Corporate Law Notes for Vth Semester Students

Course Faculty: Shri Amit Bhaskar

Subject: Corporate Law-1

Mail Id: amitbhaskar19@gmail.com

HIGHLIGHTS OF COMPANIES ACT, 2013

BACKGROUND

• The Companies Act, 1956 which was enacted with the object to
consolidate and amend the law relating to Companies and certain other
associations had been in force for about 55 years and had undergone
several amendments.

• BACKGROUND

• However, a need was felt to enact a new legislation to meet the changed
national and international economic environment and to further
accelerate the expansion and growth of economy. For this Purpose,
Companies Bill, 2009 was introduced in Parliament (Lok Sabha on 3rd
August, 2009. Subsequent to the introduction, the Government received
various suggestions from different quarters. The Bill was referred to
Parliamentary Standing Committee on Finance (which gave report on
31st August, 2010) which also made several suggestions. In view of
several and large suggestions from different quarters and stakeholders
and also including Parliamentary Standing Committee on Finance, the
Government withdrew the Bill and incorporating the recommendations of
Parliamentary Committee and other stake holders, reintroduced the Bill
in Parliament as Companies Bill, 2012 . The Companies Bill, having

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 been passed by both the House of Parliament received the assent of the
President on 29th August, 2013.

Statement of Object and Reasons: Act 2013

• In view of the changes in the national and international economic

environment and expansion and growth of economy of our country, the
Central Government decided to repeal the Companies Act, 1956 and
enact a new legislation to meet the changed national and
international economic environment and further accelerate the growth
and expansion of the economy.

COMPANIES ACT, 2013: It has 470 Sections and 7 Schedules as against 658
Sections and 15 Schedules in the 1956 Act.

HIGHLIGHTS OF 2013 ACT

1) KEY MANAGERIAL PERSONNEL (KMP): Section 2(51) Every listed

company and every other Public Company having paid up share capital of 10
Crores or more will now have to appoint whole time KMP, such as a) Managing
Director or CEO or Manager, b) Whole Time Director c) Chief Financial Officer
4) Company Secretary and such other officers as may be prescribed.

A Company, other than a Company covered above, which has a paid up share
capital of Rs 5 Crore is required to have a full time Company Secretary.

2) CLASS ACTION SUITS: Section 245 of the Companies Act, 2013

provides for Class Action Suit. It says that such number of member or
members, depositor or depositors or any class of them may if they are of the
opinion that the management or conduct of the affairs of the company are
being conducted in a manner prejudicial to the interests of the company or its
members or depositors, file an application before NCLT on behalf of the
members or depositors for seeking any of the following orders: To restrain the
Company from committing any act which is ultra vires the AOA or MOA of the

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Company; to restrain the company from committing breach of any provision of
the company’s memorandum or articles; resolution altering the MoA or AoA is
void as the resolution was passed by suppression of material facts or
misstatement to the members or depositors; to restrain the company from
acting in a manner contrary to the provisions of the Act; to claim damages or
compensation or demand any other suitable action against the company or its
directors for any fraudulent , unlawful or wrongful act or omission or conduct
or any likely act or commission; to seek any other remedy which NCLT may
deem fit; and other provisions also.

3) CORPORATE SOCIAL RESPONSIBILITY (CSR): Section 135 talks about

Corporate Social Responsibility.

Every Company (including its holding and Subsidiary Company), and a Foreign
Company having its branch office in India, having a net worth of 500 Crore or
more, or a turnover of 1,000 Crore or more or a net profit of 5 Crore or more
during any financial year shall constitute a Corporate Social Responsibility
Committee of the Board consisting of three directors with at least one
Independent Directors. The Corporate Social Responsibility Committee shall
formulate a Corporate Social Responsibility Policy which shall indicate the
activities specified in Schedule VII of the Act, which includes activities relating
to promoting education, employment, vocational skills, etc in their operational
local areas. The Act mandates that the concerned Companies have to spend, in
every financial year, at least 2% of the of the average net profits of
immediately preceding three years on CSR Activities if not, then an
explanation has to be cited in the Directors Annual Report.

4) National Company Law Tribunal (NCLT and Appellate Tribunal): Chapter

27 of the Companies Act, 2013 provides for NCLT and NCLAT. The Act
provides for the creation of NCLT and Appellate Tribunal to facilitate speedy
disposal of proceedings. Earlier the High Court was having the jurisdiction to
deal with the matters like M & A, capital reduction, etc…but now all these

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matters will be dealt by the Tribunal and an appeal shall lie to the Appellate
Tribunal from the Tribunal…thus reducing burden on the High Court which at
times was lacking expertise also. Section 419 says that there shall be
constituted such number of benches of the Tribunal as specified by the Central NCLAT -
Sudhansu Jyoti
Government. The Principal Bench shall be at New Delhi which shall be Mukhopadhaya

presided over by the Chairperson of the Tribunal(Currently Justice Mahesh NCLT -

HON'BLE
Mittal Kumar). The NCLT has been constituted with effect from 1st June, JUSTICE SHRI
MAHESH MITTAL
2016. Every effort shall be made to dispose of the petition or appeal before KUMAR

NCLT or NCLAT within 3 months from the date of presentation of Petition or

Appeal. As per Section 423 of the Act, Any person aggrieved by any order of the
Appellate Tribunal may file an appeal to the Supreme Court within 60 days of
the date of receipt of the order of the Appellate Tribunal on any question of law
arising out of such order. Under Section 425, the Tribunal and Appellate
Tribunal may punish for contempt of court. Section 424 says that Tribunal not
bound by CPC but mustfollow the principle of natural justice. They have the
same power as are vested in Civil Court for summoning and enforcing the
attendance of witness; requiring the discovery and production of documents;
receiving evidence on affidavits; issuing commission for the examination of
witness or of document; any other matter which may be prescribed; The
President, Members, Officers shall be the Public Servant within the meaning of
Section 21 IPC as Section 427 Act 2013. Section 428 says that action taken in
good faith to be protected. Section 430 of the 2013 Act says that civil court not
to have jurisdiction in respect of any matter which the Tribunal or Appellate
Tribunal is empowered to determine.

5) VIGIL MECHANISM: Every Listed Company or companies which accepts

deposit from the Public or companies which have borrowed money from the
public financial institutions in excess of 50 Crores have to establish a vigil
mechanism for directors and employees to report genuine concerns. There is a
direct access to the Chairperson of the Audit Committee in appropriate

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cases. Details of such machinery have to be disclosed on the company’s
website and in the report of the Board of Directors.

5) MERGERS AND AMALGAMATION: A fast track procedure for M & A

involving certain classes of companies, such as between a holding company
and its wholly owned subsidiary has been introduced. Approval of the Tribunal
not required if the Official Liquidator, RoC and Government has no objection.

• Mergers of Indian Companies with Foreign Companies now permissible

under new Act with the prior approval of the RBI.

In case of Compromise/arrangement between a listed transferor company and

unlisted transferee company, the Tribunal may now provide that the transferee
company shall remain an unlisted company until become a listed company.
Further, if the shareholder of the transferor company decided to exit, the exit
price cannot be less than the price under any regulations framed by SEBI.

6) DIRECTORS

• Composition in Directorship: The Act introduces the concept of a

residency test of at least (182) days stay in India in the previous
Calendar year for at least one (1) director on the Board of the Company.

• Women Director ( Section 149(1): The Act requires that every listed
company and every other public company having a paid up share capital
of 100 crores or more or a turnover of 300 crores or more, must have at
least One Women Director on its board.

Independent Directors:The Act further requires that at least 1/3rd of the

appointed directors on the Board of a listed company to be independent
directors to ensure transparency and independence in the decision of the
Board. Public companies having a paid up share capital of 10 crores or more;
or having a turnover of 100 crores or more; or which have an aggregate,

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outstanding loans, debentures and deposits, exceeding 50 crores are required
to have a minimum of 2 independent directors in its Board.

• Maximum Limit: The maximum limit on the number of directors for a

public company has been raised from 12 to 15, which may be increased
beyond 15 by shareholders voting with a 75% majority.

Number of Directorships a Person can hold in different Companies:The Act

2013 has increased the number of directorships a person can hold in different
companies. A person can now hold a directorship in 20 companies, as
opposed to 15 mandated under the 1956 Act. Out of these 20 companies, a
person can be a director in maximum of 10 public companies. A transition
period of one year has been allowed for compliance with the requirement.

Independent Directors: The Act stipulates that the Independent Directors

may be selected from a Data Bank of persons eligible and willing, which would
be maintained by Associations or institutions recognized or approved by the
Government of India. The appointment of independent directors has to approve
by the members in general meeting. Directors are not to retire by rotation and
can hold office for up to two consecutive terms of 5 years each following there
would be a three year cooling off period before the director is re-appointed.
Directors would be eligible for sitting fees, commissions from profits (as
authorized at the meeting) and reimbursement of expenses. However, they
would not be eligible for stock options which would be allowed to them
under 1956 Act. The 2013 Act also provides for a Code of Conduct for
Independent Directors, which requires them a description of their roles,
functions, duties, manner of their appointment, resignation, evaluation tests.
The Act also clarifies that a nominee director will not be independent directors.
(Several aspects of the Act are at variance with clause 49 of the Listing
Agreement which all Listed Companies are required to abide by)

Liability of Independent Directors: The Act has drawn a distinction between

the liability of an independent director and a non-executive director from the

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rest of the board. The Act has fixed the liability for independent directors only
for such acts and omission which occurred with his/her knowledge or consent
or connivance or where there has been a lack of diligence.

Duties of Directors: For the First time, the Act 2013 has codified duties of
directors and has included concepts of “acting in good faith”, “ exercise of
due care and reasonable care”, “ skill and diligence”, “ exercise of
independent judgment”, “avoiding conflict of interest”. Section 166 of the
2013 Act defines the duty of directors: It says that it shall act in good faith to
promote the object of the company, in the interest of the company, employees
and its shareholders, the community and the protection of the environment;
shall exercise his duties with due and reasonable care, skill and diligence and
shall exercise independent judgment.; must avoid conflict of interest; no undue
gain or advantage to himself or his relatives, partners or associates, and if
found guilty shall be liable to pay the amount equal to that gain to the
company; Director shall not assign his office and every assignment shall be
void; if contravene, the fine shall be not less than one lakh which may extend
to 5 lakh rupees;

Disqualification of the Directors (Section 164 of the Companies

Act, 2013):New criteria for disqualification of directors have been introduced
in the Act. Amongst others, a director is now disqualified from appointment if
any of the companies on which on which board he had been a director has not
filed any financial statements and annual returns for 3 continuous financial
years or has defaulted in payment of debentures. Every director is to inform to
the company concerned about his disqualification before he is appointed or re-
appointed.

Vacation of Office as a Director ( Section 167 ): Departing from the

1956 Act, the Act 2013 requires a director to vacate his office on a conviction of
any offence involving moral turpitude or otherwise where he is sentenced to
imprisonment for not less than 6 months irrespective of whether the director
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has preferred an appeal against his conviction. Even if he has preferred appeal
against his conviction, he shall vacate the office.

Resignation of Directors (Section 169):Earlier there was no provision

for the resignation of Directors. But now, Section 168 of the Companies Act,
2013 provides for the resignation of the directors. The resignation of a director
has to be placed before the next general meeting of the members. The Company
has to intimate the Registrar and post the information on the website within 30
days of the receipt of the information. Directors have to forward the resignation
along with the reasons for the resignation to the Registrar of Companies, within
30 days of the date of Resignation. This section is not subject to Articles of the
Company. The resignation of the director shall take effect from the date on
which the notice is received by the company or the date, if any, specified by the
director in the notice, whichever is later. (T Murari v. State (1975 Mad HC)
Case- Madras High Court Judgment).

Concept of Resident Directors:

Mandatory Resident Director

Under the Companies Act, 2013 it is mandatory for a company to have at least
1 resident director, at the time of incorporation itself. A resident director is one
who has stayed in India for a period of at least 182 days in the previous
calendar year.

Appointment of Auditors: Unlike appointment at each AGM (Annual

General Meeting) of the Shareholders under the erstwhile 1956 Act, the 2013
Act requires an auditor to be appointed for a period of 5 years and such
appointment must be ratified at AGM.

Rotation of Auditors: Under the 1956 Act, there was no provision for
compulsory rotation of auditors. To ensure independence of the audit process,
the 2013 Act has introduced the concept of mandatory rotation of auditors and

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audit firms. The Act provides that in case of listed companies, all unlisted
public companies have a paid up capital of 10 crores or more, all private
limited companies having a paid up capital of 20 crores or more. And all
companies having paid up capital of below the abovementioned limits but
having borrowing from public financial institutions, banks or public deposits of
50 crores or more , but excluding small companies and one man companies, it
would be mandatory to rotate auditors after one term of 5 consecutive years in
the case of appointment of an individual as an auditor and after 2 terms of 5
consecutive years each in the case of appointment of an audit firm with a
uniform cooling off period of five years in both cases.

Removal of Auditors: The Act empowers the Tribunal to suo motu or an

application from the Central Government or person concerned, direct the
company to change its auditors.

Restriction on Auditors from performing non-audit Services: The 2013 Act

proposes that any services to be rendered by an auditor should be approved by
the Board of Directors or the Audit Committee of the Company. Additionally,
the auditor is restricted from providing non-audit services to ensure
independence and accountability of the auditors. Auditors or the audit firms
providing if it is satisfied that the auditor has, directly or indirectly, acted in a
fraudulent manner or abetted or colluded in any fraud by or in relation to the
company or its directors. The Act 2013 further says that the permission of the
shareholders by way of a special resolution would be required for removing an
already appointed auditor of the company providing non-audit services before
the commencement of the Act have to comply with these provisions before the
closure of the first financial year after the commencement of the Act.

National Financial Reporting Authority (NFRA): ( New Body under 2013

Act): The National Advisory Committee on Accounting and Auditing Standards,
which has been constituted under the 1956 Act to advise the Government on
the formulation of accounting Standards is sought to be replaced by the NFRA

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(National Financial Reporting Authority). The NFRA shall monitor and regulate
the activities of both auditors and companies to enforce compliance of
accounting and auditing standards.

Special Courts: Chapter 28 of the Companies Act, 2013 provides for

establishment of Special Courts. Section 435 says that the Central Government
may for the purpose of speedy trial of offences constitute Special Courts or
designate as many courts as may be necessary. A Special Court shall consist of
a Single Judge who may be appointed by the Central Government with the
concurrence of the Chief Justice of the High Court within whose jurisdiction
the judge to be appointed is to be working. A person shall not be qualified as a
special judge unless immediately before such appointment, holding office of a
sessions Judge or an Additional Session Judge.Section 436 says that
notwithstanding anything contained in CrPC, 1973, all offences under this Act
shall be triable only by the special court established or designated for the area
in which the registered office of the company in relation to which the offence is
committed or where there are more special courts than one for such area, by
such one of them as may be specified in this behalf by the High Court
concerned. Section 436 (3) says that notwithstanding anything to the contrary
in the CrPC, the special court may, if think fir, try in a summary way any
offence under this Act which is punishable with imprisonment for a term not
exceeding three years. Provided that in the case of any conviction in a
summary trial, no sentence of imprisonment for a term exceeding one year
shall be passed. Section 438 says that application of CrPC to proceeding before
the Special Court. Section 439 says that Offences to be non-cognizable
notwithstanding anything contained to the contrary in CrPC, every offences
under this Act except the offence under Section 212 (6) ( it provides for number
of offences to be cognizable) shall be deemed to be non-cognizable offence. Sub-
Section (2) says that no court shall take cognizance of any offence under this
Act which is alleged to have been committed by any company or any officer
thereof , except on the compliant in writing of the Registrar, a shareholder of

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the company, or of a person authorized by the Central Government in that
behalf.

One Person Company (OPC):

Company Law Amendment Act, 2015

The Government of India had received several representations from industry

stakeholders for amending various provisions of the Companies Act, 2013 to
ensure ease of doing business in India. Towards this, the Companies
Amendment Act, 2015 received the assent from the President on 25 May 2015
after both the Houses of Parliament approved the Companies Amendment Act,
2015.

1) No Minimum Paid Up Capital: The minimum paid up share capital

requirement of INR 100,000 ( in case of a Private Company) and INR 500,000
(in case of a Public Company) has been done away with. Consequently, the
definition of Private and Public Companies stand amended. Now, minimum
paid up capital required for incorporating public and private companies.

2) Inspection of Resolution filed with the Registrar: Earlier under Section

117 read with the Section 399 of the Companies Act, 2013, certain resolutions
(all special resolutions, resolutions for terms of appointment of managing
director, winding up resolutions, resolution in relation to the sale of
undertaking/borrowing etc) filed by a Company with the Registrar of
Companies were open for inspection by any person or to obtain copies.

The Companies Amendment Act, 2015 has limited public access of such
resolutions relating mainly to the Strategic Business matters. Such document
will no longer be available for public review or permitted to take copies of. This
addresses the concerns raised by several corporates in India specifically private
companies in terms of exposure of critical business matters in public.

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3) Common Seal Optional: Companies Amendment Act, 2013 required
common optional seal to be affixed on certain documents (such as Bill of
Exchange, Share certificate etc). Now, the use of common seal as been made
optional. Consequently, various provisions of the Companies Act, 2013 dealing
with common seal have been amended.

4) No Declaration for Commencement of Business: Companies Act, 2013

required all companies to file following additional declarations with the
Registrar of Companies prior to commencement of Business or exercise any
borrowing power: I) Declaration by the Director that minimum paid up capital
has been paid; and II) Company has filed verification of Registered Office; The
Companies Amendment Act, 2013 has removed the above requirements and
deleted the Section 11 of the Companies Act, 2013. This reduces the filing to
be made by companies in India.

