COMPANY LAW
NATURE AND ADVANTAGES
Incorporation offers the following advantages to the business community as compared with all other kinds of business organisations.
1. Independent Corporate Existence
The outstanding feature of a company is its independent existence. A partnership has no existence apart from its members. It is nothing but a collection of partners. A company on the other hand, is in law a person. It is a distinct legal persona existing independent of its members. By incorporation under the Act, the company is vested with a corporate personality, which is distinct from the members who compose it. One of the effects of incorporation is stated in Section 34(2) of the Act. It says that upon the issue of the certificate of incorporation, the subscribers to the memorandum and other persons who may from time to time be the members of the company, shall be a body corporate capable forthwith of exercising all the functions of an incorporated company and having perpetual succession and common seal. Thus a company becomes a body corporate which is capable immediately of functioning as an incorporated individual. A well known illustration of this principle is the decision of the House of Lords in Salomon Vs. Salomon & Co. Ltd. (1897)
One Salomon was a boot and shoe manufacturer. His business was in sound condition and there was a substantial surplus of assets over liabilities. He incorporated a company named, Salomon Co. Ltd., for the purpose of taking over and carrying on his business. The seven subscribers to the memorandum were Salomon, his wife and daughter and four sons and they remained the only members of the company. Salomon, with his two sons, constituted the board of directors of the company. The business was transferred to the company for a sum of 40,000 pounds. In payment Salomon took 20,000 shares of 1 pound each and debentures worth 10,000 pounds. These debentures certified that the company owed Salomon 10,000 pounds and created a charge on the company’s assets. One share was given to each remaining member of his family. The company went into liquidation within a year.
On winding up, the state of affairs was broadly something like this :
Assets -- 6,000 pounds : Liabilities -- Salomon as debenture holder :10,000 pounds and unsecured creditors : 7,000 pounds. Thus paying off the debenture holder nothing would be left for the unsecured
creditors.
creditors.
The unsecured creditors, therefore, contended that, though incorporated under the Act, the company never had an independent existence ; it was in fact Salomon under another name ; he was the managing director, the other directors being his sons under his control. His vast preponderance of share made his absolute master. The business was solely his, conducted solely for and by him and the company was a mere sham and fraud, in effect entirely contrary to the intent and meaning of the Companies Act.
But it was held that Salomon & Co. Ltd., was a real company fulfilling all the legal requirements. It must be treated as a company, as an entity consisting of certain corporators, but a distinct and independent corporation.
2. Limited Liability
“The privilege of limiting liability for business debts is one of the principal advantages of doing business under the corporate form of organisation.” The Company being a separate person, is owner of its assets and bou8nd by its liabilities. Members, even as a whole, are neither the owners of the company’s undertaking, nor for its debts. In other words, the liability of the members is limited. No member is bound to contribute anything more than the nominal value of the shares held by him. In a partnership, on the other hand, the liability of the partners for the debts of the business is unlimited. They are bound to meet, without any limit, all the business obligations of the firm. The whole fortune of a partner is at stake, as the creditors can levy execution even on his private property.
Speaking of the advantage of trading with limited liability, BUCKLEY, J., observed :
The statutes relating to limited liability have probably done more than any legislation of the last fifty years to further the commercial prosperity of the country. They have, to the advantage as well of the investor as of the public, allowed and encouraged aggregation of small sums into large capitals which have been employed in undertakings of great public utility largely increasing the wealth of the country.
3. Perpetual Succession
An incorporated company dies. It is an entity with perpetual succession. Suppose, for example, that A, B and C are the only members of a company holding all its shares. The4irt shares may be transferred to, or inherited by X, Y and Z, who may, therefore, become the new members and managers of the company. But the company will remain the same entity. In spite of the total change in membership, “the company will be the same entity, with the same privileges and immunities, estates and possessions.” Perpetual succession, therefore, means that the membership of a company may keep changing from time to time, but that does not affect the company’s continuity, “in the like manner as the river
4. Separate property
A company, being a legal person, is capable of owning, enjoying and disposing of property in its own name. The company becomes the owner of its capital and assets. The share holder are not the private or joint owners of the company’s property. “The company is the real person in which all its property is vested, and by which it is controlled, managed and disposed of.” A member does not even have an insurable interest in the property of the company. A person, for example, was the holder of nearly all the shares, except one, of a timber company and was also a substantial creditor. He insured the company’s timber in his own name. The timber having been destroyed by fire, the insurance company was held liable to him. “No share holder has any right to any item of property owned by the company, for he has no legal or equitable interest therein.”
Thus, incorporation helps the property of the company to be clearly distinguished from that of its members. In a partnership, on the other hand, the distinction between the joint property of the firm and the private property of the partners is often not clear.
5. Transferable Shares
When joint stock companies were established the great object was that their shares should be capable of being easily transferred. Accordingly the Companies Act in section 82 declares : “The shares or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company”. Thus incorporation enables a member to sell his shares in the open market and to get back his investment without having to withdraw the money from the company. This provides liquidity to the investor and stability to the company. In a partnership, on the other hand, a partner cannot transfer his shares in the capital of the firm except with the unanimous consent of all the partners. I(f a transfer is made against the will of the partners, the transferee does not become a partner, although he has some right in the dissolution of the firm.
6. Capacity to sue and being sued
A company, being a body corporate, can sue and be sued in its own name.
DISADVANTAGES
The above advantages of incorporation are by no means inconsiderable and, as compared with them, the disadvantages are very few. They are as follows :
1. Lifting the Corporate Veil
The chief advantage of incorporation from which all others follows is, of course, the separate legal entity of the company. In reality, however, the business of the artificial person is always carried on by, and for the benefit of, some individuals. In the ultimate analysis some human beings are the real beneficiaries of the corporate advantages, “for while, by fiction of law, a corporation is a distinct entity, yet in reality it is an association of persons who are in fact the beneficial owners of all corporate property.” And what the Salomon case decides is that “in questions of property and capacity, of acts done and rights acquired or, liabilities assumed thereby …. The personalities of the natural persons who are company’s corporations are to be ignored.”
