UNIT 2: Memorandum and article of association:

2.1 Meaning and nature

2.2 Doctrine of Ultra-Vires.
2.3 Doctrine of constructive notice
2.4 Doctrine of indoor management

2.1 Meaning and nature

MEMORANDUM OF ASSOCIATION
Memorandum of Association is the most important document of a company. It states the objects for which
the company is formed. It contains the rights, privileges and powers of the company. Hence it is called a charter of
the company. It is treated as the constitution of the company. It determines the relationship between the company
and the outsiders.
The whole business of the company is built up according to Memorandum of Association. A company cannot
undertake any business or activity not stated in the Memorandum. It can exercise only those powers which are
clearly stated in the Memorandum.
Definition of Memorandum of Association
Lord Cairns: “The memorandum of association of a company is the charter and defines the limitation of the power of
the company established under the Act”.
Thus, a Memorandum of Association is a document which sets out the constitution of the company. It clearly
displays the company’s relationship with outside world. It also defines the scope of its activities. MoA enables the
shareholders, creditors and people who has dealing with the company in one form or another to know the range of
activities.
Contents of Memorandum of Association
According to the Companies Act, the Memorandum of Association of a company must contain the following
clauses:
1. Name Clause of Memorandum of Association - The name of the company should be stated in this clause. A
company is free to select any name it likes. But the name should not be identical or similar to that of a company
already registered. It should not also use words like King, Queen, Emperor, Government Bodies and names of World
Bodies like U.N.O., W.H.O., World Bank etc. If it is a Public Limited Company, the name of the company should
end with the word ‘Limited’ and if it is a Private Limited Company, the name should end with the words ‘Private
Limited’.
2. Situation Clause of Memorandum of Association - In this clause, the name of the State where the
Company’s registered office is located should be mentioned. Registered office means a place where the common seal,
statutory books etc., of the company are kept.The company should intimate the location of registered office to the
registrar within thirty days from the date of incorporation or commencement of business.
The registered office of a company can be shifted from one place to another within the town with a simple
intimation to the Registrar. But in some situation, the company may want to shift its registered office to another
town within the state. Under such circumstance, a special resolution should be passed. Whereas, to shift the
registered office to other state, Memorandum should be altered accordingly.
3. Objects Clause of Memorandum of Association - This clause specifies the objects for which the company is
formed. It is difficult to alter the objects clause later on. Hence, it is necessary that the promoters should draft this
clause carefully. This clause mentions all possible types of business in which a company may engage in future.
The objects clause must contain the important objectives of the company and the other objectives not included
above.
4. Liability Clause of Memorandum of Association - This clause states the liability of the members of the
company. The liability may be limited by shares or by guarantee. This clause may be omitted in case of unlimited
liability.
5. Capital Clause of Memorandum of Association - This clause mentions the maximum amount of capital that
can be raised by the company. The division of capital into shares is also mentioned in this clause. The company
cannot secure more capital than mentioned in this clause. If some special rights and privileges are conferred on any
type of shareholders mention may also be made in this clause.

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 6. Subscription Clause of Memorandum of Association - It contains the names and addresses of the first
subscribers. The subscribers to the Memorandum must take at least one share. The minimum number of members is
two in case of a private company and seven in case of a public company.
Thus the Memorandum of Association of the company is the most important document. It is the foundation
of the company.
MEANING OF ARTICLES OF ASSOCIATION
The Articles of Association can be seen as a rule book within a company. This is in a document form and is a
part of the company’s constitution alongside the memorandum. This document contains internal detailed governing
aspects of the company’s organisation. These include shares, (issue and rights attached to them) the conduct of the
company meetings and the role and powers of the directors. The Articles detail rules which govern the conduct of
directors, the rights of the shareholders and the relationship between the two.
The articles of association set out how the company is run, governed and owned. The articles can put
restrictions on the company’s powers – which may be useful if shareholders want comfort that the directors will not
pursue certain courses of action, at least without shareholder approval. By default, however, the Companies Act 2006
gives a company unlimited powers.
In addition to the articles, which is a public document, the shareholders may enter into a shareholders’
agreement to augment the articles in relation to the running, governance and ownership of the company that they
want to keep out of the public domain.
Importance of Articles of Association
Under sec 36, the memorandum and the articles when registered, shall bind the company and its members to
the same extent as if it had been signed by them and had contained a covenant on their part that the memorandum
and the articles shall be observed.
With respect to the above section, the importance of articles of association can be summed up as follows:
1) Binding on members in their relation to the company- the members are bound to the company by the
provisions of the articles just as much as if they had all put their seals to them.
2) Binding on company in relation to its members- just as members are bound to the company, the company
is bound to the members to observe and follow the articles.
3) Neither company, nor members bound to outsiders- articles bind the members to the company and
company to the members but neither of them is bound to an outsider to give effect to the articles.
4) Binding between members inter se- the articles define rights and liabilities of the members. As between
members inter se the articles constitute a contract between them and are also binding on each member as against the
other or others. Such contract can be enforced only through the medium of the company.
Contents of the Articles of Association:-
Each limited liability company must have articles of association. They are the company’s internal
regulations, which bind the company, its administrative bodies, management and auditors. The articles of
association must be complied with in the same manner as the Limited Liability Companies Act.
The formulation of the articles of association is of great importance from the point of view of the company’s
activities. Articles of association that is not suitable for the company’s purposes may decrease the benefits, which the
shareholders can obtain from the company. It is recommendable to pay due attention to the contents of the articles
of association already during the company's founding phase, because the amendments thereof always require at least
two-thirds (a qualified majority) of the votes and of the shares represented at the general meeting of shareholders. In
practice, significant amendments always need to be agreed between the shareholders. Moreover, amendments always
result in Trade Register costs as the amendments become effective only following registration in the Trade Register.
The articles of association must include provisions regarding the following:
1) Company name - The company name of a private limited liability company must include the words
“limited liability company” or the abbreviation “limited / Ltd” (in Finnish “osakeyhtiö” / “Oy”, in Swedish
“aktiebolag” / “Ab”). If the company intends to use its company name in two or more languages, the names in other
languages must be stated in the articles of association.
2) A Finnish municipality as the company’s place of business - A company may practice its activities in
several places and also abroad, but its registered place of business can only be in one Finnish municipality. The
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company’s registered place of business is of significance, as the general meetings of shareholders generally need to be
held in the municipality of the place of business and any legal actions against the company need to be brought to the
court of the municipality in question (forum domicilii).
3) The company's field of activity - The term "field of activity" refers to the fields in which the company
carries on its business activity. Any activity, which may be pursued legally in the form of a limited liability
company, can constitute the company’s field of activity. A company can have several fields of activity, but they
must all be registered. Although legislation is silent about how precise the definition of the field of activity needs to
be, inexact and unnecessarily extensive definitions should be avoided. The definition of the field of activity has legal
significance when assessing the competence of the company’s organs to take care of company matters. Moreover, the
field of activity is of importance when evaluating the use of company assets. The field of activity may also consist of
a general field of activity. Definitions of the field of activity, which are too narrow, can cause extra costs and
inconvenience, as the expansion of the company’s activity requires for the articles of association to be amended
correspondingly and for the changes to be registered with the Trade Register.
4) Share capital - The minimum amount of a private limited liability company's share capital is 2,500 euros.
The minimum amount of a public limited liability company’s share capital must be at least 80,000 euros. The share
capital can be stated either as a fixed amount or as minimum and maximum amounts. In case the share capital has
been defined as minimum and maximum capital, it can be increased and decreased within these limits without a need
to amend the articles of association.
5) Nominal value and number of shares - If the nominal value is defined in the articles of association, all
shares must have the same nominal value.
6) Number of members of the board of directors and auditors as well as the possible deputy members, or the
minimum and maximum number thereof. The number of the members of the board of directors and auditors, as well
as the possible deputy members and their term of office may be stated in the articles of association. The number of
the members may also be stated as a minimum or maximum amount. At least one of the members of the board of
directors must have his/her place of residence in the EEA, unless the National Office of Patents and Registration of
Finland grant the company a permission to deviate from this requirement. Legally incompetent or bankrupt natural
persons or a legal person cannot be members of the board of directors. In addition, the articles of association may
include special provisions concerning the eligibility of a board member and a deputy member.
There may be more than one auditor. The competence of an auditor is regulated in the Auditing Act [5.1.7
Audit]. In case only one auditor has been elected and the auditor is not an auditing KHT or HTM-firm approved in
accordance with the Auditing Act, then at least one deputy auditor must be elected in addition.
7) Notice of a general meeting of shareholders - The articles of association may stipulate the manner in which
and when the notice to the annual general meeting of shareholders must be given. The notice may be given e.g. by
announcement in a newspaper or by a written notice delivered to the persons who have been entered in the share and
shareholders’ registers. If not mentioned in the articles of association, according to the Limited Liability Companies
Act, the notice must be issued in private limited liability companies no later than one week prior to the date of the
general meeting, or the special date of registration stated in the articles of association, and no earlier than two
months prior to the date of the general meeting or the registration date.
8) The agenda of the annual general meeting - The articles of association may state the agenda of the annual
general meeting. Matters, which according to mandatory law provisions must be considered at the annual general
meeting, shall also be included on the agenda.
9) Accounting period of the company - According to the Auditing Act, the accounting period of the company
may be a calendar year or any other period of twelve (12) months. The accounting period may be shorter or longer
than this period when the company's activity is being set up or closed down or when the time for the financial
statements is being changed. The maximum length of the accounting period is eighteen (18) months.
10) Supplementary provisions - The Limited Liability Companies Act provides several legal alternatives, the
use of which requires supplementary provisions to be inserted into the articles of association. Regulating the matter
in the articles of association is usually a prerequisite, if the company wishes to derive a legal benefit from the