5) Violation of Acceptance of Deposits: The Companies Act, 2013 introduced

stringent provisions in relation to the acceptance/renewal/repayment of
deposits. However, no specific penalty was prescribed for no-compliance with
the relevant provisions i.e. Section 73 and 76. This lacuna has been filled by
the Companies Amendment Act, 2015. A new Section 76A has been
introduced for the above non-compliances. The defaulting company will be
liable for fine of a minimum amount of INR 1 Crore and a maximum of 10
Crore in addition to the amount of deposit or part thereof, along with interest.
Further, every officer of the Company in default is punishable with
imprisonment which may extend to 7 years or with a fine amounting to a
minimum of INR 25 Lakh maximum of 2 Crore or both. Such officer may
attract additional penalty for fraud under Companies Act, 2013 if the non-
compliance was done knowingly or with intention to deceive the company,
shareholders, depositors, creditors or tax authorities.

6) Reporting by Auditors in Respect of Fraud: The Companies Act, 2013

introduced the reporting obligations on the auditors of the company to the

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central government. If the auditor has reason to believe that a fraud has been
committed by officers or employees of the company irrespective of the amount
involved. The Companies Amendment Act, 2015 has provided that thresholds
will be prescribed for reporting of frauds to the Central Government or the
Audit Committee or the Board of Directors. All such instances of fraud falling
below prescribed threshold will be reported to the board or audit committee
and will need to be disclosed in the annual report of the company instead of
mandatory reporting to the Central Government. The above amendment eases
the administrative burden for the auditors, however, these amendments have
not been notified as yet.

7) Exemptions to Section 185 of the Act 2013: Section 185 includes

restrictions on loans by a Company to a director or other interested persons/
entities. However, the rules prescribed under Section 185 exempted any
loans/guarantee/Security/ by a holding company to its wholly owned
subsidiary, any guarantee or security by a holding company to a financial
institution for loan availed by its subsidiary, provided the loan in each of these
cases is utilized by the subsidiary for its principal business.

The above provisions of the Rules have now been inserted under Section 185 of
the Companies Act, 2015

8) Dividend (sum of money paid regularly (typically annually) by a company to

its shareholders out of its profits (or reserves): Section 123 is an enabling
provision for companies to declare dividend in a financial year subject to
fulfillment of prescribed conditions. The Companies Amendment Act, 2015 has
introduced a new proviso which states that a company cannot declare dividend
for a financial year, unless the losses and depreciation carried over from past
years have been set off against the profits of the company, in the year it
proposes to declare a dividend.

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9) Special Courts: Section 435 read with Section 436 provides the Central
Government the power to set up Special Courts to try offences under
Companies Act, 2013.

By way of the Special Amendment, Special Courts may now only try offences
punishable under Companies Act, 2013 with imprisonment for 2 years or more.
All other offences are to be tried by a Metropolitan Magistrate or a Judicial
Magistrate of the First Class.

Companies (Amendment) Act, 2015 and further changes to the Companies

Act, 2013 (Articles from Nisith Desai Associates, Law Firm, Mumbai)

There have been amendments to certain sections of the Companies Act, 2013
vide the Companies (Amendment) Act, 2015. Further, notification on
exemptions to private companies dated June 5, 2015 has provided certain
important exemptions to private companies bringing in relief to the business
community. Some of the important changes are as follows:

Requirement of having a minimum paid up share capital has been done away
with for public and private companies; The requirement of filing a declaration
before commencement of business has been done away with;A private company
can now freely issue hybrid instruments including preference shares with
differential rights by virtue of its articles. The issuance of shares with
differential rights by a private company are not subject any conditions;
Relaxation is provided with respect to ESOPs i.e. obtaining ordinary resolution
for approval of ESOP Scheme from shareholders in place of special resolution
required earlier; The creation of charge/mortgage on assets of the company to
secure borrowings will not require shareholders’ approval; Section 185 of CA
2013 prohibits companies from advancing loan including in form of book debt,
giving guarantee or security to its directors and to persons in whom directors
are interested. However, the provisions of Section 185 are not required to be
complied with by a private company satisfying the following conditions: in
whose share capital, no other body corporate has invested any money; and its

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borrowings from banks, financial institution or body corporate do not exceed
twice the amount of paid up share capital or INR 50 Crores – whichever is
lower and there are no subsisting defaults in repayment of such borrowings at
the time of making transaction; and there are no subsisting defaults in
repayment of such borrowings at the time of making transaction.

The compliance of Section 185 is exempted for all companies when the
transaction is between holding company and its wholly owned subsidiary and
between holding company and its subsidiary.

COMPANY AND ITS TYPES

§ Company and its Types

§ Limited and Unlimited Companies

§ Company Limited by Guarantee and Company Limited by Shares.

§ Public and Private Companies.

§ Government Companies.

§ Holding and Subsidiary Companies.

§ Associate Companies.

§ Small Companies.

§ Company and its Types

§ Foreign Companies.

§ Dormant Companies.

§ One Man Company( OMC) ( New Concept under Act 2013)

§ Nidhi Company ( Sec 406 Companies Act, 2013)

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 § Formation of Company with Charitable Object: Section 8 of the
2013 Act.

Limited and Unlimited Companies

§ Limited Company: One of the main purposes of the Companies Act is to

confer upon the business community the privilege of trading with limited
liability. A “Company Limited by Shares” is defined in Section 2(22) of
the 2013 Act as means a company having the liability of its members
limited by the memorandum to the amount, if any, unpaid on the shares
respectively held by them.

“Unlimited Company” is defined in Section 2 (92) means a company not

having any limit on the liability of its members. It must be remembered that
the right of limited liability is desirable but not the necessary adjunct to
incorporation. Companies with unlimited liability are rarely formed now but
such a company is definitely a suitable choice in case where heavy liabilities
are not to be incurred and other advantages of separate corporate personality
are desired. The Unlimited Company corresponds to the Partnership firm. The
obvious disadvantage of an unlimited company is that its members are liable
like the partners of a firm for all its trade debt without any limitation of
liability. For ex, if they fails to pay its debt, the creditor can proceed against the
company and resort to winding up and liquidators can proceed against the
members to pay the debts due to the creditors. Advantages of Unlimited
Companies: It need not have any share capital. And if it has, it may increase
or reduce its capital without any restriction. And it may .purchase its own
shares as Section 67 does not apply to the case of unlimited companies.
However, an unlimited company can get itself re-registered as a limited
liability company under Section 18 of the Act. This conversion will not affect
any debts, liabilities, obligations or contracts of the company existing at the
time of conversion.

Company Limited by Guarantee

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 § A Company limited by Guarantee means a company having the liability
of its members limited by the memorandum to such amount as the
members respectively undertakes to contribute to the assets of the
company in the event of it being wound up.

§ Whenever a Company is registered with Limited Liability, the choice is

upon the promoters to limit is to by Shares or by Guarantee. The
liability of the members of a guarantee company is limited by a fixed sum
which is specified in the memorandum and beyond which they cannot be
called upon to contribute. The memorandum of a company limited by
guarantee has to state the that each member undertake to contribute to
the assets of the company in the event of its being wound up for the
purpose of payment of the debts and obligations of the company, such
amount as may be required not exceeding a specified amount. It is not
necessary for the Guarantee Company to have any share capital. But if it
has share capital, it is subject to the same restriction as to the reduction
of its capital limited by the shares. It also does not have the liberty to
purchase its own shares.

Public and Private Companies

Public Company is defined in Section 2(71) of the Companies Act, 2013

which says that Public Company means a Company which is-

a) Not a Private Company;

b) Has a minimum paid up share capital of 5 lakh rupees (minimum paid

up requirement done way with in Companies Amendment Act, 2015 for
both public and private companies) or such higher paid up capital, as
may be prescribed.

Provided that a company which is a subsidiary of a Company, not being a

private company, shall be deemed to be public company for the purposes of

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this Act even where such subsidiary company continues to be a private
company in its articles.

Section 2(68) of the 2013 Act defines the “Private Company” (minimum
person required to form it is 2) which means a company having a minimum
paid up share capital of one lakh rupees or such higher paid up share capital
as may be prescribed, and which by its articles ( the restriction is
contained in Articles of Association),

a) Restricts the right to transfer its shares;

b) Limits the number of its members to 200;

c) Prohibits any invitation to the public to subscribe for any securities of

the Company. ( Prohibition on the issue of Prospectus) (the company
must prohibit invitation to the public to subscribe for any shares or
debentures of the company. The Company should prohibit any invitation
or acceptance of deposits from persons other than its members, directors
or their relatives). A Private Company is very suitable for carrying as the
business of a family and small scale concerns.

Thus, a Private Company is characterized by:

a) Minimum Paid up Capital of 1 lakh Rupees or such higher amount as

may be prescribed;

b) Restriction on the Transferability of Shares;

c) Restriction on the number of members ( 200);

d) Prohibition on the issue of Prospectus (no invitation from the Public).

The Act 2013 applies to private companies in all respects except where they
are expressly exempt from its operation. That’s why Private Company is
described as “an incorporated Partnership” combining the advantages of

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 both elements- the privacy of Partnership and the Permanence and origin of
the Corporate Constitution.

§ Advantages of Private Company

1) Subscription: The formation of a private company requires only a minimum

of two subscribers to the memorandum. The objective is to facilitate
harmonious functioning of private company and make it suitable for family or
friendly concerns.

2) Exemption from Prospectus Provisions: Since Private Companies are

prohibited from public participation by issue of prospectus, it is, therefore,
exempt from all the requirements of the Act relating to the Prospectus. It can
proceed to allot shares without having to wait for anything as Minimum
Subscription.

3) Regarding Directors (Section 152): Regarding the appointment of

Directors, a Private Company is entitled to certain beneficial exemptions. For
example, it is required to have only two directors. All its directors can be
permanent life directors; the requirement by rotation does not apply. All the
directors can be appointed en bloc by a single resolution. The special 14 days
notice required by Section 160 for the appointment of a new director in place of
retiring one does not apply to the case of a Private Company. No director of a
public company can act as a director unless he has within 30 days of his first
appointment signed and filed with the Registrar his consent in writing to act as
such director. This provision does not apply to a Private Company. Restriction
as to remuneration also does not apply.

4) Further issue of Capital: Under Act 2013 (Sec 62), a public company
proposing to increase its subscribed capital by allotment of further shares,
must, in certain cases, offer them to the existing members. But, the section
does not apply to a Private Company which is, therefore, free to allot new
issues to the outsiders.

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5) Disclosure of Interest: Another important exemption is related to
Disclosure of Interest. In a public company, an interested director is refrained
from participating in voting at Board’s Proceedings. But, a private company is
exempted from it and there is no obligation to retire from a meeting of the
Board in which the subject matter of his interest is discussed. He may
participate in the proceeding and exercise his vote.

§ Conversion of a Private Company into Public Company

1) Conversion by Default: A Private Company enjoy these privileges as long as

it comply with the definition contained in Section 2(68) of the Act. When a
default is made in complying with any provisions of Section 2(68), the
Company would be cease to be private and whole of the Act would apply to it as
if it were not a private Company.

2) Conversion by Choice: A Private Company may become a Public Company

by choice also. It may at any time pass a special resolution deleting from its
Articles the requirements of Section 2(68) and then, from the date of
alteration, it becomes a Public Company. And then it has to comply with all
requirements, such as, the number of shareholders and directors to a statutory
minimum. (Please look at Section 14 of 2013 Act, (Alteration of Articles): It
says a Company may by Special Resolution alter its Articles including
alterations having the effect of conversion of a) Private Company into Public
Company; and b) Public Company into a Private company.

§ Conversion of a Public Company into Private Company

§ A Public Company can also be converted into Private Company if a

Special Resolution is passed to that effect and alteration done in the
Articles of Association of the Company Secondly, no such alteration in
Article shall have effect unless such alteration has been approved by
the Tribunal.

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 § However such conversion from one to another does not change the
identity of the company( Bombay High Court AIR 1961 Bombay 292)

Government Company

Government Company is defined in Section 2(45) of the Companies Act,

2013. It means any Company in which not less than 51% of the Paid Up
Share capital is held by the Central Government, or by any State Government
or Governments, or partly by the Central Government and partly by one or
more State Governments, and includes a company which is the subsidiary
Company of such a Government Company.

Takeover of the management of a company by the Central Government under

the provisions of the Industries (Development and Regulation) Act, 1951
does not have the effect of converting the company into a Government
Company.

Please note that Industries (Development and Regulation) Act, 1951 is an

important Central Act in India to regulate and promote the industries in India
and it also provides for takeover by the Government of India of certain
Industrial concerns.

Special Provisions Relating to the Government Companies: The Auditor of

a Government Company shall be appointed or re-appointed by the Comptroller
and Auditor General of India (CAG) ( Section 139-143) who shall also direct as
to how the accounts of the company shall be audited and give the necessary
instructions to the Auditors. The CAG can also conduct Supplementary or
Test Audit of the Company’s accounts by such person as may be authorized in
this behalf by the CAG. The Auditor of a Government Company is required to
submit a copy of the Audit Report to the CAG who shall have the right to
comment upon it. Any Such comment shall be placed before the AGM of
the Company along with the Auditor Report. Where the Central
Government is a member of the Government Company, it is the duty of the

21

Central Government to prepare an annual report on the working and affairs of
the company. The report must be ready within 3 months of the Company’s
AGM before which the Audit Report is placed. The Report is laid before both
the House of Parliament and a copy submitted to the CAG.

Holding Company and Subsidiary Company

§ Holding Company is defined in Section 2(46) which says that holding

company in relation to one or more other companies, means a company
of which such companies are subsidiary companies.

§ Subsidiary Company is defined in Section 2(87) of the Act 2013, which

defines it as Subsidiary Company or Subsidiary. In relation to any other
company ( that is to say holding Company) , means a company in which
the holding company -

a) Controls the composition of the Board of Directors;

b) Exercises or controls more than one-half of the total share capital either
at its own or together with one or more of its subsidiaries companies:
Provided that such class or classes of holding companies as may be
prescribed shall not have layer of Subsidiaries beyond such numbers as
may be prescribed.

Explanation: for the purpose of this clause,-

a) A company shall be deemed to be a subsidiary company of the holding

company even if the control referred to in sub-clause (i) or Clause (ii) is of
another subsidiary company of the holding company;

b) the composition of a company’s Board of Directors shall be deemed to be

controlled by another company if that other company by exercise of some
power exercisable by it at its discretion can appoint or remove all or a majority
of the Directors.

22

c) The expression “Company” includes anybody corporate;

d) “layer” in relation to a holding company means its subsidiary or subsidiaries;

Holding Company: Where one Company has control over another, it is called
Holding Company and controlled company is called the Subsidiary Company.
One Company is said to have control over another within the meaning of
Section 2(87) in the following Cases:

a) Firstly, when one company controls the

§ Board of Directors of another Company. A company controls the

composition when it has the power to appoint, remove the majority of the
directors of that other and it is said to have these powers when a person
cannot be appointed to a directorship without its support or if a person‘s
appointment to directorship automatically follows upon his appointment
as a director or a manager in the holding company or if the directorship
is held by individual nominated by the holding company or any of its
subsidiaries.

Secondly, where one company holds the majority of shares in another

company which it is deemed to have when it controls more than half of the
total voting power in the Company.

Thirdly, where the holding company’s subsidiary has its own subsidiary, it
becomes the subsidiary of the first mentioned company. As an example, the
Section contains this illustration. Company B is the subsidiary of Company A
and Company C is the subsidiary of Company B. Company C is a subsidiary of
Company A. If the Company D is a subsidiary of Company C, Company D will
be the subsidiary of Company B and Consequently also of Company A and so
on.

Financial Statement (Section 129 (3) of the 2013 Act): It says that where a
company has one or more subsidiaries, it shall, in addition to financial

23

statements provided under Sub-Sec 2, prepare a Consolidated Financial
Statement of the Company and all of its subsidiaries in the same form and
manner as that of its own which shall also be laid before the AGM of the
Company along with the laying of its Financial Statement under Sub-section
(2).

Section 19: Subsidiary Company not to hold shares in Holding Company:

No Company shall, either by itself or through its nominees, hold any shares in
its holding company and no holding Company shall allot or transfer its shares
to any of its subsidiary companies and any such allotment or transfer of
shares of a company to its subsidiary company shall be void.

Provided that nothing is this sub-section shall apply to a case:

a) Where the Subsidiary Company holds such shares as the legal

representatives of a deceased member of the holding company: or

b) Where the subsidiary company holds such shares as a trustee; or

c) Where the subsidiary Company is a shareholder even before it became a

subsidiary company of the holding company.

Associate Company

§ Associate Company: Section 2(6) of the Act 2013 defines “Associate

Company”, in relation to another company, means a company in which
that other company has a significant influence but which is not a
subsidiary of the company having such influence and includes a joint
venture company.

§ Joint Venture

§ When two companies or parties (even partnership firm) come together to

take on a new project, it is called Joint Venture. In a joint venture, both
parties equally invest in the project in terms of money, time and effort to

24

 build on the original concept. Since, the cost of starting new project is
generally high, the joint venture allows both parties to share the burden
on the project as well as the profit.

Small Company

“Small Company”: it is defined in Section 2(85) of the Companies Act, 2013

which says that it means a company, other than a public company,-

i) having Paid up share capital of which does not exceed 50 Lakh rupees
or such higher amount as may be prescribed which shall not be more
than 5 Crore rupees;

II) Turnover of which as per its last profit and loss account does not exceed 2
crore rupees or such higher amount as may be prescribed which shall not be
more than 20 crore rupees:

Provided that nothing in this clause shall apply to

a) A holding or subsidiary company;

b) A company registered under Section 8 ( Formation of Company with

charitable objects)

c) A company or body corporate governed by any Special Act.

