COMPANY LAW CHEAT SHEET

MODULE 1
This module is also known as advisory and transactional work. This is to help your client
understand the advantages of one business vehicle over another by asking a few questions
concerning the commercial goals of the entrepreneurs.
Major features of a sole proprietorship:
i) No compliance requirements are needed.
ii) Personal assets are attached (hence, no Separate Legal Entity concept).
iii) There is no incorporation process but relevant licenses are required.
iv) Sole-proprietorships do not have a perpetual existence.
v) Unlimited liability as the owner is personally liable.
vi) There is an individual tax slab.
Major features of a partnership:
i) There is unlimited liability and mutual agency, hence, partners are collectively referred to
as the firm.
ii) Section 464, read with Companies (Miscellaneous) Rules, 2014: Rule 10 – No association
or partnership shall be formed consisting of more than 50 persons for the purpose of carrying
on any business.
Section 18, Indian Partnership Act (1932) - 18. Partner to be an agent of the firm. —Subject
to the provisions of this Act, a partner is the agent of the firm for the purpose of the business
of the firm.
iii) This vehicle does not have perpetual succession and there is no incorporation process.
Major features of an LLP:
i) This is considered a hybrid instrument since – a) There is no delegation of management
responsibilities (borrowed from the partnership) and b) there is the concept of limited liability
(borrowed from the company).
ii) As per Section 3 of the LLP Act (2008) - A limited liability partnership to be a body
corporate:
(1) A limited liability partnership is a body corporate formed and incorporated under this Act
and is a legal entity separate from that of its partners. (Separate Legal Entity) Hence, if a third
party files a case against the LLP, only the LLP’s assets would be liable and not the partners’.
This is also as per Section 27 (3) and (4) of the LLP Act, stating that –
27(3) - An obligation of the limited liability partnership whether arising in contract or
otherwise, shall be solely the obligation of the limited liability partnership.
27(4) - The liabilities of the limited liability partnership shall be met out of the property of
the limited liability partnership.
(2) A limited liability partnership shall have perpetual succession. (Perpetual Succession)
(3) Any change in the partners of a limited liability partnership shall not affect the existence,
rights, or liabilities of the limited liability partnership.
As per Section 3, it can also be inferred that the liability of partners is only limited to their
agreed contribution.
iii) As per Section 30 of the LLP Act, Unlimited liability is only applied in cases of fraudulent
transactions. As per Section 30 (2), If partners jointly carry out business fraudulently, then
they can all be held liable.
iv) There is a detailed incorporation process.
v) Compliances are simple in comparison to a company.
vi) To establish an LLP, there is a minimum of 2 people needed, but there is no maximum
limit, this is as per Section 6 of the LLP Act.
For an LLP –
“The basic purpose of the legislation is to provide for a new vehicle for the conduct of
business with the twin objectives of limiting the liability of the persons undertaking that
business and simultaneously providing them absolute flexibility in the manner of running the
business and defining, managing and regulating their relations inter-se. The general
restrictions of partnerships, i.e., unlimited liability of partners impairs their entrepreneurial
growth which has led to the emergence of the LLP Act; a notable attribute of this legislation
is insulating the personal assets of the partners from meeting the liability of the LLP.”
Major features of a Company:
The principal features of corporate law are:
i) Legal Personality – The company is a single contracting party (making it distinct from the
various individuals who own or manage the firm); hence, it creates a nexus for contracts. Due
to this aspect, it also shields the entity’s assets from an owner’s creditors.
ii) There is limited liability – Where the liability of members is limited, to the extent of their
stake in the company.
iii) Owner Shielding – An owner’s personal assets are not attached with respect to the
company’s dealings/debts owed to creditors.
“Entity shielding protects the assets of the firm from the creditors of the firm’s owners, while
limited liability protects the assets of the firm’s owners from the claims of the firm’s
creditors. Together, they set up a regime of ‘asset partitioning’ whereby business assets are
pledged as security to business creditors, while the personal assets of the business’s owners
are reserved for the owner’s personal creditors.”
iv) Transferability of shares – In the case of private companies, there is a restriction on
transferability of shares, and its members are restricted to 200 (except in OPCs).
Transferability permits the firm to conduct business uninterruptedly as the identity of its
owners’ changes, thus avoiding the complications of member withdrawal.
Historically, partnerships were extremely popular but they had some restraints – a) Lack of
capital, i.e., capital raising from the public was not possible. This was a major drawback for
entrepreneurs. b) According to Peddy Ireland – retail investors had no possible way to rent
money in order to generate a passive income flow (as only partners could make money in a
partnership).
Hence, in the 19th century, ‘corporate firms’ started developing due to the above 2 features,
and a joint stock company was formed. But there was no – i) Limited Liability and, ii) No
concept of a Separate Legal Entity. An important thing about joint stock companies is that it
introduced – members meetings and board of directors. Only in 1855, was the ‘Limited
Liability Act’ introduced.
v) Delegation of management-related responsibilities – In India, there is no concept of a two-
tier board structure, as we mainly follow the unitary board system. A two-tier board system
refers to a supervisory tier and second, a managing tier. The Board of Directors is elected by
the shareholders in general meetings as per Section 152 of the Act. Though largely/entirely
chosen by the firm’s shareholders, the board is formally distinct from them. This separation
economizes on the costs of decision-making, depending on the type of transactions involved
(Block I: Transactions that do not need the consent of shareholders, and Block II –
Transactions that need the consent of shareholders).
To tackle agency problems, there is a diversification among the board members. For example,
there is a split between Executive and Non-Executive Directors – which also includes
independent directors. Independent directors are those that do not have a pecuniary
relationship with the company, and this helps in making the decision making process more
unbiased.
vi) Investor Ownership – There are two key elements in the ownership of a firm, and they are
– a) right to participate in the control of the firm, and b) the right to receive the firm’s net
earnings. The right to participate in the control of the firm involves – i) the right to vote in the
election of directors, and to approve major transactions, or, ii) the right to receive the firm’s
residua; earnings or profits. This is in proportional to the amount of capital invested in the
firm.
vii) There is a detailed incorporation process.
viii) There are multiple compliance requirements such as the AOC-4 form (for Financial
statements) and, MGT-7 (for filing Annual returns). Some of the other compliances including
regular auditing both by external and internal accountants. This is to promote disclosures
(especially in case of a public company, as they also have more compliances).
