generally
prepared by the secretary in consultation with the chairman. It is drafted in such a manner as to
help the chairman to conduct the meeting smoothly. In drafting the agenda, the secretary should
bear in mind the following: (i) the agenda should be clear and explicit; (ii) it should be drafted
in a summary manner; (iii) all items of routine business should be put down first and the
contentious matters later; and (iv) all items of similar nature should be placed in a continuous
order.
The foregoing points are important because when a copy of the agenda is sent to a member, he
is in a position to form a definite opinion of the subject matter to be discussed at the meeting. While
preparing the agenda, care should be taken for the order of the matters to be discussed, as the
order of the agenda cannot be altered except with consent of the meeting. Sometimes, the agenda is
drafted in such a manner that it can serve the purpose of minutes later on. Some space is left
opposite each agenda item and the secretary writes it up during the meeting; this practice is very
common in the preparation of agenda for Board meetings.
Sometimes, companies maintain an Agenda Book, wherein the agenda items are entered. It is
placed before the chairman of the meeting and is regarded as the agenda. Those placed before
the members or other directors are copies only. Later, the agenda book becomes a permanent
record for future reference.
12.5.3 Proxy
In the case of a company, every member of the company entitled to attend and vote at a meeting
has the right to appoint another person, whether a member or not, to attend and vote for him.
The term ‘proxy’ is applied to the person so appointed. Also, it refers to the instrument by which
a member of a company appoints another person to attend the meeting and vote on his behalf.
However, the proper term for this document is ‘proxy form’ or ‘proxy paper’. The following points
about proxies are to be noted: (i) A proxy has no right to speak at the meeting. (ii) A proxy
195
Company Law
need not be a member of the company. (iii) The instrument appointing a proxy must be in writing
and signed by the appointor. (iv) The proxy form must bear the date of the meeting.
(v) No company can make it compulsory for anyone to lodge proxies earlier than 48 hours
before the meeting. (vi) A proxy may be revoked before the person appointed has voted. (vii) A
proxy can demand a poll. (viii) A proxy cannot vote against the wishes of his appointor.
Secretarial work as regards proxies
(a) Scrutinise the proxy forms to see whether they comply with the provisions of the Act, and
the bye-laws and rules of the company. (b) Any proxies received after the stipulated time limit
must be returned with a note that they cannot be accepted. (c) Any irregularities in proxy forms
should be reported to chairman of the meeting, as he is the final authority to accept or reject
them. (d) Each correct proxy form is countersigned by the secretary. (e) Enter the correct proxy
forms in the register of proxies. (f) Return the proxy form to the member together with an
admission card in the name of the proxy.
12.5.4 Voting and Poll
Unanimity on all matters before a meeting is always not obtained. In the absence of unanimity,
the chairman wants to know the wishes of the persons present therein. This is known as ascertaining
the sense of the house and for this purpose; he has to put the matter before the house to the members.
There are various methods which can be adopted by the chairman to put the matter to vote in order
to ascertain the wishes of the members.
In the case of a company, the Act prescribes two methods to ascertain the wishes of the members.
These are:
(i) By Show of Hands: Under this method, the chairman asks all those in favour of the
resolution to raise their right hand and when that number is noted, asks all those against
to do likewise. The chairman then declares the result of the voting indicating whether the
proposal has been carried or lost.
(ii) By Poll: In company meetings, voting by poll is according to the number of shares held by
a member. Under this method, every person present records his vote on a ballot paper and
deposits it in the ballot box provided for that purpose. The counting of ballots cast for and
against the motion reveals the results. This method ensures secrecy in casting votes. The
voting by show of hands may not always reflect the opinion of members upon a value
basis. Also, there may be a number of proxies who can vote only by poll and not by show
of hands.
Rules in respect of voting
As per the provisions of the Act, rules regarding voting may be noted as follows:
1. Every holder of equity shares shall have a right to vote [s. 87(1)].
2. Right of an equity shareholder to vote cannot be prohibited on the ground that, he has not
held his shares for any specified period before the meeting or on any other ground (s.182).
In Ananthalakshmi vs. H. I. & F. Trust, AIR 1951 Mad. 927, a provision in the Articles of a
company that only those shareholders would be entitled to vote whose names have been
there on the register for two months before the date of the meeting was held to be in
contravention of the Act.
The only ground on which the right to vote may be excluded is non-payment of calls by a
member or other sums due against a member or where the company has exercised the
right of lien on his shares (s.181).
196
3. A preference shareholder shall have the right to vote only on resolutions which directly affect
the rights attached to his preference shares [s.87(2)].
Where the directors proposed to increase the shares of the company (i) by issue of further
equity shares, or (ii) by capitalising an amount standing to the credit of the company’s
reserve account and applying the same in paying-up the new equity shares and distributing
the same as fully paid among the equity shareholders, the proposed resolution was held
to affect the rights of the preference shareholders and could, therefore, be only carried out
with their sanction [Re John Smith’s Tadcaster Brewery Co. Ltd. (1952) 2 All ER 751].
4. Voting rights of a member are not affected by the fact that his shares have been attached or
pledged or a receiver has been appointed [Balkrishnan Gupta vs. Swadeshi Polytex Ltd. (1985)
58 Comp Cas. 563].
5. Voting by show of hands in the first instance. Section 177 provides that, at any general
meeting, a resolution put to vote shall, unless a poll is demanded under s.179, be decided
on a show of hands. A declaration by the chairman that on a show of hands, a resolution
has or has not been carried either unanimously or by a particular majority and an entry to
that effect in the minutes book of the company, shall be conclusive evidence of the fact. No
proof of the number or proportion of the votes cast in favour of or against such resolution
shall be required (s.178).
Demand for Poll
Section 179 provides that before or on declaration of the result of the voting on any resolution on
a show of hands, a poll may be ordered to be taken by the Chairman of the meeting of his own
motion and shall be ordered to be taken by him on a demand made in that behalf by the person
or persons specified below:
(a) In the case of a public company having a share capital, by any member or members present
in person or by proxy and holding shares in the company: (i) which confer a power to vote
on the resolution not being less than 1/10th of the total voting power in respect of the
resolution; or (ii) on which an aggregate sum of not less than fifty thousand rupees has been
paid-up;
(b) In the case of a private company having a share capital, by one member, present in person
or by proxy if not more than seven members are personally present and by two members
present in person or by proxy, if more than seven members are personally present;
(c) In the case of any other company, by any member or members present in person or by
proxy and having not less than 1/10th of the total voting power in respect of the resolution.
The chairman of the meeting may regulate the manner in which the poll should be taken. He
must appoint two scrutinisers to scrutinise the votes given on the poll and to report thereon to
him. Then the chairman will declare the result.
Voting by companies, and Government as members (Ss.187-187-A). Where a company or a
corporation is a member of another company, it may attend the meetings of the other company
through a representative. The representative must be appointed by a resolution of the Board of
directors or the other governing body. Where the Central Government or a State Government
is a member, the President or the Governor of the State, as the case may be, has the power to appoint
representatives to attend meetings of the company. The person nominated shall hold the position
of a proxy.
197
Company Law
Self Assessment
7. Can a Company hold an AGM on public holiday?
(a) Yes (b) No
(c) (a) and (b) both are correct (d) None
8. Audit of a public company will be counted for the limit of audits
(a) Yes (b) No
9. Statutory meeting must be held in case of a public company
(a) Yes (b) No
10. Statutory meeting must be held in case of a private company
(a) Yes (b) No
12.6 Resolutions
Decisions of a company are taken by resolution of its members, passed at their meetings. Also,
the Board of directors takes certain decisions at its meeting by passing certain resolutions after
due deliberations.
The term ‘motion’ indicates a proposition made at a meeting by any member. Such a motion may
be passed without any change or modification. But if some members feel that the motion in the
form proposed needs some change or modification, they may move an amendment. A
motion when passed with or without amendment is called a resolution.
A motion should always be in writing and before it is brought before the meeting, the necessary
notice must be given. A person proposing a motion is called the mover and the motion should
be signed by him.
Once the motion has been put to the members and they have voted in favour of it, it becomes a
resolution. In the case of a company, there are three kinds of resolutions:
1. Ordinary resolution;
2. Special resolution;
3. Resolution requiring special notice.
Task One general meeting was called by a company in December, 2004. This meeting
was adjourned to March, 2005 and then held. Subsequent meeting was held in February;
2006. Is the company liable for any irregularity?
12.6.1 Ordinary Resolution [s.189(1)]
When a motion is passed by a simple majority of the members voting at a general meeting, it is
said to have been passed by an ordinary resolution. In other words, votes in favour of the
resolution are more than 50%. Still in other words, a resolution shall be an ordinary resolution
where the votes cast in favour of the resolution are more than the votes cast against the resolution.
According to s.189(1), “A resolution shall be an ordinary resolution when at a general meeting
of which the notice required under the Act has been duly given, the votes cast (whether on show
198
of hands, or on poll, as the case may be), in favour of the resolution (including the casting vote,
if any, of the chairman) by members who, being entitled to do so, vote in person or where
proxies are allowed, by proxy, exceed the votes, if any, cast against the resolution by members
so entitled and voting.”
All matters which are not required either by the Act or the company’s Articles to be done by a
special resolution can be done by means of an ordinary resolution. Some of the cases in which
only ordinary resolution is required are: alteration of authorised capital, declaration of dividend,
appointment of auditors, election of directors.
12.6.2 Special Resolution [s.189 (2)]
A resolution is a special resolution in regard to which: (a) the intention to propose the resolution
as a special resolution has been specifically mentioned in the notice calling the general meeting;
(b) 21 days notice has been duly given for calling the meeting; (c) the number of votes cast in favour
of the resolution is three times the number cast against it.
Some of the cases in which a special resolution is necessary: alteration of objects clause; change
of registered office from one State to another; alteration of the Articles; changes in the name of the
company; reduction of share capital.
12.6.3 Resolution Requiring Special Notice (s.190)
Some resolutions require special notice. The object of special notice is to give the members sufficient
time to consider the proposed resolution and also to give the Board of directors an opportunity to
indicate views, on the resolution if it is not proposed by them but by some other shareholders. Under
this, a notice of intention to move the resolution should be given to the company not less than 14
days before the date of the meeting at which it is proposed to be moved. The company in turn
must immediately give notice by advertisement in a newspaper orin any other mode allowed by
the Articles, but not less than seven days before the meeting. Some of the cases in which a special
notice is necessary are: appointing an auditor, a person other than a retiring auditor; moving a
resolution that a retiring auditor will not be re-appointed; removing a director before his term
expires.
Section 192 requires that a printed or a type written copy of each special resolution should be sent
to the registrar within 30 days of passing thereof.
12.6.4 Passing of Resolutions by Postal Ballot (s.192A)
Section 192A contains the following provisions for passing of resolution by postal ballot:
(i) A listed company may and in the case of resolution relating to such business as the Central
Government may, by notification, declare to be conducted only by postal ballot, shall, get
any resolution passed by means of a postal ballot, instead of transacting the business in
general meeting of the company.
(ii) Where a company decides to pass any resolution by resorting to postal ballot, it shall send
a notice to all the shareholders, along with a draft resolution explaining the reasons therefor,
and requesting them to send their assent or dissent in writing on a postal ballot within a period
of 30 days from the date of posting of the letter.
(iii) The notice shall be sent by registered post acknowledgement due, or by any other method
as may be prescribed by the Central Government in this behalf and shall include with the
notice, a postage pre-paid envelope for facilitating the communication of the assent or
dissent of the shareholder to the resolution within the said period.
199
Company Law
(iv) If a resolution is assented to by a requisite majority of the shareholders by means of postal ballot,
it shall be deemed to have been duly passed at a general meeting convened in that behalf.
(v) If a shareholder sends under (ii) above his assent or dissent in writing on a postal ballot
and thereafter any person fraudulently defaces or destroys the ballot paper or declaration
of identity of the shareholder, such person shall be punishable with imprisonment for a
term which may extend to 6 months or with fine or with both.
(vi) If a default is made in complying with provisions in (i) to (iv), the company and every
officer of the company, who is in default shall be punishable with fine which may extend
to 50,000 in respect of each such default.
12.6.5 Circulation of Members’ Resolution (s.188)
When some members of a company want (i) to propose a resolution at the company’s next AGM;
or (ii) desire to circulate to members any statement with respect to the matter referred to in any
proposed resolution or any business to be dealt with at any general meeting, the Act allows them
to use the administrative machinery of the company for the purpose.
If the requisite number of members make a requisition as aforesaid, the company shall be bound
to: (i) give a notice of the resolution intended to be moved at the next AGM; (ii) circulate the
statement among the members entitled to notice of any general meeting. However, before the
obligation of the company in respect of the above may arise, the following conditions shall have to
be satisfied:
The requisition must have been signed by at least: (a) members having 1/20th of the total
voting rights of all the members having the right to vote on the resolution; or (b) members,
numbering 100 (having the right to vote at the resolution) and commanding a paid-up share
capital of 1 lakh or more.
The requisition must have been deposited at the registered office of the company: (a) at least
6 weeks before the meeting in case of a requisition requiring notice of a resolution; and
(b) at least 2 weeks before the meeting in case of any other requisition.
The statement to be circulated should not contain more than 1000 words.
The requisitionists must have deposited with the company a sum reasonably sufficient to
meet the expense of the requisition.
Self Assessment
11. Every Public Limited Company having a share capital must hold a statutory meeting.
12. A company required to hold a statutory meeting must hold the meeting within one month
of obtaining the certificate to commence business.
13. The first AGM of a company must be held within 18 months of the date of incorporation.
14. If a company fails to call or hold an AGM within the prescribed time, the central government
may direct the calling and holding of the meeting on a petition of any member.
15. The statutory report is required to be certified as correct by at least two directors, one of
whom shall be the managing director, if any.
200
Case Study
shares
and issue of debentures worth £ 10,000 secured by floating charge on the company’s assets
£ 6,050; its liabilities were £ 10,000 secured by the debentures issued to Mr. Salomon and £
8,000 owing to unsecured trade creditors.
The unsecured sundry creditors claimed the whole of the company’s assets, viz. £ 6,050 on
Question
12.7 Summary
The Board of directors should also get a report, called the statutory report, sent to each
member along with the notice of the meeting.
The statutory report is required to be certified as correct by at least two directors, one of
whom shall be the managing director, where there is one.
The meeting may adjourn and the adjourned meeting has the same powers as the original
meeting.
The Company Law Department has expressed the view that the Registrar can grant
extension of time, for special reasons, up to a maximum period of 3 months, even if such
extension allows the company to hold its AGM beyond the calendar year.
Whether AGM can be called on a public holiday. Section 166(2), inter alia, provided that,
every AGM shall be called on a day that is not a public holiday.
EGM is convened for transacting some special or urgent business that may arise in between
two AGMs, for instance, change in the objects or shift of registered office or alteration of
capital.
12.8 Keywords
Agenda: The word ‘agenda’ indicates the business to be transacted at a meeting.
Motion: The term ‘motion’ indicates a proposition made at a meeting by any member. Such a
motion may be passed without any change or modification.
Proxies: In the case of a company, every member of the company entitled to attend and vote at
a meeting has the right to appoint another person, whether a member or not, to attend and vote
for him.
201
Company Law
Statutory Report: The Board of directors should also get a report, called the statutory report,
sent to each member along with the notice of the meeting.
1. What are the different kinds of general meetings of a company?
2. Define statutory meeting of a public company.
3. Give the contents of a statutory report.
4. Summarise the provisions as regards Annual General Meeting.
5. What are the provisions of the Companies Act, 1956 in respect of an Extraordinary General
Meeting to be held on requisition?
6. Define Extraordinary General Meeting.
7. Write a short note on the powers of Company Law Board to call meetings.
8. Discuss the requisites of a valid meeting.
9. Discuss the provisions of the Companies Act, 1956 relating to resolution requiring special
notice mentioning the matter for which special notice is required.
10. Explain the procedure for ascertaining the sense of general meeting of a company.
11. Write short on:
(a) Notice of a meeting
(b) Proxy
(c) Voting by poll
(d) Resolutions
1. statutory meeting 2. statutory report