This theory of corporate entity is still, indeed, the basic principle on which the whole law of corporations is based. Instances are not few in which the courts have successfully resisted the temptation to break through the corporate veil. A landlady’s bid to regain tenanted premises for self-business could not succeed as the business was in the name of the company. (Tunstall Vs. Steigmann 1962) The Supreme Court did not allow a share holder to sue for the violation of the fundamental rights of his company. (Chiranjit Lal Vs. The Union of India
But the theory cannot be pushed to unnatural limits. Circumstances must occur which compel the courts to, identify a company with its members. The following grounds have become well established.
a. Determination of Character
Occasionally it becomes necessary to determine the character of a company, for example, to see whether it is “enemy”. In such a case, the courts may in their discretion, examine the character of persons in real control of the corporate affairs. Daimler Co. Ltd. Vs. Continental Tyres & Rubber Co., is a well known illustration.
A company was incorporated in England for the purpose of selling the tyres manufactured in Germany by a German company. The German company held the bulk of the shares in the English company. The holders of the remaining shares (save one) and all the directors were Germans, resident in Germany. Thus the real control of the English company was in German hands. During the First war the English company commenced an action to recover a trade debt. And the question was whether the company had become an enemy company and should, therefore, be barred from maintaining the action.
The House of Lords laid down that “a company incorporated in the United Kingdom is a legal entity, a creation of law with the status and capacity which the law confers. It is not a natural person with mind or conscience. It can neither be loyal or disloyal. It can be neither friend nor enemy. But it may assume an enemy character when persons in de facto control of its affairs, are residents in any enemy country or, whenever resident, are acting under the control of enemies”. Accordingly the company was not allowed to proceed with the action.
If the action had been allowed the company would have been used as a machinery by which the purpose of giving money to the enemy would be accomplished. That would be monstrous and against public policy.
But where there is no such danger to the public interest, the courts may refuse to tear open the corporate veil. The American case, People’s Pleasure Park Co. Vs. Rohleder is an instructive illustration..
Certain lands were transferred by one person to another perpetually enjoining the transferee from selling the said property to coloured persons. He transferred the property to a company composed exclusively of negroes. An action was commenced for annulment of this conveyance on the ground that all the members of the company being negroes, the property had, in breach of the restrictions, passed to the hands of coloured persons.
The court, however, rejected this argument and held that members individually or collectively are not the corporation, which “has a distinct existence -- an existence separate from that of its share holders. It leads its own life … It stands apart as a separate subject and, in contemplation of law, as a stranger to its own members”.
b. For the benefit of Revenue
“The court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligation.” ( Juggilal Vs. C.I.T. 1969 S.C.) A clear illustration of this is to be found in the facts of In re Dinshaw Maneckjee Petit (1927 Bom) The assessee was a wealthy man enjoying huge dividend and interest income. He formed four private companies and agreed with each to hold a block of investment as an agent for it. Income received was credited in the accounts of the company but the company handed back the amount to him as a pretended loan. This way he divided his income in four parts in a bid to reduce his tax liability. But it was held that, “the company was formed by the assessee purely and simply as a means of avoiding super-tax and the company was nothing more than the assessee himself. It did no business, but was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assessee as pretended loans.”
c. Fraud or Improper Conduct
The Corporate entity is wholly incapable of being strained to an illegal or fraudulent purpose. The courts will refuse to uphold the separate existence of the company where it seems to have formed to defeat or circumvent law, to defraud creditors or to avoid legal obligations. One clear illustration is Gilford Motor Co. Vs. Horne (1933)
Horne was appointed as a Managing Director of the plaintiff company on the condition that “he shall not at any time while he shall hold the office of a managing director or afterwards, solicit or entice away the customers of the company”. His employment was determined under an agreement. Shortly afterwards he opened a business in the name of a company which solicited the plainti8ff’s customers.
It was held that “the company was a mere cloak or sham for the purpose of enabling the defendant to commit a breach of his covenant against solicitation. Evidence as to the formation of the company and as to the position of its shareholders and directors leads to that inference. The defendant company was a mere channel used by the defendant Horne for the purpose of enabling, for his own benefit, to obtain the advantage of the customers of the plaintiff company, and that the defendant company ought to be restrained as well the defendant Horne.
d. Agency or Trust and Government Companies
A company may sometimes be regarded as an agent or trustee of its members or of another company and may, therefore, be deemed to have lost its individuality in favour of its principal. In India this question has frequently arisen in connection with Government Companies. A large number of private companies for commercial purposes have been registered under the Companies Act with the President and a few others as the shareholders. The obvious advantage of forming a Government company is that it gives the activities of the State “a little of the freedom which was enjoyed by private corporations and the Government escaped the rules and principles which hampered action when it was done by a Government department instead of a Government corporation. In other words, it gave the Government some of the robes of the individual.” And in order to assure this freedom the Supreme Court has reiterated in a number of cases that a Government company is not a department or extension of the State.
It is not an agent of the State. Accordingly its employees are not civil servants and prerogative writs cannot be issued against it. In Ram Singh Vs. Fertiliser Corporation of India Ltd. 1980 the Punjab and Haryana High Court has held that the company being a non-statutory body and one incorporated under the Companies Act there was neither a statutory nor a public duty imposed on it by a statute in respect of which enforcement could be sought by means of a mandamus.
Liability of Directors and members: Statutory Provisions
The Act also imposes personal liability on the directors or members of a company in certain cases. Independent existence of a company is maintained and the company may also be liable. But, apart from the liability of the company, those cloaked behind it are also made liable. Following are some such provisions of the Act.
1. Reduction of Membership
Section 45 provides that “if at ant time the number of members of a company is reduced, in the case of a public company, below seven, or in the case of a private company, below two and the company carries on business for more than six months while the number is so reduced, every person who is a member of the company…. And is cognizant of the fact … shall be severally liable for the payment of the whole debts of the company contracted during that time…” The purpose of the provision is to withdraw the advantages of incorporation when the conditions of incorporation are not maintained.
2. Mis description of Name
Secondly, where in any act or contract of a company, its name is not fully or properly indicated as required by section 147 those who have actually done the act or made the contract shall be personally liable for it. Thus the directors were held personally liable on a cheque signed by them in the name of a company stating the company’s name as “L.R. Agencies Ltd.”, the real name being “L.& R. Agencies Ltd”. (Hendon Vs. Adelman 1973)
3. Fraudulent Conduct of Business
Thirdly, section 542 imposes liability for fraudulent conduct o9f a company’s business. According to this section “if 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 o9ther persons, or for any fraudulent purpose”. Those who were knowingly parties to such conduct of business may, in the discretion of the court, be made personally liable for all or any debts of the company.