§ Foreign Company

Section 2(42) of the Act 2013, defines “Foreign Company” means any
company or body corporate incorporated outside India which –

a) Has a Place of Business in India whether by itself or though an agent,

physically or through electronic mode; and

b) Conducts any business activity in India in any other manner; The Term
“Place of business” has been judicially construed in a number of cases.

25

 A Canadian Railway Company’s four directors were in England who
formed a London Committee for the purpose of raising loans for the
construction of railway company in Canada. They were using the office of
another company without rent and transacted no other business than
that of raising loans. The Court of Appeal held that the defendants were
carrying on their business in the office used by the London Committee
could therefore properly served with a writ ( A S Dampskib “Hercules”
v. Grand Trunk Pacific Railway Company ( 1912) KB 222, 223). In
the pictorial words of LJ Buckley said, “ We have only to see whether the
corporation is “ here”, if it is so, it can be served. The best test is to
ascertain whether the business is carried on here and at a defined place.
In the present case, the company has a Paramount object; to run railway
in Canada and for that purpose raise money which was its subsidiary
object. The raising of this loan capital is a part of the company’s business
and it is done here by a London Committee consisted of the Director’s
resident in London.” Similarly, where an overseas bank hired premise in
England had some staff over there for the purpose of conducting external
trade and financial relations that was held to be a “Place of Business”
though no actual banking transaction was taken up there (South India
Shipping Corporation Limited v Export Import Bank of Korea
(1985) ALL ER 219). A company established no office in England but
enlist 500 residents in the UK as member of its Titan Business Club so
as to enable them to earn by chain system. This was held to be sufficient
to give jurisdiction to the English Courts to entertain a petition for
winding up of the foreign company. The Company’s employees were
restrained from remitting any funds to the Germany (1996 ALL ER 933).
But where a Foreign Company posted a representative in India only for
the purpose of eliciting orders from the company’s customers, that was
held to be not establishing a place of business in India. The Court said
that there should be a fixed and definite place where the business like
operation are carried on for a reasonably long period of time (P J
26

 Johnson vs. Astro Amradorn (1989) 3 CLJ 5,10 Kerala). What has to
be shown in every case is that the business which was carrying on at the
relevant location was the business of the company itself.

Listed and Unlisted Companies

§ Section 2(52) of the Companies Act, 2013 defines “Listed Companies”

as a company which has any of its securities listed on any recognized
stock Exchange. The SEBI gets the jurisdiction to deal with such
Companies and they have to abide by the SEBI Regulations.

Unlisted Companies” are those which are not listed on any recognized
stock exchange.

Dormant Company

§ Section 455 of the Companies Act, 2013 defines Dormant Company.

Clause (1) says that when a company is formed and registered under this
Act for a future project or hold an asset or intellectual property and has
no significance accounting transaction , such a company or an inactive
company may make an application to the Registrar in such manner as
may be prescribed for obtaining the status of a dormant company.

Explanation: i) “inactive Company” mean a company which has not been

carrying on any business or operation, or has not made any significant
accounting transaction during the last two financial years, or has not filed
financial statements and annual returns during the last two financial years.

II) “Significant Accounting Transaction”: means any transaction other than-

§ a) payment of fees by a company to the Registrar;

§ b) payment made by it to fulfill the requirements of this Act or any other

law;

§ c) allotment of shares to fulfill the requirements of this Act;

27

 § d) payments for maintenance of its offices and records;

(2) The Registrar on considerations of the application allow the status of a

dormant company to the applicant and issue a certificate in such form as may
be prescribed to that effect;

(3) The Registrar shall maintain a register of dormant companies in such form
as may be prescribed.

(4) In case of a company, which has not filed financial statements or annual
returns for two financial years consecutively, the Registrar shall issue a notice
to that company and enter the name of such company in the register
maintained for dormant companies.

(5) A dormant company shall have such minimum number of its directors, file
such documents and pay such annual fee as may be prescribed to the
Registrar to retain its dormant status in the register and may become an active
company on an application made in this behalf accompanied by such fees and
documents as may be prescribed.

(6) The Registrar shall strike off the name of a dormant company from the
register of dormant companies, which has failed to comply with the
requirements of this Section.

ONE PERSON COMPANY

• A new business vehicle in the form of OMC has been introduced by

Companies Act, 2013 which dispense with the need to incorporate a
company with a minimum of two shareholders which is currently the
case. Requirement of the Law is that One Person Must be a Natural
Person; Must be Indian Citizen; and who must have stayed in India for
more than 182 days during the immediately preceding one. It would
encourage Entrepreneurship and Corporatization of business.

Dr JAMSHED J. IRANI COMMITTEE:

28

The J J Irani Expert Committee was set up by the Ministry of Corporate Affairs
to advise the Government on New company Law under the Chairmanship of Dr
Jamshed J Irani. The Committee took a comprehensive review of the
Companies Act, 1956 in the context of present economic and business
environment. The Chairperson in its letter to the then Minister of Corporate
Affairs Shri Prem Chandra Gupta, while submitting the Report on 31st May,
2005, said that the effort of the committee has been aimed at making India
globally competitive in attracting investments from abroad by suggesting
system in Indian corporate environment which are transparent, simple and
globally acceptable. As regards, One Person Company, the committee said that
with increasing use of IT and computers, emergence of the service sector , it is
the time that the entrepreneurial capabilities of the people are given an outlet
for participation in economic activity. Such economic activity may take place
through the creation of a economic person in the form of a company. Yet it
would not be reasonable to expect that every entrepreneur who is capable of
developing his ideas and participating in the market place should do it through
an association of persons. The Committee said that it feels that it is possible
for individuals to operate in the economic domain and contribute
effectively...To facilitate this; the Committee recommends that the law should
recognize the formation of a single person economic entity in the form of One
Person Company. Such an entity may be provided with simpler regime
through exemptions so that the single entrepreneur is not compelled to fritter
way his time, energy and resources on procedural matters, the Committee said.
The Committee recommended that One Person Company should be formed
with following characteristics:

a) The OPC may be registered as a Private Company with one member and
at least one directors;

b) Adequate Safeguards in case of death/ disability of the sole person

should be provided through appointment of another individual as
Nominee Director. On the demise of the original director, the nominee
29

 director will manage the affairs of the company till the date of the
transmission of shares to the legal heirs of the demised members.

c) Letters OPC to be suffixed with the name of the OPC to distinguish it from
other companies to unleash the entrepreneurial talent of the people in
Information Technology (IT), the Committee recommended that Law should
recognize One Man Company (OMC).

Section 2 (62) of the Companies Act 2013 defines OMC as means a company
which has only one person as a member; The Company will be a private
company and all the provisions applicable to private Companies will be
applicable to them except the provisions of minimum number of two persons.

Section 3 of the Companies Act, 2013 talks about formation of the Company.
Clause 1 says that a company may be formed for any lawful purpose by –

a) Seven or more persons, where the company to be formed is a public

company;

b) Two or more persons, where the company to be formed is 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; (Thus, Every OMC is a Private Company); by
subscribing their name or his name to a memorandum and complying with the
requirements of the Act. Section 3 further says that the memorandum of OPC
shall indicate the name of the other person, with his prior 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 (nominee) and the
written consent of such person shall be filed with the Registrar of the Company
at the time of the incorporation of the company along with its memorandum
and articles. Provided further that such other person may withdraw his
consent in such manner as may be prescribed.

30

Provided further that the member of OMC may at any time change the name of
such other person by giving notice in such manner as may be prescribed.
Provided also that it shall be the duty of the member of OPC to intimate the
company of the change in the name of the other person nominated by him and
the Company shall intimate to the Registrar any such changes within such
time and in such manner as may be prescribed.

NIDHI COMPANY

§ “Nidhi” means a company which has been incorporated as a Nidhi with

the object of cultivating the habit of thrift and savings amongst its
members, receiving deposits from, and lending to, its members only, for
their mutual benefit, and which complies with such rules as are
prescribed by the Central Government for regulation of such class of
companies. [Section 406 of the Companies Act 2013].

§ Law relating to Nidhi Companies is the Nidhi Rules 2014. These rules
apply to –

§ every company which had been declared as a Nidhi or Mutual Benefit

Society under sub-section (1) of Section 620A of the Companies Act,
1956;

every company functioning on the lines of a Nidhi company or

Mutual Benefit Society but has either not applied for or has applied for
and is awaiting notification to be a Nidhi or Mutual Benefit Society under
sub – Section (1) of Section 620A of the Companies Act, 1956; and

§ Every company incorporated as a Nidhi pursuant to the provisions of

Section 406 of the Act. [Rule 2 of the Nidhi Rules 2014]

Two Important Expert Groups on Nidhi Company:

§ Sabanayagam Committee dealing with the regulatory framework of

Nidhi Company (Ex Chairman, Income Tax Settlement Commission).

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 § Reports of the Expert Group on Nidhi Companies. (Download the
Report from Ministry of Corporate Affairs Website);

Charitable Company (Section 8 of the Act 2013): A Charitable Company is a

company having its object:

a) has in its objects, the promotion of commerce, art, science, sports,

education, research, social welfare, religion, charity, protection of environment
or any such other object;

b) Intends to apply its profit, if any, or other income in promoting its object;

c) Intends to prohibit the payment of any dividend to its members;

Such Company shall be a limited company; If the Central Government is

satisfied, it may issue a license on such terms and conditions as it may deem
fit; After receiving the application the Registrar shall, on application, in the
prescribed form, register such person or association of persons as a Company
under Section 8.

Clause (2) says that the Company registered under this section shall enjoy all
the privileges and be subject to all the obligations of limited company.

Clause (3) says that a firm may be a member of the company registered under
this section;

Clause (4) (1) says that a company registered under this section shall not alter
the provisions of its memorandum or articles except with the previous approval
of the Central Government;

Clause (4) (2) says that a company registered under this Section may convert
itself into a Company of any other kind only after complying the such
conditions as may be prescribed

PROSPECTUS

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 • A Public Company and not a Private Company is entitled by issuing a
prospectus to invite application for its shares and debentures.

“Prospectus” (Section 2(70) of Act 2013 defines it) means any document
described or issued as a prospectus and includes a red herring prospectus
referred to in Section 32 or shelf prospectus referred to in Section 31 or any
notice, Circular, advertisement or other document, inviting offer from the
public for subscription or purchase of any securities of a body corporate. ( A
Very Basic Document like a School Prospectus).

• Types of Prospectus

• Abridged Prospectus

• Red Herring Prospectus

• Shelf Prospectus

• Abridged Prospectus…..

Abridged Prospectus means a memorandum containing such salient features

of a prospectus as may be specified by SEBI by making Regulation ( Section
2(1) of the 2013 Act. The purpose is to reduce the expense burden of a public
issue. The full and Complete Prospectus has to be maintained in the office of
the Company. Section 33 says that No application Form for the purchase of
any of the securities of a company shall be issued unless such form is
accompanied by an Abridged Prospectus. The Prospectus says that nothing in
this sub-section shall apply if it is shown that the form of application was
issued -

..a) in connection with a bonafide invitation to a person to enter into an

underwriting agreement with respect to such securities;

b) In relation to securities which were not offered to the Public.

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(2) Section 33 says that A Copy of the Prospectus shall, on a request being
made by any person before the closing of the subscription list and the offer, be
furnished to them;

(3) If a company makes any default in complying with the provisions of this
section, it shall be liable to a penalty of Rs 50,000 for each default.

• Shelf Prospectus ( Section 31)

A company filing shelf prospectus with the Registrar shall not be required to
file prospectus afresh at every stage of the offer of securities by it within a
period of validity of such shelf prospectus. Shelf Prospectus or shelf offering is
a type of public offering where certain issuers are allowed to offer and sell
securities to the public without a separate prospectus for each act of offering.

Shelf Prospectus (Sec 31) Section 31 of the Act 2013 talks about “Shelf
Prospectus”. The Explanation to Section (in the last) defines the expression
“Shelf Prospectus” as it means a prospectus in respect of which the securities
or class of securities included therein are issued for subscription in one or
more issues over a certain period without the issue of further prospectus.

Clause (1) Any class or classes of companies , as the SEBI, may provide by
regulations in this behalf, may file a shelf prospectus with the Registrar at the
stage of the first offer of the Securities which shall include a period not
exceeding one year as the period of the validity of such prospectus which shall
commence from the date of the opening of the first offer of such securities
under that prospectus, and in respect of a second or subsequent offer of such
securities issued during the period of validity of that prospectus, no further
prospectus is required.

• Clause (2): A company filing a shelf prospectus shall be required to file

an information memorandum containing all material facts relating to
new charges created, changes in the financial position of the company as
have occurred between the first offer of securities and such other charges

34

 as may be prescribed, with the Registrar within the prescribed time, prior
to the issue of a second or subsequent offer of securities under the shelf
prospectus.

Shelf Prospectus

Provided that where a company or any other person has received applications
for the allotment of securities along with advanced payments of subscription
before the making of any such charge, the company or other person shall
intimate the changes to such applicants and if they express a desire to
withdraw their application, the company or other person shall refund all the
monies received as subscription within fifteen days thereof.

(3) Where an information memorandum is filed, every time an offer of

securities is made under sub-section (2) , such memorandum together with the
shelf prospectus shall be deemed to be a prospectus.

Red Herring Prospectus…Section 32

Explanation to Section 32 says that Red herring Prospectus means a

prospectus which does not include complete particulars of the quantum or
price of the securities included therein.

Clause (1) of the section says that a company proposing to make an offer of
securities may issue a red herring prospectus prior to the issue of a
prospectus. Clause (2) says that a Company proposing to issue a red herring
prospectus shall file it with the Registrar at least 3 days prior to the opening of
the subscription list and the offer. Clause (3) says that a red herring
prospectus shall carry the same obligations as are applicable to a prospectus
and any variation between the red herring prospectus and a prospectus shall
be highlighted in the prospectus.

Clause (4) says that upon the closing of the offer of securities , the prospectus
also stating therein the total capital raised, whether by way of debt or share

35

capital, and the closing price of the securities and any other details that are
not included in the red herring prospectus shall be filed with the Registrar and
the SEBI.

Prospectus: Purpose

The Purpose is to have an informed investor(s) and to prevent deception or

exaggeration by providing true account of the state of affairs (financial as well
as non-financial) of the company to the prospective investors.

A Copy of the Prospectus has to be given to the person who request for it before
closing of the offer and the subscription list( Section 33 (2).It further says that
if the company makes default in complying with the provisions of this section,
it shall be liable to pay a penalty of 50,000 Rupees for each default.

Application Form (Section 33) : The Law says that an application form for
securities cannot be issued unless they are accompanied by a memorandum
containing such salient feature of the Prospectus as may be prescribed. This is
known as Abridged Prospectus. The aim is to reduce the expense burden of
the public issue. The Full “Prospectus” has to be maintained in the office of the
company.

• Section 25 of the Act 2013 lays down the important law and it says
that Document containing offer of securities for sale to the Public
shall be a deemed Prospectus. Sub-Section (1) says that Where a
company allots or agrees to allot any securities of the company with a
view to all or any of those securities being offered for sale to the public..

…, any document by which the offer for sale to the public is made shall, for all
purposes, be deemed to be a prospectus issued by the company; and all
enactments and rules of law as to the contents of the prospectus and as to the
liability in respect of misstatements, in and omission from the prospectus or
otherwise relating to the prospectus shall apply with modifications.

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 • Section 26: Matters to be Stated in Prospectus

• Name and Address of the Company, dates of the Opening and Closing of
the issues, A separate Bank Accounts where all monies out of the issues
are to be kept, Details about Underwriting of the issues, Consent of the
directors, auditors, bankers to the issue, the authority for the issue and
the details of the resolution passed, procedure and time schedule for the
allotment and issue of securities, main objects of public offer, main
objects and present business of the company and its location,
particulars relating to management perception of the risk factor specific
to the project, gestation period of the project, extent of progress made in
the project any litigation or legal action pending or taken by a
government department or a statutory body during the last five years
immediately preceding to the year of the issue of the prospectus against
the promoter of the company, minimum subscription, details of the
directors, Financial Statements: Report by the Auditors, Profit and Loss
Reports, Reports about the business or transaction to which the
proceeds of the Securities are to be applied directly or
indirectly…etc.(Detailed information about financial and non–Financial
state of affairs of the Company which will influence a prudent mind in
making a choice about the investment in the company.

Criminal Liability for Misstatement in Prospectus

• Section 34 of Act 2013: Criminal Liability for Mis-statement in

Prospectus: Where a prospectus issued, circulated or distributed under
this Chapter , includes any statement which is untrue or misleading in
form or context in which it is included or where any inclusion or
omission of any matter is likely to mislead , every person who authorizes
the issue of such prospectus shall be liable under Section 447;

Section 447 deals with Punishment for Fraud; It says without prejudice to
any liability including repayment of any debt under this Act or any other law

37

 for the time being in force, any person who is found to be guilty of fraud
(look Section 17 of Indian Contract Act) shall be punished with
imprisonment for a term which shall not be less than 6 months but which
may extend to 10 years and shall also be liable to fine which shall not 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. The Explanation defines Fraud in relation to the affairs of the
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 ( defined in the same Explanation)

Civil Liability for Mis-statement in Prospectus: Section 35

Section 35: Civil Liability for Mis-statement: (1) Where a Person has
subscribed for securities of a company acting on any statement included, or
the inclusion or omission of any matter , in the prospectus which is misleading
and has sustained any loss or damage as a consequence thereof, the company
and every person who-

a) Is a director of the Company at the time of the issue of the prospectus;

b) Has authorized himself to be named and is named in the prospectus as a

director of the company, or has agreed to become such director, either
immediately or after an interval of time;

c) Is a promoter of the Company;

d) Has authorized the issue of the Prospectus;

e) is an expert referred to in Sub-Section (5) of Section 26;

38

Shall without prejudice to any punishment to which any person may be liable
under Section 36, (it provides punishment for fraudulently inducing any
person to invest money) be liable to pay compensation to every person who has
sustained such loss or damage;

(2) No Person shall be liable under Sub-section(1), if he proves-

• Continue…

..a) that , having consented to become a director of the company , he withdrew

his consent before the issue of the prospectus, and that it was issued without
the authority or the consent;

b) That the prospectus was issued without his knowledge or consent, and that
on becoming aware of its issue, he forthwith gave a reasonable public notice
that it was issued without his knowledge or consent.