Election of directors – Section 152, Companies Act.
Removal of directors – Section 169, Extraordinary General Meeting by requisition).
MODULE 2
The two organs of a company are – i) members' meetings and, ii) board of directors.
As per Section 179, the board of directors have broad discretionary powers, but this would be
subjected to the provisions of the Companies Act as well as other instruments such as the
Memorandum or Articles. They also cannot do something that the company must vote on as
per the general meeting. Their power is even subject to any State/Company regulations.
The main thing to keep in mind is that shareholders elect directors. Hence, this forms a
principle (shareholders) – agent (board of directors) relationship between them.
To understand agency problems, it is first important to understand the concept of separation
of management. If there is no separation of ownership and management, then:
i) there won't be any passive income flow,
ii) This would help ensure that investor confidence remains intact, and this wouldn’t
adversely affect our GDP.
iii) This would ensure that ‘compliance issues need not affect shareholders.
iv) Running a company requires expertise, and leaving it in the hands of shareholders would
not be feasible as efficiency and other responsibilities would not be guaranteed.
v) There would be no possibility of maintaining a diversified portfolio.
vi) According to Professor Stephen A. Baimbridge, investors are rationally empathetic and
this plays a role in the management of the company.
Point vi) is the crux of Agency problem I – When the welfare of the principal depends upon
the action taken by the agent. The problem lies in motivating the agent to act in the
principal’s interest rather than simply in the agent’s own interest.
Now, to look at Agency problem II –
The shareholding pattern is – i) promoter groups, ii) institutional investors and iii) retail
investors.
Theoretically – shareholders can elect directors [as per Section 152 (Companies Act)] or,
remove them [Section 169 (Companies Act)]. And with regards to Block II Transactions, the
green signal from the shareholders is a must [Section 180 (Companies Act)].
In India, however, there are 2 peculiarities observed in public listed companies –
i) Concentrated shareholding pattern.
ii) Passive Retail Investors.
Practically, retail investors are only concerned with capital appreciation; and their attendance
is extremely low in members' meetings. Meanwhile, majority shareholders (though few in
number) dominate these meetings. Hence, this brings us to Agency problem II – Conflict
between majority and minority shareholders.
An important section to keep in mind at this juncture is Section 166(1) –
(1) Subject to the provisions of this Act, a director of a company shall act in accordance with
the articles of the company.
(2) A director of a company shall act in good faith in order to promote the objects of the
company for the benefit of its members as a whole, and in the best interests of the company,
its employees, the shareholders, the community and for the protection of environment.
3) A director of a company shall exercise his duties with due and reasonable care, skill and
diligence and shall exercise independent judgment.
(4) A director of a company shall not involve in a situation in which he may have a direct or
indirect interest that conflicts, or possibly may conflict, with the interest of the company.
(5) A director of a company shall not achieve or attempt to achieve any undue gain or
advantage either to himself or to his relatives, partners, or associates and if such director is
found guilty of making any undue gain, he shall be liable to pay an amount equal to that gain
to the company.
This points us to Agency Problem III – Conflict between the stakeholder model vs.
shareholder privacy approach.
As per Section 166(2), directors should work towards the benefit of stakeholders (an example
is employees) and stakeholders (employees, environment, etc.) Now, even though this section
offers a valid claim for non-shareholders to hold directors accountable, there are no remedies
available to impose this right. This drawback is considered one of the major flaws of this
subsection. This is an example of a pluralist model – where it seems like certain rights are
available, but there is no method of imposing them.
In India both stakeholders and shareholder interests need to be taken into account, and this is
different as compared to U.K, where they follow the Enlightened Shareholder Value Model
(ESV Model).
“The ESV model(The United Kingdom Companies Act, 2006 (c.46) s. 172) prescribes board
can consider the stakeholders’ interests but only as long as such consideration ultimately
enhances the value of the shareholders in the long run. The Pluralist Model(Section 166(2),
on the other hand, prescribes that looking after the interests of the stakeholders should be the
aim of the Board as an end in itself and not just as a means to enhance shareholder value.”
Legal strategies for controlling agency costs:
a) Regulatory – They are prescriptive and ex-ante in nature (RPA). Examples – Setting the
terms of entry and exit [Section 52(4) and Section 166 (Companies Act)].
b) Governance-based – They are facilitative in nature and are ex-post (GFP). Examples – the
power to remove directors as per Section 169, Companies Act.
In India, it is preferred that regulatory strategies be used since this helps in imposing
sanctions.
Modes of enforcement:
i) Public enforcement (S. 248 etc.) – This involves a wide variety of state organs.
ii) Private enforcement (S. 245 and 241 – derivative suit) – Where private parties are acting in
their own interests.
iii) Gate-keepers – Auditors – S.102(2)(a)(i) + S.143(2)
Section 166 is not an exhaustive list on the duties of directors, and to further expand this list –
case laws are also applicable.
Problems with corporate litigation in India –
1) Business judgement Rule – The onus to prove malpractice is on the shareholders.
2) Expensive litigation Costs.
These two factors also cause Sections 241 and 245 to be rendered inactive.
Question to look into – ‘Which strategy is apposite in the Indian context, and why?’ Page 4
of Article by Mihir Naniwadekar and Umakanth Varottil – The Stakeholder Approach
Towards Directors’ Duties Under Indian Company Law: A Comparative Analysis (2016)
Answer = Regulatory + Robust Enforcement mechanism
MODULE 3
Incorporated Association – Section 2(20), Companies Act 2013 – “company” means a
company incorporated under this Act or under any previous company law.
One of the main aspects of a company is the concept of ‘separate legal personality’. Here,
limited liability was given as an onerous gift, i.e., in order to promote social welfare and
entrepreneurial spirit. Hence, if misused then authorities can lift the corporate veil and hold
directors liable for their actions. If authorities get to know of some malpractice, then the
liability of the company would become unlimited.