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alternative. For instance, a redemption right does not relate to a share, if the matter has not been stated in the
articles of association (a so-called redemption clause). Nevertheless, the inclusion of such regulations in the articles of
association is entirely voluntary. The use thereof depends on whether the company wants to utilize the alternative
provided by legislation.
11) Other provisions - In addition to mandatory provisions, the shareholders may also quite freely include
other provisions in the articles of association. The other provisions may not, however, contradict the mandatory
principles provided by the Limited Liability Companies Act, e.g. by limiting the transferability of the shares in
another way than by way of a redemption or consent clause as provided by law. These voluntary provisions may
concern e.g. following matters:
# appointment of a managing director
# the manner of calling the general meeting;
# nomination of the chairman of the general meeting or election of a director of the board;
# minimum attendance at the general meeting;
# expansion of the scope of the tasks of the general meeting to cover e.g. decisions on transfers of or mortgage
on fixed assets, or on floating charges;
# determination of the majority required for resolutions adopted by the general meeting above the ordinary;
# withdrawal of the decision power of the chairman in the event of equal votes so that the outcome may be
determined e.g. by the drawing of lots;
# an arbitration clause, which binds the company, the shareholders, the board, the supervisory board, a
member of the board and a member of the supervisory board, the managing director and the auditor with the same
effect as an arbitration agreement.
Entrenchment - The articles of association may contain entrenchment provisions. However, this concept of
entrenchment was not present in the Companies Act, 1956. The word entrench means to establish an attitude, habit,
or belief so firmly that change is very difficult or unlikely. Thus, an entrenchment clause is the one which makes
certain amendments either impossible or difficult.
The company has the discretion to include entrenchment provisions in its articles of association. Such
provision may relate to the effect that specified provisions of the articles may be altered only if conditions or
procedures as that are more restrictive than those applicable in the case of a special resolution, are met or complied
with. An entrenchment provision can be made at the time of incorporation of the company, or after the
incorporation of the company by way of an amendment to the articles of association of the company.
Conclusion
It is a settled company law principle that the articles of association of a company cannot override the
provisions of the Companies Act, 2013. Further, the articles of association of a particular company are also bound to
observe the memorandum of association of the company as the articles are subordinate to the charter which is the
memorandum of the company as well as any other company law in force at that time. Thus, it is of primary
importance that when a company is being incorporated, and the articles of association of the company are being
prepared, the same must be done in consonance with memorandum of association, the Companies Act, 2013 and any
other company law which is in force at that time.

MEMORANDUM OF ASSOCIATION ARTICLES OF ASSOCIATION

Memorandum of Association (MOA) is a
Articles of Association (AOA) is a document
document that contains all the fundamental
Definition containing all the rules and regulations that
data which are required for the company
govern the company
incorporation.
MOA must be registered at the time of
Registration The articles may or may not be registered.
incorporation.
The articles demonstrate obligations, rights, and
The Memorandum is the charter, which
powers of individuals, who are endowed with the
Scope characterizes and limits powers and
responsibility of running the organization and
constraints of the organization.
administration.

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 Status Supreme document. It is subordinate to the memorandum.
The memorandum cannot give the company The articles are constrained by the act, but they
Power power to do anything opposed to the are also subsidiary to the memorandum and
provision of the companies act. cannot exceed the powers contained therein.
The articles can be drafted according to the
Contents A memorandum must contain six clauses.
decision of the Company.
The articles provide the regulations by which
The memorandum contains the objectives
Objectives those objectives and powers are to be conveyed
and powers of the company.
into impact.
The memorandum is the dominant Any provision, as opposed to a memorandum of
Validity
instrument and controls articles. association, is invalid.

2.2 Doctrine of Ultra-Vires.

Introduction - Companies have to borrow funds from time to time for various projects in which they are engaged.
Borrowing is an indispensable part of day to day transactions of a company, and no company can be imagined to run
without borrowing from time to time. Balance sheets are released every year by the companies, and you will hardly
find any balance sheet without borrowings in the liabilities clause of it. However, there are certain restrictions while
making such borrowings. If companies go beyond their powers to borrow, then such borrowings may be deemed as
ultra-vires.
Ultra-vires Meaning-
It is a Latin term made up of two words “ultra” which means beyond and “vires” meaning power or
authority. So we can say that anything which is beyond the authority or power is called ultra-vires. In the context of
the company, we can say that anything which is done by the company or its directors which is beyond their legal
authority or which was outside the scope of the object of the company is ultra-vires.
Doctrine of Ultra-Vires
Memorandum of association is considered to be the constitution of the company. It sets out the internal and
external scope and area of company’s operation along with its objectives, powers, scope. A company is authorized to
do only that much which is within the scope of the powers provided to it by the memorandum. A company can also
do anything which is incidental to the main objects provided by the memorandum. Anything which is beyond the
objects authorized by the memorandum is an ultra-vires act.
Origin of the doctrine
The doctrine of ultra-vires first time originated in the classic case of Ashbury Railway Carriage and Iron Co.
Ltd. v. Riche, (1878) L.R. 7 H.L. 653, which was decided by the House of Lords. In this case the company and M/s.
Riche entered into a contract where the company agreed to finance construction of a railway line. Later on, directors
repudiated the contract on the ground of its being ultra-vires of the memorandum of the company. Riche filed a suit
demanding damages from the company. According to Riche, the words “general contracts” in the objects clause of
the company meant any kind of contract. Thus, according to Riche, the company had all the powers and authority
to enter and perform such kind of contracts. Later, the majority of the shareholders of the company ratified the
contract. However, directors of the company still refused to perform the contract as according to them the act was
ultra-vires and the shareholders of the company cannot ratify any ultra-vires act.
When the matter went to the House of Lords, it was held that the contract was ultra-vires the memorandum
of the company, and, thus, null and void. Term “general contracts” was interpreted in connection with preceding
words mechanical engineers, and it was held that here this term only meant any such contracts as related to
mechanical engineers and not to include every kind of contract. They also stated that even if every shareholder of the
company would have ratified this act, then also it had been null and void as it was ultra-vires the memorandum of
the company. Memorandum of the company cannot be amended retrospectively, and any ultra-vires act cannot be
ratified.

What is the need or purpose of the doctrine of ultra-vires?