• Continue……

(3) Notwithstanding anything contained in this section, where it is proved that

a prospectus has been issued with intent to defraud the applicants for the
securities of a company or any other person or for any fraudulent purpose ,
every person referred to in sub-section(1) shall be personally responsible,
without any limitation of liability, for all or any of the losses or damage that
may have been incurred by any person who subscribed to the securities on the
basis of such prospectus.

Now Look at Section 36 of the Act 2013 which talks about Punishment for
fraudulently inducing Persons to invest money. It says any person who, either
knowingly or recklessly … ..makes any statement, promise or forecast which
is false, deceptive or misleading or deliberately conceals any material facts, to
induce another person to enter into , or to offer into –

a) any agreement for, or with a view to acquiring, disposing of, subscribing

for or underwriting securities ;

39

b) Any agreement the purpose or the pretended purposes which is to secure a
profit to any of the parties from the yield of securities or by reference to
fluctuations in the value of securities;

c) Any agreement for, or with a view to, to obtaining credit facilities from any
bank or financial institutions shall be liable under Section 447.

• Section 37: Action by Affected Persons: A suit may be filed or any

other action may be taken under Section 34 or Section 35 or Section 36
by any person, group of persons or any person of associations of persons
affected by any misleading statement or the inclusion or omission of any
matter in the Prospectus.

Remedies for Misrepresentation

• 1) Damages For Deceit: Those who issued a prospectus with fraudulent

statements are liable to pay damages to anyone who purchased shares
on the faith of the prospectus. The Famous case of Derry v. Peek (1889)
AC. The prospectus of the company stated that the company had been
authorized to use steam power in moving its trams. The authority was in
fact subject to the approval of the Board of Trade, which refused its
approval. Yet the directors were held to be not liable because they were
honest, whereas the fraud requires a statement which is false and
misleading to the knowledge of the maker or which he does not believe it
to be true. The Directors were held not liable in this case. However, the
acquittal of the directors by the House of Lords caused widespread
resentment and within a year, the British Parliament passed the
Directors Liability Act, 1890 which makes the directors liable for false
statements although they might believe it to be substantially true.

Derry v. Peek Facts: The Plymouth, Devonport and District

Tramways company’s prospectus stated that the company had
permission to use steam trams (trams run by stem engine or mechanical

40

 power), rather than horse powered ones. In fact, it did not because the
right to use steam power was subject to the Board of Trade’s (the
function of the Board is to promote trade in UK and to promote economic
activity in UK) consent. The company applied, honestly believing that
they would get it because permission was a mere formality. In fact, after
the prospectus was issued, they did not get permission of the Board of
Trade and the Company was wound up. Shareholders, represented by Sir
Henry Peek, who had purchased their stakes in the company on the
faith of the statement, sued when the company. Peek sued for tort of
deceit. The tort of deceit would have been established only if the
misstatements had been fraudulently made. That is, for there to be deceit
or fraud (which is the same) it must be shown that a defendant knows a
statement is untrue, or has no belief in its truth, or is reckless as to
whether it is true or false. (Test laid down by Lord Herschel) The court
said that for the establishment of deceit, misrepresentation alone is not
enough to prove liability. In this case, Plaintiff relied on the prospectus,
which may have been misrepresentation, but Defendants reasonably
believed they could get approval of the board of trade and should not be
held liable for their later failure to do so. Directors were not made liable
under tort of deceit by House of Lords.

This was the law laid down in Section 62 of the Companies Act, 1956 and now
in Section 35 of the Act 2013 which talks about Civil Liability for
Misstatement in Prospectus. Four types of Persons are liable under this
Section:

a) Every person who is a director at the time of the issue of the prospectus.

b) Every person who has authorized himself to be named as a director in

the prospectus.

c) Every person who has authorized the issue of the prospectus….

41

 d) Every person who is an expert referred to in Section 26(5).

Liability is Joint and Several: (the aggrieved party may sue anyone or all of
them and the person who is made liable may recover contribution from the
others equally guilty. They are liable to compensate investor(s) for any loss
sustained by him by reason of any statement subject to the defence that may
be allowed.

2) Rescission for Misrepresentation: The Shareholders can also sue the

company for the rescission of the contract. Under this, the contract is cancelled
and the money given by the shareholders refunded. Section 75 of the Indian
Contract Act, 1872 will come into picture which says that a person who
lawfully rescinds a contract is entitled to compensation for any damage which
he has sustained through non-fulfillment of the contract. This right is lost in
the following circumstances:

a) Affirmation: If the allottee with full knowledge of the misrepresentation,

upheld the contract, he cannot afterwards rescind. Affirmation may be express
or implied. An implied affirmation takes place by the shareholders conduct, for
example, he endeavours to sell his shares, attend meetings of the company,
receive dividends etc.

b) By Unreasonable Delay: Any member who claims to retire from a company

on the ground that he was induced to become a member by misrepresentation ,
is bound to exercise his option at the earliest possible opportunity after he
became aware of the misrepresentation. An action of five months was held to
be too late ( Christineville vs. Rubber Estate Limited, In re( 1911) LJ

C) By Commencement of Winding Up: The right to rescission is lost on the

commencement of winding up of the company. But where a shareholder has
started active proceedings to be relieved of his shares, the passing of the
winding up order during their pendency would not prevent his getting the
relief.

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Derry v. Peek Compared with R v. Kylsant (1932) 11 KB

R v. Kylsant; the prospectus of the company correctly disclosed that the

company had paid dividends from 1911 to 1927 but did not disclose that
company had suffered losses from 1921 onwards and dividends had been paid
out of war time profits (abnormal situation). Although what the prospectus said
was true, it was held to be a misleading prospectus and those who issued it
were held liable for the fraudulent misrepresentation where a statement is true
at the time of the issue of the Prospectus, but ceases to be so when allotment is
made, the allotment is voidable.

Further, it is also necessary to avail of the remedies (case against the

company) that Plaintiff or the aggrieved party must have purchased his shares
on the faith of the prospectus directly from the company. A purchaser of share
in the open market has no remedy against the company or its officers even if he
was influenced b the prospectus. But where a company has so placed its
prospectus as to induce purchase of shares in the open market, the liability
arises.

It must be remembered that the law says that no application for shares or
debentures of a company can be issued unless the appeal is accompanied by a
memorandum containing such salient features of a prospectus as may be
prescribed.

R v. Kylsant Detailed Facts: Popularly known as Royal Mail Case

Royal Mail Steam Packet Company was a British Shipping Company founded
in London in 1839 by James Macqueen. It became the largest shipping
company in the world when it took over white Star Line Company in 1927.
Kylsant was the Chairman of the Company. The Company prospered during
the World War as the Government requisitioned to use its ship as military
ships for military supply and troop transport. The Company had saved the
profits in the Secret Reserves account. (Reserve is cash on hand to sustain the

43

organization in times of difficulty). Between 1921 and 1925, the profits of the
company rapidly declined and from 1926, it did not earn any profits. In 1929,
the Company asked the H M Treasury (Her Majesty Exchequer Department of
the British Government responsible for executing British Government Public
Finance Policy and Economic policy). The treasury first demanded the audit of
the Company’s accounts and sent one Mr. William to prepare a report. Mr.
William discovered that Company had not earned any trade profits since 1926
but was still paying dividends by taking money from the reserves. The company
had reported profits of Pound 439,000 for 1926 but had drawn pound 750,000
out of the reserves and falsified accounts ot make it appear that money came
from trading. In 1927, the company made a trading loss of pound 507,000 but
money was again drawn from reserves to make it appear that company had
made profits for pound 478,000. In 1928, the company had issued a
fraudulent prospectus inviting customers to buy shares in the company saying
that it had earned an average of pound 500,000 a year in the last decade.
Arrest warrant issued against Lord Kylsant and John Mooreland, the company
auditor. Kylsant was found guilty of falsifying prospectus and sentenced to 12
months in prison. The Company was liquidated and reconstituted as Royal
Mail Line Ltd with the backing of the British Government. The case was also of
falsifying accounts and records of the company. It generated massive protest in
accountancy world and questions the way in which accounts were audited. It
highlighted the flaw in the way the company accounts were reviewed and
audited.

Aftermath

• Secret Reserves has to be disclosed in Company’s Audit.

• Accountancy Approach: Previously, only legal duty but now the
accountants were expected to use their ethical and moral judgment in
the accounting. The Case fell like an atom bomb and disturbed both the
business and accountancy world and linked to the public distrust of big

44

 business. The case probably had a greater impact on the quality of
published data than all the companies Act passed together.

Disclosure in the Prospectus: Disclosure should give true and fair view of the
company’s position. The rule as to disclosure was laid down by KINDERSELY
VC in New Brunswick and Canada Railway and London co v. Muggeridge (
1860) 3 LT which is called as a…

Golden Rule. The Rule is: Those who issues a Prospectus hold out to the public
great advantage which will accrue to the person who will take share in the
proposed undertaking. Public is invited to take shares on the faith of the
representation contained in the Prospectus. The public is at the mercy of the
Company’s Promoters. Everything, therefore, must be stated with strict and ……
scrupulous accuracy. Nothing should be stated as a fact which is not so and no
fact should be omitted the existence of which might in any degree affect the
nature or quality of the privileges and advantages which the prospectus hold out
as inducement to take shares. In other words, true nature of the company’s
ventures should be disclosed.

Remedies for Misrepresentation

1) Damages for Fraud or Deceit: (Burden of proof upon the Plaintiffs/

aggrieved parties). It has to be proved:
a) Fraudulent Misrepresentation: Fraud is proved when it is shown
that false representation has been made-(Lord Herschel in Derry v.
Peek)

• Knowingly;

• Without belief in its truth;

• Recklessly or carelessly whether it be true or false; ( Look at Section

17, Contract Act, 1872)

45

If the directors published a statement with knowledge that it is false or without
any knowledge, whether it be true or false , it is Fraud.

b) Misrepresentation must relate to the facts: Secondly, the false

representation must relate to the some existing facts which are material to the
contract of purchasing shares. The purpose for which new money is to be used
is an important fact.

Edington v. Fitzmaurice (1885); The Directors of a Company issued a

prospectus inviting subscriptions for debentures and stating that the objects of
the issue of debentures were to complete alterations in the buildings of the
company; to purchase horses and vans and to develop the trade of the
company. The real object of the loan, however, was to enable the directors to
pay off the existing liabilities. Relying upon the statement, the Plaintiff
advanced money and the Company’s became insolvent and the plaintiff sued
the Director’s for the Fraud. Held, the Directors were liable. The Directors
contended that the suggestion of possible purposes to which the money might
be applied was not a statement of existing facts. But they were held liable.
BOWEN LJ said that the directors had misrepresented their state of mind. The
statement was also regarded as a material to the contract. A man who lends
money reasonably wishes to know for what purpose it is borrowed and he is
more willing to advance of he knows that it is not wanted to pay off the
liabilities already incurred. Thus, Edington v. Fitzmaurice is authority for
the proposition that representation of one’s state mind is also a representation
of fact the directors’ contention that representation related to the state of their
mind as to what use the money was going to be put and that they could change
their mind and ,therefore, it was not a misrepresentation of fact. The Court of
Appeal, however, pointed out that the state on man’s mind is as much as a fact
as a state of his digestion.

Plaintiff as Direct allottees: Thirdly, the plaintiff should have taken the
shares directly from the company by allotment. Then only, they can have

46

remedy against the directors. A purchaser of shares in the open market has no
remedy against the company or the promoters though he might have bought on
the faith of the representation contained in the prospectus. This rule owes its
origin to the Peek v. Gurney (1873) LR; A deceitful prospectus was issued by
the defendants on behalf of the company. The plaintiff received a copy of it but
did not take any shares originally in the company. The allotment was
completed and several months afterwards the plaintiff bought 2000 shares on
the stock exchange. His action against the directors for the deceit was rejected.
The Court said, “ The office of a prospectus is to invite persons to become
allottees , and the allotment having been so completed , such office is
exhausted and the liability to allottees does not follow the shares into the
hands of the subsequent transferees. Directors cannot be made liable ad
infinitum for all the subsequent dealings which may take place with regard to
those shares upon the stock exchange. Thus, Peek v. Gurney is the authority
for the proposition that if a person to whom the statement was not addressed
voluntarily, chooses to act upon it, he is not entitled to rescission.

Buyers in the Secondary Market: Where the object with which the prospectus
of the company is issued is not merely to induce application for allotment of
shares , but also to induce persons to whom it is sent to purchase shares in
the market, its function is not exhausted when the company has gone to
allotment , and the person issuing the prospectus is responsible for the
consequence of false representation contained in it. In other words, there must
be something to connect the directors making the representation with the party
with the party complaining that has been deceived and injured by it, as for
example, where the fraudulent prospectus is delivered to persons who
thereupon become the purchaser of the shares.

Andrews v. Mockford (1896) QB The defendant sent to the plaintiff

prospectus of a company which they knew would be a sham or pretended
company in order to induce the plaintiff to purchase shares therein. The
plaintiff did not then do so. The prospectus having produced a scanty
47

subscription for shares, the defendant thereupon fraudulently published a
telegram in a newspaper. The plaintiff believing in the truth of the telegram was
induced to purchase shares in the open market. The directors were held liable
for the systematic fraud. The Queen’s Bench held that the function of the
prospectus was not exhausted, and the false telegram was brought into play by
the defendant to reflect back upon and countenance the false statement in the
prospectus (They were part of the same transaction).

• Al Nabib Investment ( JerseY) v. Longcraft (1991 BCLC)

A prospectus was circulated among the existing shareholders inviting tem to

subscribe to the company’s right issue and one of them not only accepted the
right issues offered by the company but also purchased it from the open
market. He was not allowed to hold the company liable for the misleading
statement

• in the prospectus in respect of his market purchases. The Court said

that there was no sufficient proximity for a duty to be owed to those
buying shares in the open market.

• In Possfund Custodians Trestel Ltd v. Diamond (1996) BCLC 665, the

Court said that the purchasers would have to establish that they had
reasonably relied on the representation made in the prospectus and
reasonable believed that the representation intended them to act on the
statement and there existed a sufficiently direct connection between the
purchaser and the representor (someone representing the company) to
render the imposition of such a duty, fair, just and reasonable.

• Greenwood v. Leather Show Wheel Company ( 1900) 1 Ch 421

The Prospectus issued by a wheel manufacturing company stated: “ orders

have already been received from the House of Commons ..Wheels for the
trolleys in the House of Commons have been ordered and are now in use”. In

48

fact, no single order has been obtained except for trial and by way of
experiment. It was held that the prospectus contained untrue statement.

Liability of the Company

The Company may also be sued for damages provided that the fraud was
committed by the Directors within the scope of their authority. But the action
against the Company was beset with the limitations earlier. The House of Lords
held in Houldsworth v. City of Glasgow Bank (1880) that the contract of
allotment must first be rescinded. One cannot remain in the company as a
shareholder and yet sue it for damages. But the English Misrepresentation Act,
1967 now entitles the court to award damages in lieu of rescission. Thus,
rescission is no longer necessary as pre-requisites for liability of the company.

• Compensation under Section 35

• The decision of the House of Lords in Derry v. Peek (1889) LR 14

exposed the inadequacy of the action for deceit (fraud) to protect the
interest of the thousands of the investors in the market. The directors’ in
the case had, no doubt, told their statements innocently but that would
not help innocent investors. His loss is same whether the representation
is fraudulent or innocent. Within a year of the judgment, the British
Parliament passed the Directors’ Liability Act, 1890 and the directors
were liable for the false statement whether made innocently or
fraudulently and even though they might believe their assertion to be
substantially true. Same is the Law laid down in Section 35 ( Civil
liability for mis-statement in the prospectus.) of the Companies Act,
2013

Under Section 34, the relevant persons are liable to compensate the investors
for any loss sustained by him by reason of any (misleading word is used in
Section 35)untrue statement in the prospectus. Thus, the relevant persons
will be liable whether the misleading statement is fraudulently or innocently

49

made. The advantage of this Section is that one does not have to prove fraud. If
the representation is misleading, directors and other relevant persons cannot
escape liability even if they have made it bonafide and without any intention to
deceive. In such cases, the Company as well as those persons will be liable to
pay compensation to every person who has sustained losses however ,the
clause (3) of the same section expressly uses the word fraud (in the form of
word defraud) and reads that where it is proved that a prospectus has been
issued with intent to defraud the applicants , every such person shall be
personally liable without any limitation of liability for all or any losses that
have been incurred by the persons.

Change of Circumstances: Must be notified to the Investors/Applicants

There is often an interval of time between the publication of a prospectus and

the allotment of shares. During this interval, a statement which was true when
made may cease to be so owing to some change of circumstances.

• T.S. Rajagopala Iyer v. South Indian Rubber Works Limited

• The Plaintiff had applied for shares in a Company on the basis of a

prospectus containing the name of several persons as directors. But
before the allotment took place, there were changes in the directorships,
some directors having retired. This was held to be sufficient to entitle the
plaintiff to revoke his application as some matters are very important
such as the name of the directors. The Court held that the person who
has applied for shares one the faith of one state of things should have
the option of retiring when a totally different state of things comes into
existence.