3. the auditors of the company 4. AGM
5. (b) 6. (d)
7. (b) 8. (a)
9. (a) 10. (b)
11. True 12. False
13. True 14. True

15. True
202

www.webopedia.com
203
Company Law
Unit 13: Borrowing and Debentures
CONTENTS
Objectives
Introduction
13.1 Investments
13.1.1 Meaning of Investment
13.1.2 Investments to be in Company’s Own Name (s.49)
13.1.3 Register of Investments not Held in the Company’s Own Name
13.2 Borrowing
13.2.1 Power of a Company to Borrow
13.2.2 Ultra Vires Borrowing
13.2.3 Borrowing Intra Vires the Company but Ultra Vires the Directors
13.2.4 Other Restrictions on the Borrowing Powers of the Board
13.2.5 Procedure for Delegating Powers to Borrow Money otherwise than on

Debentures
13.3 Prevention of Oppression and Mismanagement
13.3.1 Rule of Majority
13.3.2 Powers of Company Law Board for Prevention of Mismanagement and

Oppression (Ss. 397-399 and 402)
13.4 Summary
13.5 Keywords
Objectives
Explain investment;
Define borrowing;
Describe ultra vires borrowing;
Elaborate upon provisions for prevention of oppression and mismanagement.
Introduction
A condition requiring or binding an applicant for shares in or debentures of a company to waive