4. Holding and Subsidiary Companies
A company qualifies as a holding company when it has power to control the composition of the board of directors of another company or holds a majority of its shares. It has been seen that a subsidiary company, even a 100 percent subsidiary, is a separate legal entity and its creator and controller is not to be held liable for its acts merely because he is the creator and controller. nor is the subsidiary to be held as a asset of the holding company. The decision of the Delhi High Court in Freewheel (India
A fifty-two percent subsidiary company proposed to issue further capital which, following Section 81, was offered to the existing holders of the equity shares. The holding company requested the court that its subsidiary should be restrained from going ahead with the issue as it would deprive its parent of their controlling interest and would also depreciate the value of its shares. Kapur, J. refused to issue the injunction prayed for and said : “ Here the parent company holds only a nominal majority in the share capital of the subsidiary. With the meagre majority alone I am not prepared to hold, even if it were possible to do so for such a purpose, that the subsidiary company has lost its identity as a separate legal entity.”
A subsidiary company may, however, lose its separate identity to a certain extent in two cases. Firstly, the legislature may brush aside the legal forms and require the companies in a group to present a joint picture. Thus Sections 212-214 contain provisions “designed primarily to give better information of the accounts and financial position of the group as a whole to the creditors, shareholders and the public.”
Secondly, the court may, on the facts of a case, refuse to grant a subsidiary company an independent status. “it may not be possible to put in a strait jacket of judicial definition as to when the subsidiary company can really be treated as a branch, or agent, or a trustee of the holding company. Circumstances such as profits of the subsidiary company being treated as those of the parent company, the control and conduct of business of the subsidiary company resting completely in the nominees of the holding company……. May indicate that in fact the subsidiary company is only a branch of the holding company.”
Subsidiary of Multinational
A group of oil companies in the United Kingdom owned and controlled certain oil companies in Rhodesia. The English parent company was called upon to produce certain documents relating to pipe line contract which were in the possession of its subsidiaries. The court rules empowered the court to require the disclosure of all documents in the “possession, custody or power” of a party. The question was whether the documents in the possession of a foreign subsidiary could be deemed to be in the possession of the “parent”. The Court of Appeal answered the question in the negative. Lord Denning laid emphasis upon the position of the company in the setting of local laws applicable to it and degree of freedom from interference by the parent :
These South African and Rhodesian companies were very much self controlled. Their directors were local directors—running their own show, operating it, with comparatively little inference from London. They wee subject, of course, to all local laws and ordinances. That seems to be a different position from the concept of a one-man- company—or a 100 percent Company—which is operating in this country with the self-same directors, or a 100 percent parent with various subsidiaries. It is important to realise that subsidiaries of multinational companies have a great deal of autonomy in the countries concerned.
Conclusion
Thus it is abundantly clear that incorporation does not cut off personal liability at all times and in all circumstances. “Honest enterprise, by means of companies is allowed ; but the public are protected against kiting and hum-buggary.” “The sanctity of a separate corporate identity is upheld only in so far as the entity is consonant with the underlying policies which give it life.” Those who enjoy the benefits of the machinery of incorporation have to assure a capital structure adequate to the size of the enterprise. They must not withdraw the corporate assets or mingle their own individual accounts with those of the corporation or represent to third parties that no difference exists between themselves and the company. “The courts have at times seized upon these facts as evidence to justify the imposition of liability upon the shareholders.”
2. Formality and Expense
Another disadvantage of incorporation is its expense and formality. Incorporation is a very expensive affair and requires a number of formalities to be complied with. As compared with it, the formation of a partnership is very simple. Again, the administration of a company has to be carried on strictly in accordance with the provisions of the Act. General meetings must be held in time ; accounts must be prepared and audited and then presented to the shareholders in general meeting ; copies of accounts are to be filed with the Registrar ; mortgages and charges and certain resolutions have to be filed with the Registrar and in many other ways companies are under Government control and regulation. As many return are to be filed with the Registrar as there are weeks in a year and every failure is penalised. According “corporate directors wake up each morning as potential criminals”.
Company is not a citizen
Lastly, it may be added that a company, though a legal person, is not a citizen either under the constitution of India or under the Citizenship Act. This has been the conclusion of a special bench of the Supreme Court in State Trading Corporation of India Ltd. Vs. C.T.O.
A company is, however, a person in the eye of law and it can claim the protection of such fundamental rights as are guaranteed to all persons whether citizens or not. A company cannot claim the protection of such fundamental rights as are expressly guaranteed to citizens only.
A company does, however, have a nationality, domicile and residence. The same principles apply to the determination of the residence of a company. Lord Loreburn stated in a case before the House of Lords that in applying the concept of residence to a company we ought to proceed as nearly as we can upon the analogy of an individual. “A company cannot eat or sleep, but it can keep house and do business. We ought, therefore, to see where it really keeps house and does business. An individual may be of foreign nationality and yet reside in the United Kingdom, so may a company. Otherwise it might have its chief seat of management and its centre of trading in England
Registration and Incorporation
Procedure of registration
To obtain the registration of a company an application has to be filed with the Registrar of Companies. The application must be accompanied by the following documents :
1. Memorandum of Association
2. Articles of Association, if necessary.
The documents for registration must be supported by a declaration stating that all the requirements of the Act relating to registration have been complied with. The declaration must be signed by an Advocate of the Supreme Court or of a High Court or an attorney or a pleader entitled to appear before a High Court or a chartered accountant practising in India, who is engaged in the formation of a company or a person named in the articles as a director, managing agent, secretaries and treasurers, manager or secretary of the company.
When the requisite documents are presented for registration, the Registrar has to see whether they answer the requirements of the Act. He may, however, accept the declaration as sufficient evidence of compliance. He then registers the company and other documents and places the name of the company in the Register of Companies. A certificate of incorporation is then issued by which the registrar certifies “under his hand that the company is incorporated and, in the case of a limited company, that the company is limited.”