False Representation

There must be a false representation in the Prospectus. False representation

means a positive misstatement or concealment of material facts. Lord

50

McNaughten said in Gluck stein v. Barnes (1900 AC) , “Everybody knows
that sometimes half a truth is no better than downright falsehood.”

In Henderson v. Lacon (1867), a prospectus stated that the directors and

their friends have subscribed a large portion of the capital and they now offer
to the public remaining shares , the fact being that the director had subscribed
only 10 shares each. The representation was held to be false.

In another case (Ross v. Estates Investment Co ( 1868) LR 3, the prospectus

stated that more than half the shares have already been sold, when in fact only
one promoter of the company had signed documents applying for more than
half the shares, but had not paid any money and ultimately took away only
2002 shares, the representation was held to be false.

Misrepresentation must be of facts and not of Laws

….In the first place, misrepresentation must not be of law and must be of facts.
For example, if the prospectus says that company’s fully paid up shares will be
issued at half the nominal price, when the Companies Act prohibits the issue of
shares at so much discount, it is a misrepresentation of law and a per son
deceived will have no remedy. Again, the fact must be material to the contract
which will influence the mind of the prudent investors in deciding whether to
purchase the share or not and at what price.

Reliance and Inducement: It is further necessary that the plaintiff should

have acted in reliance on the statements contained in the prospectus.
Misrepresentation should have direct nexus with his getting induced to
purchase the shares but a recipient of a prospectus is entitled to rely on it . He
is not bound to verify it. It cannot be a answer to his claim that he might have
known the truth by proper verification.

By or on behalf of the Company: A company is not responsible for the

statement in a prospectus unless it is shown that the prospectus was issued by

51

the company or by someone with the authority of the company i.e. Board of
Directors.

• SEBI Regulations

Apart from the basic requirements laid down in Companies Act, the Listed
Companies have to follow the SEBI Regulation on the matter. See.. SEBI
Guidelines for Disclosure and Investor Protection of 1992. (SEBI DIP
Guidelines in Short)

Company Basic Points:

• Applicability of Companies Act, 2013: Section 1 (4): The provisions of

this Act shall apply to ( extends to the Whole of India including Jammu
and Kashmir) —

(a) Companies incorporated under this Act or under any previous company
law;

a. (b) insurance companies, except in so far as the said provisions are

inconsistent with the provisions of the Insurance Act, 1938 or the
Insurance Regulatory and Development Authority Act, 1999;
b. (c) banking companies, except in so far as the said provisions are
inconsistent with the provisions of the Banking Regulation Act, 1949;
c. (d) companies engaged in the generation or supply of electricity, except
in so far as the said provisions are inconsistent with the provisions of
the Electricity Act, 2003;
d. (e) any other company governed by any special Act for the time being in
force,
e. except in so far as the said provisions are inconsistent with the
provisions of such special Act; and

52

 f. Such body corporate, incorporated by any Act for the time being in
force, as the Central Government may, by notification, specify in this
behalf, subject to such exceptions, modifications or adaptation, as may
be specified in the notification.

• According to Section 2 (20) of the 2013 Act, a Company is a Company

formed under Companies Act, 2013 or under any of the previous law
relating to the Companies.
• The companies Act, 2013 has come into existence on 29.08.2013
(Received the assent of the President of India on 29/08/2013). Notified
on 30/08/2013.
• In September 2014, the erstwhile Companies Act, 1956 was replaced by
Companies Act, 2013 ( Date of notification of New Companies Act)
• The 2013 Act is divided into 29 chapters containing 470 sections as
against 658 Sections in the Companies Act, 1956 and has 7 schedules.
• A total of another 184 sections came into force from 1 April 2014.
• Two Powerful Institutions: Board of Directors and General Meeting of
the Shareholders.
• (Governed by two Resolutions: Special and General Resolutions)
• Key Managerial Personnel: The definition of the term Key Managerial
Personnel is contained in Section 2(51) of the Companies Act, 2013. The
said Section states as under:“key managerial personnel”, in relation to a
company, means—(i) the Chief Executive Officer or the managing director
or the manager;(ii) the company secretary;(iii) the whole-time director;(iv)
the Chief Financial Officer; and(v) such other officer as may be
prescribed;
• National Financial Reporting Authority :( Government Plan to Keep
Check on CAs). The Companies Act 2013 provides for setting up a
National Financial Reporting Authority (NFRA). The recent report of
Parliament’s standing committee on finance on the Companies

53

 (Amendment) Bill 2016 has reopened what appeared to be the settled
position on auditor regulation. (

Article from the Hindu Business line)

• NFRA has a larger remit than NACAS (National Advisory Committee on

Accounting Standards), which it is meant to replace. NACAS only
recommends accounting standards. NFRA will set accounting and
auditing standards, monitor and enforce compliance with the standards,
and oversee the accounting profession’s record of ensuring compliance. It
will take away significant regulatory powers from the Institute of
Chartered Accountants of India (ICAI). Self-regulation works only up to a
point. Society expects that the professions will police themselves
effectively. Neither is probable because the members elect representatives
who decide whom to punish and what the punishment should be. It is no
longer the well-intentioned mechanism at work. The political process
takes over and there will inevitably be compromises. (Regarding failure of
ICAI in disciplining auditors and accountants) self-regulation hurts those
outside the accounting community. Investors and lenders are often
victims of dodgy accounting and incompetent auditing. They would have
no confidence in the fairness of the process when their complaints are
heard by other accountants. To them it is a clubby world. For this
reason, many who have suffered at the hands of accountants are unlikely
to have even complained to the ICAI. So the relatively low number of
complaints does not mean that all is well. In fact, the opposite is likely.
External supervision matters: That is why in most countries outsiders
oversee the work of accountants. The Public Company Accounting
Oversight Board (PCAOB) in the US and the Financial Reporting Council
(FRC) in the UK are examples of effective outside regulation. Surprisingly,
the ICAI and its members will be the biggest beneficiaries of external
regulation. When there is greater assurance that improper conduct will
be punished, the value of the ICAI’s franchise will go up. Scrupulous

54

 members can apply stricter accounting and auditing requirements and
be more forthright in expressing disagreement. They don’t have to fear
losing clientele. They can expect to be paid more for being strict. They
can invest more in training and technology and pay their employees
better. Eventually, inferior firms will drop out of the audit market.
Overall, it will be a better outcome for the accounting community.NFRA
can enhance investor protection by effective oversight of accounting and
auditing. It will fill a critical gap in the current arrangements by
enforcing compliance with standards. Dumping NFRA will be a clear case
of regulatory capture by the accounting industry.

2013 ACT NOW FOR MORE TRANSPARENCY

Some key norms companies will have to follow under the new Companies Act;

• Transparency and Accountability are its Hallmark.

• Have to devise strategy and policy for implementing CSR norms
• Reconstitute boards to add woman director(s), small shareholders
directors and at least one resident Indian director
• Finalise a new code for independent directors
• Implement succession planning for its independent directors as they are
required to be rotated after 10 years.
• Reconstitute Audit Committee and establish Nomination and
Remuneration Committee.
• Directors will have to sign a director’s responsibility statement.
• Will be required to make new disclosures pertaining to risk management,
board evaluation, remuneration, CSR.
• File returns with the Registrar of Companies on changes in top 10
shareholders.

PROMOTERS: Those who take preliminary steps for the purpose of

registration and floating of the company; To be a Promoter, one need not be
necessarily associated with the initial formation of the Company, One who

55

subsequently helps to arrange the capital may also be a promoter; Any
individual, company, association, partnership which takes all the necessary
steps to create and mould a company and set it going is a promoter; The date
on which a person becomes a promoter of the company is of great importance
as number of sections imposes civil as well as criminal liability.; Generally, it is
believed that status of a promoter is terminated when the Board of Directors
has been formed and it started functioning; They need not be the directors.

Chronologically, the first persons who control or influence the company’s

affairs are its promoters. It is they who conceive the idea of forming the
company and it is they who take necessary steps to incorporate, to provide it
with share and loan capital and acquire the business or the property which is
to manage.

• Section 2(69) of Companies Act, 2013 the term Promoters is defined as:-
“Promoter” means a person— (a) who has been named as such in a
prospectus or is identified by the Company in the annual return referred
to in section 92; or (b) who has Control over the affairs of the Company,
directly or indirectly whether as a shareholder, director or otherwise; or
(c) in accordance with whose advice, directions or instructions the Board
of Directors of the Company is accustomed to act:

Provided that nothing in sub-clause (c) shall apply to a person who is acting
merely in a professional capacity;

“Control” which is defined in 2(27) of the Act which is as below:-

“control” shall include the right to appoint majority of the directors or to
control the management or policy decisions exercisable by a person or persons
acting individually or in concert, directly or indirectly, including by virtue of
their shareholding or management rights or shareholders agreements or voting
agreements or in any other manner;

56

 • The expression ‘promoter’ has not been defined under the Companies
Act, 1956, although the term is used expressly in sections 62, 69, 76,
478 and 519.

In Twycross v. Grant promoter was described as “one who undertakes to form

a company with reference to a given project, and to set it going, and who takes
the necessary steps to accomplish that purpose.
In USA, the Securities Exchange Commission Rule 405(a) defines promoter as
a person who, acting alone or in conjunction with other persons directly or
indirectly takes the initiative in founding or organizing the business enterprise.
In Lagunas Nitrate Co. v. Lagunas Syndicate [1889] 2 Ch. 392 (p. 428, C.A.),
it was stated that “to be a promoter one need not necessarily be associated with
the initial formation of the company; one who subsequently helps to arrange
floating of its capital will equally be regarded as a promoter.

Corporate Identity Number (CIN):- Each Indian Company (Listed or Unlisted)

has a unique 21 Digit CIN (Corporate Identity Number). This is required to be
quoted on all forms. Once this number is filled, company details are
automatically filled in E-Forms issued by MCA by using pre-fill function.

Digit No. What it Shows? Remarks

1st digit Listing status If Company is Listed it will start

with ‘L ‘and if Company is not
Listed it will start with ‘U’

Next 5 digit Industry code

Next 2 digit State code i.e. MH for Maharashtra.

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Next 4 digit Year of incorporation I.e. for Company formed in
Calendar Year 2011 the same
will be 2011.

Next 3 digit Ownership PLC for Public Limited

Company

PTC for Private Limited

Company.

Last 6 digit ROC reg. i.e. 090868 for ROC- Mumbai

i.e. 090633 for ROC- KOLKATA

As Per Section 12 ( 1st April, 2014) , a Company has to mention CIN Number
mandatorily along with the name and address on registered offices, invoices,
notices and all official publications. For default, fine of Rs 1,000 per day on
company and every officer but shall not exceed 1 lakh rupees.

Registrar (Power of Registration and De-registration of the Company): Section

2 (75) of the 2013 Act; 396 of the 2013 Act; Responsibility includes registering
Companies and ensure that companies complies with statutory requirements;
Filing of documents with the Registrar; Every Company to have a Registered
Office.

Registered Office of the Company is where the Government departments will

send notice. It will decide the state in which company is incorporated. The
Company has to maintain certain documents at the registered office. It is the
place where all official communications are sent. Provisions regarding
registered office of a company are primarily contained in Section 12 of the
Companies Act, 2013.

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Directors (Section 2(34) - Trustee and Agent of the Company; DIN Number;
Different Types of Directors; Every Company to have a Board of Directors.

Independent Directors: Act 2013 (First time)

Woman Directors: (Act 2013): Rule 3 of The Companies (Appointment and

Qualification of directors) Rules, 2014 (Chapter 11), the following class of
companies are required to appoint at least one Woman Director-

(i) Every listed company;

(ii) Every other public company having –

(a) paid–up share capital of 100 crore rupees or more; or

(b) Turnover of 300 crore rupees or more.

AUDITORS under Companies Act, 2013

Appointment of first auditor shall be made by board within 30 days of

registration of company. If Board fails to appoint the first auditor within given
time then it shall inform to members and members shall make the
appointment of first auditor within 90 days of information at an EGM. The First
Auditor shall hold office till the conclusion of first AGM.

• Appointment of auditor shall be made by members at First AGM and

every subsequent 6th AGM. Company shall intimate the auditor about
appointment. After intimating, company shall obtain written consent and
certificate (in accordance with the conditions prescribed in section 141)
from auditor. Then, company is required to file a notice with the registrar
about the appointment within 15 Days of the meeting.
• The Auditor shall hold office for a period of 5 Years.
• Every auditor need to comply with auditing standard [143(9)].
• Auditor shall report the fraud to the CG within prescribed time and
manner and the same shall not be construed as breach of duty[143(12))

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 • If auditor fails to comply with above mentioned provisions then he shall
be punishable with fee of Rs. 100,000 Rs. 500,000 [143(15)].
• Auditor has to attend general meeting unless exempted by the company
[146].
• Only Chartered Accountants can be the Auditors.
• If an individual is appointed as an auditor for 1 term i.e. for 5
consecutive years then that individual will not be eligible for
reappointment for next 5 years from the expiry of his term as an auditor
of company.

• Whereas, if an audit firm is appointed as auditor for 2 term i.e. for 10

consecutive years then that audit firm will not be eligible for
reappointment for next 5 years from the expiry of its term as an auditor
of company.

• Audit firm having common partner to the old audit firm of the company
will not be eligible for appointment.

• Any existing listed company is required to comply with the above

mentioned provisions within 3 years from the commencement of this Act.
• Audit Committee: Majority of them to be independent director to
appoint auditors for the company.

AUDITORS

Chapter X of the 2013 Act Deals with the Auditors: ( From Section 139 to
Section 148)

• Section 139 of the Companies Act, 2013 provides that every company
shall, at the first AGM shall appoint an individual or firm as an auditor
who shall hold office from the conclusion of that meeting till the

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 conclusion of its sixth AGM and thereafter till the conclusion of every
sixth AGM.
• The Manner and Procedure of Selection of the Auditors by the members
of the Company shall be such as may be prescribed.
• The Company shall place the matter relating to such appointment for
ratification by members at every AGM.
• The Auditor’s Consent: Before such appointment is made, the written
consent of the Auditors to such appointment and certificate from him to
the effect that appointment if made shall be in accordance with the
conditions as may be prescribed shall be obtained from the Auditor.
• The above Certificate shall also confirm that whether Auditor satisfies the
criteria laid down under Section 141 (Eligibility, Qualifications and
Disqualification of Auditors) of the 2013 Act.
• The Company shall inform the Auditor of his appointment and notice of
such appointment shall be given to the Registrar within the 15 days of
the meeting in which auditor is appointed. (The word Appointment shall
also include Re-appointment).
• Sub-Section 2 of Section 139 of the Companies Act, 2013 provides that
No listed Company or company belonging to such class or classes of
companies as may be prescribed, shall appoint or re-appoint ;
a) An individual as auditor for more than one term of consecutive 5
years; and
b) An Audit Firm for more than two terms of five consecutive years;
• Provided that an individual Auditor who has completed his term under
above clause shall not be eligible for re-appointment as auditor in the
same company for five years from the completion of his terms and an
Audit firm which has completed its term as above shall not be eligible for
re-appointment as auditor in the same company for five years from the
completion of such terms..;

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 • Section 139 further provides in case of Government Company or any
other company owned or controlled directly or indirectly by CG or SG or
Partly by CG and Partly by one or more SG, the CAG shall appoint an
Auditor within 180 days of the commencement of the financial year who
shall hold office till the conclusion of AGM.
• Section 139(6) Provides that the first Auditor of the Company, other
than a Government Company, shall be appointed by the BoD within 30
days from the date of registration of the company and in case of any
failure of the BoD to appoint such Auditor, it shall inform the members
of the Company who shall within 90 days by calling EGM shall appoint
an Auditor and such auditor shall hold office till the conclusion of first
AGM.
• In case of Government Company or any other company owned or
controlled directly or indirectly by CG or SG or Partly by CG and Partly
by one or more SG, the First Auditor shall be appointed by the CAG
within 60 days of the Registration of the Company and in case CAG does
not appoint such Auditor within the said period, the BoD shall appoint in
next 30 days and in case BoD fails to appoint , it shall inform the
members who shall appoint such Auditor within 60 days at an EGM who
shall hold office till the conclusion of the first AGM.
• Casual Vacancy in the office of Auditors: Any Casual Vacancy in the
office of an Auditor shall -
• I) in the case of a Company other than a company whose accounts are
subject to Audit by an Auditor appointed by the CAG, be filed by the BoD
within 30 days but if such casual vacancy is as a result of the
resignation of an Auditor, such appointment shall also be approved by
the Company at a general meeting convened within 3 months of the
recommendation of the Board and he shall hold the office till the
conclusion of the next AGM.

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 • II) in the case of a Company whose accounts are subject to Audit by an
Auditor appointed by the CAG , be filed by the CAG within 30 days.
Provided that in case the CAG does not fill the vacancy within the said
period, the BoD shall fill the vacancy within 30 days.
• Subject to the Provision ( 1) of Section 139, a retiring Auditor may be
re-appointed at an AGM, if
a) He is not disqualified for re-appointment
b) He has not given the company a notice in writing of his unwillingness
to be re-appointed.
c) A Special Resolution has not been passed at that meeting appointing
some other auditor or providing expressly that he shall not be re-
appointed.
• Section 141 deals with Eligibility, Qualifications and
Disqualification of Auditors:
Ø Nobody can be Auditor unless he is a Chartered Accountant.
Ø In case of firm, where majority of partners are CA and
practicing in India, can be appointed by its firm name as
Auditor.
Ø Where a Firm including LLP is appointed as a auditor of the
company, only the partners who are CA shall be authorized
to act and sign on behalf of the firm.