compliance with any of the requirements of this section (S.56), or purporting to affect him with
notice of any contract, document or matter not specifically referred to in the prospectus, shall be
void.
204
No one shall issue any form of application for shares in or debentures of a company, unless the form
is accompanied by memorandum containing such salient features or a prospectus as may be
prescribed which complies with the requirements in connection with a bona fide invitation toa
person to enter into an underwriting agreement with respect to the shares or debentures; or in
relation to shares or debentures which were not offered to the public. If any person acts in
contravention of the provisions of this sub-section, he shall be punishable with fine which may
extend to five thousand rupees.
13.1 Investments
13.1.1 Meaning of Investment
The Act does not define the term ‘investment’ though it uses the same in a number of sections
which are discussed below. In common parlance, it includes any property or right in which
money is put. However, the word ‘investment’ in the following sections is confined to the act of
a company in buying securities, viz., shares and debentures of another company.
13.1.2 Investments to be in Company’s Own Name (s.49)
All investments made by a company on its own behalf shall be made and held by it in its own
name. There are, however, certain exceptions to this rule. These exceptions are as follows:
1. If any other law, for the time being in force, permits, the investments of the company may
be made and held by it in any other name.
2. Where the company has a right to appoint any person or persons as a director or directors
of any other body corporate, shares in such other body corporate, up to an amount not
exceeding the nominal value of the qualification shares, may be registered or held by the
body corporate jointly in the names of the company itself and of each such person or
nominee or in the name of each such director.
3. A company may hold any shares in its subsidiary in the name or names of any nominee or
nominees of the company to ensure that the number of members of any subsidiary is not
reduced, where it is a public company, below seven and where it is a private company,
below two.
4. If the investments are made by a company, whose principal business consists of the buying
and selling of shares or securities, the company may hold its investments in any other
name. Securities include stock and debentures.
5. A company may deposit with a bank, being the bankers of the company, any shares or
securities for the collection of any dividend or interest payable thereon.
6. A company may deposit, or transfer to, or hold in the name of, the State Bank of India or
a Scheduled Bank, being the bankers of the company, shares or securities, in order to facilitate
the transfer thereof. The company can do so only for a period of 6 months. If the transfer of
such shares or securities does not take place within 6 months, the company shall, as soon as
practicable after the expiry of that period of 6 months, have the shares or securities re-
transferred to it from the State Bank of India or the Scheduled Bank or, as the case may be,
and again hold the shares or securities in its own name.
7. A company may deposit with, or transfer to, any person any shares or securities, by way
of security for the repayment of any loan advanced to the company for the performance of
any obligation undertaken by it.
205
Company Law
The certificate or letter of allotment relating to the shares or securities in which investments have
been made by a company shall, except in cases (4) to (7) referred to above, be in the custody of the
company or with the State Bank of India, or a Scheduled Bank, being the bankers of the company.
13.1.3 Register of Investments not Held in the Company’s Own Name
Where any shares or securities in which investments have been made by a company are not held
by it in its own name, the company shall enter in a register maintained by it for the purpose:
(a) the nature, value and such other particulars as may be necessary fully to identify the shares
or securities in question; and (b) the bank or person in whose name or custody the shares or
securities are held. The register shall be open to the inspection of any member or debenture holder
of the company. If any inspection of the register is refused, the Central Government may, by order,
direct an immediate inspection of the register.
If default is made in complying with s.49, the company and every officer of the company who is
in default, shall be punishable with fine which may extend to 50,000.
Self Assessment
Fill in the blanks:
1. includes any property or right in which money is put.
2. All investments made by a company on its own behalf shall be made and held by it in its
.......................................
3. A company may deposit, or transfer to, or hold in the name of, the State Bank of India or
a Scheduled Bank, being the bankers of the company, ..............................., in order to facilitate
the transfer thereof.
4. Securities include ..............................and debentures.
13.2 Borrowing
13.2.1 Power of a Company to Borrow
Every trading company has an implied power to borrow but it is wise to include an express
power to borrow in the objects clause of the Memorandum. Non-trading companies, however,
must be expressly authorised to borrow by their Memorandum.
A power to borrow, whether express or implied, includes the power to charge the assets of the
company by way of security to the lender.
The Companies Act does not expressly empower companies to borrow money. Therefore, most
of the companies expressly provide for such borrowing powers in the Memorandum. In such
cases, where Memorandum authorises the company to borrow, the Articles provide as to how
and by whom these powers shall be exercised. It may also fix up the maximum amount which
can be borrowed by the company.
Exercise of Borrowing Powers
A public company cannot exercise its borrowing powers until it secures the certificate to
commence business [s.149 (1)]. A private company may, however, exercise the borrowing powers
immediately after its incorporation.
206
The power to borrow money is generally exercised by the directors but Articles normally provide
for certain restrictions on their power to borrow. Section 293 also limits the directors’ power to
borrow, to the aggregate of the paid-up capital of the company and its free reserves apart from
temporary loans obtained from the company’s bankers in the ordinary course of business.
Task The loan of the Debenture-holders was secured by a floating charge on the assets of
the company. The company had the power to sell the whole of its undertaking as per a
clause in its Memorandum. The company sold the undertaking. The Debenture-holders
insisted that their floating charge had been crystallised by the act of the sale of the
undertaking. Is their contention correct? [Hint: The contention of Debenture-holders is
not correct as none of the conditions for the conversion of the floating charge into a fixed
charge has been satisfied].
13.2.2 Ultra Vires Borrowing
Borrowing by a company shall be deemed to be ultra vires where the company borrows in spite
of no power to borrow, or borrows beyond the limit fixed by the Memorandum or Articles. Any
such loan to the company is null and void and does not create an actionable debt. However, the
following remedies shall be available to such a lender:
1. Injunction and Recovery: If the money, assets, property, etc., purchased with such money
is identifiable and are still in the possession of the company, the lender can obtain an
injunction to restrain the company from parting with them and seek a tracing order to
trace and recover them.
2. Subrogation: If the borrowed money was applied in payment of lawful creditors of the
company, the lender can subrogate to the rights of those creditors, i.e., he will step into the
shoes of the old creditors for the purpose of recovering his money [Sinclair vs. Brougham
(1914) A.C. 398]. However, he shall not have any priority over other creditors even if the
debts paid off had priority [Re. Wirexhan Mold & Cohmah’s Quau Rly. (1899) 1Ch. 440].
3. Suit against the Directors: The lender may claim damages from the directors and sue
them personally for a breach of warranty of authority [Firbank’s Executors vs. Humphreys
(1866) 18 O.B.D.64]. But if the fact that, the company has no powers to borrow was apparent
upon reference to the company’s Memorandum or Articles, the lender shall not be entitled
to claim damages from directors upon this ground as he was not misled because he is
deemed to have knowledge of these public documents [Ranshdall vs. Ford (1866) E.R.Q.
Fq Cas. 750].
13.2.3 Borrowing Intra Vires the Company but Ultra Vires the Directors
If the borrowing is in excess merely of the power of directors but not of the company, e.g., where
the Articles provide that the directors shall have power to borrow only up to 2,00,000 and, for
borrowing beyond this amount prior approval of the shareholders in general body meeting
must be obtained, any borrowing beyond 2,00,000 without shareholders’ approval (i.e., ultra
vires the directors) can be ratified and rendered valid by the company. If ratified, the loan shall
become perfectly valid and binding upon the company. However, even where the company
refuses to ratify the directors’ act, the ‘Doctrine of Indoor Management’ shall protect a lender
provided he can establish that he advanced the money in good faith. The company may in turn
proceed against the directors and claim indemnity.
207
Company Law
13.2.4 Other Restrictions on the Borrowing Powers of the Board
The Board can exercise the following powers, inter alia, only by means of resolutions passed at Board
meeting and not by the circulation of resolution: (i) the power to issue debentures; (ii) the power to
borrow money otherwise, than on debentures. The Board may, however, by a resolution passed at a
meeting, delegate the power in (iii) above, to any committee of directors, the managing director, the
manager or any other principal officer of the company, mentioning therein the limit up to which
amount can be borrowed by the delegate. Also, the Act empowers the companyin general meeting
to impose restrictions and conditions on the powers of the Board to issue debentures and borrow
money.
13.2.5 Procedure for Delegating Powers to Borrow Money otherwise

than on Debentures
Section 292 empowers the Board to borrow money on behalf of the company by means of resolution
passed at the meeting of the Board. However,
1. Section 292 (1) permits the Board to delegate, by means of a resolution passed at a meeting,
to a committee of directors, the manager or any other principal officer of the company, the
power to borrow money otherwise than on debentures.
2. Section 292 (2) further provides that, every resolution delegating the power referred to
above, relating to the power to borrow money otherwise than on debentures must specify
the total amount outstanding at anyone time up to which money may be borrowed by the
delegate. In case a company has a branch office, the power to borrow as referred to above
may be delegated to the principal officer of such branch.
The company thus, should follow the following procedure for delegating its power to borrow
money otherwise than on debentures:
1. Convene a meeting of the Board of directors.
2. Ensure that every director gets the proper notice of the meeting along with the agenda.
3. Pass a resolution in the board’s meeting delegating the stated power to the desired official
of the company.
4. Ensure that the resolution does state the maximum amount that the official shall be allowed
to borrow.
13.3 Prevention of Oppression and Mismanagement
13.3.1 Rule of Majority
The principle of rule by majority is made applicable to the management of affairs of the company.
The shareholders pass resolutions on various subjects either by simple majority or by three-fourths
majority. Once a resolution is passed, then it is binding on all the members of the company. As a
resultant corollary, the court will not intervene to protect minority against the resolution, as on
becoming a member, the shareholder agrees to submit to the will of the majority of the members.
Thus, if a wrong is done to the company, it is the company which is legal entity having its own
personality, which can institute a suit against the wrongdoer; and shareholders do not have a right
to do so. This rule was laid down in the leading case of Foss v. Harbottle the facts of this case were
as follows:
208
F and T brought an action on behalf of themselves and all other shareholders against the
defendants who consisted of 5 directors, a solicitor and an architect of the company alleging that
by concerted and illegal transactions they had caused the company’s property to be lost to the
company. It was also alleged that there was no qualified Board. F and T claimed damages from
the defendants to be paid to the company. The Court held, that the action could not be brought
by the minority shareholders. The wrong done to the company was one which could be ratified
by the majority of members. The company was the proper plaintiff for wrongs done to the
company and the company can act only through its majority shareholders. The majority of the
members should be left to decide whether to commence proceedings against the directors. The
principle of majority rule has since then been applied to a number of cases.
In Rajahmundry Electric Supply Co. v. Nageshwara Rao, AIR (1956) S. C. 213, the Supreme Court
observed that: The Courts will not, in general, intervene at the instance of shareholders in
matters of internal administration and will not interface with the management of the company
by its directors so long as they are acting within the powers conferred on them under articles of
the company. Moreover, if the directors are supported by the majority shareholders in what
they do, the minority shareholders can, in general, do nothing about it.
One may notice that the aforesaid decisions are essentially a logical extension of the principle
that a company is a separate legal person from the members who compose it. Once it is admitted
that a company is a separate legal person, it follows that ‘if a wrong is done to it, the company is
the proper person to bring an action. This is a simple rule of procedure which applies to all
wrongs, viz., only the injured party may sue. If, for instance, X intentionally pushes Y down the
stairs and Y breaks his leg in consequence, C, who has seen the whole incident can not bring an
action against X. C has not been hurt; he is not the injured party; he is the wrong plaintiff. The
right plaintiff is Y.
The rule, as applied to companies, however, appears a little more complicated. After all, the
directors who have been fraudulent have injured the company. The company is composed of
members. Losses to the company affect all the members, not simply the majority or the minority
or any particular member. Why then, should an individual member not sue, since he has been
injured?
The answer is that injury is not enough. The plaintiff must show that the injury has been caused
by a breach of duty to him. In the course of existence a person suffers many injuries for which no
action can be brought, for no duty owned to him has been broken. The individual shareholders
or even the minority shareholders who try to show that the directors owe a duty to them personally
in their management of the company’s assets will definitely fail. The directors own no duty to
the individual members, but only to the company as a whole. A company is a personand if it
suffers injury through breach of duty owed to it, then the only possible plaintiff is the company itself
acting, as it must always act, through its majority.
It should, however, be noted that the aforesaid principle of Foss v. Harbottle applies only where
a corporate right of a member is infringed. The rule doesn’t apply where an individual right of
a member is denied. The shareholder, by his contract with company undertakes with respect to
his rights which his membership carries to accept as binding upon him the decisions of the
majority of shareholders, if arrived at in accordance with the law and the articles; these
membership rights are referred to as corporate membership rights. Other rights of the shareholder,
such as right to vote, or right to receive dividend are his personal or individual rights and cannot
be taken away by the majority and if the company refuses to record his vote or pay him the
dividend, he can sue in his own name and this right of action is unaffected by any decision of the
majority.
The BOD of a Pvt. Co. has borrowed money for long-term purposes in excess of the aggregate of
the paid-up capital and free reserves. Is it binding on the company?
209
Company Law
Exceptions to ‘The Majority Rule’ (Protection of Minority Rights)
In the following cases, the rule of Foss v. Harbottle does not apply, i.e., the minority the shareholders
may bring an action to protect their interest:
1. Where the act done is illegal or ultra-vires the company: A shareholder is entitled to bring
an action against the company and its officers in respect of matters which are illegal or ultra-
vires the company since no majority of shareholders (not even the entire body of
shareholders) can sanction such matters. [Burland v. Earle (1902) A.C.83].
2. Breach of fiduciary duty: When a director is in breach of fiduciary duty, every shareholder
may be regarded an authorised organ to bring the action [Santya Charan Lal v. Rameshwar
Prasad Bajoria (1950) S.C.R. 394]. In Blakesly v. Johnson (1980), a U.S. case, the President
Director of a corporation who was also the majority stockholder did not make adequate
disclosure to the minority shareholder of facts concerning the sale of the business and as
a result the latter allowed his stock to be redeemed by the corporation for an inadequate
price. Held, the president was guilty of breach of fiduciary duty.
3. Where the act complained of constitutes a fraud on the minority: Where the majority of a
company’s members use their power to defraud or oppress the minority, their conduct is
liable to be impeached even by a single shareholder. Justice Evershed, M.R. in Greenhalgh
v. Ardene Cinemas Ltd. (1951) said, “a special resolution would be liable to be impeached
if the effect of it were to discriminate between the majority shareholders and minority
shareholders, so as to give the former an advantage of which the latter were deprived.”
Thus, where the majority of members of company ‘A’, who were also members of company ‘B’,
passed a resolution to compromise an action against company ‘B’. The resolution was
charged to be favourable to company ‘B’ but unfavourable to company ‘A’. Held, the
minority of company ‘A’ could get the compromise set aside (Menier v. Hooper’s Telegraph
Works Ltd.)
4. Where an act which requires special resolution to be effective but has, in fact, been done by
a simple majority: An action by minority shall be maintainable where it is bought to
restrain the company from doing an act for which a special resolution is required and such
a resolution has not properly been passed or passed by means of a trick.
5. Where the personal rights of an individual member have been infringed: As already noted,
the principle of majority rule is applicable only to the corporate membership rights of a
member. Infringement of a member’s individual rights like right to vote, right to receive
dividends, etc., entitles him to proceed in his own name.
6. Protection under the Companies Act: The Companies Act, 1956, vide certain specific
provisions, extends protection to the minority shareholders by conferring certain rightson
them:
(i) Variation of Class Rights: Where the share capital of a company is divided into different
classes of shares, the rights attached to the shares of any class can be varied as provided
in the memorandum or articles of the company with the consent of the 3/4th majority
of the shareholders of that class. Where this is done and the rights are varied by the
requisite majority vote, the holders of not less than 10 per cent of the issued shares of
that class who had not assented to the variation may apply to the Court for the
cancellation of the variation under s.107.
(ii) Scheme of Reconstruction and Amalgamation: Section 394 provides for schemes of
reconstruction and gives protection to minorities. No compromise or arrangement
in connection with a scheme for the amalgamation of the company shall be sanctioned
210
by the court unless it has received a report from the Registrar that the affairs of the
company have not been conducted in a manner prejudicial to the interest of its members
or to public interest.
(iii) Oppression and Mismanagement: The principle of majority rule does not apply to cases
where Ss.397 and 398 are applicable for prevention of oppression and
mismanagement. A member, who complains that the affairs of the company are
being conducted in the manner oppressive to some of the members including
himself, may apply to the Court by petition under s.397. In O.P. Gupta v. Shiv General
Finance (p) Ltd. (1977), the Delhi High Court held, that a member’s right to move the
Court under s.397 was a statutory right and cannot be affected by an arbitration
clause in the Articles of Association of a company.
(iv) Rights of dissentient shareholders at the time of takeover bids: When an offer for the
purchase of all the shares is received and the offer is accepted by the holders of 90 per
cent of the shares, the party making the offer may, on the same terms acquire the
remaining shares also. But a notice is to be given to the dissenting shareholders who
have a right to apply to the court praying that their shares should not be allowed to be
acquired, on the terms of the scheme. On hearing the parties concerned, the court makes
an order as it may think fit.
Self Assessment
5. Debenture which are repayable only on the happening of an event of winding up is called
(a) Redeemable (b) Irredeemable
(c) Perpetual (d) Both (b) and (c)
6. For the purpose of debt equity ratio Fully Convertible Debentures are classified as
(a) Debt (b) Equity
(c) Both (a) and (b) (d) None of the above
7. In case of Partly Convertible Debentures nonconvertible portion is classified as
(a) Debt (b) Equity
(c) Both (a) and (b) (d) None of the above
8. Amount due on redemption including interest should be claimed with in how much time.
(a) 10 year (b) 9 year
(c) 8 year (d) 7 year
13.3.2 Powers of Company Law Board for Prevention of Mismanagement

