Master in Business Laws Part I Course No.

: III
Corporate Law Module Nos. : I - IX

CORPORATE LAW

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in
1

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 CONTENTS

TOPICS

1. Formation of a Company (Module No. I) .................................................................... 3

2. Characteristics of Corporate Personality (Module No. II) ......................................... 68

3. Corporate Management (Module Nos. III & VI) ........................................................ 121

4. Company Law and Secretarial Functions (Module No. IV)....................................... 169

5. Corporate Investment and Investors’ Protection (Module No. V) ............................ 220

6. Monopolies and Restrictive Trade Practices (Module No. VII) ................................. 280

7. Corporate Accounts and Audit (Module No. VIII) ..................................................... 317

8. Winding up and Alternative Devices (Module No. IX) .............................................. 368

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 Master in Business Laws

Corporate Law

Course No: III

Module No: I

FORMATION OF A COMPANY

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in
3

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Materials Prepared By :
1. Prof. M.P.P. Pillai
2. Prof. N.L.Mitra

Materials Checked By :
1. Ms. Archana Kaul
2. Ms. Sudha Peri

Materials Edited By :
1. Prof. T.Devidas
2. Dr.P.C.Bedwa

© National Law School of India University

Published By :
Distance Education Department
National Law School Of India University
Post Bag No: 7201
Nagarbhavi, Bangalore - 560 072
India

Printed By :
National Printing Press, Koramangala, Bangalore -95

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 INSTRUCTIONS
Basic Readings
The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics
included in the course. Experts in the area have collected the basic information and thoroughly analysed the same
in topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative
provisions are also included. Care has been taken to communicate basic information required for decision making
in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading
information provided are to be selected by making marginal notes using markers. The first reading, therefore,
necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the
implications of those informations. In the second reading the reader has to critically analyse the material supplied
and jot down in a separate note book points stated in the material as well as the critical comments on the same. A
third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving
problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at
every stage.)
Supplementary Reading
Several supplementary readings are suggested in the materials. It is suggested that the reader should register with
a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National
Library, any University Library where externals are registered for the purpose of library reading, any commercial
library or any other public library run by Government or any private institution. Readers in Metropolitan and other
big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept
in the course file. Supplementary readings are also required to be read more than once and marginal notes, marking
notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her
place may request the Course Coordinator to photocopy the material and send it by post for which charges at the
rate of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in
advance. The Course Coordinator shall take prompt action on receiving the request and the payment.
Case Law
The course material includes some case materials generally based upon decided cases. These cases are to be
studied several times for,
(a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified
It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis
of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and
practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/
appellant. Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter
arguments on behalf of the defendant/respondent. These exercise can take days. After these exercises are done
one has to prepare the arguments for or against and then decide on the issues. While deciding it may be necessary
often to evolve a guiding principle which also must be clearly spelt out. Subsequently the reader takes up the
decision given in the case by the judge and compare his/her own exercise with the judgment delivered. A few
exercise of this type shall definitely sharpen the logical ability, the analytical skill and the lawyering competence.
Though it is not compulsory, the reader may send his/ her exercises to the Course Coordinator for evaluation. On
receiving such request the Course Coordinator shall get the exercises evaluated by the experts and send the
experts’ comment to the students. Through these exercises one can build up an effective dialogue with the experts
of the Distance Education Department (DED).
Problems and Responses
After reading the whole module which is divided into several topics and sub-topics the reader has to solve the
problems specified at the end of the module. The module is designed in such a manner that a reader can take about
a week’s time for completing one module in each of the four courses. It is expected that after finishing the module
over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit
is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving
the problem - which may be half an hour per problem - and maintain self discipline. While solving the problems
the candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already
prepared. After completing the exercise the student is directed to send the same to Course Coordinator for
evaluation. Though there is no time stipulation for sending these responses a student is required to complete these
exercises before he/she can be given the certificate of completion to appear for final examination.

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 FORMATION OF A COMPANY AND
COMMENCEMENT OF BUSINESS

TOPICS

1. Features of a Company form of

Business Organisation : An introductory note ............................................................ 7

2. History of Company Law................................................................................................ 14

3. Formation of a Company and its

Constitutional documents ............................................................................................. 19

4. Detail provisions of Constitutional documents :

Memorandum ............................................................................................................... 25

5. Detail provisions of Constitutional documents :

Articles ........................................................................................................................... 37

6. Commencement of business and

outline for necessary legal steps ................................................................................... 53

7. Case Law............................................................................................................................. 60

8. Problems............................................................................................................................ 64

9. Supplementary readings ................................................................................................ 67