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 This doctrine assures the creditors and the shareholders of the company that the funds of the company will
be utilized only for the purpose specified in the memorandum of the company. In this manner, investors of the
company can get assured that their money will not be utilized for a purpose which is not specified at the time of
investment. If the assets of the company are wrongfully applied, then it may result into the insolvency of the
company, which in turn means that creditors of the company will not be paid. This doctrine helps to prevent such
kind of situation. This doctrine draws a clear line beyond which directors of the company are not authorized to act.
It puts a check on the activities of the directors and prevents them from departing from the objective of the
company.
Difference between an Ultra-Vires and an Illegal act
An ultra-vires act is entirely different from an illegal act. People often mistakenly use them as a synonym to
each other, while they are not. Anything which is beyond the objectives of the company as specified in the
memorandum of the company is ultra-vires. However, anything which is an offense or draws civil liabilities or is
prohibited by law is illegal. Anything which is ultra-vires, may or may not be illegal, but both of such acts are void-
ab-initio.
The doctrine of ultra-vires in Companies Act, 2013
Section 4 (1)(c) of the Companies Act, 2013, states that all the objects for which incorporation of the
company is proposed any other matter which is considered necessary in its furtherance should be stated in the
memorandum of the company.
Whereas Section 245 (1) (b) of the Act provides to the members and depositors a right to file a application
before the tribunal if they have reason to believe that the conduct of the affairs of the company is conducted in a
manner which is prejudicial to the interest of the company or its members or depositors, to restrain the company
from committing anything which can be considered as a breach of the provisions of the company’s memorandum or
articles.
Basic principles regarding the doctrine
1. Shareholders cannot ratify an ultra-vires transaction or act even if they wish to do so.
2. Where one party has entirely performed his part of the contract, reliance on the defense of the ultra-vires was
usually precluded in the doctrine of estoppels.
3. Where both the parties have entirely performed the contract, then it cannot be attacked on the basis of this
doctrine.
4. Any of the parties can raise the defence of ultra-vires.
5. If a contract has been partially performed but the performance was insufficient to bring the doctrine of
estoppels into the action, a suit can be brought for the recovery of the benefits conferred.
6. If an agent of the corporation commits any default or tort within the scope of his employment, the company
cannot defend it from its consequences by saying that the act was ultra-vires.
Exceptions to the doctrine
1. Any act which is done irregularly, but otherwise it is intra-vires the company, can be validated by the
shareholders of the company by giving their consent.
2. Any act which is outside the authority of the directors of the company but otherwise it is intra-vires the
company can be ratified by the shareholder of the company.
3. If the company acquires property in a manner which is ultra-vires of the contract, the right of the company
over such property will still be secured.
4. Any incidental or consequential effect of the ultra-vires act will not be invalid unless the Companies Act
expressly prohibits it.
5. If any act is deemed to be within the authority of the company by the Company’s Act, then they will not be
considered as ultra-vires even if they are not expressly stated in the memorandum.
6. Articles of association can be altered with retrospective effect to validate an act which is ultra-vires of
articles.
Types of ultra-vires acts and when can an ultra-vires act be ratified?
Ultra-vires acts can be generally of four types:
1. Acts which are ultra-vires to the Companies Act.
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 2. Acts which are ultra-vires to the Memorandum of the company.
3. Acts which are ultra-vires to the Articles of the company but intra-vires the company.
4. Acts which are ultra-vires to the directors of the company but intra-vires the company.
Acts which are ultra-vires to the Companies Act - Any act or contract which is entered by the company which
is ultra-vires the Companies Act, is void-ab-initio, even if memorandum or articles of the company authorized it.
Such act cannot be ratified in any situation. Similarly, some acts are deemed to be intra-vires for the company even
if they are not mentioned in the memorandum or articles because the Companies Act authorizes them.
Acts which are ultra-vires to the memorandum of the company - An act is called ultra-vires the memorandum
of the company if, it is done beyond the powers provided by the memorandum to the company. If a part of the act or
contract is within the authority provided by the memorandum and remaining part is beyond the authority, and both
the parts can be separated. Then only that part which is beyond the powers is considered as ultra-vires, and the part
which is within the authority is considered as intra-vires. However, if they cannot be separated then whole contract
or act will be considered as ultra-vires and hence, void. Such acts cannot be ratified even by shareholders as they are
void-ab-initio.
Acts which are ultra-vires to the Articles but intra-vires to the memorandum - All the acts or contracts which
are made or done beyond the powers provided by the articles but are within the powers and authority given by the
memorandum are called ultra-vires the articles but intra-vires the memorandum. Such acts and contracts can be
ratified by the shareholders (even retrospectively) by making alterations in the articles to that effect.
Acts which are ultra-vires to the directors but intra-vires to the company - All the acts or contracts which are
made by the directors beyond the powers provided to them are called acts ultra-vires the directors but intra-vires the
company. The company can ratify such acts and then they will be binding.
Development of the doctrine
Eley v The Positive Government Security Life Assurance Company, Limited, (1875-76) L.R. 1 Ex. D. 88
It was held that the articles are not a matter between the company and the plaintiff. They may either bind the
members or mandate the directors, but they do not create any contract between plaintiff and the company.
The Directors, &C., of the Ashbury Railway Carriage and Iron Company (Limited) v Hector Riche, (1874-75)
The objects of the company as per the memorandum of association were to supply and sell some material
which is required in the construction of the railways. Here the contract was for construction of railways which was
not in the memorandum of the company and thus, was contrary to them. As the contract was ultra-vires the
memorandum, it was held that it could not be ratified even by the assent of all the shareholders. If the sanction had
been granted by passing a resolution before entering into the contract, that would have been sufficient to make the
contract intra-vires. However, in this situation, a sanction cannot be granted with a retrospective effect as the
contract was ultra-vires the memorandum.
In Shuttleworth v Cox Brothers and Company (Maidenhead), Limited, and Others, [1927] 2 K.B. 9
It was held that if a contract is subject to the statutory powers of alteration contained in the articles and such
alteration is made in good faith and for the benefit of the company then it will not be considered as a breach of the
contract and will be valid.
In Re New British Iron Company, [1898] - It was held that in this particular case the directors will be ranked
as ordinary creditors in respect of their remuneration at the time of the winding-up of the company. This was stated
because generally articles are not considered as a contract between the company and the directors but only between
shareholders. However, in this particular case, the directors were employed, and they had accepted office on the
footing of the articles of association. So at the time of winding-up of the company they were considered as the
creditors.
Effects of ultra vires Transactions – Doctrine of Ultra Vires
1. Void ab initio: The ultra vires acts are null and void ab initio. These acts are not binding on the company.
Neither the company can sue, nor it can be sued for such acts.[Ashbury Railway Carriage and Iron Company
v. Riche ].
2. Estoppel or ratification cannot convert an ultra-vires act into an intra-vires act.

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 3. Injunction: when there is a possibility that company has taken or is about to undertake an ultra-vires act,
the members can restrain it from doing so by getting an injunction from the court. [Attorney General v. Gr.
Eastern Rly. Co., (1880) 5 A.C. 473].
4. Personal liability of Directors: The directors have a duty to ensure that all corporate capital of the company is
used for a legitimate purpose only. If such funds are diverted for a purpose which is not authorized by the
memorandum of the company, it will attract a personal liability for the directors. In Jehangir R. Modi v.
Shamji Ladha, [(1866-67) 4 Bom. HCR (1855)], the Bombay High Court held, “A shareholder can maintain
an action against the directors to compel them to restore to the company the funds of the company that have
by them been employed in transactions that they have no authority to enter into, without making the
company a party to the suit”.
Criminal action can also be taken in case of a deliberate misapplication or fraud. However, there is a small line
between an act which is ultra-vires the directors and acts which are ultra-vires the memorandum. If the company has
authority to do anything as per the memorandum of the company, then an act which is done by the directors beyond
their powers can also be ratified by the shareholders, but not otherwise.
1. If any property is purchased with the money of the company, then the company will have full rights and
authority over such property even if it is purchased in an ultra-vire manner.
2. Relationship of a debtor and creditor is not created in an ultra-vires borrowing. [In Re. Madras Native
Permanent Fund Ltd., (1931) 1 Com Cases 256 (Mad.)].
Effects of an act which is Ultra Vires – on borrowings
Any borrowing which is made by an act which is ultra-vires will be void-ab-initio. It will not bind the company and
company and outsiders cannot get them enforced in a court.
Members of the company have power and right to prevent the company from making such ultra-vires borrowings by
bringing injunctions against the company.
If the borrowed funds of the company are used for any ultra-vires purpose, then directors of the company will be
personally liable to make good such act. If the company acquires any property from such funds, the company will
have full right to such property.
No estoppels or ratification can convert an ultra-vires borrowing into an intra-vires borrowing; as such acts
are void from the very beginning. As no debtor and creditor relationship is created in ultra-vires borrowings only a
remedy in rem and not in personam is available.
Conclusion
No company can be imagined to run without borrowings. However, at the same time, it is necessary to
protect the interest of the creditors and investors. Any irregular and irresponsible act may result in insolvency or
winding up of the company. This may cause considerable losses to them. So to protect the interest of the investors
and the creditors, specific provisions are made in the memorandum of the company which defines the objectives of
the company.
Directors of the company can act only within the purview of the authority provided to them under these
objectives. If any borrowing is made beyond the authority provided by these objective mentioned in the
memorandum, it will be considered as ultra-vires. Any borrowing which is made through an ultra-vires act is void-
ab-initio, and hence, directors are personally responsible for these acts. However, if such borrowings are ultra-vires
only to the articles of the company or ultra-vires directors, then they can be ratified by the shareholders. Then after
such ratification, they will be considered valid.
Thus, directors must be very cautious while borrowing funds, as it may not only make them personally liable for the
consequences of such acts but also may result in considerable losses to investors and creditors.