Certificate of incorporation
The certificate of incorporation brings the company into existence as a legal person. Upon its issue the company is born. For the Act provides that “from the date of incorporation such of the subscribers of the memorandum and other persons, as may from time to time be the members of the company, shall be a body corporate,…. capable forthwith of exercising all the functions of an incorporated company.” The company’s life commences from the date mentioned in the certificate of incorporation and the date appearing on it is conclusive, even if wrong.
Not only does the certificate create the company. It also is “the conclusive evidence that all the requirements of this Act have been complied with in respect of registration and matters precedent and incidental thereto and that the association is a company authorised to be registered and duly registered under this Act”. In other words the validity of the certificate cannot be disputed on any ground whatsoever. This is illustrated by the decision of the Judicial Committee of the Privy Council in Moosa Goolam Ariff Vs. Ebrahim Goolam Ariff (1913)
The memorandum of association of a company was signed by two adult persons and by a guardian of the other five members, who were minors at the time, the guardian making a separate signature for each of the minors. The Registrar, however, registered the company and issued under his hand a certificate of incorporation. The plaintiff contended that this certificate should be declared as void.
Lord MACNAGHTEN said :
Their Lordships will assume that the conditions of registrations prescribed by the Indian Companies Act were not duly complied with ; that there were no seven subscribers to the memorandum and that the Registrar ought not to have granted the certificate. But the certificate is conclusive for all purposes.
“Thus the position is firmly established that if a company is born, the only method to get it extinguished is not by assailing its incorporation, but by resorting to the provisions of enactments, which provide for winding up of the companies.” This summary view of the position is to be found in the judgement of CHANDRA REDDY, C.J. in Krishna Vs. Andhra Prabha (Pvt.) Ltd. !960.
In this case the Express Newspaper (Pvt.) Ltd. were the leading publishers of newspapers and weeklies. Government adopted certain recommendations of the Wage Board for the improvement in terms of service and salaries of the working journalists. Thereupon the Express Newspapers sold its undertaking to a new company known as Andhra Prabha (Pvt.) Ltd. It was alleged that the new company was formed for the illegal purpose of evading the new responsibility imposed by the Wage Board and, therefore, the registration of the company should be declared as void.
The court, however, did not assent to the proposition that the purpose for which the company was formed was in any way unlawful or opposed to public policy and, therefore, held that the company was validly incorporated. But even if some of the objects were illegal, the legal persona of the company could not have been extinguished by cancelling the certificate. Even in such a case the certificate is conclusive and the remedy would be to wind up the company. The illegal objects, however, do not become legal by the issue of the certificate. Section 12 clearly mentions that “persons associated for any lawful purpose may …… form a company”
Pre-incorporation Contracts
Sometimes contracts are made on behalf of a company even before it is duly incorporated. But no contract can bind a company before it becomes capable of contracting by incorporation. “Two consenting parties are necessary to a contract, whereas the company, before incorporation, is a non-entity”. Thus In English & Colonial Produce Co. (1906) : A solicitor, on the instructions of certain gentlemen, prepared the necessary documents and obtained the registration of a company. He paid the registration fee and incurred the incidental expenses of registration.
But the Company was held not bound to pay for those services and expenses
“The company could not to be sued for those expenses, inasmuch as it was not in existence at the time when the expenses were incurred …. and ratification was impossible”
Commence of business ( Section 149)
A private company can commence business right from the date of its incorporation. But, in case of a public company, a further certificate for the commencement of business has to be obtained. Where a company has issued a prospectus inviting the public to subscribe for its shares, it will be entitled to the certificate subject to the following conditions:
- shares payable in cash must have been allotted up to the amount of the minimum subscription;
- directors must have paid in cash the application and allotment money in respect of the shares contracted to be taken by them for cash;
- no money is liable to become refundable to the application by reason of the failure to apply for or to obtain permission for shares or debentures to be dealt in on any recognised stock exchange.
A declaration signed by any director of the company or its secretary that the above requirements have been complied with should be filed with the Registrar. A company which has not issued a prospectus has only to file a statement in lieu of prospectus and to certify that every director, has paid his application and allotment money for shares contracted to be taken by him for cash. When this is done, the Registrar certifies that the company is entitled to commence business. The certificate is conclusive evidence that the company is so entitled.
No public company can commence any business or exercise any borrowing power unless this certificate is obtained. Any contract made before the date at which the company is entitled to commence business shall be provisional only and shall not be binding on the company until the certificate is obtained.
The Amendment Act of 1965 has introduced certain new conditions for the commencement of business by a company. It has added two new sub-sections to section 149.
As a result of the amendment of section 13, the objects clause of a company incorporated after the amendment will have to be divided into two sub-clauses, namely :
1. Main Objects : This will state the main objects of the company and the objects incidental or ancillary to the attainment of the main objects.
2. Other objects : This will include a statement of other objects not mentioned in the above clause.
The objects clause of a company already in existence before the commencement of the Amendment Act can remain as it is.
Now, if a company wishes to start a business included in the “other objects” it shall have to obtain the authority of a special resolution of its shareholders. Similarly, when an existing company wants to commence any new business which it has been carrying on at the commencement of the Amendment Act, it shall have to obtain the authority of a special resolution. Where, however, a special resolution has not been passed, but the votes cast in favour of the resolution exceed the votes cast against it, the Central Government may, on an application by the Board of Directors, allow the company to commence such business. In both the above cases there must be filed with the Registrar a declaration by the secretary or a director that the requirement as to resolution has been complied with.
Memorandum of Association
An important step in the formation of a company is to prepare a document called the memorandum of association. Its importance lies in the fact that it contains the following fundamental clauses which have often been described as the conditions of the company’s incorporation:
- Name Clause ;
- Registered Office Clause ;
- Objects Clause ;
- Liability Clause; and
- Capital Clause.
NAME
The first clause of the memorandum is required to state the name of the proposed company. A company, being a legal person, must have a name to establish its identity. “The name of a corporation is the symbol of its personal existence”. Any suitable name may be selected subject, however, to the following restrictions.
In the first place, no company can be registered with a name which, in the opinion of the Central Government, is undesirable. [Section 20 (1)]. The name of the company should not be identical with or should not too nearly resemble, the name of another registered company, for such a name may be declared undesirable by the Central Government. [Section 20 (2)] Moreover, the other company can also apply for an injunction to restrain the new-comer from having an identical name.