Persons not eligible for Appointment as Auditor: Section 141(3)

Ø A Body Corporate other than LLP registered under LLP

Act, 2008.
Ø An officer or employee of the Company;
Ø A person who is a partner or who is in employment of an
officer of or employee of the company;
Ø A Person who or his relative or his partner-

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 Ø i) is holding any security of or interest in the company or
its subsidiary or of its holding or associate company or a
subsidiary of such holding company. Provided that
relative may hold security or interest in the company of
face value of not exceeding 1000 Rupees or such sum as
may be prescribed.
Ø ii) is indebted to the company or its subsidiary or its
holding company or associate company or a subsidiary of
such holding company , in excess of such amount as
may be prescribed
Ø iii) has given a guarantee or provided any security in
connection with the indebtedness of any third person to
the company or its subsidiary , or its holding or associate
company or a subsidiary of such holding company , for
such amount as may be prescribed.
Ø A Person or a firm, whether directly or indirectly, has
business relationship with the company or it subsidiary
or its holding or associate company or subsidiary of such
holding company or associate company of such nature as
may be prescribed.
Ø A Person whose relative is a director or in the
employment of the company as a director or KMP.
Ø If a Person or a Partner of the firm is at the date of such
appointment or re-appointment holding appointment as
auditor of more than 20 companies;
Ø A person has been convicted by a court of an offence
involving Fraud and a period of ten years has not been
elapsed from the date of such conviction.
Ø Any Person whose subsidiary or associate company or
any other form of entity is engaged as on the date of

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 appointment in consulting and specialized services as
provided in Section 144 of the Companies Act, 2013.
• Section 141 (4) further provides that where a person is appointed as an
auditor of a company incurs any of the disqualifications mentioned in
Sub-Section (3) after his appointment, he shall vacate the office as such
auditor and as such auditor and such vacation shall be deemed to be a
casual vacancy in the office of the Auditor.
• Section 140 of the 2013 Act deals with the Removal, Resignation of the
Auditor and giving of Special Notice:
• Regarding Removal: Section 140 lays down an important law that an
Auditor appointed under Section 139 of the Companies Act, 2013. It
says that Auditor appointed under Section 139 may be removed from his
office before the expiry of his term only by passing a Special Resolution
of the Company, after obtaining previous approval of the Central
Government in that behalf by the Prescribed manner. The Section 140
further provides that before taking action under this Section the Auditor
concerned shall be given a reasonable opportunity of being heard
(Principle of Natural Justice).
• Resignation of Auditor: The Auditor who has resigned from the
company shall file within a period of 30 days from the date of
resignation, a statement in the prescribed form with the company and
with the Registrar, and in case of companies referred to in Section 139
(5), the Auditor shall also file such statement with the CAG, indicating
the reasons and other facts as may be relevant with regard to his
resignation. If the Auditor does not comply, he or it shall be punishable
with fine which shall not be less than 50,000 Rupees but which may
extend to 5 Lakh Rupees.
• Requirement of Special Notice for a Resolution at an AGM: Section
140(4) provides that Special Notice shall be required for a resolution at
an AGM appointing as Auditor a person other than a retiring auditor or

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 providing expressly that a retiring auditor shall not be re-appointed
except where the retiring auditor has completed a consecutive tenure of 5
years or as the case may be of ten years provided under Section 139(2).
On receipt of such special notice, the company shall forthwith send a
copy to the Retiring Auditor. If the retiring auditor desires to make
representation in writing to the company (not exceeding a reasonable
length) and request its notification to the members of the company, the
company shall, unless the representation received is too late; i) in any
notice of the resolution given to members of the company, state the fact
of the representation having been made; and ii) send a copy of the
representation to every member of the company to whom notice of the
meeting is sent , whether before or after the receipt of the representation
by the company. And if the copy of the representation is not sent as
aforesaid because it was received too late or because of the Company’s
default, the auditor may (without prejudice to his right to being heard
orally) require that the representation shall be read out at the meeting. A
Copy of representation shall be filed with the Registrar. Provided that if
the NCLT is satisfied on an application either of the company or
aggrieved person, that the rights conferred by this Sub-Section (
regarding Written Representation) is about to be abused by the Auditor,
then the copy of Representation need not be sent and read out at the
Meeting.
• Section 140 (5) lays down an important law that the NCLT may suo
motu or on an application made by the CG or any other person
concerned if it is satisfied that the auditor of the company has directly or
indirectly acted in a fraudulent manner or abetted or colluded in any
fraud by or in relation to the company or its directors or officers, it may,
by order direct the Company to change its Auditors. Provided that if the
application is made by the CG and the Tribunal is satisfied that any
change in the Auditor is required, it shall within 15 days of the receipt of

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 such application, make an order that he shall not function as an Auditor
and CG may appoint another auditor in his place. Provided further that
an Auditor, whether individual or firm, against whom final order has
been passed by the Tribunal under this Section shall not be eligible to be
appointed as an Auditor of the Company for a period of five years from
the date of passing of order and the Auditor shall also be liable for action
under Section 447 of the Act.
• For the purpose of Section 140, the Auditor shall include Firm of
Auditors.
• Section 144 of the Companies Act Provides for certain services
which Auditor should not provide: Section 144 says that Auditor
appointed shall provide such services which BoD of the Company
approves but which shall not include any of the following services,
directly or indirectly: namely:-
Ø Accounting and Book Keeping Services
Ø Internal Audit
Ø Design and Implementation of any Financial Information
System.
Ø Actuarial Services.
Ø Investment Advisory Services.
Ø Investment Banking Services.
Ø Rendering of Outsourced Financial Services.
Ø Management Services.
Ø Any other kind of services as may be Prescribed.
• Section 144 of the Companies Act further provides that an Auditor or an
Audit Firm who or which has been performing any non-audit services on
or before the commencement of this Act shall comply with the provisions
of this section before the closure of the first Financial Year after the date
of such commencement.

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 • Section 146: Auditors to attend General Meeting of the Company:
Section 146 of the 2013 Act says that All notices of and other
communications relating to any General Meeting shall be forwarded to
the Auditor of the Company and the Auditor shall, unless otherwise
exempted by the company, attend either by himself or through his
authorized representatives , who shall also be qualified to be an Auditor ,
any General Meeting and shall have the right to be heard at such
meeting on any part of the business which concerns him as the Auditor.
• Section 143 of the 2013 Act talks about Powers and Duties of
Auditors and Auditing Standards:
• Powers of Auditors: Every Auditor of the Company shall have a right to
access at all times to the Books of Account and Vouchers (written
instrument that serves to confirm or witness (vouch) for some fact such
as a transaction) of the Company, whether kept at the Registered office of
the Company or at any other place and shall also be required from the
officers of the company such information and explanations as he may
consider necessary for the performance of his duties as auditor and
amongst other matters, he may enquire into the following matters:
Ø Whether loans and Advances made by the Company on the basis
of security have been properly secured and whether the terms on
which they have been made are prejudicial to the interests of the
company or its members.
Ø Whether transactions of the Company which are represented
merely by the book entries are prejudicial to the interests of the
company.
Ø Where the Company not being an investment company or a
banking company, whether so much of the assets of the
company as consists of the Shares, debentures and other
securities have been sold at a price less than that at which they
were purchased by the company.

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 Ø Whether Loan and Advances made by the Company have been
shown as Deposits;
Ø Whether Personal expenses have been charged to revenue
accounts;
Ø Where it is stated in the books and documents of the company
that any shares have been allotted for cash, whether cash has
actually been received in respect of such allotment and if no cash
has actually been received, whether the position as stated in the
account books and the balance sheet is correct, regular and not
misleading.
• The same Section 143 also provides that the auditor of a company which
is a holding company shall also have the right to access to the records of
all its subsidiaries in so far as it relates to the consolidation of its
financial statements with that of its subsidiaries.
• Section 143 also talks about Auditor Report which the Auditor shall
make a report to the members of the company on the accounts examined
by him and on every financial statements which are required by the
Companies Act, 2013 to be laid before the Company in General Meeting
and the Auditor Report shall after taking into account the provisions of
this Act the accounting and auditing standards and the matters which
are required to be included in the Auditor Report under Act 2013 or
under Section 143(11) and to the best of his information and knowledge,
the said accounts, financial statements gives a true and fair view of the
state of the company’s affairs as at the end of its financial year and profit
or loss and cash flow for the year and such other matters as may be
prescribed.
• Some other Points in Section 143:
Ø Every Auditor shall comply with the Auditing Standards.
Ø Auditing Standards: The CG may prescribe the standards of
auditing as recommended by the ICAI constituted under Section 3

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 of the Chartered Accountants Act, 1949, in consultation with and
after examination of the recommendation made by the National
Financial Reporting Authority. Till such time the auditing
standards are notified, any standard or standards of auditing
specified by the ICAI shall be deemed to be the auditing standards.
Ø Auditors Detecting Fraud: Sub-Section 12 of Section 143
provides that if an auditor of the company, in the course of
performance of his duties as auditor, has reason to believe that an
offence involving fraud is being or has been committed against the
company by officers or employees of the company, he shall
immediately report the matter to the CG within such time and in
such manner as may be prescribed. If the Auditor submits the
report to CG under Sub-Section 12 in good faith, it shall not be
construed as if auditor has contravened any duty.
Ø Applicability of the Provisions: The Provisions of this Section
shall apply mutatis mutandis to: a) the Cost Accountant in
practice conducting Cost Audit under Section 148; b) the Company
Secretary in Practice conducting Secretarial Audit under Section
204.
• The Auditor’s Report shall also state ( Section 143) :
a) Whether he has sought and obtained all the information and
explanations which to the best of his knowledge and beliefs were
necessary for the purpose of his audit and if not the details thereof
and the effect of such information on the financial statements;
b) Whether, in his opinion, Proper Books of Account as required by law
have been kept by the company so far as appears from his
examination of those books and proper returns adequate for the
purposes of his audit have been received from branches not visited by
him.

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 c) Whether the report on the accounts of any branch offices of the
company audited under Sub-Section (8) by a person other than the
company’s auditor has been sent to him under the proviso to that
sub-section and the manner in which he has dealt with it in preparing
reports.
d) Whether the Company’s balance sheet and profit and loss account
dealt with in the report are in agreement with the books of accounts
and returns;
e) Whether in his opinion financial statements comply with the
accounting Standards;
f) The observations or comments of the auditors on financial
transactions or matters which have any adverse effect on the
functioning of the company.
g) Whether any Director is disqualified from being appointed as Director
under Section 164(2).
h) Any qualification, reservation or adverse remark relating to the
maintenance of accounts and other matters connected therewith;
i) Whether the company has adequate internal financial control system
in place and the operating effectiveness of such controls;
j) Such other matter as may be prescribed;

Some Points on Auditors from Earnest Young Website

• The Audit rules also require the Audit Committee to recommend auditors
for appointment. The draft rules required that if the board does not agree
with the Audit Committee recommendation and decides to eventually
propose its own nominee at the AGM, the board will explain the reasons
for not accepting the Audit Committee recommendation in the board
report. It was expected that to avoid such disclosures, there will be
pressure on the board to accept the Audit Committee recommendation.
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 In the Audit Rules, it is stated that the board will record reasons for its
disagreement with the Audit Committee and send its own
recommendation to the AGM. Though the Audit Rules do not specifically
require disclosure in the board report, section 177(8) of the 2013 Act
requires that if the board has not accepted any recommendation of the
Audit Committee, the same will be disclosed in the board report with
reasons.
• Evaluate pending proceedings against the proposed auditor: To help
the audit committee/board evaluate pending proceedings against the
proposed auditor, the Audit Rules require the proposed auditor to submit
a list of proceedings against the auditor or audit firm or any partner of
the firm with respect to professional matters of conduct.
• Under the 2013 Act, an auditor is appointed for a term of 5 years.
However, the appointment needs to be ratified each year at the AGM. The
Audit Rules clarify that “if the appointment is not ratified by the
members of the company, the board of directors shall appoint another
individual or firm as its auditor or auditors after following the procedure
laid down in this behalf under the Act.
• Regarding Re-appointment of Auditors: In accordance with the 2013
Act, listed companies and companies belonging to the prescribed class
cannot appoint or re-appoint the auditor for: (a) More than two terms of
five consecutive years, if the auditor is an audit firm; (b) More than one
term of five consecutive years if the auditor is an individual. Under the
draft rules, the prescribed class included all companies excluding one-
person companies and small companies. This is changed in the Audit
Rules. Under the Audit Rules, auditor rotation applies to the following
classes of companies excluding one person companies and small
companies:

• All listed companies

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 • All non-listed public companies having either (i) paid-up share
capital of 10 crore or more, or (ii) public borrowings from financial institutions,
banks or public deposits of `50 crores or more.

• All private limited companies having either (i) paid-up share capital
of `20 crore or more, or (ii) public borrowings from financial institutions, banks
or public deposits of 50 crores or more.

• The auditor, who has completed his term, will not be eligible for re-
appointment as auditor in the same company for five years from
completion of the term. The same restriction applies to the audit firm
which has common partner(s) with the outgoing audit firm at the time of
appointment.
• Incoming auditor/audit firm is also not eligible for appointment if they
are part of the same network as the outgoing auditor. In simple words,
the auditor has to be rotated outside the network firm and not within the
network firm. The term “same network” has been explained to include
the firms operating or functioning, hitherto or in future, under the same
brand name, trade name or common control.
• If a partner in the outgoing audit firm, who is in charge of the firm and
also certifies financial statements of the company, retires from the said
firm and joins another firm of chartered accountants, such other firm
will also not be eligible to be appointed as auditor for a period of five
years.
• Transitional requirements: Like the draft rules, the Audit Rules
are clear that holding of the office by the auditor prior to the
commencement of the 2013 Act will be included to determine the time of
rotation. In other words, rotation applies retrospectively. In determining
the time of rotation, service period also includes period served by
network firms. For example, firm A audited Client X for the first four
years. Thereafter, it moved to firm B which is the firm under the same

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 network. Hence, service period completed by firm A and firm B will be
included to determine the time of rotation.
• Effective date: Section 139 (2) of the 2013 Act dealing with auditor
rotation is applicable from 1 April 2014. The Audit Rules also apply from
the same date. One of the provisos to section 139(2) of the 2013 Act
states that existing companies, which are covered under auditor rotation
requirement, should comply with those requirements within three years
from the date of commencement of the 2013 Act. Section 1(3) of the 2013
Act states that different dates may be appointed for bringing into force
different provisions of the 2013 Act and any reference in any provision to
the commencement of the 2013 Act will be construed as a reference to
the coming into force of that provision. Hence the three year period in
this regard starts from 1 April 2014. Illustration 2 given in paragraph
6(3) of the Audit Rules also confirms this point. One heading in the
illustration indicates that three years countdown starts from the AGM
held after the commencement of section 139(2), i.e., from the first AGM
held on or after 1 April 2014.
• Financial interest and indebtedness, guarantee or
security:
A person is not eligible for appointment as auditor if he himself, his
relative or partner:
• Holds any security or interest in a company, or its subsidiary,
holding or associate company or subsidiary of such holding company.

However, the relative is allowed to hold security or interest in the

company having face value not exceeding `1 lac. The Audit Rules state
that if any security or interest is acquired by a relative above the
prescribed threshold, corrective action needs to be taken within 60 days
of such acquisition or interest.
•Is indebted to the company, its subsidiary, holding or associate
company or subsidiary of such holding company, in excess of `5 lac.

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 • Has given any guarantee or provided any security in connection with
indebtedness of any third person to the company, or its subsidiary,
holding or associate company or subsidiary of such holding company, in
excess of `1 lac.
• Business relationship: Under the 2013 Act, a person or an audit
firm are not eligible for appointment as auditor, if it, directly or
indirectly, has business relationship with the company, its subsidiary, its
holding, or associate company or subsidiary of such holding company or
associate company. The draft rules explained the term “Business
relationship” to mean any transaction entered into for a commercial
purpose except professional services permitted to be rendered by an
auditor.
• Hence, there was a concern that an auditor cannot purchase/ avail
goods/services from the auditee company, its subsidiary, its holding, or
associate company or subsidiary of such holding company or associate
company. This was likely to pose serious practical problems not only to
the auditors but also to the companies they audit. For example, an
auditor of a hospital would not have been able to avail services of that
hospital even if the hospital charged the same price as it would have to
any other patient, and it would not have mattered if that was the only
hospital available to the auditor.
• In the Audit Rules, exemption regarding professional services permitted
to be rendered by an auditor has been retained. To address the above
concern, the Audit Rules additionally allow parties to enter into
commercial transactions that are in the ordinary course of business of
the company at arm’s length price, e.g., sale of products/services to
auditor as customers in the ordinary course of business, by companies
engaged in the business of telecommunications, airlines, hospitals,
hotels and such other similar businesses.