2.3 Doctrine of constructive notice

The term Constructive Notice is based on the term ‘constructive’ which means something which can be
deduced by inference, a fact that was apparent and must have been known to the party. Therefore, a constructive
notice shall mean such facts that are expected to be known to a person by virtue of some inference. This inference is
drawn because of a legal duty that is put on a person to be aware of certain circumstances. In the corporate
jurisprudence, it means such information which is expected to be known to a person who is transacting with a
company because such information is available in public domain, irrespective of the fact whether it was known to

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him or not. The doctrine of constructive notice is a legal fiction that puts the liability on a person to have known any
fact regarding the company which is available in the public domain.
The law providing for this presumption is provided under Section 399 of the Act which allows any person to
inspect, take extracts from or make records of any document of any company which has been registered with the
Registrar of Companies. The section provides for a fee, on payment of which, this right shall be provided to the
applicant. The right extends to the inspection of any public document of any company. The MOA and AOA of the
company are public documents and available for scrutiny at all times. Under this provision, the doctrine of
constructive notice was instituted whereby a person is expected to be aware of the contents of any document which is
available in the public domain. Before a person plans to transact with a company, he must inspect all the documents
related to the company and ensure that the content of his transaction conforms to the rules of the company. This is
an implied and a presumed notice given to the person who wishes to transact with the company notably called the
‘Doctrine of Constructive Notice’.
This doctrine applies to such provisions which are available in the public domain. In the case of Oakbank Oil
Co. v. Crum it was held that anyone who is dealing with the company shall be presumed to have read and understood
the MOA and AOA of the company, thus presumes to be a notice to the public. Such a notice is called constructive
notice.
Impact of Doctrine of Constructive Notice
The effect of the doctrine of constructive notice is harsh on a person who wishes to transact business with the
company. It puts the liability on the person transacting any business with the company to inspect all the documents
of the company available in the public domain to ensure that his contract conforms with the rules of the company.
This matter was discussed in the case of Kotla Venkataswamy v. Rammurthy. In this case, the plaintiff accepted a
mortgage deed executed by the secretary who was a working director of the company only. The AOA of the company
specified that such a deed needs to be executed by three specific officers of the company and it shall not be valid
otherwise. Therefore, they were denied any protection by the application of this doctrine.
Another necessary implication of this rule is that a person transacting business with the company is
considered to have read all the public documents of the company and understood them for what they mean. Such a
person is also presumed to understand the powers that the company’s officers are authorised to execute. In the case
of Re Jon Beaoforte (London) Ltd case, an insolvent company’s objects were to manufacture dresses but the
company was manufacturing veneered panels. The knowledge of this development was with the creditors. Therefore,
in the insolvency proceedings, their claim was not carried out for being ultra vires.
In a case where the act is declared to be ultra vires the company’s AOA or MOA, a person cannot claim any
relief on the ground that he was unaware of the said provision in the documents. The principle of common law
jurisprudence of corporate law provides ample protection to an innocent person who is dealing with the company in
good faith where the act concerned is not ultra vires to the company, but the protection cannot be extended in a case
where the said act is beyond the authority of the company.
The doctrine of constructive notice was established by the House of Lords in the case of Ernest v.
Nicholls where it was held for the first time that any person who is dealing with the company is deemed to be familiar
with the contents of all the public documents of the company. Further, in the case of Mahony v. East HolyFord
Mining Co. where it was held by the House of Lords that in the case of absence of the doctrine of constructive
liability, the rules of the partnership will apply.
However, it was also categorically accepted by the British courts that the rule of constructive notice has
drastic impacts on the corporate world and mainly investors. The courts are bound to apply them even if that equals
to injustice for the persons involved. At times, the provision may be vague and subject to an internal procedure of
the company. In such a scenario, the application of the Doctrine of Constructive Notice will amount to an injustice
being met on persons. Therefore, to mitigate such a situation, the doctrine of Indoor Management, also known as
Turquand’s Rule was established by the courts. It has been held to be an exception to the rule of constructive
liability.

2.4 Doctrine of indoor management

The doctrine of indoor management evolved 150 years ago. Its also known as Turquand’s rule. The role of the
doctrine of indoor management opposed to that of the rule of constructive notice. The Doctrine of Constructive

9
Notice protects company from the outsider. Whereas, the Doctrine of Indoor management protects outsider from
company.
The outsider has no clue how the internal part of company works. He presumes that there are no
irregularities the internal machinery of company. This doctrine is also a possible safeguard against the possibility of
abusing the doctrine of constructive notice.
A person contracting with the company only needs to inspect the memorandum and article of association of
company. He is not required to conduct inspection on internal irregularities. If there are any internal irregularities,
then its company’s liability to compensate him for any loss. But person needs to act in good faith and did not know
about the internal irregularities of the company. This doctrine protects the outsider from company as he is unaware
of the activities which happen behind the closed door of the company.
Origin of the Doctrine
This doctrine was laid down in the case of Royal British Bank V. Turquand
The directors of the company borrowed some money from the plaintiff. The article of company
provides for the borrowing of money on bonds but there was a necessary condition that a resolution should passed in
general meeting. Now in this case shareholders claims that as there was no such resolution passed in general meeting
so company is not bound to pay the money. It was held that the company is bound to pay back the loan. As
directors could borrow but subjected to the resolution, so the plaintiff had the right to infer that the necessary
resolution must have been passed.
It was held that Turquand can sue the company on the strength of the bond. As he was entitles to
assume that the necessary resolution had been passed. Lord Hatherly observed- “Outsiders are bound to know the
external position of the company, but are not bound to know its indoor management.”
Exceptions to Doctrine of Indoor Management
Following are the exception to doctrine of Indoor Management:
1. Knowledge of irregularity - The first exception to this doctrine is that the person dealing with company
should not have any knowledge about the internal irregularities of the company. Knowledge of irregularity arises
from the fact that the person contracting was himself a party to the inside procedure. The principle is clear that a
person who is himself a part of the internal machinery cannot take advantage of irregularities.
2. Forgery - Doctrine of indoor management does not apply to forgery because forgery is void ab- initio. Lord
Loreburn said: “It’s quite true that persons dealing with limited liability companies not bound to inquire into their
indoor management. But not affected by irregularities of the company if they have no knowledge about such
irregularities. It cannot apply to a forgery.
3. Negligence on the part of the outsider - If loss suffered due to negligence of outsider, relief cannot be
claimed under doctrine of Indoor Management. If the person dealing with the company already had a hint about the
internal irregularities of the company and still by neglecting the irregularities, he enters into contract with the
company, and then he cannot claim under doctrine of Indoor Management.