Use of the word “Limited” and Publication of Name
Secondly, whatever be the name of the company, if the liability of the company is limited, the last word of the name must be “Limited”,. And in the case of a private limited company “Private Limited”. This is to ensure that all persons dealing with the company shall have clear notice that the liability of the members is limited. And for the same reason it is further required that such name of the company must be printed on the outside of every place where the business of the company is carried on. (Section 147) Such name, including the address of the registered office, must also be mentioned on all business letters and other official publications, on all negotiable instruments issued or endorsed by the company and all other orders, receipts, etc. Any defect in this respect might involve the officers of the company in most serious consequences. For example a bill of exchange is issued by a company on which its name is not properly mentioned or if the word “limited” has been omitted, and if the company fails to pay the bill, the officer who issued or authorised the issue of such bill would be personally liable under it and also will be punishable with a fine.
But the omission must be deliberate or of negligent origin and not merely accidental. Thus in Dermatine Co. Ltd. Vs. Ashworth (1905) A bill of exchange was drawn upon a limited company in its proper name and it was accepted by two directors of the company. The word “limited”, however, did not appear in acceptance. The reason was that the rubber stamp by which the words of acceptance were impressed on the bill was longer than the paper of the bill, and therefore, the word “limited” overlapped the paper.
On the company’s failure to pay the bill it was held that the directors would not be personally liable thereon. “It was an obvious error of most trifling kind and the mischief aimed at by the Act did not exist.”
But in Nassan Stream Press Vs. Tyler
It was held that the name of the company was not mentioned in accordance with the requirements of the Act and that the company not having paid the bill, the defendants were personally liable thereon. Correct name of the company should be inserted. Any omission or addition amounting to misdescription would make the persons purporting to sign the bill personally liable.
On the same principle the directors were held personally liable on a cheque signed by them on the company’s behalf stating the name as “L.R. Agencies Ltd.”, the real name being “L &.R. Agencies Ltd.”
Licence to drop “Limited” [S. 25]
The Central Government may, by licence, allow a company to drop the word “Limited” from its name. The licence is granted subject to the following conditions :
1. The company should be formed for the promotion of commerce, art, science, religion, charity or any other useful object.
2. The company should apply its income in promoting its objects and must prohibit the payment of dividends to its members.
The licence is revocable at the discretion of the Central Government. The discretion is unrestricted, but it may be exercised only the fundamental conditions of the licence are contravened. This should be apparent from sub-section 8(a) which prohibits the company from changing its objects “except with the previous approval of the Central Government”.
Change of Name
A company may change its name by passing a special resolution and with the approval of the Central Government signified in writing. (S. 21) But if a company has been registered with a name which subsequently appears to be undesirable or resembling the name of another company, it may change its name by passing an ordinary resolution and with the approval of the Central Government. Sec. 22(1) (a) In such a case the Central Government can also within twelve months of registration direct the company to change its name. Sec.22 (1) (b) If a direction is issued the company must change its name within three months from the date of the direction unless the time is extended. Sec.23.
The change of name does not affect the rights and obligations of the company. For Section 22(3) provides :
The change of name shall not affect any rights or obligations of the company, or render defective any legal proceedings by or against it ; and legal proceedings 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.
REGISTERED OFFICE
The second clause of the memorandum must specify the State in which the registered office of the company is to be situated.
Within thirty days of incorporation or commencement of business, whichever is earlier, the exact place where the registered office is to be located must be decided and notice of the situation given to the Registrar who is to record the same. [Section 146]
All communications to the company must be addressed to its registered office. [Section 51]
Change of Registered Office Clause
A company can shift its registered office from one place to another within the same city, town or village. [Section 146(2)] But if it is proposed to carry the registered office from one city to another within the same State, a special resolution to that effect must be passed. A notice of any such change must be given to the Registrar within thirty days of the change.[Section 146(4)]
Shifting of the registered office from one State to another is a much more complicated affair, as it involves alteration of the memorandum itself. The alteration of the memorandum for this purpose is subject to the provisions of section 17 which requires, in the first place, a special resolution of the company and, in the second, confirmation by the Company Law Board. The Board can confirm the alteration only if the shifting of the registered office from one state to another is necessary for any of the purposes detailed in Section 17(1). When this condition is fulfilled, the second stage is reached, namely, to consider the objections of a “person or class of persons whose interest will, in the opinion of the Board, be affected by the alteration.” [Section 17 (3)] In two cases before the Orissa High Court, (Orient Paper Mills Ltd. Vs. The State 1957 and In re Orissa Chemicals and Distilleries 1962) shifting of the registered offices of certain companies to places outside Orissa was opposed by the State on the grounds, including the loss of revenue and employment opportunities.
OBJECTS AND POWERS
In the third clause, the memorandum must state the objects for which the proposed company is to be established. The Companies (Amendment) Act, 1965, now requires that in the case of companies in existence before this amendment, the object clause has simply to state the objects of the company. But in the case of a company to be registered after the amendment, the objects clause must be divided into three sub-clauses, namely :
1. Main objects : This sub-clause must state other objects to be pursued by the company on its incorporation and objects incidental or ancillary to the attainment of the main objects.
2. Other Objects : This sub-clause must state other objects which are not included in the above clause.
3. States to which objects extend : In case on non-trading companies, whose objects are not confined to one State, this sub-clause has to mention the States to whose territories the objects extend.
Choice of objects lies with the subscribers to the memorandum and their freedom in this respect is almost unrestricted. The only obvious restrictions are that the objects should not go against the law of the land and the provisions of the Companies Act. For example, law prohibits gambling. Obviously, no company can be incorporated for that purpose. Thus where a company was incorporated for conducting a lottery it was ordered to be wound up, that object being illegal. Again, for example, the Act provides that a company limited by shares cannot, subject to a few exceptions, purchase its own shares.[Section 77] Accordingly, any clause in the memorandum giving the company a power to purchase its own shares will be inoperative.
Why objects ?.
The ownership of the corporate capital is vested in the company itself. But in re4ality that capital has been contributed by the shareholders and is held by the company as though in trust for them. Such a fund must obviously be dedicated to some defined objects so that the contributors may know the purposes to which it can be lawfully applied. The statement of objects, therefore, gives a very important protection to the shareholders by ensuring that the funds raised for one undertaking are not going to be risked in another.