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 • Limit on maximum number of Audits: In accordance with the
2013 Act, a person or a partner of a firm will not be eligible for
appointment, if such persons or partner at the date of
appointment/reappointment holds appointment as auditor of more than
20 companies. Private companies are also included in the maximum limit
of 20 companies.
• Conviction by the Court: In accordance with the 2013 Act, a
person is not eligible for appointment as auditor, if that person has been
convicted by a court of an offence involving fraud and period of ten years
has not elapsed since such conviction.
• A proviso to section 141(1) states that a firm whose majority of partners
practising in India are qualified for appointment as auditor may be
appointed by its firm name to be auditor of a company.
• A collective reading of the two clauses suggest that if a partner in a
partnership firm (including limited liability partnership), proposed to be
appointed as auditor, is convicted of fraud, it may not render the entire
firm ineligible for appointment as auditor. However, this is subject to a
condition, viz., majority of partners practicing in India are qualified for
appointment as auditor.
• Prohibition on Providing Non-Audit Service: Under the 2013 Act, an
auditor is allowed to provide only such non-audit services to the
company as are approved by its board or audit committee. However, the
auditor is not allowed to render the following services either directly or
indirectly to the company, its holding or subsidiary company:
o Accounting and book keeping services
o Internal audit
o Design and implementation of any financial information system
o Actuarial services
o Investment advisory services
o Investment banking services

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 o Rendering of outsourced financial services
o Management services
o Any other kind of services as may be prescribed
• From an audit firm’s perspective, the term ‘directly or indirectly’ includes
rendering of services by the firm itself or through any of its partners or
through its parent, subsidiary or associate entity or through any other
entity in which the firm or any partner of the firm has significance
influence or control, or whose name or trade mark or brand is used by
the firm or any of its partners.
• Transitional requirements: If an auditor has been rendering non-
audit services to a company on or before the commencement of the 2013
Act, the auditor will need to comply with the above restrictions before the
end of the first financial year. This implies that:
• For existing services, an auditor is required to comply with the above
requirements on or before 31 March 2015.All engagements with an audit
client or its parent or subsidiary company for any prohibited service need
to be completed/terminated by 31 March 2015.
• An auditor is not allowed to enter into any new engagement with an
audit client or its parent or subsidiary company for any prohibited
services on or after 1 April 2014.
• Fraud Reporting: In the Audit Rules, distinction between material
and immaterial frauds has been removed. The auditor is required to
report all frauds to the Central Government irrespective of
materiality. The Audit Rules state that if an auditor has sufficient
reason to believe that an offence involving fraud, is being or has been
committed against the company by officers or employees of the company,
the auditor will report the matter to the Central Government immediately
but not later than sixty days of his knowledge. The Audit Rules prescribe
the following procedure for fraud reporting:

77

 • The auditor will forward his report to the board or the Audit Committee,
as the case may be, immediately after a fraud comes to his knowledge,
seeking their reply or observations within 45 days.
• On receipt of reply/observations, the auditor will forward his report,
reply received and his comments on the reply to the Central Government
within 15 days.
• If the auditor fails to get any reply/observations within 45 days, he will
forward his report to the Central Government along with a note
explaining the fact.
• Non-Compliance with the Above Requirements: Non-compliance with
this requirement knowingly and willfully is punishable with a fine of
minimum 1 lac which may extend to 25 lac.
• To report the fraud related matters to the Central Government, the Audit
Rules have prescribed Form ADT-4. The form requires that the report on
fraud, with form ADT-4, is to be given in a sealed cover to the Secretary,
Ministry of Corporate Affairs.

• Regarding Civil and Criminal Liability of the Auditors of the Firm:

Section 147(5) of the 2013 Act states that “where, in case of audit of a
company being conducted by an audit firm, it is proved that the partner
or partners of the audit firm has or have acted in a fraudulent manner or
abetted or colluded in any fraud by, or in relation to or by, the company
or its directors or officers, the liability, whether civil or criminal as
provided in this Act or in any other law for the time being in force, for
such act shall be of the partner or partners concerned of the audit firm
and of the firm jointly and severally.”
• The Audit Rules clarify that in case of criminal liability, the liability will
devolve only on the concerned partner or partners, who acted in a
fraudulent manner or abetted or, as the case may be, colluded in any
fraud.

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NCLT

NCLT (Section 408) and NCLAT (2013 Act): Prior to the constitution of NCLT,
multiple forums dealt with company matters in the following manner:

Forum Powers

High Courts Order winding up of companies

CLB Handle matters on oppression and mismanagement in companies

Board for Industrial and Deal with rehabilitation and revival of companies
Financial Reconstruction (BIFR)

Appellate Authority for Industrial Hear appeals from the decisions of BIFR
and Financial Reconstruction
(AAIFR)

An appeal from an order of the NCLT will lie before the NCLAT that has also
been set up from June 2016. Appeals from the orders of NCLAT will lie
before the Supreme Court.

• The establishment of NCLT as a single forum is a key milestone in the

journey towards institutional reforms for quicker resolution of company
law matters.
• The Central Government has constituted National Company Law
Tribunal (NCLT) under section 408 of the Companies Act, 2013 (18 of
2013) w.e.f. 01st June 2016. (NCLT Website).
• In the first phase the Ministry of Corporate Affairs have set up eleven
Benches, one Principal Bench at New Delhi and one each Regional

79

 Benches at New Delhi, Ahmedabad, Allahabad, Bengaluru, Chandigarh,
Chennai, Guwahati, Hyderabad, Kolkata and Mumbai. These Benches
will be headed by the President and 16 Judicial Members and 09
Technical Members at different locations (from NCLT Website).
• The Companies (Second Amendment) Act, 2002 provides for the setting
up of a National Company Law Tribunal and Appellate Tribunal to
replace the existing Company Law Board (CLB) and Board for Industrial
and Financial Reconstruction (BIFR). The setting up of the NCLT as a
specialized institution for corporate justice is based on the
recommendations of the Justice Eradi Committee (Former Judge of
SC) , a committee set up to examine the existing law relating to winding
up proceedings of companies in order to re-model it in line with the latest
developments and innovations in the corporate law and governance and
to suggest reforms in the procedure at various stages followed in the
insolvency proceedings of companies to avoid unnecessary delays in tune
with the international practice in this field. The setting up of the NCLT
and NCLAT are part of the efforts to move to a regime of faster
resolution of corporate disputes, thus improving the ease of doing
business in India.
• Remember, India Lower Ranking in Ease of Doing Business released by
World Bank (New Companies Act along with faster dispute resolution
process in the form of NCLT + new Insolvency and Bankruptcy Code,
2016 will change the Scenario).

Constitutionality of NCLT Challenged in Madras Bar Association v. UOI

A Constitution Bench ruling of the Supreme Court in Madras Bar Association

(2010) v. Union of India, which upheld the constitutionality of the 2013 Act’s
provisions relating to NCLT subject to certain qualifications. In 2010, a
constitution bench of the Supreme Court, in Union of India vs R. Gandhi,
President, Madras Bar Association [2010] 11 SCC 1, finally upheld the
constitutional validity of these tribunals. However, the Supreme Court also
80

found certain provisions of law relating to selection criteria of technical
member of these tribunals, and the selection committee (which has the power
select members of NCLT and NCLAT) were constitutionally invalid, and directed
that unless these defects are cured by legislative amendment, constitution of
NCLT and NCLAT could not be proceeded with.

• The Court essentially echoed its decision in the year 2015 in Madras Bar
Association v. Union of India on the ground that all arguments pertaining
to constitutionality were already addressed by the Court in that case
(2010 Decision) and it “specifically rejected the contention that
transferring judicial function, traditionally performed by the Courts,
to the Tribunals offended the basic structure of the Constitution”.
While the petitioner sought to invoke a September 2014 decision of the
Supreme in Madras Bar Association v. Union of India in which the
establishment of the National Tax Tribunal under NTT Act (“NTT”) was
held unconstitutional, the Court reemphasized that there were
significant differences between the NCLT and the NTT that would justify
arriving at a different conclusion.

(NCLT CHALLENGE)

• Constitutionality of NCLT was challenged twice (one in 2010 and another

in 2015). On 14th May, 2015, the Constitution Bench ruling of the
Supreme Court in Madras Bar Association v. Union of India, which
upheld the constitutionality of the 2013 Act’s provisions relating to NCLT
subject to certain qualifications. The challenge in 2015 essentially
related to the qualifications of the Technical Members of the NCLT. The
core issue at hand was that while the Supreme Court in MBA in 2010
provided that “only officers who are holding the ranks of Secretaries or
Additional Secretaries alone are to be considered for appointment as
technical Members of the NCLT”, the 2013 Act “again makes Joint
Secretary to the Government of India or equivalent officer eligible for

81

 appointment”, if he has the relevant experience. This was found to be
invalid, and contrary to the ruling in MBA. The Court observed that
“corrections are required to be made in Section 409(3) to set right the
defects contained therein.
• In terms of the final order, the Supreme Court noted in 2015 Judgment:
Since, the functioning of the NCLT and NCLAT has not started so far and
it’s high time that these Tribunals starting functioning now, we hope that
the respondents (Government of India) shall take remedial measures as
per the directions contained in this judgment at the earliest, so that the
NCLT & NCLAT are adequately manned and start functioning in the near
future.

Regarding Special Courts (New Provisions in 2013 Act):

Now, 8 special courts for speedy trials under company’s law; 22 May, 2016
(The Economic Times, 22 May 2016):

NEW DELHI: The government has designated eight special courts in different
parts of the country to ensure speedy trial of offences violating companies law
provisions. Envisaged under the Companies Act, 2013, the courts have been
designated after more than two years since provisions of this began to take
effect. It also comes at a time when the government is working on ways to
further improve the ease of doing business and reduce the number of
litigations pending at various courts. Eight courts have been designated as
special courts by the Ministry after receiving the concurrence of the respective
High Court Chief Justices, according to the Corporate Affairs Ministry.

These would be in J&K, Maharashtra, Gujarat, Goa, Madhya Pradesh, West

Bengal as well as the union territories of Andaman and Nicobar Islands; Dadra
and Nagar Haveli and Daman and Diu.

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In a notification, the Ministry said the special courts would deal with trial of
offences under Companies Act that are punishable with imprisonment of two
years or more as per provisions of the companies law. The special courts were
to be set up under the Act and now they have been notified. It would help in
speedy trials, a senior official said.

As per estimates, thousands of cases pertaining to companies law are pending.

"... the central government appoints May 18, 2016 as the date on which
provisions of clause (iv) of sub-section (29) of section 2, section 435 to 438
(both sections inclusive) and section 440 of the said Act shall come into force,"
the Ministry said in another notification.

These provisions pertain to matters related to the special courts.

"The central government may, for the purpose of providing speedy trial of
offences under this Act, by notification, establish or designate as many special
courts as may be necessary," according to Section 435 of the Companies Act,
2013.

Among others, the special court shall be deemed to be a court of session and
the person conducting a prosecution before a special court shall be deemed to
be a public prosecutor.

Most provisions of the Companies Act, 2013 -- that seeks to put in place
stringent norms to ensure good corporate governance practices and protect
shareholder interests -- came into force from April 1, 2014.

Out of the total 470 sections in the law, more than 280 have come into effect so
far. Among others, the process for establishment of the National Company Law
Tribunal and its appellate tribunal are in the final stages.

Functioning of SEBI: (comes into picture for Listed Company; SEBI Act,
1992);

83

Primary Functions: to protect the interest of the Investors in Securities
Markets; and to promote the development and regulation of Securities market;

Other Functions: Promoting investors education and training; regulating the

business of stock exchange; regulating the working of stock brokers;)

Securities Contract Regulation Act, 1956 and Securities Contract

Regulation Rules, 1957.(An Act to prevent undesirable transaction in
Securities; Recognition of Stock Exchange; Withdrawal of Recognition of Stock
Exchange; making bye laws by Stock Exchange; Submit report to CG;

Benefit of Listing: From Bombay Stock Exchange India Website:

Benefits of Listing of the Company on Stock Exchange

Listing provides an exclusive privilege to securities in the stock exchange. Only

listed shares are quoted on the stock exchange. Stock exchange facilitates
transparency in transactions of listed securities in perfect equality and
competitive conditions. Listing is beneficial to the company, to the investor,
and to the public at large.

The important advantages of listing are listed below

Fund Raising and exit route to investors

Listing provides an opportunity to the corporates / entrepreneurs to raise

capital to fund new projects/undertake expansions/diversifications and for
acquisitions. Listing also provides an exit route to private equity investors as
well as liquidity to the ESOP-holding employees.

Ready Marketability of Security

Listing brings in liquidity and ready marketability of securities on a continuous

basis adding prestige and importance to listed companies.

Ability to raise further capital

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An initial listing increases a company's ability to raise further capital through
various routes like preferential issue, rights issue, Qualified Institutional
Placements and ADRs/GDRs/FCCBs, and in the process attract a wide and
varied body of institutional and professional investors.

Supervision and Control of Trading in Securities

The transactions in listed securities are required to be carried uniformly as per

the rules and bye-laws of the exchange. All transactions in se¬curities are
monitored by the regulatory mechanisms of the stock exchange, preventing
unfair trade practices. It improves the confidence of small investors and
protects them.

Fair Price for the Securities

The prices are publicly arrived at on the basis of demand and supply; the stock
exchange quotations are generally reflective of the real value of the security.
Thus listing helps generate an independent valuation of the company by the
market.

Timely Disclosure of Corporate Information

The listing agreement signed with the exchange provides for timely dis¬closure
of information relating to dividend, bonus and right issues, book clo¬sure,
facilities for transfer, company related information etc by the company. Thus
providing more transparency and building investor confidence.

Collateral Value of Securities

Listed securities are acceptable to lenders as collateral for credit facili¬ties. A

listed company can also borrow from financial institutions easily as it is rated
favorably by lenders of capital; the company can also raise additional funds
from the public through the new issue market with a greater degree of
assurance.

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Better Corporate Practice

Since the violation of the listing agreement entails the de-listing/suspension of

securities from the rings of the exchange, the listed companies are ex¬pected to
follow fair practices to the advantage of investors and public.

Benefits to the Public

The data daily culled out by the stock exchange in the form of price quotations
and others; provide valuable information to the public which can be used for
project and research studies. The stock exchange prices can be an index of the
state of the economy. Financial institutions, NRl, individual investor’s etc. can
take wise decisions before making investments.

Subdivision and Consolidation of Holdings

Stock exchange bye-laws provide for explicit rules for sub division and
consolidation of securities as desired by the investors. There is special trading
sessions in the exchange for conversion of odd lots into market lots arranged
by financial and institutional investors. Thus listing helps to provide flexibility
to investors in the subdivision and consolidation of their holdings with speed
and earnestness.

Legal Principles

Union of India v. Madras Bar Association (2010 SC):

86

K.G. Balakrishnan, C.J., R.V. Raveendran, D.K. Jain, P. Sathasivam and
J.M. Panchal, JJ. ( 5 Judge Constitutional Bench Decision)

Decided On: 11.05.2010

The Judgment is important as it deals with Constitutionality of National

Company Law Tribunal established under Companies Amendment Act,
2002:

Grievance of Madras Bar Association (MBA) : that the High Court ought to
have held that constitution of such Tribunals taking away the entire Company
Law jurisdiction of the High Court and vesting it in a Tribunal which is not
under the control of the Judiciary, is violative of doctrine of separation of
powers and the independence of Judiciary which are parts of the basic
structure of the Constitution.

MBA also contends that the decisions of this Court in Union of India v. Delhi
High Court Bar Association MANU/SC/0194/2002 : 2002 (4) SCC 275, with
reference to constitutional validity of the provisions of the Recovery of Debts
Due to Banks and Financial Institutions Act, 1993 providing for
constitution of the Debt Recovery Tribunals and State of Karnataka v.
Vishwabharathi House Building Co-op., Society MANU/SC/0033/2003 : 2003
(2) SCC 412 in regard to the constitutional validity of Consumer Protection
Act, 1986 providing for constitution of consumer fora require reconsideration.

R.V. Raveendran, J.

• Case Note. Constitution - Legislative Competence of Parliament for

creation of Tribunals - Entries 77, 78, 79 and Entries 43, 44 read with
Entry 95 of List I, Item 11A read with Entry 46 of List III of the Seventh
Schedule. Whether Parliament have the legislative competence to vest

87

 intrinsic judicial functions that have been traditionally performed by the
High Courts for nearly a century in any Tribunal outside the Judiciary
• Held, legislature has the power to create Tribunals with reference to
specific enactments and confer jurisdiction on them to decide disputes in
regard to matters arising from such special enactments which includes
companies Act - Therefore, it cannot be said that legislature has no
power to transfer judicial functions traditionally performed by
Courts to Tribunals - Legislative competence of Parliament to provide for
creation of courts and Tribunals can be traced to Entries 77, 78, 79 and
Entries 43, 44 read with Entry 95 of List I, Item 11A read with Entry 46
of List III of the Seventh Schedule.

• Constitution - Violation of Doctrine of separation of power

QUESTION BEFORE COURT Whether the constitution of the National

Company Law Tribunal and transferring the entire company jurisdiction to
it, is violative of the doctrine of separation of powers and independence
of the Judiciary which are parts of the basic structure of the
Constitution - Held, Legislature has the competence to make laws
providing which disputes will be decided by courts and which disputes will
be decided by Tribunals subject to constitutional limitations and in view the
principles of Rule of Law and separation of powers –

In the present case, the creation of National Company Law Tribunal

and National Company Law Appellate Tribunal and vesting in them, the
powers and jurisdiction exercised by the High Court in regard to
company law matters, are not unconstitutional Various provisions of
Chapters IB and IC of the Act which are defective and unconstitutional,
being in breach of basic principles of Rule of Law, Separation of Powers and
Independence of the Judiciary to be made operational by making suitable
amendments by the Government.

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 • Ratio Decidendi: Legislature has the power to create Tribunals with
reference to specific enactments including companies Act but such
constitution must not be violative of the doctrine of separation of powers
and independence of the Judiciary which are parts of the basic structure
of the Constitution.

Appeal to Supreme Court: These appeals arise from the order dated
30.3.2004 of the Madras High Court in WP No. 2198/2003 filed by the
President of Madras Bar Association (MBA for short) challenging the
constitutional validity of Chapters 1B and 1C of the Companies Act, 1956 (`Act'
for short) inserted by Companies (Second Amendment) Act 2002 (`Amendment
Act' for short) providing for the constitution of National Company Law Tribunal
(`NCLT' or `Tribunal') and National Company Law Appellate Tribunal (`NCLAT'
or `Appellate Tribunal').

Madras Bar Association (`MBA') raised the following contentions:

1) Parliament does not have the legislative competence to vest intrinsic judicial
functions that have been traditionally performed by the High Courts for nearly
a century in any Tribunal outside the Judiciary.