and Oppression (Ss. 397-399 and 402)
Section 397 provides that any member of a company who complains that its affairs are being
conducted in a manner oppressive to any member or members (including any one or more of
themselves) may apply to the Company Law Board under this section. With a view to bring an
end the matters complained of, the Company Law Board may make such order as it thinks fit
under this section, if it is of opinion that– (i) 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;
and (ii) to wind up the company would unfairly prejudice the members who have lodged the
211
Company Law
complaint, but the court would be prepared to make a winding up order on the ground that it is
just and equitable that the company should be wound up.
An application may also be made under s.398 to the Company Law Board by any members of a
company who complain that– (i) the affairs of the company are being conducted in a manner
prejudicial to public interest or in a manner prejudicial to the interest of the company; or (ii) a
material change has taken place in the management or control of the company and that by
reason of such change, it is likely that the affairs of the company will be conducted in a manner
prejudicial to public interest or in a manner prejudicial to the interests of the company.
After hearing the petition, the Company Law Board may pass such order as it thinks fit.
Persons Entitled to Complain
Section 399 specifies the persons who are entitled to apply to the Company Law Board, for relief
in cases of oppression and mismanagement complained of in pursuance of Ss.397-398. The
numbers necessary to make such application is: (i) in the case of a company having a share
capital, 100 members or 10 per cent of the total number of its members whichever is less, or
members holding 10 per cent of the issued share capital; (ii) in the case of a company not having
a share capital, 20 per cent (one fifth) of the total number of its members. The Central Government
is empowered in an appropriate case to authorise any lesser number of members to make such
application to the Company Law Board.
Power of CLB to Provide Relief
Section 402 provides for the relief that can be provided by the Company Law Board and the
CLB’s order may include:
1. The regulation of the conduct of the company’s affairs in future;
2. The acquisition of the shares or interests of any members by other members or by the
company;
3. The consequent reduction of the share capital in case of (b) above;
4. Termination, setting aside or modification of any agreement, however arrived at, between
the company and the manager, managing director or any other director;
5. Termination, setting aside or modification of any agreement between the company and
any other person with the latter’s consent;
6. Setting aside of any transfer, delivery of goods, payment, execution or other act relating to
the property made or done by or against the company within three months of the application
which would amount to fraudulent preference in case of an individual’s insolvency;
7. Any other matter for which, in the opinion of the company law board, it is just and
equitable that provision should be made.
ABC Ltd realised on 2 May, 2006 that particulars of charge created on 12 March, 2006 in favour of
a bank were not filed with ROC for registration. What procedure should the company follow to get
the charge registered with the ROC? Would the procedure be different if the charge was created on
12 February, 2006 instead of 12 March, 2006?
Powers of Central Government to Prevent Oppression or Mismanagement
Section 408 empowers the Central Government to prevent oppression or mismanagement by

nominating directors on the Board of directors of a company.
212
Investigation
Besides the aforesaid provisions, to prevent oppression or mis-management by those who

control the affairs of the company, the Act contains certain provisions under the head
‘Investigation’.
Self Assessment
9. A resolution passed by the shareholders empowering the directors to borrow beyond the
aggregate of paid-up capital and free reserves is void.
10. An entry has to be made in the register of investments within seven days of making the inter-
corporate investment.
11. A public company has paid up capital and free reserves of 250 crores and 50 crores
respectively. For making the inter-corporate investment, it must pass a special resolution
and obtain approval of the central government.
12. Investments made by a company on its own behalf must be held by it in its own name.
13. An investment company need not hold its investments in its own name.
Case Study
the the c
on the affairs of the Company thinking that his rights and interest are secured to mandatory
Question
What is the nature of remedy available under the provisions meant to prevent the continuing
oppression and mismanagement? Give your own views in detail.
213
Company Law
13.4 Summary
All investments made by a company on its own behalf shall be made and held by it in its
own name.
If the investments are made by a company, whose principal business consists of the buying
and selling of shares or securities, the company may hold its investments in any other
name.
A company may deposit with, or transfer to, any person any shares or securities, by way
of security for the repayment of any loan advanced to the company for the performance of
any obligation undertaken by it.
A power to borrow, whether express or implied, includes the power to charge the assets of the
company by way of security to the lender.
The power to borrow money is generally exercised by the directors but Articles normally
provide for certain restrictions on their power to borrow.
Section 292 empowers the Board to borrow money on behalf of the company by means of
resolution passed at the meeting of the Board.
13.5 Keywords
Borrowing: A power to borrow, whether express or implied, includes the power to charge the
assets of the company by way of security to the lender.
Investment: The Act does not define the term ‘investment’ though it uses the same in a number
of sections.
Rule of Majority: The principle of rule by majority is made applicable to the management of
affairs of the company.
Suit against the Director: The lender may claim damages from the directors and sue them
personally for a breach of warranty of authority
1. What are the conditions imposed by section 372A of the Companies Act, 1956 as regards
investments of a company?
2. Discuss the provisions of the Companies Act, 1956 relating to inter-corporate investments.
3. What are the provisions of the Companies Act, 1956 as regards purchase by a company of
shares of other companies?
4. Discuss the law and state the procedure relating to inter-corporate loans.
5. What are the legal requirements which a company must comply with while borrowing?
6. What is ultra vires borrowing? What remedies, if any, are open to a lender if a company
resorts to ultra vires borrowing?
7. What are the restrictions imposed on the borrowing powers of the Board of directors?
8. What is a floating charge? Distinguish it from a fixed charge.
9. Comment on the characteristics of a floating charge. When does such a charge crystallise
into a fixed charge?
214
10. What charges are registered under the Companies Act, 1956? What is the effect of non-
registrable of a registrable charge?
1. Investment 2. own name

3. shares or securities 4. stock
5. (d) 6. (b)
7. (a) 8. (d)
9. True 10. True
11. True 12. True

13. True

www.webopedia.com
215
Company Law
Unit 14: Winding Up of Companies
CONTENTS
Objectives
Introduction
14.1 Winding Up
14.2 Modes of Winding Up (S. 425)
14.2.1 Winding Up by the Court
14.3 Procedure for Winding Up Order
14.4 Consequence of Winding Up Order
14.4.1 Statement of Affairs to be made to the Liquidator (s.454)
14.4.2 Committee of Inspection
14.5 General Powers of the Court
14.6 Voluntary Winding Up
14.6.1 Consequences of Voluntary Winding Up
14.7 Types of Voluntary Winding Up
14.7.1 Members’ Voluntary Winding up
14.8 Summary
14.9 Keywords
Objectives
Describe the modes of winding up;
Evaluate the consequences of winding up;
Describe voluntary winding up;