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UNIT 3: Capital of a Company:
3.1 Prospectus – definition, contents.
3.1.1. Liability for mis-statement in the prospectus,
3.2 Shares- definition, kinds.
3.3 Debentures- definition, kinds.
3.3.1 Charges- definition, kinds.
3.1 Prospectus – definition, contents.
3.1.1. Liability for mis-statement in the prospectus,
Prospectus:
Section 2(70) of the Companies Act, 2013 defines a prospectus as ““A prospectus means Any documents
described or issued as a prospectus and includes any notices, circular, advertisement, or other documents inviting
deposit from the public or documents inviting offer from the public for the subscription of shares or debentures in a
company.” A prospectus also includes shelf prospectus and red herring prospectus. A prospectus is not merely an
advertisement.
A document shall be called a prospectus if it satisfies two things:
1. It invites subscription to shares or debentures or invites deposits.
2. The aforesaid invitation is made to the public.
Contents of a prospectus:
1. Address of the registered office of the company.
2. Name and address of company secretary, auditors, bankers, underwriters etc.
3. Dates of the opening and closing of the issue.
4. Declaration about the issue of allotment letters and refunds within the prescribed time.
5. A statement by the board of directors about the separate bank account where all monies received out of
shares issued are to be transferred.
6. Details about underwriting of the issue.
7. Consent of directors, auditors, bankers to the issue, expert’s opinion if any.
8. The authority for the issue and the details of the resolution passed therefore.
9. Procedure and time schedule for allotment and issue of securities.
10. Capital structure of the company.
11. Main objects and present business of the company and its location.
12. Main object of public offer and terms of the present issue.
13. Minimum subscription, amount payable by way of premium, issue of shares otherwise than on cash.
14. Details of directors including their appointment and remuneration.
15. Disclosure about sources of promoter’s contribution.
16. Particulars relation to management perception of risk factors specific to the project, gestation period of
the project, extent of progress made in the project and deadlines for completion of the project.
Various Categories of Prospectus
1. Statement in lieu of Prospectus: A public company, which does not raise its capital by public issue, need not
issue a prospectus. In such a case a statement in lieu of prospectus must be filed with the Registrar 3 days before the
allotment of shares or debentures is made. It should be dated and signed by each director or proposed director and
should contain the same particulars as are required in case of prospectus proper.
2. Deemed Prospectus: Section 25 of the companies Act, 2013 provides that all documents containing offer of
shares or debentures for sale shall be included within the definition of the term prospectus and shall be deemed as
prospectus by implication of law.
Unless the contrary is proved an allotment of or an agreement to allot shares or debentures shall be deemed
to have been made with a view to the shares or debentures being offered for sale to the public if it is shown
a. That the offer of the shares or debentures of or any of them for sale to the public was made within
6 month after the allotment or agreement to allot; or
b. That at the date when the offer was made the whole consideration to be received by the company
in respect of the shares or debentures had not been received by it.
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All enactments and rules of law as to the contents of prospectus shall apply to deemed prospectus.
3. Abridged Prospectus [Sec. 2(1)]: Abridged prospectus means a memorandum containing such salient
features of a prospectus as may be specified by the SEBI by making regulations in this behalf. No form of
application for the purchase of any of the securities of a company shall be issued unless such form is accompanied by
an abridged prospectus. 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 him.
Legal requirement regarding issue of prospectus: (Sec. 26 of the Companies Act, 2013)
The Companies Act has defined some legal requirements about the issue and registration of a prospectus. The
issue of the prospectus would be deemed to be legal only if the requirements are met.
1. Issue after the incorporation: As a rule, the prospectus of a company can only be issued after its incorporation. A
prospectus issued by, or on behalf of a company, or in relation to an intended company, shall be dated, and that date
shall be taken as the date of publication of the prospectus.
2. Registration of prospectus: it is mandatory to get the prospectus registered with the Registrar of Companies before
it is issued to the public. The procedure of getting the prospectus registered is as under:
A. A copy of the prospectus, duly signed by every person who is named therein as a director or a proposed
director of the company must be filed with Registrar of Companies before the prospectus is issued to the public.
B. The following document must be attached thereto:
i) Consent to the issue of the prospectus required under any person as an expert confirming his
written consent to the issue thereof, and that he has not withdrawn his consent as aforesaid appears in the
prospectus.
ii) Copies of all contracts entered into with respect to the appointment of the managing director,
directors and other officers of the company must also be filed with Registrar.
iii) If the auditor or accountant of the company has made any adjustments in the company’s
account, the said adjustments and the reasons thereof must be filed with the documents.
iv) There must be a copy of the application which is to be filled for the issue of the company’s shares
and debentures attached with the prospectus.
v) The prospectus must have the written consent of all the persons who have been named as auditors,
solicitors, bankers, brokers, etc.
C. Every prospectus must have, on the face of it, a statement that:
i) A copy of the prospectus has been delivered to the Registrar for registration.
ii) Specifies that any documents required to be endorsed by this section have been delivered to the
Registrar.
D. A copy of the prospectus must be filed with the Registrar of Companies.
E. According to the Section 26, no prospectus shall be issued more than ninety days after the date on which a
copy thereof is delivered for registration.
If a prospectus issued in contravention of the above –stated provisions, then the company and every person
who knows a party to the issue of the prospectus shall be punishable with a fine.
Misstatements in the prospectus
Since prospectus is relied on by the members of the public to subscribe or purchase the securities of a
company, any misstatements on it invite penal consequences. Misstatement may occur when a statement which is
untrue or misleading in form or context is included in the prospectus. Also, any inclusion or omission of any matter
which is likely to mislead will also be considered as a misstatement (sec. 34). For e.g., a statement on the purpose of
offering shares which is untrue, or statement on the locations of offices for a company which is misleading will
amount to misstatement in the prospectus.
Liability for misstatement in the prospectus
A person who has signed and given consent to the prospectus is liable for misstatement. Persons who had the
management of the whole, or substantially whole of the affairs of the company can be held liable for misstatement in
prospectus if they have signed the prospectus and had given consent for the same. Managers, Company Secretaries,
and Directors will come under this category. However, the mere signing of the declarations in the prospectus will not
result in liability for misstatement if the person signing is neither a manager of the company nor draw salary from
12
the company. In the Matter of Sahara India Commercial Corporation Ltd., SEBI 31 Oct. 2018. Here, SEBI
considered the submission of the Company Secretary that he signed the prospectus on behalf of the directors under
their power of attorney and concluded that he was not liable for misstatement as the director of the company.
Likewise, in Hafez Rustom Dalal vs Registrar of Companies, the Gujarat High Court observed that while
issuing notices, the respondent authority has to point out the statements in the Prospectus which they consider false
or deliberate or made to induce the public for subscribing the shares of the Company.
A misstatement in the prospectus can invoke criminal (sec. 34) and civil liabilities (sec. 35). Misstatements can lead to
punishment for fraud under Sec. 447.
 Criminal liability
A person who authorizes the issue of a prospectus which has untrue or misleading statements is liable for punishment
under Sec. 34. Such a punishment is for fraud as set out in Sec. 447. “Fraud” under Sec. 447 includes an act, omission,
concealment of any fact with an intent to deceive, gain undue advantage, or to injure the interests of the company or
its shareholders or its creditors or any other person. It is not necessary that such an act involve any wrongful gain or
wrongful loss. Abuse of position committed by a person is also considered fraud under this section. Sec. 447 further
sets out the punishment for fraud:
 If the fraud involves an amount of ten lakh rupees or more, or one per cent. of the turnover of the
company (whichever is lower) the person who is found guilty of fraud shall be punishable with imprisonment
for a minimum term of six months which may extend to ten years. Such a person shall also be liable to a fine
of an amount not less than the amount involved in the fraud and the fine may extend to three times of such
amount.
 If the fraud involves an amount less than ten lakh rupees or one per cent. of the turnover of the
company (whichever is lower) and does not involve public interest, the imprisonment may extend to five
years or with fine which may extend to fifty lakh rupees or with both.
 If the fraud in question involves public interest, the term of imprisonment shall not be less than three years.

 Civil liability
Civil liability for misstatements in prospectus will arise when a person has sustained any loss or damage by subscribing
securities of a company based on a misleading prospectus (sec. 35). In such instances the following persons shall be
liable under sec 447 and will have to pay compensation to persons who have sustained such loss or damage:
1. director of the company at the time of the issue of the prospectus;
2. person who has agreed to be named as a director in the prospectus and is named as a director of the company,
or has agreed to become such director;
3. is a promoter of the company;
4. has authorised the issue of the prospectus; and
5. is an expert who has been engaged or interested in the formation or promotion or management of the
company.
Prohibition of the Company and directors from dealing with securities following misstatement
In the Matter of Taksheel Solutions Limited, the SEBI (25 Oct. 2013) found that the Red Herring
Prospectus/Prospectus had several missing vital pieces of information which resulted in misstatement. SEBI had
earlier prohibited the company, its promoters/directors and independent directors from buying, selling, or dealing in
securities in any manner. The Board noted that the company had the duty to make true and correct disclosures and
statements in the Prospectus to help the applicants take an informed investment decision. The Board further
observed that the Prospectus failed to disclose a related party transaction too. Therefore, the Board confirmed the
interim order of prohibition on the Company and its Promoters/Directors in dealing with securities. However, the
Board vacated the prohibition on the independent directors who had resigned from the Company and had undergone
the restraint for more than twenty-one months.
Suspension of the auditor for false certificate attached to the Prospectus
In The Institute of Chartered Accountants of India v. Mukesh Gang, Chartered Accountant, Referred Case.
No.2 of 2011, the High Court of Andhra Pradesh noted that the prospectus is a special document and a false
certificate is issued by the auditor would amount to his failure to discharge his statutory duties. The court added that