“The law helps those who are smart and not over-smart”
There are two categories of lifting of corporate veil – 1) statutory provisions and, 2) judicial
precedents.
Salomon v. Salomon [1897]
Mr. Salomon was a boot and shoe manufacturer trading on his own sole proprietorship under
the name of ‘A Salomon and Co.’, with the help of 4 of us sons. The sons were later
complaining that they were not partners of the firm and were ‘slaves’, hence, they kept
pressuring the father to give them a share in the concern. Due to these demands, Mr. Salomon
converted this firm into a private company (under the provisions of the 1862 Companies Act).
This move would make the sons part owners. As per the provisions of the Companies Act
(1862), there was a need for 7 signatories; hence, his own family became the signatories. The
value of the sole proprietary concern was 40,000 pounds, where Salomon became the
majority shareholder as he had 20,000 shares (1 pound each), 10,000 in debentures (in which
he was a secured creditor), and 10,000 in cash. Salomon was also still managing the affairs of
the company.
After facing certain financial difficulties, Salomon got in touch with Edmund Broderip and
had borrowed 5000 pounds from him, for the company. However, this financial difficulty
persisted and the company had to enter into a stage of liquidation. Mr. Edmund was paid as
per the waterfall mechanism and Mr. Salomon was to be paid next (since he was a secured
creditor). But the liquidator had claimed that this company was a sham and wanted to impose
unlimited liability on the company, as Mr. Salomon should be personally responsible for the
company’s debts.
“The company’s liquidator claimed that the company’s business was still Salomon’s, in that
the company was merely a sham to limit Salomon’s liability for debts incurred in carrying it
on, and the repayment of Salomon’s debenture should be postponed until the company’s other
creditors were satisfied.”
In the Court, Lord Vaughan Williams J had agreed with the liquidator and on appeal, Lord
McNaughton had stated that the liquidator was wrong and that, i) the other signatories are not
required to have their independent will and judgement while exercising their duties as
signatories/directors, since the only requirement is that 7 signatures should be there. Hence,
even if the 7 signatories are strangers or family members, it shouldn’t matter. ii) And there
was nothing wrong with Salomon to solely manage the company as a 1 man company and,
iii) there is nothing which shows bad faith by Saloman, but there are acts of good faith as he
originally contacted Mr. Edmund. Hence, according to this judgement – only bad faith
transactions attract liability.
Kondoli Tea Co. Ltd. [1886 Cal]
8 people had converted their firm from a partnership to a company and had transferred a tea
estate to that company in order to avoid ad valorem duty. The total consideration of this
transfer was 43,320 pounds. (Payable in shares and debentures of the company taken at par).
As mentioned earlier, these shareholders had stated that they were merely transferring the
property to themselves as they were the majority shareholders in the company to whom the
property was sold to.
The main issue contended in this case was – ‘Whether the document carrying out a particular
transfer is a conveyance?’
Held, the Court tried to identify the reason for this transaction and looked at two questions –
Was it done to make a profit? – Yes
Was it done to escape liability? – Yes
Hence, the shareholders were trying to escape liability by selling it to a company (where they
were majority shareholders) instead of a natural person. This is a classic case of conveyance,
where the registered name was the shareholders, but now is the company in which the
shareholders held a majority stake. In cases of the lifting of the corporate veil, it is not always
the case that the State brings the case as even the company itself can ask for the veil to be
lifted. What the shareholders tried showing is that since they were the majority shareholders,
they were merely selling the property to themselves. However as seen from the concepts
discussed, the company is separate from the shareholders. Hence, this was an act purely done
to escape the liability of taxation.
Re Sir Dinshaw Maneckji Petit Bari [1927 Bom.]
There was a super tax imposed on Dinshaw Maneckji and he disputed the tax imposed on the
– 1) dividend income received by him and, 2) the interest he received on government bonds.
Dinshaw had formed 4 private companies and had agreed with each of them to hold a block
of their investments as an agent for them. Out of the 498 shares he held, 254 were in his own
name. 200 in his wife’s name and the rest in 13 other nominees. He credited the income
received by him in the accounts of the companies and took it back in the form of a pretended
loan. The whole idea was to split his income into 4 parts with a view to evade taxes.
Held, the company was formed by Dinshaw (the assessee) purely as a means of avoiding tax
and the company was nothing more than the assessee himself. The companies did not do any
business and it was created simply as a legal entity to receive dividends and interests from its
investments, only to hand them over to the assessee as pretended loans. The money received
by the assessee will be regarded as dividends paid by the company and they were no genuine
loans but merely withdrawals of income disguised as loans.
Dinshaw wanted to cash out on these profits but couldn’t do so directly from the company
and hence, it was given in the form of loans.
Daimler Co. Ltd v. Continental Tyre and Rubber Co. Ltd. (1916)
The Continental Tyre company was incorporated in England, but all of its shares were held
by German residents – except one. Even the directors of the company were German.
Continental Tyre would supply tires to Daimler but Daimler was concerned that since
Continental Tyres shares were mainly held by German residents, they would be considered an
enemy of the State as per Section 3(1) of the ‘Trading with the Enemy Act (1914)’ (which
came about due to World War I).
At the Trial Court, they held that everything was legal and the Act would not apply to the
company as it was incorporated in England, hence, the residential status of the shareholders
should not be taken into consideration.
In appeal, the House of Lords had held that even though the company was incorporated in the
U.K., it would still attract enemy character due to the German residents holding most of the
shares. During wartime residential status of shareholders should be taken into consideration
as they are responsible for the company’s dealings in day-to-day business, as well as due to
the fact that they can influence the actions taken by a particular company. Since this is a case
where the shareholders are of German residence, the Act would apply and it is in these
emergency circumstances (such as war) where the corporate veil should be lifted.
The other landmark aspect of the case is shown in the fact that the Act is applicable even to
artificial persons.
Macaura v. Northern Assurance Company (1925)
Macaura was originally the owner of a sole proprietorship – Killymoon estate and had sold
timber to Irish Canadian Sawmills Ltd, for a consideration of 42,000 pounds (fully paid by
shares worth 1 pound each). Macaura was also an unsecured creditor for 19,000 pounds.