The object clause, in the second place, affords a certain degree of protection to the creditors also. The creditors of a company trust the corporation and not the shareholders and they have to seek their payment only out of the company’s assets. The fact that the corporate capital cannot be spent on any project not directly within the terms of the company’s objects gives the creditors a feeling of security.
Thirdly, by confining the corporate activities within a defined field, the statement of objects serves the public interest also. It prevents diversification of a company’s activities in directions not closely connected with the business for which the company may have been initially established. It also prevents concentration of economic power.
The doctrine of ultra Vires
The reasons which explain the necessity of an objects clause require that the company should devote itself only to the objects set out in the memorandum and to no others. It is the function of the memorandum “to delimit and identify the objects in such plain and unambiguous manner as that the reader can identify the field of industry within which the corporate activities are to be confined.” And it is the function of the courts to see that the company does not move in a direction away from that field. That is where the doctrine of ultra vires comes into play in relation to joint stock companies. “Ultra” means beyond, “Vires” means powers. An action outside the memorandum is ultra vires the company. Its application to such companies was first demonstrated by the House of Lords in Ashbury Railway Carriage and Iron Co. Ltd. Vs. Riche.(1875)
The memorandum of association of a company thus defined its objects : “The objects for which the company is established are to make and sell or lend on hire, railway carriages and wagons and all kinds of railway plants, etc……; to carry on the business of mechanical engineers, and general contractors…….” The company entered into a contract with Riche, a firm of railway contractors, to finance the construction of a railway line in Belgium. The company, however, repudiated the contract as one ultra vires. And Riche, brought an action for damages for breach of contract. His contentions were that the contract in question came well within the meaning of the words “general contractors” and, was, therefore, within the powers of the company, and, secondly, that the contract was ratified by a majority of the shareholders.
But the House of Lords held that the contract was ultra vires and, therefore, null and void.
In the next leading case of Attorney – General Vs. The Great Eastern Railway Co., (1880) the House of Lords observed that the doctrine of ultra vires, as it was explained in Ashbury case, should be maintained. But it ought to be reasonably and not unreasonably understood and applied and that whatever may be fairly regarded as incidental to the objects authorised ought not to be held as ultra vires, unless it is expressly prohibited.
Thus a company may do an act which is : (a) necessary for, or (b) incidental to, the attainment of its objects, or (c) which is otherwise authorised by the Act.
The company’s Act now requires incidental objects also to be stated in the memorandum. {Section 13(1) (c)] But even if they are not so stated, they would be allowed by the principle of unreasonable construction. Thus a railway company, having authority to keep steam vessels for the purpose of a ferry, may use them for excursion trips to the sea when they are otherwise unemployed. Again a railway company whose railroad is carried over arches may convert the arches into shops, otherwise “it might as reasonably be contended that a railway company are not entitled to sell hay which grows on their banks so as to make something out of it.” A chemical manufacturer was allowed to distribute £ 1,00,000 to universities and scientific institutions for the furtherance of scientific education and research as it was conducive to the continued progress of the company as chemical manufacturers.
But no company can devote any part of its funds to an object which is neither essential nor incidental to the fulfilment of its objects, how beneficial so ever that object might seem likely to prove.
In India the origin of the doctrine dates back to 1866 when the Bombay High Court applied it to a joint stock company and held on the facts of the case before it that “the purchase by the directors of a company, on behalf of the company, of shares in other joint stock companies, unless expressly authorised in the memorandum is ultra vires.”
The doctrine has been affirmed by the Supreme Court in its decision in A. Lakshamanaswami Mudaliar Vs. Life Insurance Corporation of India
Objects, Powers and Charitable Contributions
The above decision of SHAH, J. is an authority for two propositions. Firstly, that a company’s funds cannot be diverted to every kind of charity even if there is an unrestricted power to that effect in the company’s memorandum. Secondly, that objects must be distinguished from powers. The power, for example, to borrow or to make a charity, is not an object. Objects have to be stated in the memorandum, but not powers. Even if powers are stated, they can be used only to effectuate the objects of the company. They do not become independent objects by themselves.
In Hutton Vs. West Cork Rly. Co. BOWEN, L.J. explained the judicial attitude :
Charity has no business to sit at boards of directors qua charity, There is, however, a kind of charitable dealing which is for the interest of those who practise it, and to that extent and in that grab, charity may sit at the board, but for no purpose.
Thus the interests of the company cannot be elbowed out. Charity is allowed only to the extent to which it is necessary in the reasonable management of the affairs of the company. There must be proximate connection between the gift and the company’s interests. Thus “gifts to foster research relevant to the company’s activities” exgratia payments to workers to induce them to work hard and “payment to widows of ex-employees on the footing that such payment encouraged persons to enter the employment of the company have been upheld.
Main objects Rule of Construction
The ultra vires doctrine confines corporate action within preset limits. While it handicaps the ambitious manager, it lays a trap for the unwary creditor. That is why there has been a revolt against it almost ever since its inception.
The business has been always endeavoured to escape the limitations imposed by the doctrine. One of the methods of by-passing ultra vires is the practice of registering memoranda containing a profession of objects and powers.
For example, in Cotman Vs. Broughman {1918}, the House of Lords had to consider a memorandum which contained an objects clause with thirty sub-clauses enabling the company to carry on almost every conceivable kind of business which a company can adopt. Such an objects clause naturally defeats the very purpose for which it is there In a bid to control this tendency the courts adopted the “main objects rule” of construction. The rule owes its origin to the decision in the Ashbury case where it was held that the words “general contractors” must be read in connection with the company’s main business. In re German Date Coffee Co. (1882) is another illustration of its application.
The memorandum of a company stated that it was formed for working a German patent which would be granted for manufacturing coffee from dates ; for obtaining other patents for improvements and extensions of the said invention ; and to acqui9re and purchase any other invention for similar purposes. The intended German patent was never granted, but the company purchased a Swedish patent, and also established works in Hamburg where they made and sold coffee from dates without any patent.
A petition having been presented by two shareholders, it was held that the main object for which the company was formed had become impossible and, therefore, it was just and equitable that the company should be wound up. LINDLEY, L.J. said : “In construing a memorandum in which there are general words …………. They must be taken in connection with what are shown by the context to be the dominant or main objects. It will not do under general words to turn a company for manufacturing one thing into a company for improving something else. Taking that as the governing principle, it seems to be plain that the real objects of this company which is called German date Coffee Co., was to manufacture a substitute for coffee in Germany
This principle will, however, be of no help where a company is formed for general purposes as apposed to a defined subject-matter.