Explain the general powers of the court in relation to winding up.
Introduction
For the purposes of jurisdiction to wind up companies, the expression “registered office” means
the place which has longest been the registered office of the company during the six months
immediately preceding the presentation of the petition for winding up. (S.10)
216
The memorandum of a company limited by guarantee shall also state that each member undertakes
to contribute to the assets of the company in the event of its being wound up while he is a member
or within one year after he ceases to be a member, for payment of the debts and liabilities of the
company, or of such debts and liabilities of the company as may have been contracted before he
ceases to be a member, as the case may be, and of the costs, charges and expenses of winding up, and
for adjustment of the rights of the contributories among themselves, such amount as may be
required, not exceeding a specified amount. (S. 13)
14.1 Winding Up
Winding up of a company is the process whereby its life is ended and its property administered
for the benefit of its creditors and members. An administrator, called a ‘liquidator’, is appointed
and he takes control of the company, collects its assets, pays its debts and finally distributes any
surplus among the members in accordance with their rights. In simple words, winding up means
applying the assets of a company in the discharge of its liabilities and returning any surplus to
those entitled to it, subject to the cost of doing so. The statutory process by which thisis achieved
is called ‘liquidation’. Winding up of a company differs from insolvency of an individual in as
much as a company cannot be made insolvent under the insolvency law. Besides, even a solvent
company may be wound up.
14.2 Modes of Winding Up (S. 425)
A company may be wound up in any of the following three ways:
1. Compulsory winding up under an order of the court.
2. Voluntary winding up.
3. Voluntary winding up under the supervision of the court.
14.2.1 Winding Up by the Court
Court having jurisdiction. For the purpose of filing the petition for compulsory winding up, the
following courts have jurisdiction:
(a) High court having jurisdiction in relation to the place at which the registered office of the
company is situated. The expression ‘registered office’ means the place which has longest been
the registered office of the company during the six months immediately preceding the
presentation of the petition for winding up.
(b) A District court, subordinate to the High Court on which jurisdiction has been so conferred.
However, it shall necessarily be a High Court in ‘respect of a company having a paid up
capital of 1 lakh or more (s. 10].
Example: X Ltd has its registered office in Mumbai. Mr. Y is a creditor of the company
and he resides in Chennai. He files a petition in the High Court at Chennai. The paid up capital
of the company is one crore.
The High Court at Chennai does not have the jurisdiction to entertain the petition. It is the High
Court at Mumbai to which the petition for winding up should be made.
Winding up by the court, also called compulsory winding up, may be ordered in cases mentioned in
s.433. The court will make an order for winding up on an application by and of the persons
enlisted in s.439.
217
Company Law
Grounds for Compulsory Winding Up [s.433(3)]
A company may be wound up by the court on the following grounds:
1. Special Resolution: The company may by special resolution, resolve that it be wound up
by the court. The resolution may be passed for any cause whatsoever. However, the court
may not order winding up if it finds it to be opposed to public interest or the interest of the
company as a whole.
2. Default in Holding Statutory Meeting: If default is made in delivering the statutory report to
the Registrar or in holding the statutory meeting, the company may be ordered to be
wound up. Petition on this ground can be presented either by the Registrar or by a
contributory. If it has to be filed by any other person, it should be filed before the expiration of
14 days after the last day on which the statutory meeting ought to have been held [s.439
(7)].
3. Failure to Commence Business: If a company does not commence business within a year from
incorporation or suspends business for a whole year, it may be ordered to be wound up.
Failure to commence or to carry on business is not treated as a ground for compulsory winding
up unless the company has no intention of carrying on business or it has become impossible
to do so.
4. Reduction in Membership: If the number of members is reduced below the statutory
minimum of 7 in a public company or 2 in a private company, the company may be ordered
to be wound up.
5. Inability to Pay Debts: The Court may order a company to be wound up if it is unable to
pay its debts. According to s.434, a company shall be deemed to be unable to pay its debts
if: (a) a creditor for more than one lakh rupees has served on the company at its registered
office a demand under his hand requiring payment and the company has for three weeks
thereafter neglected to pay or secure or compound the sum to the reasonable satisfaction
of the creditor; or (b) execution or other process issued on a judgement or order of any
court or court in favour of a creditor of the company is returned unsatisfied in whole or in part;
or (c) it is proved to the satisfaction of the court that, the company is unable to pay its debts,
taking into account its contingent and prospective liabilities.
Though a contingent and prospective liability is not a debt, the provision that, the court is
to take into account the company’s contingent and prospective liabilities is important. A
company which has to date paid all its debts as they fell due may still be ordered to be wound
up if a consideration of its assets and liabilities shows that, it will or may shortlybe unable
to do so. Inability is to be seen in the commercial sense of a running enterprise and not in the
sense of liquidation, i.e., if the company cannot meet its current demand, even though its
assets, when realised, would exceed its liabilities, it will be deemed to be unable to pay its debt
and may be wound up.
But the important condition to be fulfilled is that, the creditor should have a complete title
to the debt and the debt – a determined or definite sum of money – must have become
payable immediately. Where there is a bona fide dispute regarding the debt, the company
cannot be charged to have neglected to pay it.
The application money due to be refunded to an applicant who applied for shares, but his
application was not accepted, is not a debt. Also, the interest due on such an amount is not
a debt.
Also wages or salary which is due by the company to an employee is not a debt.
218
The petition on the ground of a company’s inability to pay its debts can be made by a
creditor (including a secured creditor) a debenture holder, and a trustee for debenture
holders. Even a contingent creditor, such as a holder of bill of exchange may make a
petition. The company itself can file a petition. The registrar has a limited right to file a
petition for winding up of a company.
6. Just and Equitable: The court may also order for the winding up of a company if it is of the
opinion that, it is just and equitable that, the company should be wound up. In exercising
its power on this ground, the court shall give due weight to the interest of the company, its
employees, creditors and shareholders and the interest of the general public. The relief based
on the just and equitable clause is in the nature of a last resort when other remedies are not
efficacious enough to protect the general interests of the company. While in the above five
cases definite conditions should be fulfilled but in the ‘just and equitable’ clause the entire
matter is left to the ‘wide and wise’ direction of the court. The winding up must be just and
equitable not only to the persons applying but also to the company and to all its
shareholders. [Hind Overseas Pvt. Ltd. vs. R.P. Jhunjhunwala (1977) ASIL. XIII] A few of the
examples of ‘just and equitable’ grounds on the basis of which the court may order the
winding up are given below:
(i) When the substratum of the company has gone: The substratum of a company is deemed
to be gone where its objects have failed or become impossible of achievement.
Some tests to ascertain whether the substratum of the company is gone were laid
down in In re Kaithal and General Mills Co. Ltd. (1951.) 31 Comp Cas 46 These are:
(a) Where the only subject matter of the company is gone; or
(b) The object for which it had been incorporated has substantially failed; or
(c) It is impossible for the company to continue except at a loss; or
(d) The existing liabilities are far in excess of existing and possible assets.
(ii) When there is a complete deadlock in the management: A company will be wound up on
this ground even though it is making good profits. In re Yenidje Tobacco Co. Ltd.
[1916]2 Ch 426, A and B, the only shareholders and directors of a Private Limited
company became so hostile to each other that neither of them would speak to the
other except through the secretary. Held: There was a complete deadlock and
consequently the company was ordered to be wound up.
(iii) Where the company was formed for fraudulent or illegal purposes: For this purpose, fraud
in the prospectus or in the manner of conducting company’s business is not sufficient.
It must be shown that, the original object of creating the company was fraudulent or
illegal [re T.E. Brismead & Sons Ltd. (1897)1 Ch.45].
(iv) Where the principal shareholders have adopted an aggressive or oppressive policy towards the
minority: [R. Sabapathy Rao vs. Sabapathy Press Ltd. AIR (1925) Mad. 489] However,
the court will order winding up only when it is satisfied that it is impossible for the
business of the company to be carried on for the benefit of the company as a whole
because of the way in which voting power is held and used.
(v) When the company is a ‘bubble’: This means it never had any real business [re London
and Country Coal Co. (1867) L.R. 3 Eq. 365].
(vi) Where the business of the company cannot be carried except at loss: But, mere apprehension
on the part of some shareholders that loss instead of gain will result has been held
to be no ground [Re Mahamandal Shastra Prakashik Samiti Ltd. (1917) 15 All L.T. 193].
Similarly, in re Shah Steamship Navigation Co. [(1901) 10 Bom. L.R. 107], it was
219
Company Law
held that ‘the Court will not be justified in making winding up order merely on the
ground that the company has made losses and it was likely to make further losses.
(vii) Where a private company is in essence or substance a partnership: It may be ordered to be

wound up if such circumstances exist under which it would be just and equitable for the
Court to order for the dissolution of the partnership firm. In Re Davis & Coltett Ltd.
[(1935) Ch. 693] one member improperly excluded the other, who held half the shares,
from taking part in the company’s business. Held, the company be woundup.
In this context, some guiding principles for the application of just and equitable
ground for winding up were laid down in Ebrahimi v. Westbourne Galleries Ltd.
[1972] 2 All ER 492. These are:
(a) The company was formed based on personal relationship and mutual
confidence;
(b) An agreement or understanding that all or some of the shareholders will
participate in the conduct of the business as in the case of a partnership concern;
and
(c) Restrictions on the transfer of a members’ interest in the private company.