13
he must be presumed to be aware of the consequences that flow from such gross negligence of a false certification
because the public subscribe to the shares based on the invitation (Prospectus). The court further observed that as
per Section 65 of the Companies Act, 1956 untrue statements in the prospectus will result in liability for the loss or
damage sustained by a person while subscribing for shares or debentures based on such statements in the Prospectus.
Here, the court found that the certification by the statutory auditor has resulted in misleading the general public
into subscribing to the shares of the company by placing faith on such a certificate. Therefore, the court suspended
the respondent from practising as a Chartered Accountant for a period of three years under Section 21(5) of the
Chartered Accountants Act, 1949.
Exceptions from liability for misstatements in Prospectus
A person shall not be criminally liable under sec. 34 if he proves that: the statement or omission was immaterial or
 he had reasonable grounds to believe that the statement was true or the inclusion or omission was necessary
and believed in it up to the time of issue of the prospectus.
Likewise, a person shall not be liable under sub-section (1) of sec. 35 (civil liability), if he proves that:
 he withdrew his consent to become a director of the company before the issue of the prospectus, and that it
was issued without his authority or consent; or
 the prospectus was issued without his knowledge or consent, and
 on becoming aware of its issue, he gave a reasonable public notice that it was issued without his knowledge or
consent.
A person may not be liable for a misleading statement made by an expert if:
 the report is a correct and fair representation of the statement, or
 a correct copy or a correct and fair extract of the report or valuation; and
 he had reasonable ground to believe that such expert was competent to make the statement and had given
the consent required by sub-section (5) of section 26 to the issue of the prospectus and had not withdrawn
that consent before delivery of a copy of the prospectus for registration. (sec. 35(2)(c)).
Conclusion
The prospectus being an invitation to the public to subscribe to the securities of a company must be made
with utmost care. The public rely on the statements and reports attached to the prospectus to take an investment
decision. Therefore, the Companies Act provide for liabilities and punishments for persons who provide misleading
and untrue statements in the prospectus.

3.2 Shares- definition, kinds.

Each unit of ownership denotes an equal amount of a business's wealth. It enables the shareholders to an
equal right to the business's profits and an equal responsibility for the business's arrears and deficits. A share is a
document that acknowledges the ownership of a company to the limit of the amount contributed. So, the share is
defined as an interest in the company reflecting the ownership then and entitling to receive profit proportionately.
The share capital of a company is divided into fixed number of units and each such unit is called a share.
Major types of shares are one having voting and major company rights and claim holders of the profit and the other
are the one who have no voting rights or major company rights but are promised of a certain periodic income or
interest. Therefore, a share can be defined as a unit of share capital reflecting the extent of the interest of a
shareholder
Types of Shares The shares of the company can be divided into the following categories:
1. Equity shares - Equity shares are also called ordinary shares. These shares have no preferential rights on
the payment of dividend or repayment of capital. The amount of dividend on such shares is not fixed. The dividend
on these shares is paid from profits only after paying interest on debentures and dividends in preference share capital.
Similarly, equity shareholders are paid only after the payment of all debts and preference share capital at the time of
winding-up of the company. Equity shareholders are the true risk bearers of the company and they are the ultimate
claimants of the profit. Another feature of equity shares is that the equity shareholders enjoy the voting rights for
the management and control of the company. Equity shares are important to the company as well as to the
shareholders. Its importance can be pointed out as follows:
Importance to the company: There is no need to pay the dividend in case of the loss or deficit of the
company. Another major important aspect of equity shares is that there is no need to refund money to the equity
14
shareholders before winding-up of the company so that the company can utilize the equity share capital
permanently. Also, the board of directors and its head are elected from the equity shareholders for the effective
management of the company. So, equity shareholders hold a powerful position in the company.
Importance to the shareholders: Every shareholder has a voting right to elect the company’s board of
directors. Equity shareholders can claim and enjoy a higher amount of dividend in case of a higher profit of the
company. So, if any company gains huge profit in a year then equity shares are benefited the most as they get the
huge amount of dividend more than preference shareholders. Equity shareholders can also easily sell or transfer their
shares to others.
2. Preference Shares - Preference shares are those shares that are entitled to certain privileges. The dividend
on preference share is paid at a fixed rate. The dividend on such shares is paid before any dividend is paid to equity
shareholders. So, from the profit of the company, the first claim of the profit amount goes to the preference
shareholders. So, preference shareholders can be taken as the secured shares as it provides fixed benefit and security
to the owners. Similarly, at the time of winding-up the company, the preference capital is repaid before such a
repayment is made to the equity shareholders. However, the preference shareholders do not have any voting rights
or major company rights which are enjoyed by the equity shareholders. They cannot influence the major decisions of
the company nor can they participate in the board of directors.
The major types of preference shares are as follows:
 Cumulative preference shares: Cumulative preference shares are those shares on which a number of unpaid
dividends are accumulated and is carried forward as a liability. Therefore, the unpaid dividends of the past years
are paid when adequate profits are earned by the company. If the Article of Association of the company is silent
about the accumulation of dividends on preference shares, it is assumed that such shares are cumulative. When
there is the huge amount of profit in the next years, the cumulative figure or amount is paid off to the
preference shareholders.
 Non-Cumulative preference shares: Non-cumulative preference shares are those shares on which the arrears of
dividend do not accumulate. As such, the arrears of past years’ dividend on account of no profit or loss are
not paid in the following years. So, the figure is not added for the upcoming years but is to be paid in the
same year.
 Redeemable preference shares: Redeemable preference shares are those that can be redeemable within a
specific period of time. The terms and conditions for redemption of preference shares need to be specified at
the time of the issue of shares.
 Irredeemable preference shares: Irredeemable preference shares are those which cannot be redeemed within a
specific period of time but can be redeemed only at the time of liquidation of the company. The amount of
capital is not paid back to the shareholders before winding-up of the company.
 Participating preference shares: Participating preference shares are those preference shares which have a
certain right to participate in any surplus profit of the company after paying a dividend to equity
shareholders. They are specified in the Article of Association during the time of purchase of the preference
shares.
 Non-participating preference shares: Non-participating preference shares are those shares which do not carry
any such rights in the profit or surplus of the company after the payment of the dividend of the equity
shareholders. If the Article of Association of the company is silent, preference shares are assumed to be non-
participating preference shares.
 Convertible preference shares: Convertible preference shares are those shares which can be easily converted
into equity shares. The conversion becomes possible when the company provides such opportunity to the
preference shareholders. These shares are converted into equity shares according to the terms and conditions
of their issue and decisions of the company.
 Non-Convertible preference shares: Non-convertible preference shares are those which cannot be converted
into equity shares. Usually, preference shares are non-convertible unless it is stated in the Articles of
Association and by the company

3.3 Debentures- definition, kinds.

3.3.1 Charges- definition, kinds.
15
Debentures
A debenture is one of the capital market instruments which help business houses to raise funds from the
market for the development of the business. The word debenture has been derived from the Latin word “debere”
which means borrowing or taking a loan. In layman’s language, debenture can be defined as an acknowledgement of
debt issued by the company to the third parties under the common seal of the company. In accordance with Section
2(30) of the Companies Act, 2013, debentures include debenture stock issued by the company as an evidence of debt
taken by such company, either by creation or non-creation of the charge over the assets of the company.
Salient Features of Debentures
Some of the salient features of debentures are as follow:
1. It is an acknowledgement of the debt;
2. It is issued by the company under its common seal;
3. Debentures can be both secured or unsecured;
4. The rate of interest and the date of payment is pre-determined;
5. Debentures issued are freely transferrable by debenture holders;
6. Debenture holders do not get any voting right in the company;
7. Interest payable to the debenture holders are charged against the profits of the company.
Provisions Governing Debentures
Following provisions of the Companies Act, 2013 governs the floatation, issue and allotment with regards to the
debentures:
1. Section 2(30) – Definition;
2. Section 44 – Nature of debentures;
3. Section 71 – Provisions relating to issue and allotment of debentures;
4. Rule 18 of the Companies (Share Capital and Debenture) Rules, 2014 – Rules pertaining to issue and
allotment of debentures.
Types of Debentures
There are various forms of debentures which a company can issue depending upon its requirement.
Debentures can be issued based on various factors i.e. performance, security, priority, convertibility and record.
1. Based on Performance
Based on the performance, there are two types of debentures which are issued i.e.
o Redeemable Debentures
Redeemable debentures are the debentures where the date of redemption of the debentures are
specifically mentioned in the debenture certificate issued, where on such date, the company is legally bound to return
the principal amount to the debenture holder.
o Irredeemable Debentures
Irredeemable debentures continue for perpetuity and unlike redeemable debentures, there is no fixed
date on which the company needs to pay the debenture holders. It becomes redeemable only when the company goes
into liquidation.
2. Based on security
o Secured Debentures
When the debentures are issued by way of creation of charge over the assets of the company, then
such debentures are called as secured debentures. The charge created over the debentures may be fixed or maybe
floating. In accordance with the provisions of the Companies Act, 2013, such charge created has to be registered with
the Registrar within 30 days of such creation.
o Unsecured Debentures
Unlike secured debentures, unsecured debentures are issued by the company without creation of
charge over the assets of the company. In other words, these debentures do not offer any protection to the debenture
holder in case the company is unable to pay the principal amount on the due date.
3. Based on Priority
o First Mortgaged Debentures