Effects of ultra Vires Transactions
When a company gets involved in a ultra vires transaction the question arises what are its effects.
1. Injunction
In the first place, that members are entitled to hold a registered company to its registered objects has been recognised long since. Hence whenever an ultra vires act has been or is about to be undertaken, any member of the company can get an injunction to restrain it from proceeding with it.
2 .Personal Liability of Directors
It is one of the duties of the directors to see that the corporate capital is used only for the legitimate business of the company. If any part of it has been diverted to purposes foreign to the company’s memorandum, the directors will be personally liable to replace it. Thus, for example, the Bombay High Court in Jehangir R. Modi Vs. Shamji Ladha [1855] held that –
A shareholder can maintain an action against the directors to compel them to restore to the company the funds of the company that have by them been employed in transactions that they have no authority to enter into, without making the company a party to the suit.
3. Breach of warranty of authority
It is the duty of an agent to act within the scope of his authority. For if he goes beyond he will be personally liable to the third party for breach of warranty of authority. The directors of a company are its agents As such it is their duty to keep within the limits of the company’s powers. If they induce, however innocently, an outsider to contract with the company is a matter in which the company does not have the power to act, they will be personally liable to him for his loss. In Weeks Vs. Propert (1873)
A railway company invited proposals for a loan on debentures. At that time the advertisement was published the company had issued debentures of the amount of £60,000 being the full amount which it was by its constitution authorised to issue. It had, thus, exhausted its borrowing powers. The plaintiff offered a loan of £ 500 upon the footing of that advertisement. The directors accepted it and issued to him a debenture of the company. The loan being ultra vires was held to be void. In an action by the plaintiff against the directors, it was held that the directors by inserting the advertisement had warranted that they had power to borrow which they did not in fact possess. Their warranty consequently was broken and they were personally liable.
It must, however be remembered that the representation of authority which the directors hold out must be a representation of facts and not of law. For example, whether a company is authorised by its memorandum to borrow is a question of law which every man dealing with the company is supposed to know. But where the memorandum authorises a company to borrow, whether that power has been fully exercised or not becomes a question of fact. A misrepresentation of the former will not, but that of the latter will, give a case of action against the directors.
4. Ultra vires acquired Property
If a company’s money has been spent ultra vires in purchasing some property, the company’s right over that property must be held secure. For, that asset, though wrongly acquired, represents the corporate capital. Thus, for example, the Madras High Court in the case of Ad. Sait Vs. Bank of Mysore (1930) allowed a company to sue on a mortgage to recover the money lent i9n spite of the fact that the transaction was beyond the powers of the company. The court relied upon the following observation of Brice on the Doctrine of ultra vires ; “Property legally and by formal transfer or conveyance transferred to a corporation is in law duly vested in such corporation, even though the corporation was not empowered to acquire such property.
Similarly in Selangor United Rubber Estates Vs. Cradock (1968) it was held that “the fact that the companies act makes it unlawful for a company to give any financial assistance for anyone to purchase any of its shares does not prevent such a person from being held a constructive trustee for the company of such of its money as are unlawfully provided for such purpose.”
5. Ultra vires Contracts
“A contract of a corporation”, observes Mr. Justice Gray, “which is ultra vires, that is to say, outside the objects as defined by its memorandum is wholly void and of no legal effect.” The objections to an ultra vires contract is, not merely that the corporation ought not to have made it, but that it could not make it. The question is not as to the legality of the contract : the question is as to the competency and power of the company to make it. “An ultra vires contract, being void ab initio, cannot become intra vires by reason of estoppel, lapse of time, ratification, acquiescence or delay.” “No performance on either side can give the unlawful contract any validity or be the foundation of any right of action upon it.”
6. Ultra vires torts
The rule of constructive notice of memorandum and articles explains why a company is not liable for an ultra vires contract, but that does not solve the problems of injustice involved. Moreover, the rule altogether fails to hold ground when a company is sought to be made liable for a tort committed by a servant of a company while acting beyond the company’s powers. Anyone dealing with a company may, at the pain of losing the bargain, be required to acquaint himself with the company’s memorandum. But that can hardly be expected of a person who has been a victim of an ultra vires tort. For example, a company is operation omnibus—a venture entirely alien to its objects as described in the memorandum. The driver of one such bus negligently injures the plaintiff who sues the company for the tort. It can, no doubt, be contended against him that the driver was not a servant of the company.
The company, having no existence outside its corporate sphere, could not have appointed him. But can it be said that the plaintiff ought to have known this fact. Doubtless the plaintiff deserves to be compensated. As the law seems to stand at present, to make a company liable for any tort it must be shown that---
- that the activity in the course of which it has been committed falls within the scope of the memorandum, and
- that the servant committed the tort within the course of his employment.
Conclusion
This brief study of the nature and consequences of ultra vires rule points to some of its inherent complications resulting in occasional injustice. It has to be conceded that the rule of ultra vires is not based on any dogmatic concept of a limited liability company. The statement of objects indicates the permissible range of corporate activity. Everything else beyond that is implicitly prohibited so that the corporate capital may be preserved for the protection of shareholders and creditors. But that protection does not in any way suffer if the memorandum, like articles, is made a contract only between shareholders and the company. Every contract made on behalf of the company whether within or beyond its powers should be valid. But if it involves a misapplication of corporate capital the directors should be, and already are, bound to replace it.
Alteration of Objects
Section 17 allows alteration of objects within certain defined limits. “the intention of the legislature is to prevent too easy an alteration of the conditions contained in the memorandum.” The exercise of the power is, therefore is, therefore, fenced round by safeguards which are calculated to protect the interests of creditors and of the shareholders. The limits imposed upon the power of alteration are of two kinds, namely, substantive and procedural. The former defines the physical limits of alteration and the latter the procedure by which it can be effected.