2) The constitution of the National Company Law Tribunal and transferring the
entire company jurisdiction of the High Court to the Tribunal which is not
under the control of the Judiciary is violative of the doctrine of separation of
powers and independence of the Judiciary which are parts of the basic
structure of the Constitution.

3) Article 323B of the Constitution enables the appropriate Legislature to

provide for adjudication or trial by Tribunals of disputes, complaints or
offences with respect to all or any of the matters specified in Clause (2). Clause
(2) enumerate the matters in regard to which Tribunals can be constituted.
ARGUMENT: The said list is exhaustive and not illustrative. The list does not

89

provide for constitution of Tribunal for insolvency, revival and restructuring of
the company. In the absence of any amendment to Article 323B providing for a
National Tribunal for revival of companies and winding up companies, there is
no legislative competence to provide for constitution of NCLT and NCLAT.

• The various provisions of Chapters IB and IC of the Act (Sections 10FB,

10FD, 10FE, 10FF, 10FL(2), 10FO, 10FR(3), 10FT and 10FX) are
defective and unconstitutional, being in breach of basic principles of Rule
of Law, Separation of Powers and Independence of the Judiciary.
• The Union of India submitted that it had constituted a High Level
Committee on Law relating to Insolvency of Companies under the
Chairmanship of Justice V. Balakrishna Eradi, a retired Judge of this
Court, with other experts to examine the existing laws relating to
winding-up proceedings of the company in order to remodel it in line with
the latest developments and innovations in corporate laws and
governance and to suggest reforms to the procedures at various stages
followed in insolvency proceedings of the company in order to avoid
unnecessary delay, in tune with international practices in the field. The
said Committee identified the following areas which contributed to
inordinate delay in finalisation of winding-up/dissolution of companies :
(a) filing statement of affairs; (b) handing over of updated books of
accounts; (c) realization of debts; (d) taking over possession of the assets
of the company and sale of assets; (e) non-availability of funds for the
Official Liquidator to discharge his duties and functions (f) settlement of
the list of creditors; (g) settlement of list of contributories and payment of
calls; (h) finalisation of income-tax proceedings; and (i) disposal of
misfeasance proceedings. The Committee found that multiplicity of
court proceedings is the main reason for the abnormal delay in
dissolution of companies. MULTIPLICITY OF PROCEEDINGS: It also
found that different agencies dealt with different areas relating to
companies, that Board for Industrial & Financial Reconstruction (BIFR)

90

 and Appellate Authority for Industrial & Financial Reconstruction
(AAIFR) dealt with references relating to rehabilitation and revival of
companies, High Courts dealt with windingup of companies and
Company Law Board (CLB) dealt with matters relating to prevention of
oppression and mismanagement etc. Considering the laws on
corporate insolvency prevailing in industrially advanced countries,
the Committee recommended various amendments in regard to the
provisions of Companies Act, 1956 for setting-up of a National
Company Law Tribunal which will combine the powers of the CLB
under the Companies Act, 1956, BIFR and AAIFR under the Sick
Industrial Companies (Special Provisions) Act, 1985 as also the
jurisdiction and powers relating to winding-up presently vested in
the High Courts.
• It is stated that the recommendations of the Eradi Committee were
accepted by the Government and Company (Second Amendment)
Act, 2002 was passed providing for establishment of NCLT and
NCLAT to take-over the functions which are being performed by
CLB, BIFR, AAIFR and the High Courts.
• Benefits of the NCLT:It is submitted that the establishment of NCLT
and NCLAT will have the following beneficial effects: (i) reduce the
pendency of cases and reduce the period of winding-up process from 20
to 25 years to about two years; (ii) avoid multiplicity of litigation before
various fora (High Courts and quasi-judicial Authorities like CLB, BIFR
and AAIFR) as all can be heard and decided by NCLT; (iii) the appeals will
be streamlined with an appeal provided against the order of the NCLT to
an appellate Tribunal (NCLAT) exclusively dedicated to matters arising
from NCLT, with a further appeal to the Supreme Court only on
points of law, thereby reducing the delay in appeals; and (iv) with the
pending cases before the Company Law Board and all winding-up cases
pending before the High Courts being transferred to NCLT, the burden on
High Courts will be reduced and BIFR and AAIFR could be abolished.
91

 • Cases: P. Sampath Kumar v. Union of India MANU/SC/0851/1987 :
1987 (1) SCC 124, L. Chandrakumar v. Union of India
MANU/SC/0261/1997 : (1997) 3 SCC 261; Union of India v. Delhi High
Court Bar Association MANU/SC/0194/2002 : (2002) 4 SCC 275 and
State of Karnataka v. Vishwabharathi House Building Co-operative
Society MANU/SC/0033/2003 : 2003(2) SCC 412.
• The Madras High Court by its order dated 30.3.2004 held that creation of
the NCLT and vesting the powers hitherto exercised by the High Courts
and CLB in the Tribunal was not unconstitutional. It referred to and
listed the defects in several provisions (that is mainly Sections
10FD(3)(f)(g)(h), 10FE, 10FF, 10FL(2), 10FR(3), 10FT) in Parts IB and IC
of the Act. It therefore declared that until the provisions of Part IB and IC
of the Act, introduced by the Amendment Act which were defective being
violative of basic constitutional scheme (of separation of judicial power
from the Executive and Legislative power and independence of judiciary
enabling impartial exercise of judicial power) are duly amended by
removing the defects that were pointed out; it will be unconstitutional to
constitute a Tribunal and Appellate Tribunal to exercise the jurisdiction
now exercised by the High Court or the Company Law Board.
• The Union of India has accepted that several of the defects pointed
out by the High Court in Parts IB and IC of the Act, require to be
corrected and has stated that those provisions will be suitably amended
to remove the defects:
• To narrow down the controversy in regard to the appeal by the Union, we
note below the defects pointed out by the High Court in regard to various
provisions in Parts IB and IC of the Act and the stand of Union of India
in respect of each of them.
• The High Court held that unless the term of office is fixed as at least five
years with a provision for renewal, except in cases of incapacity,
misconduct and the like, the constitution of the Tribunal cannot be

92

 regarded as satisfying the essential requirements of an independent and
impartial body exercising judicial functions of the state.
• The Union Government has accepted the finding and agreed to amend
Section 10FE and 10FT of the Act to provide for a five year term for the
Chairman/President/Members. However, the Government proposes to
retain the provision for reappointment instead of `renewal', as the
reappointments would be considered by a Selection Committee which
would be headed by the Chief Justice of India or his nominee. As the
Government proposes to have minimum eligibility of 50 years for first
appointment as a Member of the Tribunal, a Member will have to
undergo the process of re-appointment only once or twice.
• The Union Government has submitted that in view of the proposed longer
tenure of five years as against the three years, the government proposes
to permit the members to retain their lien with their parent
cadre/Ministry/Department for a period of three years, as one year may
be too short for the members to decide whether to give up the lien or not.
• The High Court has suggested that it would be appropriate to confine the
choice of persons to those who have held the position of a Judge of a
High Court for a minimum period of five years instead of the existing
provision which provides that Central Government shall appoint a person
who has been, or is qualified to be, a Judge of a High Court, for the post
of President of the Tribunal.

• The Government has agreed in part and proposes to amend the Act
for appointment of a retired or serving High Court Judge alone as
the President of the Tribunal. It however feels that minimum length of
service as experience, need not be fixed in the case of High Court Judges,
as the Selection Committee headed by the Chief Justice of India or his
nominee would invariably select the most suitable candidate for the post.

93

Question before the Court of Law

i) To what extent the powers and judiciary of High Court (excepting judicial
review under Article 226/227) can be transferred to Tribunals?

(ii) Is there a demarcating line for the Parliament to vest intrinsic judicial
functions traditionally performed by courts in any Tribunal or authority
outside the judiciary?

(iii) Whether the "wholesale transfer of powers" as contemplated by the

Companies (Second Amendment) Act, 2002 would offend the constitutional
scheme of separation of powers and independence of judiciary so as to
aggrandize one branch over the other?

• Therefore the Three Judge Bench, by order dated 13.5.2007 directed the
appeals to be heard by a Constitution Bench, observing that as the
issues raised are of seminal importance and likely to have serious
impact on the very structure and independence of judicial system.

Difference between Courts and Tribunals

The term `Courts' refers to places where justice is administered or refers to

Judges who exercise judicial functions. Courts are established by the state for
administration of justice that is for exercise of the judicial power of the state to
maintain and uphold the rights, to punish wrongs and to adjudicate upon
disputes. Tribunals on the other hand are special alternative institutional
mechanisms, usually brought into existence by or under a statute to
decide disputes arising with reference to that particular statute, or to
94

determine controversies arising out of any administrative law. Courts refer
to Civil Courts, Criminal Courts and High Courts. Tribunals can be either
private Tribunals (Arbitral Tribunals), or Tribunals constituted under the
Constitution (Speaker or the Chairman acting under Para 6(1) of the Tenth
Schedule) or Tribunals authorized by the Constitution (Administrative
Tribunals under Article 323A and Tribunals for other matters under Article
323B or Statutory Tribunals which are created under a statute (Motor Accident
Claims Tribunal, Debt Recovery Tribunals and consumer fora). Some Tribunals
are manned exclusively by Judicial Officers (Rent Tribunals, Motor Accidents
Claims Tribunal, Labour Courts and Industrial Tribunals). Other statutory
Tribunals have Judicial and Technical Members (Administrative Tribunals,
TDSAT, Competition Appellate Tribunal, Consumer fora, Cyber Appellate
Tribunal, etc.

In Harinagar Sugar Mills Ltd. v. Shyam Sundar Jhunjhunwala

MANU/SC/0060/1961 : (1962) 2 SCR 339, Hidayatullah J., succinctly
explained the difference between Courts and Tribunals, thus:

All Tribunals are not courts, though all courts are Tribunals". The word
"courts" is used to designate those Tribunals which are set up in an organized
state for the administration of justice. By administration of justice is meant the
exercise of juridical power of the state to maintain and uphold rights and to
punish "wrongs". Whenever there is an infringement of a right or an injury, the
courts are there to restore the vinculum juris, which is disturbed........

When rights are infringed or invaded, the aggrieved party can go and
commence a querela before the ordinary Civil Courts. These Courts which are
instrumentalities of Government, are invested with the judicial power of the
State, and their authority is derived from the Constitution or some Act of

95

Legislature constituting them. Their number is ordinarily fixed and they are
ordinarily permanent, and can try any suit or cause within their jurisdiction.
Their numbers may be increased or decreased, but they are almost always
permanent and go under the compendious name of "Courts of Civil
Judicature". There can thus be no doubt that the Central Government does not
come within this class.

Paragraph 54 of the Judgment (Important Para): Parts IC and ID of the

Companies Act proposes to shift the company matters from the courts to
Tribunals, where a `Judicial Member' and a `Technical Member' will decide
the disputes. If the members are selected as contemplated in Section 10FD,
there is every likelihood of most of the members, including the so called
`Judicial Members' not having any judicial experience or company law
experience and such members being required to deal with and decide complex
issues of fact and law.

Whether the Tribunals should have only judicial members or a

combination of judicial and technical members is for the Legislature to
decide.?? But if there should be technical members, they should be
persons with expertise in company law or allied subjects and mere
experience in civil service cannot be treated as Technical Expertise in
company law. The candidates falling under Sub-section 2(c) and (d) and Sub-
sections 3(a) and (b) of Section 10FD have no experience or expertise in
deciding company matters.

55. Regarding Erroneous Assumption: There is an erroneous assumption

that company law matters require certain specialized skills which are
lacking in Judges. There is also an equally erroneous assumption that
members of the civil services, (either a Group-A officer or Joint Secretary level

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civil servant who had never handled any company disputes) will have the
judicial experience or expertise in company law to be appointed either as
Judicial Member or Technical Member. Nor can persons having experience of
fifteen years in science, technology, medicines, banking, industry can be
termed as experts in Company Law for being appointed as Technical Members.
The practice of having experts as Technical Members is suited to areas which
require the assistance of professional experts, qualified in medicine,
engineering, and architecture etc.

Lastly, we may refer to the lack of security of tenure. The short term of
three years, the provision for routine suspension pending enquiry and the
lack of any kind of immunity, are aspects which require to be considered
and remedied.

DEFECT: Para 56 Defect pointed out by Supreme Court: We may now

tabulate the defects in Parts IB and IC of the Act:

(i) Only Judges and Advocates can be considered for appointment as

Judicial Members of the Tribunal. Only the High Court Judges or Judges
who have served in the rank of a District Judge for at least five years or a
person who has practiced as a Lawyer for ten years can be considered for
appointment as a Judicial Member. Persons who have held a Group A or
equivalent post under the Central or State Government with experience in the
Indian Company Law Service (Legal Branch) and Indian Legal Service (Grade-1)
cannot be considered for appointment as judicial members as provided in Sub-
section 2(c) and (d) of Section 10FD. The expertise in Company Law service
or Indian Legal service will at best enable them to be considered for
appointment as technical members.

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(ii) As the NCLT takes over the functions of High Court, the members should
as nearly as possible have the same position and status as High Court
Judges. This can be achieved, not by giving the salary and perks of a High
Court Judge to the members, but by ensuring that persons who are as nearly
equal in rank, experience or competence to High Court Judges are appointed
as members. Therefore, only officers who are holding the ranks of
Secretaries or Additional Secretaries alone can be considered for
appointment as Technical members of the National Company Law
Tribunal. Clauses (c) and (d) of Sub-section (2) and Clauses (a) and (b) of Sub-
section (3) of Section 10FD which provide for persons with 15 years experience
in Group A post or persons holding the post of Joint Secretary or equivalent
post in Central or State Government, being qualified for appointment as
Members of Tribunal is invalid. (INVALID)

(iii) A `Technical Member' presupposes an experience in the field to which the

Tribunal relates. A member of Indian Company Law Service who has worked
with Accounts Branch or officers in other departments who might have
incidentally dealt with some aspect of Company Law cannot be considered as
`experts' qualified to be appointed as Technical Members. Therefore Clauses (a)
and (b) of Sub-section (3) are not valid. (v) The first part of Clause (f) of Sub-
section (3) providing that any person having special knowledge or professional
experience of 15 years in science, technology, economics, banking, industry
could be considered to be persons with expertise in company law, for being
appointed as Technical Members in Company Law Tribunal, is invalid. (
INVALID)

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(iv) Persons having ability, integrity, standing and special knowledge and
professional experience of not less than fifteen years in industrial finance,
industrial management, industrial reconstruction, investment and
accountancy, may however be considered as persons having expertise in
rehabilitation/revival of companies and therefore, eligible for being considered
for appointment as Technical Members. ( VALID).

(v) In regard to category of persons referred in Clause (g) of Sub-section (3) at

least five years experience should be specified.

(vi) Only Clauses (c), (d), (e), (g), (h), and later part of Clause (f) in Sub-section
(3) of Section 10FD and officers of civil services of the rank of the Secretary or
Additional Secretary in Indian Company Law Service and Indian Legal Service
can be considered for purposes of appointment as Technical Members of the
Tribunal.

(vii) Instead of a five-member Selection Committee with Chief Justice of India

(or his nominee) as Chairperson and two Secretaries from the Ministry of
Finance and Company Affairs and the Secretary in the Ministry of Labour and
Secretary in the Ministry of Law and Justice as members mentioned in Section
10FX, the Selection Committee should broadly be on the following lines:

(a) Chief Justice of India or his nominee - Chairperson (with a casting vote);

(b) A senior Judge of the Supreme Court or Chief Justice of High Court -
Member;

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(c) Secretary in the Ministry of Finance and Company Affairs - Member; and

(d) Secretary in the Ministry of Law and Justice - Member.

(viii) Regarding Term: The term of office of three years shall be changed to a
term of seven or five years subject to eligibility for appointment for one more
term. This is because considerable time is required to achieve expertise in the
concerned field. A term of three years is very short and by the time the
members achieve the required knowledge, expertise and efficiency, one term
will be over. Further the said term of three years with the retirement age of 65
years is perceived as having been tailor-made for persons who have retired or
shortly to retire and encourages these Tribunals to be treated as post-
retirement havens. If these Tribunals are to function effectively and efficiently
they should be able to attract younger members who will have a reasonable
period of service.

(ix) Regarding Lien: The second proviso to Section 10FE enabling the President
and members to retain lien with their parent cadre/ministry/department while
holding office as President or Members will not be conducive for the
independence of members. Any person appointed as members should be
prepared to totally disassociate himself from the Executive. The lien cannot
therefore exceed a period of one year.

(x) Regarding Suspension: To maintain independence and security in service,

Sub-section (3) of Se ction 10FJ and Section 10FV should provide that

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suspension of the President/Chairman or member of a Tribunal can be only
with the concurrence of the Chief Justice of India.

(xi) The administrative support for all Tribunals should be from the Ministry of
Law & Justice. Neither the Tribunals nor its members shall seek or be provided
with facilities from the respective sponsoring or parent Ministries or concerned
Department.

(xii) Two-Member Benches of the Tribunal should always have a judicial

member. Whenever any larger or special benches are constituted, the number
of Technical Members shall not exceed the Judicial Members.

57. SC disposing off the Appeal: We therefore dispose of these appeals, partly
allowing them, as follows:

(i) We uphold the decision of the High Court that the creation of National
Company Law Tribunal and National Company Law Appellate Tribunal and
vesting in them, the powers and jurisdiction exercised by the High Court
in regard to company law matters, are not unconstitutional.

(ii) We declare that Parts 1B and 1C of the Act as presently structured, are
unconstitutional for the reasons stated in the preceding para. However, Parts
IB and IC of the Act, may be made operational by making suitable
amendments, as indicated above, in addition to what the Union Government
has already agreed in pursuance of the impugned order of the High Court.

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