16
 Basically, the distinction of debentures based on priority can be called as a subcategory of the secured
debentures. First Mortgaged Debentures are those debentures which has first preference over all the other debentures
issued by the company. Such preference is claimed at the time of liquidation of the company when the assets of the
company are distributed among the credit holders.
o Second Mortgaged Debentures
Second Mortgage Debenture, as the name suggests, has second preference over the assets of the
company at the time of liquidation after the first mortgaged debentures. Only after the first mortgaged debenture
holders are satisfied, will the second mortgaged debenture holders can claim their principal amount from the
company at the time of liquidation.
4. Based on Convertibility
o Fully Convertible Debentures
Fully convertible debenture holders have the right to convert their debentures into equity shares of
the company at a future date, at the option of the debenture holders. The conversion ratio, the rights of the
debenture holders post-conversion and the trigger date for conversion are defined at the time of issue of these
debentures.
o Partially Convertible Debentures
Partially convertible debentures can be divided into two parts. The first part being the debentures
which are convertible to equity shares of the company and the second part being non-convertible debentures which
shall redeem at the expiry of its tenure. An option is given to the debenture holder to partially convert its debt into
shares of the company. Partially convertible debentures are also deemed as optionally convertible debentures.
o Non-Convertible Debentures
Debentures which do not have an option to get converted into equity shares of the company are
called non-convertible debentures. These debentures get redeemed at the end of the maturity period.
5. Based on Record
o Registered Debenture
In case of registered debenture, the name, address, number of debentures and other details pertaining
to holding are entered by the company in the register of debentures. In such cases, the transfer of debentures from
one debenture holder to another debenture holder is recorded in the register of debenture holders as well as register of
transfer.
o Unregistered Debentures
Unregistered debentures are also called bearer debentures. Unlike registered debentures, the company
does not maintain the records of such debentures and the principal amount and the interest is paid to the bearer of
the instrument as against the name written over such instrument. These debentures are easily transferrable in the
market.
Use of Debentures
Debentures are issued by the company in order to raise funds from the market. Such funds are then used by
the company for research and development and growth in the market. Debentures or debt financing is preferred over
the issue of equity shares for two major reasons i.e. issue of debentures does not lead to dilution of the ownership in
the company and the cost of raising funds through debt is cheaper as compared to cost of raising equity.
Considering its various types, debentures are issued by the company as required by the investor investing in
the company. In case the investor insists on issuing first mortgaged debenture to have an added protection over and
above the secured debenture, the company may issue such debenture to the investor, which again depends on the
necessity of funds to the company. In the usual course of business, registered non-convertible redeemable secured
debentures are issued by the company as it provides protection to the investors against the failure of the company to
repay the principal amount. Where the investor prefers to have a shareholding in the company after a fixed period of
time, the company may be required to issue fully or optionally convertible debentures.

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UNIT 5: Winding up of the Company:
5.1 Kinds of winding up.
5.2 Official liquidator
5.1 Kinds of winding up.
Introduction - Winding up of a company
Winding up of a company is defined as a process by which the life of a company is brought to an end and its
property administered for the benefit of its members and creditors. An Administrator, called a liquidator is
appointed and he takes control of the company, collects its assets, pays its debts and finally distributes any surplus
among the members in accordance with their rights.”
According to Halsburry's Laws of England, “Winding up is a proceeding by means of which the dissolution of
a company is brought about & in the course of which its assets are collected and realised; and applied in payment of
its debts; and when these are satisfied, the remaining amount is applied for returning to its members the sums which
they have contributed to the company in accordance with Articles of the Company.” Winding up is a legal process.
Under the process, the life of the company is ended & its property is administered for the benefits of the members &
creditors. A liquidator is appointed to realise the assets & properties of the company. After payments of the debts, is
any surplus of assets is left out they will be distributed among the members according to their rights. Winding up
does not necessarily mean that the company is insolvent. A perfectly solvent company may be wound up by the
approval of members in a general meeting.
There are differences between winding up and dissolution. At the end of winding up, the company will have
no assets or liabilities. When the affairs of a company are completely wound up, the dissolution of the company takes
place. On dissolution, the company's name is struck off the register of the companies and its legal personality as a
corporation comes to an end.
WINDING UP DISSOLUTION
Winding up is a proceeding by means of which company
is dissolved and in course of dissolution, assets are The legal existence of company is brought to an end
realized, liabilities are paid off and surplus is distributed by dissolution
among members.
It is the final stage where the existence of company is
Winding up precedes the dissolution.
withdrawn by law.
The liquidator can present the company in winding up Once the order of dissolution is made by the Court,
proceeding. liquidator cannot represent the company.
Winding up proceeding can be started without the For the dissolution of the company, order of the court
intervention of the court. is essential.
Any person can proceed against the company which is No proceedings can be started against the company
being wound up. which has been dissolved.
As per section 270 of the Companies Act 2013, the procedure for winding up of a company can be initiated either –
a) By the tribunal or,
b) Voluntary.
WINDING UP OF A COMPANY BY A TRIBUNAL:-
As per Companies Act 1956, a company can be wound up by a tribunal on the basis of the following reasons:
1. Suspension of the business for one year from the date of incorporation or suspension of business for
whole year.
2. Reduction in number of minimum members as specified in the act (2 in case of private company
and 7 in case of public company)
But with the introduction of new Companies Act 2013, these above stated grounds for winding up have been
deleted and some new situations for winding up have been inserted.
As per new Companies Act 2013, a company can be wound up by a tribunal in the below mentioned circumstances:
1. When the company is unable to pay its debts
2. If the company has by special resolution resolved that the company be wound up by the tribunal.

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 3. If the company has acted against the interest of the integrity or morality of India, security of the
state, or has spoiled any kind of friendly relations with foreign or neighbouring countries.
4. If the company has not filled its financial statements or annual returns for preceding 5 consecutive
financial years.
5. If the tribunal by any means finds that it is just & equitable that the company should be wound
up.
6. If the company in any way is indulged in fraudulent activities or any other unlawful business, or
any person or management connected with the formation of company is found guilty of fraud, or any kind of
misconduct.
Winding up by Tribunal
 National Company Law Tribunal can be initiated by an application by way of petition for winding up order.
 It should be resorted to only when other means of healing an ailing company are of absolutely no avail.
 Remedies are provided by the statute on matters concerning the management and running of the company.
 It is primarily the NCLT which has jurisdiction to wind up companies under the Companies Act, 2013.
 There must be strong reasons to order winding up as it is a last resort to be adopted.