However, the fact that an existing partnership firm was converted into a private
company does not necessarily imply that the company retains the features of a
partnership firm [Official Liquidator v. Ram Swarup (1997) Cas 569.]
(viii) Requirements for Investigation: Where Directors were making allegations of dishonesty
against each other in respect of defalcations of the funds of the company, the company
was ordered to be wound up on the ground that, it was a case in which the conduct
of some of the officers of the company required an investigation which could only
be obtained in a winding up by the Court [Re Varieties Ltd. (1893) 2 Ch. 235].
Task Company was incorporated for the purpose of manufacturing machinery tools,
implements, etc. It spent a substantial part of its subscribed capital on fixed assets. It
borrowed a sum of 30 Lakhs from a bank for providing working capital. As the company
was unable to pay back this loan, the bank obtained a decree from a court. The stock-in-
trade, plant and machinery and all the fixed assets of the company were sold out in
execution of the decree, leaving no surplus for the company.
Would it be just and equitable to wind up the company in the circumstances?
[Hint: The company in question may be wound up on just and equitable grounds since its
subject matter is gone.]
Self Assessment
Fill in the blanks:
1. of a company is the process whereby its life is ended and its property
administered for the benefit of its creditors and members.
2. The statutory process by which this is achieved is called ......................................
3. If a company does not commence business...................................... from incorporation or

suspends business for a whole year, it may be ordered to be wound up.
220
4. The Court may order a company to be wound up if it is unable to pay its ....................................
5. or salary which is due by the company to an employee is not a debt.
14.3 Procedure for Winding Up Order
1. The winding up petition must be presented to the court.
2. After the presentation of the petition but before the hearing, application may be made to
the court by either the company, creditor or contributories: to appoint a provisional
liquidator to safeguard the assets pending the hearing. Before making such appointment,
however, the court must give notice to the company so as to enable it to make its
representation in the matter unless, for reasons to be recorded in writing, it thinks fit to
dispense with such notice. The powers of the provisional liquidator are the same as those
of a liquidator unless limited by the court (s.450).
3. On hearing a winding up petition, the court may [s.443(1)]: (i) dismiss it, with or without
costs; or (ii) adjourn the hearing conditionally or unconditionally; or (iii) make any interim
order that it thinks fit; or (iv) make an order for winding up the company with or without
costs, or any other order that it thinks fit.
The court cannot, however, refuse to make a winding up order on the ground only that,
the assets of the company have been mortgaged to an amount equal to or in excess of those
assets or that the company has no assets. “Where the petition is presented on the ground
that, it is just and equitable that the company should be wound up, the court may refuse to
make an order of winding up if it is of the opinion that, some other remedy is available to
the petitioners and that they are acting unreasonably in seeking to have the company
wound up instead of pursuing that other remedy.” [s.443 (2)].
Where the petition is presented on the ground of default in delivering the statutory report
to the Registrar or in holding the statutory meeting, the court may: (a) instead of making
a winding up order, direct that the statutory report shall be delivered or that a meeting
shall be held; and (b) order the costs to be paid by persons who, in the opinion of the
Court, are responsible for the default [s.443 (3)].
In all matters relating to the winding up of a company, the court may have regard to the wishes
of creditors or contributories of the company as proved to it by any sufficient evidence and for
the purpose may direct that their meetings may be held or conducted as directed by the Court
(s.557).
14.4 Consequence of Winding Up Order
The consequence of the winding up order by the court are as follows:
1. The court must, as soon as the winding up order is made, cause intimation thereof to be
sent to the official liquidator and the Registrar (s.444).
2. The petitioner and the company must also file with the Registrar within 30 days a certified
copy of the order [s.445(1)]. The Registrar should file with himself a certified copy of the
winding up order of the court when he himself is a petitioner under s.439. If default is made
in filing the certified copy of the order, the petitioner, or the company and every officer
of the company who is in default, shall be punishable with fine upto 1,000 for every day
during which the default continues (s.445).
3. The Registrar should then make a minute of the order in his books relating to the company
and notify in the official gazette that such an order has been made [s.445(2)].
221
Company Law
4. The order for winding up is deemed to be a notice of discharge to the officers and employees
of the company, except when the business of the company is continued [s.445(3)].
5. The order operates in the interests of all the creditors and all the contributories, no matter
who in fact asked for it (s.447).
6. The official liquidator, by virtue of his office becomes the liquidator of the company and
takes possession and control of the assets of the company (s.449).
7. All actions and suits against the company are stayed, unless the court gives leave to
continue or commence proceedings (s.446).
8. All the powers of the Board of directors cease and the same are then exercised by the
liquidator [Ss.491 & 505].
9. On the commencement of winding up, the limitation ceases to run in favour of the company.
10. Any disposition of the property of the company and any transfer of shares in the company
or alteration in the status of members made after the commencement of winding up shall,
unless the court otherwise orders, be void [s.536(2)].
11. Any attachment, distress or execution put in force, without leave of the court, against the
estate or effects of the company after the commencement of the winding up shall be void
[s.537 (a)] but not for dues payable to Government [s.537(2)].
12. Any sale held, without leave of the court, of any of the properties or effects of the company
after the commencement of winding up shall be void [s.537(b)].
13. Any floating charge created within 12 months preceding the commencement of winding
up is void unless it is proved that, the company after the creation of the charge was
solvent, except as to, any cash advanced at the time of or subsequent to the creation of the
charge or to any interest on that amount @ 5% or such other rate notified by the Central
Government (s.534).
Example: A company created a floating charge of its current assets in favour of a bank to
secure a current account, which was in debit of 5 lakhs and also to secure further working capital
facilities provided by the bank. The charge created on January 1, 2007 was duly registered with ROC.
The bank advanced 10 lakh subsequent to the creation of the charge. The companyhas gone into
creditors voluntary liquidation pursuant to a resolution passed on September 1, 2007. There is no
case of a fraudulent preference.
As it is a creditors voluntary winding up, the floating charge is void being made within 12
months of winding up resolution, unless the charge is against cash advanced at the specified rate
of interest (s. 534).
Example: If in the above example, if it was a members’ voluntary winding up, then the
floating charge is valid.
The secured creditor is outside the winding up and can realise his security without the leave of the
court.
222
14.4.1 Statement of Affairs to be made to the Liquidator (s.454)
When a winding up order is made by the court, the directors of the company must make to the
liquidator a statement as to the affairs of the company, stating the following particulars: (i) the debts
and liabilities of the company; (ii) the assets of the company, showing separately the cash in hand
and in bank, if any; (iii) the name, residence and occupation of each creditor stating separately the
amount of secured debts and unsecured debts; (iv) the debts due to the companyand the name,
residence and occupation of each person from whom the sum is due and the amount likely to be
realised there from.
The object of such a statement is to give the liquidator an idea as to the financial affairs and liabilities
of the company. The creditors and contributories of the company can inspect the statement. The
statement should be made within 21 days (or such extended time not exceeding3 months as the
official liquidator or Tribunal may for special reasons allow) after the relevant date. The relevant
date is the date of the winding up order by the court or where a provisional liquidator is appointed,
the date of his appointment. The statement must be submitted and verified by affidavit by one or
more of the persons who, at the relevant date are the directors and by the person who at that time
is the manager, secretary or other chief officer of the company. Defaulter shall be punishable with
imprisonment up to 2 years or with fine up to 1,000 for every day during which default continues
or with both.
14.4.2 Committee of Inspection
The court may, at the time of making an order of winding of a company or at any time thereafter,
direct that there shall be appointed a committee of inspection to act with the liquidator. In such
a case the liquidator must, within 2 months from the date of such direction convene a meeting of the
creditors of the company for the purpose of determining who are to be members of the committee.
Within 14 days from the date of the creditors meeting (or such further time as the Court in its
direction may grant for the purpose), the liquidator should convene a meeting of the contributories
to consider the decision of the creditors’ meeting with respect to the membership of the committee.
It is open to the meeting of the contributories to accept the decision of the creditors’ meeting with or
without modifications or to reject it. The liquidator must apply to the court for directions as to what
the composition of the committee shall be and who shall be members thereof. However, it will not
be necessary to seek directions in this regard where the meeting of the contributories accept the
decision of the creditors’ meeting in its entirety.
Section 465 provides: (i) a committee of inspection cannot have more than 12 members; (ii) the
committee shall have the right to inspect the accounts of the liquidator at all reasonable times;
(iii) it must meet at such times as it may from time to time appoint and the liquidator or any
member of the committee may also call a meeting of the committee as and when he thinks
necessary; (iv) the quorum for the meeting of the committee shall be 1/3rd of the total number
or two whichever is higher; (v) a member of the committee may resign by notice in writing. But
where a member of the committee is adjudged an insolvent or compounds or arranges with his
creditors, or is absent from five consecutive meetings of the committee without the leave of the
members, he shall cease to remain a member.
223
Company Law
Self Assessment
6. Match list-I and list-II.
List-I List-II
A. Special resolution 1. If a company does not commence business within
a year from incorporation or suspends business for
a whole year, it may be ordered to be wound up.
B. Default in holding 2. The company may, by special resolution, resolve