Following the sale, he had effected insurance policies in his own name with the respondent
insurance company and others, covering the timber against fire. Two weeks later, almost all
of the timber was destroyed in a fire. However, the respondents refused to pay since the
timber was owned by the company and not Macaura.
As per Lord Sumner’s judgement, it was held that – Macaura (the appellant) had no insurable
interest in the timber described. Even though he was the majority shareholder of the
company, he only had an interest in the company as a shareholder. Whereas, the legal interest
pertaining to the timber is solely vested in the company as it is a separate legal entity from its
shareholders. Hence, a company’s assets would remain with the company itself and not with
the shareholders. Hence, he had no ‘legal or equitable’ relation to the timber at all (no
equitable interest since, his shares in the company were not harmed by the fire, only the
timber). As mentioned earlier, the timber was an asset of the company and not Macaura.
Prest v. Petrodel Resources Ltd (2013)
As per the Matrimonial Causes Act 1973, ancillary relief was claimed by Ms. Yasmin Prest
under Sections 23 and 24 of the aforementioned Act. In the matrimonial proceedings
concerning the division of assets worth approximately 35 million pounds, the appellant wife
applied to have certain residential properties transferred to her. But an important aspect to
note here is that these properties were actually owned by a group of companies and not the
husband (even though these companies were operated and controlled by the Husband).
The Trial Court judge had held that even though they are not empowered to follow the
Companies Act, they could still pierce the corporate veil as it is part of the process of
providing ancillary relief, where the husband has to make relevant disclosures regarding the
assets he has. While piercing the corporate veil, the Trial Court had justified doing so by
establishing the power held by the husband w.r.to the companies by owning and controlling
them.
The Court of Appeal had reversed the trial Court’s decision, holding that there were no
legitimate grounds for piercing the corporate veil and the Family Courts had no jurisdiction
of doing so unless – i) the corporate personality of the company was being abused for a
purpose which was in some relevant respect improper, or ii) on the particular facts of the case
it could be shown that an asset legally owned by the company was held in trust for the
husband.
In the Supreme Court it was held that – the Court of Appeals was right and Section 24 of the
Matrimonial Causes Act (1973) did not provide a distinct power to pierce the corporate veil
in matrimonial cases. The Court had seen that through the facts, the disputed properties were
held in a trust where the company was the settler and the husband was the beneficiary. Hence,
these properties had belonged to him. Therefore, the wife is entitled to the properties in
dispute.
Vodafone International Holdings BV v. UOI (2012)
Hutchinson Ltd has a subsidiary Hutchinson SR in India.
They wanted to leave India and thus decided to sell its Indian Subsidiary to Vodafone India.
The parent companies making the transaction were in Tax Haven Zones and hence the
transaction was made there.
The transaction was concluded without any Indian laws being used or Indian authorities
involved.
At that time, Indian laws were not equipped to deal with indirect transactions.
The Bombay HC:
• Vodafone is required to pay capital gains tax as buying and selling of shares amounts
to assets being transferred
• IT regulations have extraterritorial application
At the SC,

There is only a transfer of controlling interest.

Restriction of the autonomy of directors does not imply that they are puppets to the holding
company. It would be required to be proven.
If it is alleged that the transaction was made to evade tax, then that would need to be proven
State of Rajasthan v. Gotan Lime Stone Khanji Udyog Pvt. Ltd
GLKU was a partnership firm that held a mining lease (of limestone) from the State of
Rajasthan for 40 years. This is transaction 1.
After obtaining the necessary consent from the Government, GLKU transferred the lease to
GLUKLPL, with no consideration involved. GLKUPL came into existence as a result of a
conversion of the partnership firm into a private limited company and the partners of the firm
became the directors of the company. This was transaction 2.
Later, members of GLKUPL sold their entire shareholding to a new company (a subsidiary of
UTCL) for Rs. 160 crores. This effectively gave rise to a sale of the mining lease. No
separate formalities were followed as it only involved a transfer of shares and not a transfer
of the lease, which continued to be held by the company.
After a few days, an FIR was lodged against the directors as the government alleged that the
mining rights were also transferred to the new company, without involving the government as
this was not permissible under Article 297 of the Constitution.
It was held that, in the second transaction, the requisite consent was taken and nothing
seemed to be wrong at first. But in the third transaction, even though the lease rights were not
sold (and only shares were), the combined effect of the transactions had transferred lease-
holding rights to a third party for consideration. Mining rights belong to the State and not to
the lessee and the lessee has no right to profiteer by trading such rights. In fact, the lessee has
also not claimed such a right. Giving that this transaction involved mining lease, which is a
public good, it was treated as welfare legislation thereby affecting public interest.
The Court observed that –
“The principle of lifting the corporate veil as an exception to the distinct corporate
personality of a company or its members is well recognized not only to unravel tax evasion
but also where protection of public interest is of paramount importance and the corporate
entity is an attempt to evade legal obligations and lifting of veil is necessary to prevent a
device to avoid welfare legislation. It is neither necessary nor desirable to enumerate the
classes of cases where lifting the veil is permissible, since that must necessarily depend on
the relevant statutory or other provisions, the object sought to be achieved, the impugned
conduct, the involvement of the element of the public interest, the effect on parties who may
be affected etc. For this reason, the Supreme Court allowed the appeal of the State of
Rajasthan.”
In the present case, the entity had tried to conceal the transfer by showing two separate
transactions. T2 where the partnership firm was converted to a private company, and T3
where all the shareholding was transferred to the subsidiary of UTCL. Hence, GLKU had
indirectly tried to sell the mining rights that are vested in the State.
Section 2(87) of the Companies Act defines a subsidiary company, in relation to the holding
company, as a company in which the holding company either (i) controls the composition of
the board of directors; or (ii) exercises or controls more than 50% (fifty percent) of the total
voting power, either on its own or together with one or more of its subsidiary companies.
The explanation to the section further clarifies that a company shall be deemed to be a
subsidiary company of the holding company even if the control referred to above, is of
another subsidiary company of the holding company.
State of U.P and Ors. v. Renusagar Power Co. and Ors. (1988)
During 1985, the U.P. government was giving a lot of tax concessions to industrialists as they
wanted to encourage setting up of industrial plants. U.P. made a declaration that if the
company could manage its electricity generation on its own, it would get a special
concession.