Grounds on which a Company may be wound up by the Tribunal

Under Section 271, a company may be wound up by the tribunal if-
 Company is unable to pay the debts;
 If the company has, by special resolution, resolved that the company be wound up by the Tribunal;
 If the company has acted against the interests of sovereignty and integrity of India, the security of the State,
friendly relations with foreign States, public order;
 If the Tribunal has ordered the winding up of the company under Chapter XIX;
 If on an application made by the Registrar or any other person authorized by the Central Government by
notification under this Act, the tribunal is of opinion that affairs of the company have been conducted in a
fraudulent manner or the company was formed for fraudulent or unlawful purpose or the persons concerned
in formation misfeasance or misconduct in connection therewith and that it is proper that company be
wound up;
 If the company has made default in filing with the Registrar its financial statements or annual returns for
immediately preceding five consecutive financial years;
 If the tribunal is of the opinion that it is just and equitable that the company should be wound up.
Inability to pay debts – A company is deemed to be unable to pay the debts under Section 271 (2) of the Companies
Act, 2013 if a creditor to whom company has to pay an amount exceeding Rs. 1 lakh has served a notice at the
registered office of the company by registered post or otherwise, which requires the company to pay the due amount
and the company has failed to pay the sum within 21 days or If any execution or other process issued by decree of
court or order in creditor’s favour is returned unsatisfied in whole or in part or if the tribunal is satisfied that the
company is unable to pay its debts and the Tribunal shall take into account the contingent and prospective liabilities
of the company while determining whether the company is unable to pay its debts.
Who may file petition for winding up
A petition for winding up may be presented by any of the following persons under Section 272 of The Companies Act,
2013-
 The company; or
 Any creditor or creditors, including any contingent or prospective creditor or creditors; or
 Any contributory; or
 All or any of the above three specified parties; or
 The Registrar; or
 Any person authorised by Central Government in this behalf;
 By the Central Government or State Government in case of Company acting against the interest of
sovereignty and integrity of India.
As per Section 272 of the Companies Act, 2013, within the meaning of creditor comes a secured creditor,
holder of debentures, trustee for holder of debentures.
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 A contributory can present the petition of winding up of company even if he may be holder of fully paid up
shares or that company may have no assets or no surplus to distribute among shareholders after the satisfaction of
its liabilities and some shares were originally allotted to him or have been held by him and registered in his name for
6 months during immediately preceding 18 months before commencement of winding up.
A petition for winding up shall be admitted by the Tribunal only if it is accompanied by statement of affairs
in such form and in such manner as may be prescribed.
Under this section, a copy of the petition shall also be filed with the Registrar who shall submit his views to
the Tribunal within 60 days of receipt of petition.
Powers & Functions of the Tribunal
As per Section 274 of the Companies Act, 2013 on the filing of petition for winding up by any person other
than the company, if the tribunal is satisfied, it shall direct the company by an order to file objections along with
statement of affairs within 30 days, which could get extended by another 30 days in special circumstances.
As per Section 275 of the Companies Act, 2013 an official liquidator or a liquidator from panel shall be
appointed by the Tribunal at the time of passing of winding up order. A panel consisting of CS/CS/Advocates and
other notified professionals with at least 10 years experience in company matters is maintained by the Central
Government.
As per Section 281 of the Companies Act, 2013, a report shall be submitted by Liquidator within 60 days to
the Tribunal, containing details such as-
Nature and details of assets of company with their location and value; amount of capital issued, subscribed &
paid up; the existing and contingent liabilities of the company including names and other details; the debts due to
company and names, address; list of contributories with amount details; details of trademark, intellectual properties,
if owned by company; details of contracts, joint ventures and collaborations, if any; details of holding and subsidiary
company, if any; details of legal cases filed by or against the company; any information which the tribunal may
direct or liquidator may consider necessary.
On consideration of the report of Liquidator, Tribunal shall fix the time limit within which entire
proceedings shall be completed and company be dissolved. The Tribunal may also order a sale of Company as a going
concern or its assets or part thereof. After passing of winding up order by the Tribunal, the Tribunal shall settle list
of contributories, cause rectification of register of members in all cases where required and shall cause assets of the
company to be applied to discharge its liability.

VOLUNTARY WINDING UP
In voluntary winding up, Company and its creditors settle their affairs without going to Court. One or more
liquidators are appointed by company in general meeting for purpose of winding up. A voluntary winding up
commences from date of passing of resolution for voluntary winding up, a petition is presented for winding up by the
Court.
Section 304 deals with the circumstances in which a company may be wound up voluntarily-
The company can be wound up voluntarily by the mutual decision of members of the company, if:
Ø the Company passes a Special Resolution stating about the winding up of the company.
Ø the Company in its general meeting passes a resolution for winding up as a result of expiry of the
period of its duration as fixed by its Articles of Association or at the occurrence of any such event where the articles
provide for dissolution of company.
The procedures involved in Voluntary Winding up of a Company
 Step 1 - Conduct a board meeting with 2 Directors and thereby pass a resolution with a declaration given by
directors that they are of the opinion that company has no debt or it will be able to pay its debt after
utilizing all the proceeds from sale of its assets.
 Step 2 - Issues notices in writing for calling of a General Meeting proposing the resolution along with the
explanatory statement.
 Step 3 - In General Meeting pass the ordinary resolution for the purpose of winding up by ordinary majority
or special resolution by 3/4th majority
 Step 4 - Conduct a meeting of creditors after passing the resolution, if majority creditors are of the opinion
that winding up of the company is beneficial for all parties then company can be wound up voluntarily.

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  Step 5 - Within 10 days of passing the resolution, file a notice with the registrar for appointment of
liquidator.
 Step 6 - Within 14 days of passing such resolution, give a notice of the resolution in the official gazette and
also advertise in a newspaper.
 Step 7 - Within 30 days of General meeting, file certified copies of ordinary or special resolution passed in
general meeting.
 Step 8 - Wind up the affairs of the company and prepare the liquidators account and get the same audited.
 Step 9 - Conduct a General Meeting of the company.
 Step 10 - In that General Meeting pass a special resolution for disposal of books and all necessary documents
of the company, when the affairs of the company are totally wound up and it is about to dissolve.
 Step 11 - Within 15 days of final General Meeting of the company, submit a copy of accounts and file an
application to the tribunal for passing an order for dissolution.
 Step 12 - If the tribunal is of the opinion that the accounts are in order and all the necessary compliances
have been fulfilled, the tribunal shall pass an order for dissolving the company within 60 days of receiving
such application.
 Step 13 - The appointed liquidator would then file a copy of order with the registrar.
 Step 14 - After receiving the order passed by tribunal, the registrar then publish a notice in the official
Gazette declaring that the company is dissolved.

5.2 Official liquidator

INTRODUCTION
In general sense, liquidator is a person who conducts the whole process of liquidation. When a company is
about to wind up it is required to realise the assets of the company and it should be distributed among the
“debenture holders”, “creditors” “shareholders” etc. For this purpose a person is appointed who does all the required
things before the company “cease to exist”. This person is called Liquidator under Company Law. So liquidator
comes into scene in the time of winding up of a company.
Official liquidator is appointed in the time of compulsory winding up. The Official liquidator is the officer of
high court. He is appointed from the date of the order of the winding up. He has certain duties to perform under the
Companies Act and he has to do all the required things in respect of compulsory winding up of a company according
to the instruction of the high court
Powers and duties of Company Liquidator - Section 290
1. Subject to directions by the Tribunal, if any, in this regard, the Company Liquidator, in a winding up of
a company by the Tribunal, shall have the power—
a. to carry on the business of the company so far as may be necessary for the beneficial winding up
of the company;
b. to do all acts and to execute, in the name and on behalf of the company, all deeds, receipts and
other documents, and for that purpose, to use, when necessary, the company’s seal;
c. to sell the immovable and movable property and actionable claims of the company by public
auction or private contract, with power to transfer such property to any person or body corporate, or to sell the same
in parcels;
d. to sell the whole of the undertaking of the company as a going concern;
e. to raise any money required on the security of the assets of the company;
f. to institute or defend any suit, prosecution or other legal proceeding, civil or criminal, in the
name and on behalf of the company;
g. to invite and settle claim of creditors, employees or any other claimant and distribute sale
proceeds in accordance with priorities established under this Act;
h. to inspect the records and returns of the company on the files of the Registrar or any other
authority;
i. to prove rank and claim in the insolvency of any contributory for any balance against his estate,
and to receive dividends in the insolvency, in respect of that balance, as a separate debt due from the insolvent, and
rateably with the other separate creditors;

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 j. to draw, accept, make and endorse any negotiable instruments including cheque, bill of
exchange, hundi or promissory note in the name and on behalf of the company, with the same effect with respect to
the liability of the company as if such instruments had been drawn, accepted, made or endorsed by or on behalf of
the company in the course of its business;
k. to take out, in his official name, letters of administration to any deceased contributory, and to
do in his official name any other act necessary for obtaining payment of any money due from a contributory or his
estate which cannot be conveniently done in the name of the company, and in all such cases, the money due shall, for
the purpose of enabling the Company Liquidator to take out the letters of administration or recover the money, be
deemed to be due to the Company Liquidator himself;
l. to obtain any professional assistance from any person or appoint any professional, in discharge
of his duties, obligations and responsibilities and for protection of the assets of the company, appoint an agent to do
any business which the Company Liquidator is unable to do himself;
m. to take all such actions, steps, or to sign, execute and verify any paper, deed, document,
application, petition, affidavit, bond or instrument as may be necessary,—
i. for winding up of the company;
ii. for distribution of assets;
iii. in discharge of his duties and obligations and functions as Company Liquidator; and
n. to apply to the Tribunal for such orders or directions as may be necessary for the winding up of
the company.
2. The exercise of powers by the Company Liquidator under sub-section (1) shall be subject to the overall
control of the Tribunal.
3. Notwithstanding the provisions of sub-section (1), the Company Liquidator shall perform such other
duties as the Tribunal may specify in this behalf.

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