statutory meeting that it be wound up by the court.
C. Failure to commence 3. If default is made in delivering the statutory
business report to the Registrar or in holding the statutory
meeting, the company may be ordered to be
wound up.
D. Reduction in 4. If the number of members is reduced below the
membership statutory minimum of 7 in a public company or 2
in a private company, the company may be ordered
to be wound up.
Codes:
A B C D
(a) 2 4 3 1
(b) 2 3 1 4
(c) 3 4 1 2
(d) 4 1 3 2
7. Match the list-I and list-II
List-I List-II
A. The powers of the provisional liquidator are the same as those 1. s 443(2)
of a liquidator unless limited by the court
B. In all matters relating to the winding up of a company, the court 2. (s.444).
may have regard to the wishes of creditors orcontributories of the
company as proved to it by any sufficient evidence and for the
purpose may direct that their meetings may be held or
conducted as directed by the Court
C. Where the petition is presented on the ground that, it is just 3. (s.450)
and equitable that the company should be wound up, the court
may refuse to make an order of winding up if it is of theopinion
that, some other remedy is available to the petitioners and that
they are acting unreasonably in seeking to have the company
wound up instead of pursuing that other remedy
D. The court must, as soon as the winding up order is made, 4. (s. 557)
cause intimation thereof to be sent to the official liquidator and
the Registrar
224
Codes:
A B C D
(a) 2 4 3 1
(b) 2 3 1 4
(c) 3 4 1 2
(d) 4 1 3 2
14.6 General Powers of the Court
The general powers of the court are as follows:
1. Power of Court to Stay Winding Up (s.446): The court may at any time after making a
winding up order (on the application either of the official liquidator of any creditor or
contributor and on proof to the satisfaction of the court that, all proceedings in relation to
the winding up order be stayed) make an order staying the proceedings either altogether
or for a limited time, on such terms and conditions as the court thinks fit.
2. Settlement of the List of Contributories (s.467): The court has the power to cause the assets
of the company to be collected and applied in discharge of its liabilities. For this purpose the
court has the power to make a list of contributories. In settling the list of contributories the
court shall distinguish between those who are contributories in their own right and those
who are contributories as being representatives of, or liable for the debts of others.
3. The Power to Make Calls (s.470): The court is empowered to make call on all or any of the
contributories to the extent of their liability. It should be noted that, no statutory liability
for an unpaid call can be set off against a credit except in the following cases: (a) in the case
of an unlimited company, a contributory may set off his debt against any money due to
him from the company on any independent dealing or contract with the company. But no
set off is allowed for any money due to him as a member of the company in respect of any
dividend or profit; (b) if, in the case of a limited company, there is any director or manager
whose liability is unlimited, he shall have the same right of set off as described in (a) above;
(c) in the case of any company, whether limited or unlimited when all the creditors have been
paid in full, any money due on any account whether to a contributory from the company may
be allowed to him by way of set off against any subsequent call.
4. Payment into Bank of Moneys Due to Company (s.471): The court may order any
contributory, purchaser or other person from whom any money is due to the company to
pay the money into the public account of India in the Reserve Bank of India instead of to
the liquidator.
5. Power to Exclude Creditors not Proving in Time (s.474): The court may fix a time or times
within which creditors are to prove their debts or claims. In such a case, if the creditors fail
to establish their claims in time, they may be excluded from the benefit of any distribution
made.
6. Adjustment of Rights of Contributories (s.475): The court is empowered to adjust the right
of the contributories among themselves and distribute any surplus among the person entitled
thereto.
7. Power to Order Costs (s.476): The court may, in the event of assets being insufficient to
satisfy the liabilities, make an order for the payment out of the assets, of the costs, charges
and expenses incurred in the winding up, in such order of priority inter se as the Court
thinks just.
225
Company Law
8. Power to Summon Persons suspected of having property of company, etc. (s.477): The court
may summon before it any officer of the company or person known or suspected to have in his
possession any property or books or papers of the company or known or suspected to be
indebted to the company. Any such person may be examined on oath. The court may also
require him to produce any books and papers in his custody or power relating to the
company; but where he claims any lien on books or papers produced by him, the production
must be without prejudice to that lien.
If any officer or person summoned, after being paid or tendered a reasonable sum for his
expenses, fails to appear before the court at the time appointed without any valid reason,
the court may cause him to be apprehended and brought before the court for examination.
9. Power to Order Public Examination of Promoter, Directors, etc. (s.478): Where the Official
Liquidator has made a report to the court, stating that in his opinion a fraud has been
committed by any person in the promotion or formation of the company, or by any officer
of the company since its formation, the court may direct that person or officer may appear
before the court and be publicly examined. Examination shall relate to the promotion or
formation or the conduct of the business of the company, or as to his conduct and dealings as
an officer thereof. Official liquidator, any creditor or contributory may take part in such
examination. The court may put such questions to the person examined as it thinks fit. The
person shall be examined on oath and must answer all such questions as the Tribunal may put
or allow to be put, to him. of the examination must be taken in writing and must be read
over to or by and signed by the person examined and may thereafter be used in evidence
against him. Statement so recorded shall be open to the inspection of any creditor or
contributory at all reasonable times.
10. Power to arrest a Contributory Intending to Abscond (s.479): At any time (either before or
after making a winding up order), the court may, on proof of probable cause for believing
that a contributory is about to quit India or otherwise to abscond or is about to remove or
cancel any of his property, for the purpose of evading payment of calls or of avoiding
examination in respect of the affairs of the company, cause: (a) the contributory to be arrested
and safely kept until such time as the Tribunal may order; and (b) his books and papers and
movable property be seized and safely kept until such time as the Court may order.
11. Power to Order for Dissolution of the Company (s.481): When the affairs of a company have
been completely wound up or when the court is of the opinion that, the liquidator cannot
proceed with the winding up of a company for want of funds and assets or for any other reason
whatsoever and it is just and reasonable in the circumstances of the case that an order of
dissolution of the company should be made, the court shall make an order that the company
be dissolved from the date of the order. The liquidator must, within 30 days, send a copy of the
order to the Registrar who shall make in his books a minute of the dissolution of the company.
If he makes a default in forwarding a copy as aforesaid, he shall be punishable with fine
which may extend to 500 for every day during which the default continues. On the expiry of
5 years from the date of dissolution, the name of the company should be struck off the register.
But within 2 years of the date of the dissolution on application by the liquidator of the
company or by any other person who appears to the court to be interested, the court may
make an order, upon such terms as the court thinks fit, declaring the dissolution to have been
void. After such an order is passed, such proceedings may be taken as might have been taken
if the company had not been dissolved (s.559).
226
Task Randhir and Vipin formed a private company in which they were the only directors
in
getting winding up order? [Hint: He will succeed; there being a deadlock in management.
14.6 Voluntary Winding Up
Winding up by the creditors or members without any intervention of the court is called ‘voluntary
winding up’. In voluntary winding up, the company and its creditors are left to settle their affairs
without going to the court for directions or orders if and when necessary. Winding up should
not be confused with insolvency. Company may be solvent and running a prosperous business
yet it may decide to be wound up voluntarily, e.g., in pursuance of a scheme of reconstruction
or amalgamation.
A company may be wound up voluntarily: (1) if the company in general meeting passes an
ordinary resolution for voluntary winding up where the period fixed by the Articles for the
duration of the company has expired or the event has occurred on which under the Articles the
company is to be dissolved; (2) if the company resolves by special resolution that it shall be
wound up voluntarily (s.484).
When a company has passed a resolution for voluntary winding up, it must within 14 days of the
passing of the resolution, give notice of the resolution by advertisement in official gazette and
also in some newspaper circulating in the district where the registered office of the company is
situated. In case of default, the company and every officer of the company who is in default shall
be punishable with fine which may extend up to 500 for every day during which the default
continues (s.485).
14.6.1 Consequences of Voluntary Winding Up
The consequences of voluntary winding up are as follows:
1. A voluntary winding up is deemed to commence at the time when the resolution for voluntary
winding up is passed (s.486). This will be so even when after passing a resolution for voluntary
winding up, a petition is presented for winding up by the court (s.441).
2. The company, from the commencement of winding up, must cease to carry on its business
except so far as may be required to secure a beneficial winding up, although the corporate
state and powers of the company continue until final dissolution (s.487).
3. All transfer of shares and alterations in the status of members, made after the
commencement, are void unless sanctioned by the liquidator (s.536).
4. A resolution to wind up voluntarily operates as notice of discharge to the employees of

the company [Fowler vs. Commercial Times Co.] except: (a) when the liquidation is only
with a view to ‘reconstruction’ [Midland Counties Bank Ltd. vs. Attwood (1905) 1 Ch. 357]
or (b) when business is continued by the liquidator for the beneficial winding up of the
company.
5. On the appointment of the liquidator, all the powers of the Board of directors, managing
director or ‘manager’ shall cease except (s.491): (a) for the purpose of giving notice to the
Registrar about the name of the liquidator appointed, or (b) insofar as the company ingeneral
meeting or the liquidator may sanction the continuance of their powers.
227
Company Law
Self Assessment
8. Under which sec. if company fails to commence its main object the court may order
winding up
(a) 403 (f) (b) 413 (f)
(c) 423 (f) (d) 433 (f)
9. Deposit holder can file winding up petition under which sec.
(a) 433 (a) (b) 433 (c)
(c) 433 (e) (d) 433 (f)
10. The capital which is part of the uncalled capital of the company which can be called up
only in the event of its winding up it is called
(a) Issued capital (b) Nominal capital
(c) Authorised Capital (d) Reserve capital
11. Commencement of winding up of a company does not affect the nature of

(a) A fixed charge (b) A floating charge
(c) Both a and b (d) None of the above
14.7 Types of Voluntary Winding Up
Voluntary winding up may be of three types: (a) Members’ Voluntary winding up; (b) Creditors’
Voluntary winding up; (c) Voluntary winding up under supervision of court.
14.7.1 Members’ Voluntary Winding up
Members’ Voluntary winding up is possible only when the company is solvent and is able to pay
its liabilities in full. Following are the important provisions regarding members’ voluntary
winding up.
Declaration of Solvency (s.488)
Where it is proposed to wind up a company voluntarily, its directors, or in case the company has
more than two directors, the majority of the directors, may at a meeting of the Board, make a
declaration verified by an affidavit, to the effect that they have made a full enquiry into the affairs
of the company and that having done so, they have formed the opinion that the company has no
debts, or that it will be able to pay its debts in full within such period not exceeding 3 years from
the commencement of the winding up as may be specified in the declaration. In order to be
effective, this declaration must be: (i) made within five weeks immediately preceding the date
of passing of the winding up resolution by the members; (ii) delivered to the Registrar for filing
before the said date; (iii) accompanied by a copy of the report of the auditors of the company on
the profit and loss account prepared since the date of the last account and the balance-sheet of
the company made out as on the last mentioned date and also embodies a statement of the
company’s assets and liabilities as at that date.
Any director of a company making a declaration under this section without having reasonable
grounds for the opinion that the company will be able to pay its debts in full within the period
specified in the declaration, shall be punishable with imprisonment for a term which may
228
extend to six-months, or with fine up to 5,000 or with both. If the company is wound up in
pursuance of a resolution passed within the period of five weeks after making the declaration,
but its debts are not paid or provided for in full within the period specified in the declaration, it
shall be presumed, until the contrary is shown, that the director did not have reasonable grounds for
his opinion.
If the above provisions are not complied with, the winding up shall not be a members’ voluntary
winding up [Vosica vs. Janda Rubber Works AIR (1950) East Punjab 180] and in such case provisions
(s.490 and 498) relating to members voluntary winding up cannot apply and if liquidator is
appointed in pursuance of s. 490 or 498 such appointment would be bad in law. In such a case, the
provisions relating to creditor’s voluntary winding up (Ss. 500-509) should be followed and the
violation of these provisions will make the winding up proceedings void ab initio (M. Kakshmiah
vs. Registrar of Companies, Trivandrum-unreported case decided by the Kerala High Court)
and if default is made in calling a meeting of the creditors then the company and the Directors’
as the case may be, shall be punishable with fine which may extend to 10,000 and in the case of
default by the company, every officer of the company who is in default, shall be liable to the like
punishment [s.500 (6)]. The Court may, if moved by the company or its shareholders, instead of
treating the winding up proceedings as invalid, direct the company to convene the creditors
meeting [Light of Asia Insurance Company, I.L.R. 1940 (2) Cal.325]. The above rules will be
applicable even where a declaration of solvency has been filed but in accordance with the
provisions of s.488(2).
The company, however, may pass a fresh resolution for its winding up after complying with the
requirements of s.488 (Declaration of Solvency).
Appointment and Remuneration of Liquidators (s.490)
The company in general meeting must: (a) appoint one or more liquidators for the purpose of
winding up the affairs and distributing the assets of the company; and (b) fix the remuneration,
if any, to be paid to the liquidator or liquidators.
Any remuneration so fixed cannot be increased in any circumstances whatever, whether with or
without the sanction of the Court. No liquidator shall take charge of his office unless his remuneration
is fixed. Further, if a vacancy occurs by death, resignation or otherwise in the office of the
liquidator appointed by the company, the company in general meeting may, subject to any
arrangement with its creditors, fill the vacancy. For this purpose a meeting may be convened by
any contributory or the continuing liquidator or by the Court on the application of any of them
(s.492).
Board’s Power to Cease
On the appointment of a liquidator, all the powers of the Board of directors and of the managing
director or whole-time directors or manager shall cease except for purpose of giving a notice of
such appointment to the Registrar. But their powers may continue if sanctioned by the general
body or by the liquidator so far as the sanction applies (s.491).
Notice of Appointment of Liquidator to be given to the Registrar (s.493)
The company must give notice to the Registrar regarding the appointment of liquidator within
10 days of his appointment. In case of default, the company and every officer of the company
(including liquidator) who is in default, shall be punishable with fine which may extend to
1,000 for every day during which the default continues.
229
Company Law
Power of Liquidator to Accept Shares, etc., as consideration of Sale of Property of the