HINDALCO (referred to as ‘H’) came to U.P. and decided to generate electricity through its
subsidiary – Renusagar (reffered to as ‘R’), and Renusagar was a wholly owned subsidiary.
And ‘R’s only objective was to generate electricity and sell it to ‘H’.
For holding and subsidiary companies, they are still considered separate companies due to the
S.L.E concept. But an exception to the S.L.E. concept would be S.E.E. (Single Economic
Entity).
‘H’ had later received a notice from the revenue department to pay tax since they did not
generate electricity in their own, but ‘H’ had claimed that, the relationship between them and
‘R’ was that of a S.E.E. due to R’s object clause. It is also important to note that ‘H’ also has
complete control over ‘R’s day-to-day decisions. The Court had accepted this argument.
For 1 company to be considered a holding company, as per S.2(87) – i) the holding company
should either be able to control the composition of the subsidiaries Board of Directors, or
remove them and, ii) Has control over 50% of the subsidiary’s total voting power (through its
own or through another subsidiary).
Hence the directors of ‘H’ had complete powers over the directors of ‘R’ and this is called a
transfer of competency/decision-making power. This is different from the term ‘restriction on
autonomy’, which holding companies usually have on subsidiaries. The difference is solely
on the basis of decision-making power. Just because the shareholders have an influence over
the subsidiaries, doesn’t make the relationship as an S.E.E. Only thing that does is whether
the holding company has complete autonomy over the subsidiary’s activities – even its day-
to-day workings, so much so that the subsidiary can no longer be regarded to perform these
activities on their own.
MODULE 4
(1) We understand that a registered company comes into existence on the date specified in
the certificate of incorporation [Section 7(2) and 7(3) of the Companies Act] as the date of
incorporation. The birth of a company is neither automatic nor spontaneous
7(2) The Registrar on the basis of documents and information filed under sub-section (1)
shall register all the documents and information referred to in that subsection in the register
and issue a certificate of incorporation in the prescribed form to the effect that the proposed
company is incorporated under this.
7(3) On and from the date mentioned in the certificate of incorporation issued under sub-
section (2), the Registrar shall allot to the company a corporate identity number, which shall
be a distinct identity for the company and which shall also be included in the certificate.
Section 3 – Formation of a company, depending on the type of company –
(a) seven or more persons, where the company to be formed is to be a public company;
(b) two or more persons, where the company to be formed is to be a private company; or
(c) one person, where the company to be formed is to be One Person Company that is to say,
a private company, by subscribing their names or his name to a memorandum and complying
with the requirements of this Act in respect of registration:
Provided that the memorandum of One Person Company shall indicate the name of the other
person, with his prior written consent in the prescribed form, who shall, in the event of the
subscriber‘s death or his incapacity to contract become the member of the company and the
written consent of such person shall also be filed with the Registrar at the time of
incorporation of the One Person Company along with its memorandum and articles.
These people mentioned above are called promoters (before they subscribe to the
memorandum of association).
Promoters undertake all promotional activities which inter alia includes planning activities.
At this stage, the company does not come into existence but many of the important and
primary decisions which are to be taken in the pre-incorporation are done by them.
In Palmer’s `Company Precedents, the promoter has been described as a person who
originates the scheme for the formation of the company, has the memorandum and articles of
association prepared, executed and registered, and finds the first directors, settles the terms of
the preliminary contracts and prospectus (if any) and makes arrangements for advertising and
circulating the prospectus and placing the capital. Promoters are the persons who `control the
formation and future of the company’. But a promoter need not be associated in the entire
activities involved in the formation of a company or its flotation. A person may be a
promoter even though he has taken only a comparatively minor part in the promotion
activities.
Section 7(1)(b) – Type 1 declaration – this is in the pre-incorporation stage, along with this,
Rule 12 of the Companies Incorporation Rules 2014 is referred.
As per Section 7(1)(c) an affidavit is also required from the subscribers and the first directors,
stating that they have not been convicted for a criminal offence in connection with the
promotion, formation or management of any company, or that they have not been found
guilty of any fraud or misfeasance or of any breach of duty to any company under this Act or
any previous company law during the preceding five years.
The declaration above is known as a type-2 declaration.
7(1)(d) = address
7(1)(e) = subscriber information
7(1)(f) = first director information
7(1)(g) = the particular interests in other firms of the first directors need to be disclosed.
After the Registrar examines all these documents, a CIN will be issued as well as a certificate
of incorporation.
As per Section 7(7), if the authorities (after a company receives a certificate of
incorporation), realize that certain information was missing originally or they have
fraudulently misrepresented certain information, then the authorities would notify the
tribunal. The tribunal has the following powers such as –
(a) pass such orders, as it may think fit, for regulation of the management of the company
including changes, if any, in its memorandum and articles, in public interest or in the interest
of the company and its members and creditors; or
(b) direct that the liability of the members shall be unlimited; or
(c) direct removal of the name of the company from the register of companies; or
(d) pass an order for the winding up of the company [This should also be read in reference to
Section 271(1)]; or
(e) pass such other orders as it may deem fit:
Provided that before making any order under this sub-section,—
(i) the company shall be given a reasonable opportunity of being heard in the matter; and
(ii) the Tribunal shall take into consideration the transactions entered into by the company,
including the obligations, if any, contracted or payment of any liability.
Powers of a tribunal are extensive and they even have a list of them mentioned in Section
242.
Section 7(5) states the liability of any person for furnishing false information, and this is read
with Section 447.
447. Punishment for fraud.— Without prejudice to any liability including repayment of any
debt under this Act or any other law for the time being in force, any person who is found to
be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less
than six months but which may extend to ten years and shall also be liable to fine which shall
not be less than the amount involved in the fraud, but which may extend to three times the
amount involved in the fraud:
Provided that where the fraud in question involves public interest, the term of imprisonment
shall not be less than three years. Explanation.—For the purposes of this section—
(i) “fraud” in relation to affairs of a company or anybody corporate, includes any act,
omission, concealment of any fact or abuse of position committed by any person or any other
person with the connivance in any manner, with intent to deceive, to gain undue advantage
from, or to injure the interests of, the company or its shareholders or its creditors or any other
person, whether or not there is any wrongful gain or wrongful loss;
(ii) “wrongful gain” means the gain by unlawful means of property to which the person
gaining is not legally entitled;
(iii) “wrongful loss” means the loss by unlawful means of property to which the person losing
is legally entitled.