1. Substantive Limits
Section 17 provides that a company may change its objects only in so far as the alteration is necessary for any of the following purposes :
(i) To enable the company to carry on its business more economically or more efficiently.--- The alteration which is contemplated in this clause seems to be an alteration which will leave the business of the company substantively what it was before, with only such changes in the mode of conducting it as will enable it to be carried on more economically or more efficiently. In Re Scientific Poultry Breeders Association [193] a company was allowed amendment to enable it to pay remuneration to its managers, which was formerly forbidden, being necessary for efficient management.
(ii) To enable the company to attain its main purpose by new or improved means.--- This clause is intended to enable companies to take advantage of new scientific discoveries. With the objects remaining the same, only the means of carrying them out are permitted to be changed under this clause.
(iii) To enable or change the local area of the company’s operations. --- This is to enable companies to carry their trades to new quarters of the globe For example, In re Indian Mechanical Gold Extracting Co. a company was allowed to drop the words from its memorandum which required it to confine business to the “empire of India
(iv) To carry on some business which under existing circumstances may conveniently or advantageously be combined with the business of the company---- This is the only clause which allows a company to undertake any new business having no relation to its existing business except that it must be such as can conveniently or advantageously be combined with the company’s existing business. What new business can be so combined must be determined by the persons engaged in the business. Thus a tyre company was allowed to undertake the general business of bankers and financiers.[ in re Patent Tyre Co.,] (1923) The new business must not, of course, be inconsistent with the existing business. Thus in Re Cyclists’ Touring Club [1907], a club incorporated to protect cyclists on public roads was not allowed to undertake protection of motorists also, as cyclists had to be protected against motorists.
These principles have been largely followed in India also. The choice of new objects must rest with the shareholders of the company and their directors and an alteration will ordinarily be confirmed except when “it is detrimental to, or inco0nsistent with, the existing business”. Thus a company formed originally for “business in jute” has been allowed to include “business in rubber” and a “spinning and weaving company” to manufacture “industrial and power alcohol”. [ In re Modi Spinning and Weaving Mills Co. Ltd.,]
But where the company is in sound financial position and the alteration is not objected to by its shareholders and creditors, the Board may take a lenient view and allow any kind of alteration resolved upon by the company. Accordingly, when the business of an insurance company was taken over by the Central Government, the Punjab High Court allowed the company to alter its objects so as “to include business in engineering works, cotton and importing and exporting.” And the same court allowed a cable manufacturing company to undertake hoteling services. Similarly, the Madras High Court has held that where a company’s assets greatly exceed its liabilities, an expansion of business activities in the light of the company’s special resolution should be allowed.
(5) To restrict or abandon any of the objects specified in the memorandum.
(6) To sell or dispose of the whole, or any part of the undertaking, of the company.
(7) To amalgamate with any other company or body of persons.
2. Procedure of alteration
A special resolution authorising the alteration must be passed at a general meeting of the company. But the alteration does not take effect until it is confirmed by the Company Law Board on petition. The Company Law Board must be satisfied that sufficient notice has been given to every debenture holder and to every other person whose interest is likely to be affected by the proposed alteration. If any creditor, having the right to do so, has raised an objection to the alteration, his consent must be procured or his claim must be satisfied. [Section 17(3)] The Company Law Board must cause a notice of the alteration to be served on the Registrar as he is also entitled to state his objections and suggestions, if any, with respect to the confirmation of the alteration. [Section 17(4)]
The Company Law Board is also required to have regard to the rights and interests of the members of the company. If there are any dissentient members the Board may order that an arrangement be made for the purchase of the interest of such member.
The Company Law Board has the discretion to refuse to confirm the alteration or to confirm it either wholly or in part or subject to such conditions as may be deemed fit. [Section 17(5)] For example, in a case before the Allahabad High Court, an alteration was confirmed only in part and that too subject to the condition that a separate profit and loss account in respect of the new business should be maintained for a period of five years.
Before the Companies (Amendment) Act, 1974, this power was vested in the court and now has been transferred to the Company Law Board. Now petitions for confirmation of any alteration in the registered office and objects clauses are to be presented to the Board. Pending proceedings will, however, be disposed of by the courts, and this will also include proceedings for the registration of the alteration.
Sine the power of the Board has been expressly declared to be judicial in nature, it is expected that the Board will follow the principles which have been evolved by the courts. In any case, when a matter is brought before the Court under appeal, the same principles will again come into play.
The above procedure has to be followed only for the alteration of the conditions contained in the memorandum. And only those provisions are regarded as conditions as are required by section 13 to be stated in the memorandum, that is, its five clauses. Anything else contained in the memorandum can be altered simply by passing a special resolution.
Registration of Alteration [S.18]
A certified copy of the Board’s order and a printed copy of the altered memorandum must be filed with the Registrar within three months of the Board’s order. Within one month the Registered will certify the registration. Alteration takes effect when it is so registered. If an application for registration is not made within the above time, the whole proceedings of alteration will lapse. In computing the period of three months the time taken for obtaining the copy thereof is to be excluded. The Board has the power to extend time for registering an alteration when there is sufficient cause to excuse the delay.
LIABILITY CLAUSE
The fourth clause has to state the nature of liability that the members incur. If the company is to be incorporated with limited liability, the clause must state that “the liability of the members shall be limited by shares.” This means that no member can be called upon to pay anything more than the nominal value of the shares held by him, or so much thereof as remains unpaid ;and if his shares be fully paid up his liability is nil. If it is proposed to register the company 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. The clause will run like this : “Every member of the company undertakes to contribute to the assets of the company in the event of its being wound up such amounts as may be required, not exceeding one thousand rupees.” [Sections 13(3) and 12 (2) (b)]
CAPITAL CLAUSE
The last clause states the amount of the nominal capital of the company and the number and value of the shares into which it is divided. [Section 13(4) (a)]
SUBSCRIPTION
The memorandum concludes with the subscribes’ declaration. The subscribers declare ; “We, the several persons whose names and addresses 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.” The memorandum has to be subscribed by at least seven persons in the case of a public company and by at least two in the case of a private company. [Section 12] Each subscriber must sign the document and must write opposite his name the number of shares he takes. [Section 15]
But no subscriber shall less than one share. [Section 13(4) (b) and (c) After incorporation no subscriber can withdraw his name on any gound whatsoever. “The subscriber to the memorandum cannot have rescission on the ground that he was induced to become a subscriber by misrepresentation of an agent of the company.” But he may withdraw his name before the memorandum is actually registered as up to that time “there is no contract at all”