Company (s.497)
The liquidator may accept shares, policies or like interests in consideration of the sale of the
company’s undertaking to another company, with an object to distribute them amongst the members
of transferor company, provided: (a) a special resolution is passed by the company to that effect;
and (b) he purchases the interest of any dissenting member at a price to be determined by agreement
or by arbitration.
The money to the dissenting members should be paid before the company is dissolved and
should be raised in such manner as may be determined by special resolution.
Duty of Liquidator to call Creditor’s meeting in case of Insolvency (s.495)
If the liquidator is at any time of opinion that the company will not be able to pay its debts in full
within the period stated in the declaration of solvency, or that period has expired without the
debts having been paid in full, he must forthwith summon a meeting of the creditors and must
lay before the meeting a statement of the assets and liabilities of the company. If he fails to
comply with the above requirements, he shall be punishable with fine which may extend to
5,000.
Duty of the Liquidator to call General Meeting at the end of each year (s.496)
In case winding up continues for more than one year the liquidator must: (a) call a general
meeting of the company at the end of the first year from the commencement of winding up and
at the end of each succeeding year, or as soon thereafter as may be convenient within 3 months
from the end of the year or such longer period as the Central Government may allow; and (b) lay
before the meeting an account of his acts and dealing and of the conduct of the winding up
during the preceding year.
Final Meeting and Dissolution [s.497]
As soon as the affairs of the company are fully wound up, the liquidator must: (a) make up an
account of the winding up showing how the winding up has been conducted and the property of
the company has been disposed of; and (b) call a general meeting of the company for the purpose
of laying the account before it, and giving any explanation thereof.
The meeting must be called by advertisement specifying the time, place and object of the meeting
and must be published at least one month before the meeting in the official gazette and also in
some newspaper circulating in the district where the registered office of the company is situated.
Within one week after the meeting, the liquidator must send to the Registrar and the official
liquidator each, a copy of the account and the return regarding holding of the meeting. In case
quorum was not present at the meeting called, he must report accordingly.
On receipt of the above documents, the Registrar will register them and the official liquidator shall
make a scrutiny of the books and papers of the company and report to the court, the result of his
scrutiny. If the report of the official liquidator shows that the affairs of the company have not
been conducted in a manner prejudicial to the interest of its members or to public interest, then,
from the date of submission of report of the court, the company shall be deemed to be dissolved. In
the case of an unfavourable report, the court shall direct the official liquidator to make a further
investigation of the affairs of the company. On receipt of the report of the official liquidator on such
further investigation, the court may either make an order that the company stands dissolved with
effect from the date specified in the order or make such order as the circumstances of the case
brought out in the report permit.
230
Self Assessment
12. In the case of compulsory winding up, the official liquidator, by virtue of his office,
becomes the liquidator of the company.
13. The terms ‘liquidation’ and ‘dissolution’ can be used interchangeably.
14. An unregistered company can be wound up either voluntarily or by court.
15. Any transfer of property, movable or immovable, or any delivery of goods made by a
company within a period of one year before the commencement of its winding up is void
as against the liquidator.
16. The liquidator has an absolute power to disclaim onerous property of a company.
Case Study How to avoid Compulsory Liquidation
P
rotecta (Plymouth) Limited (a fictional company) is a security services company
providing security guards to other businesses. The company has 50 employees. The
company has minimal overheads, apart from the “wage cost” of the employees.
The company had four main customers, the largest of which failed leaving Protecta
(Plymouth) Limited with a bad debt of £ 100,000. Since that bad debt was incurred three
months ago the company has recovered its previous level of turnover, but that turnover is
now spread over ten customers.
The cash flow reduction of £ 100,000 caused by the bad debt resulted in Protecta (Plymouth)
Ltd “stretching the due dates” of the payments needed to be made to the company’s
creditors. One of those creditors issued a winding up petition two weeks ago and the court
is to consider whether or not to make a winding up order at a hearing set to take place in
three weeks time.
As soon as they receive the winding up petition the directors of Protecta (Plymouth) Ltd
arrange to see a turn around specialist.
The realisable assets of the company are determined to be:
£
Good trade debtors 170,000
Five vans 25,000
Office equipment 2,000
Goodwill ?
Total realisable value of assets 197,000
Contd...
231
Company Law
£ £
Bank (secured by a debenture) 160,000
VAT 120,000
PAYE 60,000
Other unsecured creditors 20,000 200,000
Total creditors 360,000
The adviser explains that since a change in the law on 15th September 2003 VAT and PAYE
£
Realisable value of Assets 197,000
Less: Payable to bankers under their floating charge 160,000
Surplus cash available for other creditors which total £200,000 37,000
(subject to settling liquidators costs)
Question
14.8 Summary
Winding up of a company is the process whereby its life is ended and its property
A District court is subordinate to the High Court on which jurisdiction has been so
conferred.
Winding up by the court, also called compulsory winding up, may be ordered in cases
mentioned in s.433.
The Court may order a company to be wound up if it is unable to pay its debts.
The court may also order for the winding up of a company if it is of the opinion that, it is
just and equitable that, the company should be wound up.
The court has the power to cause the assets of the company to be collected and applied in
discharge of its liabilities.
The court is empowered to make call on all or any of the contributories to the extent of
their liability.
14.9 Keywords
Committee of Inspection: The court may, at the time of making an order of winding of a company or
at any time thereafter, direct that there shall be appointed a committee of inspection to act with
the liquidator.
232
Members’ Voluntary Winding up: Members’ Voluntary winding up is possible only when the
company is solvent and is able to pay its liabilities in full.
Voluntary Winding up: Winding up by the creditors or members without any intervention of
the court is called ‘voluntary winding up’.
Winding up: Winding up of a company is the process whereby its life is ended and its property
1. What is winding up?
2. Define the term ‘contributory.’ Discuss the liability of members of a company in the event
of its being wound up.
3. State the liabilities of contributories as present and past members.
4. Discuss the circumstances in which a company may be wound up by the court.
5. Explain the circumstances in which a company may be wound up by the court on the
ground that the company is unable to pay its debts.
6. What are the circumstances in which a company may be wound up on the ground that it is
just and equitable to wind it up?
7. State the ground on which the registrar may present a petition for winding up of a company.
8. What is the effect of a winding up order passed by the court?
9. Explain the procedure to wind up a company voluntarily.
10. What are the powers of the court to order winding up subject to its supervision? What are
the consequences of such an order?
1. Winding up 2. ‘liquidation’
3. within a year 4. debts
5. Wages 6. (b)
7. (c) 8. (d)
9. (c) 10. (d)
11. (c) 12. True
13. False 14. False

15. True 16. False
233
Company Law

www.webopedia.com
234
EXCEL BOOKS PRIVATE LIMITED
PLOT No. 1E/14, Jhandewalan Extension,
New Delhi-110055
For Enquiry: +91-8130694903
Phone: 011-47520129
Email: [email protected]

Company Law

Uploaded by

Copyright:

Available Formats

Company Law

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Company Law

Uploaded by

Copyright:

Available Formats

Company Law

Produced & Printed by

Sr. No. Topics

3. Articles of Association: contents, alteration, Doctrine of Indoor Management, Constructive notice of

Unit 1: Nature of the Companies Act, 1956 1

Unit 1: Nature of the Companies Act, 1956

After studying this unit, you will be able to:

Define application and scheme of the Company Act;

Explain Company Law administration;

1.1 Extent, Application and Scheme of the Act

1.1.1 Extent of the Act

The Act extends to the whole of India except:

1.1.2 Application of the Act

The Act applies to the following companies:

1. Companies formed and registered under the Companies Act, 1956.

4. Unlimited companies registered as limited companies in pursuance of any previous

6. Foreign Companies (s.592 to 602).

9. Government Companies (s.617).

1.1.3 Non-applicability of the Act

1. Companies established under Special Acts of Parliament, such as Life Insurance

4. Trusts which are governed by the Indian Trusts Act, 1882.

5. Societies registered under the Societies Registration Act, 1860.

1.1.4 Scheme of the Act

Fill in the blanks:

1......................................... s codified in the Companies Act, 1956.

2. Companies formed and registered under the ......................................

1.2 Company Law Administration

1.2.1 The Central Government (s.637)

1.2.2 Constitution of Board of Company Law Administration

Section 10 E provides as follows:

1. It empowers the Central Government to constitute the Board of Company Law

Appeals against the Orders of the CLB

1.2.3 National Advisory Committee on Accounting Standards

1.2.4 The Securities and Exchange Board of India

(i) Listed public companies;

Task Discuss the application of companies act in respect of J&K state.

1.2.5 Official Liquidator

appointed from a panel of professional firms of chartered accountants, advocates, company

a whole time or a part time officer, appointed by the Central Government.

1.2.6 Advisory Committee

According to section 2, the ‘Court’ means:

As regards to the jurisdiction of Courts, section 10 provides as follows:

1. The court having jurisdiction under this Act shall be:

6. What is the correct sequence of the following assignments?

1.3 Some Important Definitions

Some important definitions related to companies act are:

(i) They are members of a Hindu undivided family; or

(ii) They are husband and wife; or

Schedule 1A provides the following list of relatives:

(ii) Mother (including step-mother), Mother’s mother, Mother’s father.

(iv) Daughter (including step-daughter), Daughter’s husband, Daughter’s son, Daughter’s

(ii) The whole time director or directors;

(iii) The manager;

(iv) The secretary;

(i) II to IV (ii) III to IV

(iii) Parts I to II (iv) Parts IV to V

9. Property of the company belongs to ....................................

(iii) Members (iv) Promoters

10. In the case of company, audit is ......................................

(i) Compulsory (ii) Optional