As per Section 7(6) – If after incorporation, it is found that the company has been set up
while relying on false information, then liability will be imposed as per Section 447
(mentioned above)

(2) The formation of a company has several phases:

Phase 1 – Scholars (such as Joseph H. Gross in his book ‘Who is a Company Promoter?’)
were of the view that the term promoters should not be defined in the statutes. Their
reasoning was that it would ensure that their liability could be interpreted in a broad manner
(by the judiciary) and is not subject to rigid criteria.
This was also probably a reason why the Indian Companies Act (1956) was silent on who a
promoter was but had still fixed liabilities for promoters.
Later, however, Justice Bowell in a landmark case of Whaley Bridge Co. v. Green had stated
that promotion is a term of commerce and is divided into 2 parts – Technical and Non-
technical.
Phase 2 – In India, it is being concerned with SEBI ICDR (2009) and Companies Act (1956).
Phase 3 – Now the situation w.r.to promoters has changed and it is now concerned with the
Companies Act (2013) and SEBI ICDR (2018)– Section 2(o)(o). As per Section 2(o)(o) – if a
person’s name has been mentioned in the draft offer document (also known as the
prospectus)/in the annual return, then that person would be considered to be a promoter.
[Important point to remember – a person need not take part in all antecedent steps to be
considered a promoter. Hence, even if a person takes part in 3/20 antecedent stages in
forming a company, they would still be considered a promoter.
There are 2 types of promoters: i) promoter simpliciter and, ii) promoter at an antecedent
stage (defined in Section 2(69)(a).
Section 2(69)(b) – anyone who has control over the company. The term “control” is defined
under Section 2(27).
Section 2(69)(c) – Shadow directors (who are also promoters). However, people working in a
professional capacity within the operations of the company do not count (such as Accountants
or Lawyers).
The legal role that a promoter has –
i) They have a fiduciary relationship with a company – which is a relationship built out of
trust between both parties (like in contracts). They are not agents since the company
(principal) has not come into existence yet, and it is for the same reason that they are not
considered to be beneficiaries (like in a trust relationship). Promoters being in a fiduciary
relationship with the company was discussed in the Erlenger case.
ii) Promoters have to make all sorts of disclosures (such as whether they have any personal
interests in the transactions the company is involved in) and they cannot make any secret
profits.
According to Professor Gawar –
Promoters are in a position to abuse their powers by:
i) Offloading purchase property at a premium. This is allowed as long as a full and frank
disclosure is made to the first directors (not to members since they are usually passive in
decision-making).
This scenario gives rise to 2 problems: a) What if the first directors themselves are the
promoters simpliciters? Or, b) if the first directors are their cronies?
If it is proved that the first directors were not using their independent skill and judgement
while exercising their functions as a director, and if the promoter simpliciters did not elect
fair and impartial first directors, then the profits would have to be returned to the company.
This is as per the case of Erlenger v. New Sombrero Porphate Co. (1878).
Erlenger v. New Sombrero Porphate Co. (1878)
The lease of an island in West Indies was acquired by a syndicate headed by Mr. Erlenger for
55,000 pounds. The Syndicate had later formed New Sombrero Porphate Co. (hereinafter
referred to as ‘S’). Most of the first directors were puppets of Erlenger.
The promoters (syndicate members had sold the lease to ‘S’ for 1,10,000 pounds and had
made a profit of 55,000 pounds. The sale was later ratified by the first directors without doing
an inquiry and without using their collective wisdom to see whether the sale was beneficial
for the company or not.
Later, ‘S’ went public and rolled out an offer document. In the IPO offer document, the profit
of 55,000 pounds was not disclosed. After undergoing certain difficulties, a new board was
appointed for ‘S’ and these directors found out about the profits made. Thereafter, they
wanted the sale rescinded by the promoters.
The Court held that the promoters have to ensure that the decisions they make are done in the
best interests of the company. The important points that arise out of this judgement are that:
i) Promoters have a duty towards the company.
ii) There should be full and frank disclosures made by the promoters.
iii) Promoters have a fiduciary relationship with the company.
iv) Promoters cannot make secret profits.
Contracts between promoters and the company are voidable and hence, they can be rescinded
if taken to Court. Hence, the sale was rescinded.
“An important part of the judgement was delivered by Lord Cairns, and he stated that - it is,
in my opinion, incumbent upon the promoters to take care that in forming the company they
provide it with an executive, that is to say, with a board of directors, who shall both be aware
that the property which they are asked to buy is the property of the promoters, and who shall
be competent and impartial judges as to whether the purchase ought or ought not to be
made.”
Lord O’Hagan also reaffirmed that promoters have a very important duty towards securing
the best interests of the company. Hence, they should be impartial and independent.
Gluckstein v Barnes (1900)
There was a syndicate formed by Gluckstein (hereinafter referred to as ‘G’) and 3 others.
This syndicate had taken some debentures from the old Olympia (referred to as ‘O’). When
‘O’ entered into a stage of liquidation, the Syndicate had bought ‘O’ at 1,40,000 pounds. But
including the debentures, they had gotten 20,000 pounds back.
After this, the Syndicate floated a new company = O1, and then sold O to O1 for 1,80,000
pounds. Hence, the profits = 20,000 (from returns on debentures) + 40,000. G’ and 3 other
members later became the first directors of O1. O1 had decided to go public and in the
prospectus, the 40,000-pound profit was disclosed but the 20,000 profit was not. After O1 had
difficulties and entered into the stage of liquidation, the liquidators wanted the secret profit of
20,000 pounds to be disclosed, but ‘G’ and the others said that they had already made full and
frank disclosures to the first directors.
Lord McNaughton had held that, since ‘G’ and 3 other members were themselves acting as
first directors, the disclosures they made were a farce. Promoters cannot escape liability by
disclosing to a few cronies constituting the company’s initial members. The Court also saw
that the first directors were not impartial.
Knowledge booster - It has been accepted at least since Salomon v A Salomon & Co Ltd that,
if there is no independent board of directors, the company may be bound by the consent of all
the original members, provided that full disclosure is made to them of all material facts. But,
as is shown by Gluckstein v Barnes even this will not protect a promoter if the original
members themselves are not independent and the scheme as a whole is designed to attract and
deceive the investing public at large.
----------------------------- X -------------------
Remedies for breach of promoter’s duty:
i) Voidable contracts – Erlenger case
ii) Dislodging of secret profits – applies only when the individual was acting as a promoter at
the time of purchasing property/transaction.
iii) 12. Liability of Promoters: The companies Act, 2013 in various sections mention about
promoter’s role in corporate governance specially in sections Sec 2(59), 2(60), 7, 26, 34, 35,
42(10), 92, 102, 149, 167, 184, 230, 266, 284, 289, 300, 339, 361.
(a) Civil liability under Section 35
(b) Criminal liability under Section 34
c) There is also liability under Section 339 (anyone found guilty of committing fraud).
How to secure remuneration of promoters, for preliminary expenses incurred:
i) By including a provision in the Articles authorizing directors to pay reasonable expenses to
promoters.
ii) A resolution may be passed at a Board meeting to pay the remuneration and expenses of
the promoters (in the absence of a provision such as the one mentioned above). Although this
mode is risky as it is subjected to Agency Problem II.
iii) Promoters (after making full and frank disclosures) sell property to directors, at a
premium. This would ensure that they get some form of remuneration.
Kelner v. Baxter (1866)
Plaintiff and Defendant were both promoters of Gravesend Royal Alaxendra Hotel Company
(referred to as ‘A’), in which the plaintiff was supposed to be the Manager. The Plaintiff had
later offered to sell a stock of wine for 900 pounds and this sale was accepted by the
defendants on Jan 27th 1866 and ratified on February 1st. But the issue came about since the
certificate of incorporation was only issued on 20th February.
The Court had held that “Until the company has been incorporated, it cannot contract or enter
into any other Act in law. And even after it becomes incorporated, it cannot be made liable to
perform or ratify any of the pre-incorporation contracts it entered into.
Hence arises the question –
How do we deal with pre-incorporation agreements?
The problem in pre-incorporation agreements is twofold. On the first hand the promoters are
at risk as the company may avoid such agreements holding that these were beyond the scope
of incorporation and it can make the promoters personally liable and on the second hand the
third parties may be at risk as the contract may be avoided by company after incorporation
saying so that it was not authorized by it. In 1962 on the recommendations of Jenkins
Committee this problem was removed in England under English Companies Act, 1985 under
section 36 and in Indian under Specific Relief Act, 1963 provisions were incorporated
regarding pre-incorporation agreements.
According to Sec.19(e) of the Specific Relief Act, specific performance can be enforced
against a company where its promoters have before its incorporations entered into a Contract
for the purpose of the company, and such contract is warranted by terms of incorporation.
Later, the Madras High Court extended the principle by its decision in Weavers Mills Ltd Vs.
Balkies Ammal [AIR 1969 Mad 462]. In this case, promoters agreed to purchase some
properties for and on behalf of the company to be promoted. On incorporation, the company
had assumed possession and built structures upon it. Hence, a company bears the
benefit/burden of a pre-incorporation contract even if they weren’t in existence if they take
steps towards the enjoyment of the terms of the contract (as in this case). The case had also
defined promoter in a way that encapsulates some of their duties –“ He makes purchase of
moveable and immoveable assets, enters into contracts involving rights and obligations and
applies to authorities for a variety of things, all on behalf of the company to be formed."
As per Section 15(h) of the Specific Relief Act – if the company wants to sue third parties on
the basis of pre-incorporation contracts, they are empowered to do so. Hence, Section 19(e) is
where the promoters can claim specific performance against the company.

MODULE 5 (Week 5 and 6)

The important Sections in this module are 4-6 and 13-16.
The doctrine of Ultra Vires – A Latin maxim which means beyond power.
A company can only do things within the objects of the company (under the Memorandum of
Association – Section 4(c) of the Companies Act) and all other things that are incidental to
the objects of the company. Everything else that is not authorized is ultra vires. This ensures
that the funds of the company are utilised in a manner which helps the company’s growth and
business, and to ensure that the people involved in the workings of the company do not Act
beyond their scope.
If members feel that the management/conduct of the affairs of the company are prejudicial to
the interests of the company or its members, then, an application for a class Action suit can be
filed before the tribunal on behalf of the members seeking reliefs – under Section 245,
Companies Act.
Share capital – To put it simply, it is the money raised by a company from selling stock.
Authorized share capital – This is the maximum amount of money a company is authorized to
make from a public offer, or, the maximum amount of capital that a company can issue to
stakeholders as agreed in its articles of association.
Section 5 talks about Articles of Association (AOA) which states how a company’s
management is regulated. It also states that the Articles may contain provisions for
entrenchment to the effect that specified provisions of the Articles may be altered only if
conditions or procedures as that are more restrictive than those applicable in the case of a
special resolution are met/complied with.
Section 6 of the Companies Act establishes a hierarchy wherein – the Companies Act, 2013 is
at the top  Followed by the MoA and AoA  Followed by other agreements (shareholders
agreement).
Section 13 lays down the procedure regarding the Alteration of the memorandum.
Section 14 lays down the procedure regarding the alteration of the Articles.
The alterations mentioned above shall be noted in every copy issued – as per Section 15.
Section 16 lays down the procedure regarding the rectification of the name of the company.
Shareholders Agreement – This is an agreement between investors and founders of a
company, which provides that investors have certain control over the company’s decisions
(the extent of control is specified within the clauses of the agreement). This is to ensure that
the risk involved in investing in the company is mitigated to a certain extent. This is also
known as a safety net.
Possible clauses in an SHA are – dispute resolution, voting rights, transfer of shares,
ownership and capital contribution, non-compete, and confidentiality clause.
The MoA and AoA are very powerful as they bind the company and the members to the
provisions contained in them (as per Section 10, Companies Act). But nowhere in this section
is it mentioned that shareholders' agreements are held to the same extent.
As per Section 399, such agreements are not subject to public disclosures – hence, they are
private in nature. This is unlike MoA and AoA which are in the public domain.
The question is which form of company undertakes shareholder agreements?
Private companies undertake such agreements as they are a close-knit group (minimum
shareholders = 2, maximum = 200)
Any changes in the shareholder's agreement result in the new agreement being followed and
every other agreement being inapplicable – hence, there are overriding clauses in these
agreements.
The Companies Act is silent with regard to the contents of shareholders agreements. But they
are still binding as per Section 58(2), as an enforceable contract.
But if shareholders agreement and AoA talk about the rights of the shareholders, then which
one takes precedence? This question would be answered through the relevant case laws –
Royal British Bank v Turquand (1856)
Doctrine of constructive notice – Outsiders dealing with the company must read MoA and
AoA, as they are available in the public domain.
Turquand was appointed as an official manager and was responsible to liquidate the
Cameron’s Coalbrook Steam, Coal and Swansea and London Railway Company which was
insolvent. The Company was incorporated under the Joint Stock Companies Act, 1944.
A bond of 2000 pounds were issued by the company to the Royal British Bank and this was
issued under the seal of the company and was signed by the 2 directors and the secretary of
the company. The bank secured the company’s drawings on its current account. The bank had
later secured the company’s drawings on their current account. But the bank had then sued
the plaintiffs for non-payment.
The Contention of the defendants was that the company’s AoA stated that the directors were
given the power to borrow only after a resolution was passed, but in this case, no resolution
was adopted and the bond was issued without authority.
Held, the judgement had introduced the Turquand rule – which protects the interest of bona
fide third parties who are unaware of the internal irregularities of a company (if any) having
the potential to affect the validity of the contract or a transaction with the company. Hence,
the bond was valid and the defendants would have to pay. The Court had also looked into the
doctrine of indoor management – stating that the company would have to take necessary steps
to ensure that their internal compliances are dealt with in a lawful manner.
Exceptions –
i) The outsider had the knowledge, or it was possible to ascertain that there was no
compliance of the internal requirements of the company.
ii) The outsider acted in bad faith.
Hence, the judgement laid down a rule stating that a person dealing with a company must
look only at the Memorandum of Association and the Article of Association to know the
extent of the authority and not need to inquire into the regularity of the internal proceedings.
[Case Note - Ashbury Rly. Carriage & Iron Company v. Riche (1875) – A Company cannot
go beyond what is stated in the object clause of a MoA.]
Lakshmanaswami Mudaliar v. LIC (1963)
Appellants were the directors of United India Life Insurance Compay (referred to as ‘U’) and
they were also trustees of a separate trust which was to be formed. In pursuance of the EGM
of ‘U’, a resolution was passed to sanction a donation of a loan of Rs. 2 Lakh to the trust, but
after LIC took over the insurance business – the transaction was held ultra vires and the
trustees were asked to refund the money.
The AoA states that the directors had the authority to make payments towards any charitable
object, or for any general public, or useful object. However, this can only be done if the MoA
allows the achieving of the object specified or for doing anything incidental to the object. As
per the objects specified in the MoA (under clause III) – the company was allowed to invest
and trade with funds and assets of the Company on securities or investments and in such
manner fixed by the AoA. Hence, this clause does not give the power to the directors to do
whatever they like with the funds. Subclause v) of the MoA also states that the company can
do all things that are incidental/conducive to the attainment of the above objects, i.e., the
company’s own objects.
Held, The Articles may explain the Memorandum but they do not expand its scope. Acts
incidental to or conducive to the main object are those that have a reasonably close
connection with the object. An indirect or distant benefit that they company may/may not
receive by doing an act is not authorized. Now, the trust has numerous objects and one of
them is to promote knowledge in various fields (such as art, science, business)– including
banking and insurance. But there is no obligation upon the trustees to utilize the fund for
promoting education in insurance, nor is there any guarantee that persons trained in the trust
would take up employment with the company. Hence, the ultimate benefit received by the
company was too indirect to be regarded as incidental/naturally conducive to the object of the
company. Hence, the act of donating funds was not within the objects mentioned in the MoA
and was hence, ultra vires.
The Appellants are also personally liable to make good the amount belonging to the company.
V.B. Rangaraj v. V.B. Gopalakrishnan and Ors. (1992)
There was a company in which the plaintiffs had 13 shares, and others from outside the
plaintiff’s family had 37 shares. Later, this family bought the remaining 37 shares. There
were 2 brothers in this family – Baluswamy (B) and Guruviah (G) – each holding 25 shares.
They had an agreement in 1951 stating that the branches of their families should always
have 25 shares, and if any shareholder wanted to sell their shares, the right of first refusal
would lie within the branch family before selling to others.
D1 ( one of B’s sons) had sold his shares to the sons of (G), which went against the
agreement. Hence the sons of (B) had filed an application to the Court for declaring: i) the
sale to be void, ii) to order the sons of (G) to transfer the shares to them, and iii) to have an
order preventing (G’s) sons from registering the shares in their name.
Held, the Court had acknowledged that shares are transferrable and are movable property
which are regulated based on the Articles. Even though there was a prior agreement between
the two brothers (shareholders agreement) regarding the restriction on the transfer of shares
(the restriction was that a shareholder was only allowed to transfer shares to the same
members of the branch family) – the fact is that, in the Articles, there was no restriction
regarding the transferability of shares. Hence the restrictions on transferability of shares are
not binding on the shareholders or the company.
Vodafone case
This case had stated that when the Articles are silent, a SHA can gain precedence over it.
World Phone India Private Limited v. WPI Group Inc. USA (2013)
A resolution was passed by the board of directors of a private company pertaining to the
rights issue. According to the shareholder's agreement, for such a resolution to pass, an
affirmative vote of the appellant was required but the same was not exercised.
The Delhi HC had stated that since there was no such thing mentioned in the Articles, the
SHA cannot supersede the Articles.
An SLP was filed against this Delhi HC judgement but was refused by the Supreme Court of
India.