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1. FEATURES OF A COMPANY FORM OF BUSINESS ORGANISATION:
AN INTRODUCTORY NOTE
SUB-TOPICS
1.1 Introduction
1.2 Various types of business organisations
1.3 Essential features of a Company
1.4 Different modes of incorporation
1.5 Various types of Companies
1.6 Why a Company?
1.7 Organs of a Company
1.8 Applicability of Companies Act, 1956
1.9 Applicability of English Law in India
1.10 Problem of 20th Century : A concluding remark
1.1 INTRODUCTION
20th century has aptly been described as the ‘age of
corporations’. Though our legal system facilitates the formation
and operation of business organisations of different hues and
colours, the corporation or ‘the company’ as we call them, is
found to be the most suitable vehicle to carry out industrial and
commercial activities. It has virtual monopoly of the
manufacturing, distribution and service activities of the modern
world. It is the most important economic institution of the
century having its tremendous impact felt in the social and
political frontiers as well. Our society is heavily dependant on
modern corporations.
Of the different types of Corporations operating in the business
world the ‘registered company’ is the most prominent one. More
than 90% of business corporations belong to this category. The
registered company had its origin in the English Law by the
middle of the 19th century (i.e., by 1844). During the early
days it had close affinity with the Partnership firm. In fact, the
predecessor of the registered company was a large partnership
firm popularly known as the deed of settlement company. But
in the subsequent years which brouhgt out revolutionary changes
in its character and functioning many new issues have sprung
up recently which were not contemplated by the traditional law.
A typical instance is the change brought out in the concept and
use of property. In industrially advanced countries the bulk of
productive property is in the form of investments in Corporate
securities. The control and use of this property is not in the
hands of the investors, but is vested with the Corporate
Management. As pointed out by Bearle and Means in their
classical work, ‘The modern corporation and Private Property’,
the modern corporation effected a divorce between ownership
of property and its control and management.
1.2 VARIOUS TYPES OF BUSINESS
ORGANISATIONS
The following Flow Chart shows various types of business
organisation:

Flow Chart 1
Business Organisation

Individual Collective
Ownership or Proprietorship Ownership

Joint Hindu Partnership Companies Cooperative Trust

Family business Societies

Partnership Joint
at will Venture

Unlimited Private Ltd Public Ltd Government Corporations

Company Company Company Company

Each of these business organisations are briefly described on the next page:
7

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1. A Proprietorship form of business is one where an individual
subscribes the capital, generates other necessary funds by way
of securing loan and manages the business himself. Inspite of
the importance of Companies as a form of business organisation
in modern times proprietorship outnumbers all other forms of
business organisations taken together. Of course, it basically
dominates the wholesale and retail trade.
2. Joint Hindu Family business is a sui generis or a class by
itself in India. Joint Hindu families in India have a long tradition
of being engaged in business and trading activities. Even today
this form of business organisations dominate in North, West
and Central India. These are neither Partnership firms nor
Companies. The joint Hindu family business occassionally
termed as HUF in taxation laws cannot be said to be an
association of persons because it doesn’t arise out of agreement.
It cannot also be called a plural proprietorship because excepting
the Karta other members of the HUF cannot deal with any
business without authorization of the Karta. The Karta is usually
the senior-most male member of the family who himself runs
the business either personally or through his authorised
representatives. The Karta himself has unlimited liability for
all transactions. Other members’ liability is restricted to their
share of the HUF resources invested in the business. HUF
business has some similar features with limited partnership in
England. In such a partnership firm atleast one member’s
liability is unlimited and other members’ liability is limited.
Importance of HUF business organisation in India may be one
of the reasons why limited partnership is not allowed in India,
though this form of business organisation is very common in
England specially in wholesale and retail trade.
3. Partnership at will is a form of business organisation where
the partners enter into the business contract without either fixing
the duration of, or determining their partnership. This
partnership organisation can do any business for any period of
time until the partners break their relations. [See Sec. 7 of the
Partnership Act, 1932]
4. Loosely speaking, all forms of organisation owned by more
than one person can be called as joint venture. But specifically
speaking a partnership between two or more natural or legal
persons to perform a specific adventure or undertaking is known
as joint venture. Recently these types of joint ventures between
foreign Companies and Indian Companies have gone up [See
Sec. 8 of the Partnership Act, 1932]. Joint ventures are therefore,
specific agreements relating to joint carrying on of a venture.
5. An Unlimited Company is one where the liability of its
member or members is not limited.
6. A Private Limited Company is one which is registered as
private Limited Company, restricting by its Articles the
transferability of shares and limiting its number of members to
fifty. It has also to prohibit invitation to the public for raising
public subscription. [See Sec. 3(i)(iii) of the Companies Act,
1956]
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7. A Public Limited Company is one which is not a private
limited Company. It means that the shares of such companies
are transferable, membership is unlimited and it can raise fund
from the public. [See Sec. 3(1)(iv) of the Companies Act, 1956]
8. A Government Company means any company in which
not less than fifty one percent of the paid up share capital is
held by Central Govt or by the State Govts or by both the Govts
or by one or more State Govts. [See Sec. 617 and 619(6) of the
Companies Act, 1956].
9. A Company specially floated by an Act of Parliament is
known as a Corporation in strictu sensu. But Companies Act
itself provides the status of Corporation aggregate by assigning
the status of body corporate to all companies registered under
the Companies Act. As such, all types of Companies are also
generally formed as Corporations in the sense that they have a
Corporation aggregate which is a distinct identity from the
identity of its members.
10. In India Cooperative Societies registered under the
Cooperative Societies Act is an incorporated body. It also is an
important form of business organisation. Of course according
to sec.2(7) of the Companies Act a Cooperative Society is not a
body Corporate for the purpose of the Companies Act.
11. A Trust is a society registered under the Indian Trust Act.
In some parts of India, Trust is a very popular institution amongst
the business communities for undertaking business organisation
for the benefit of the beneficiaries. This is popular primarily
because of certain tax incentives and concessions given to trusts.
Incorporated societies can also be created under Socieity
Registration Act. Such societies cannot extend any benefit to
either its members or to any stipulated group of people. [See
Sec. 2 of the Indian Trust Act].
1.3 ESSENTIAL FEATURES OF A COMPANY
1. Legal Nature
The registered Company is an incorporated body and is one
among the different species of Corporations. Jurisprudentially,
Corporation has a legal existence which is distinct and separate
from persons who constitute its corpus or body. The Corporation
may be a ‘Corporation sole’ or ‘Corporation aggregate’. At
any given time a corporation sole will consist of only one person,
whereas a corporation aggregate will consist of two or more
persons. As stated by Salmond in his text book on Jurisprudence
the former is a series of successive persons (eg : the Bishop of a
Dioces) whereas the latter consists of a group of co-existing
persons (eg : a registered company). The companies Act uses
the expression ‘body corporate’ to denote a Corporation
aggregate. As a business organisation, we are concerned with
the ‘Corporation aggregate’ only which may also be called a
body corporate. Another variety of body corporate engaged in
business activities is the statutory corporation. Like the Life
Insurance Corporation, Unit Trust of India, State Bank of India,
Air India International etc.
2. Perpetual Existence
A Company is a legal person and therefore until it is legally
extinguished it has a perpetual existence. As for example,
suppose a Company with all its assets and its entire body of
members were destroyed and killed as the case may be in
Hiroshima,when the atom bomb was dropped on it during the
second world war. The Company would still have existence
and therefore it could sue or be sued on claims. Here,the mere
fact that all the members were killed and the registered office
was destroyed would not mean that the Company was dead until
and unless the Company was wound-up the Company would
continue. [See Sec. 34(2) of the Companies Act, 1956]
3. Common Seal
Every registered Company shall have a Common seal [Refer to
Sec. 34(2) of the Companies Act, 1956]. This Common seal is
required to be affixed to all documents, deeds, contracts,
communications, etc, in order to bind the Company.
4. Separate Personality
A Company is a separate and legal person as mentioned earlier.
On account of this separation between the Company and its
members a shareholder can be the creditor or debtor to the
Company. He cannot be held liable for the acts of the Company
even though he holds virtually the entire capital. Similarly
shareholders cannot bind the Company by their acts as they are
not its agents. These points, were brought out by the House of
Lords in the case of Salomon Vs Salomon Ltd [(1897) A.C
22]. In this case Salomon who carried on a prosperous leather
business sold his concern for the sum of £,30,000 to a company
which he formed consisting of himself, his wife, daughter and
his four sons as its shareholders. His daughter, wife and four
sons took £1 share each whereas Salomon took 20,000 £1 shares
and debentures worth £10,000. The debentures were secured
by a floating charge on the Company’s assets. The Company
ran into difficulties and had to wound up. The total assets realised
were £ 6,050. The unsecured creditors having a claim of £ 8,000
demanded the entire amount from the assets realised. The plea
of them was that the Company and Salomon were one and the
same person and that the Company was merely an alias or agent
for Salomon. The House of Lords rejected the contention and
held that as soon as the Company was incorporated it became a
separate and distinct person from Salomon and was not his agent
or trustee. Salomon was a secured creditor and therefore must
be paid out of the assets in priority to the unsecured creditors.
Lord Macnaghten observed : “The Company is at law a different
person altogether from the subscribers ..... and, though it may
be after incorporation the business is precisely the same as it
was before, and the same persons are managers, and the same
hands received the profits, the Company is not in law the agent
of the subscribers or trustee for them. Nor are the subscribers
or members, liable in any shape or form, except to the extent
and in the manner provided by the Act”. A similar decision was
given in Tunstann Vs Steigman [(1962) 2 All.E.R. 417] and in
Dhulia Transport Co Vs Roy Chand [AIR 1962 Bom 337].
5. Limited Liability
Legal personality of the Company and the limited liability of
the members are two sides of the same coin having similar
importance. Of course the Company’s liability towards any claim
against it is unlimited but the members’ liability is limited by
the nominal amount of the shares held by the concerned
member(s) or the guaranteed amount which he promised to pay
in the event of winding up of the Company. In Bacha, F.
Gazadar Vs. CIT, Bombay (AIR 1955 S.C 74), the Court held
that the persons buying shares, become entitled to participate in
the profits when the company decides to divide them, and is at
liberty to dispose of them (i.e., the shares)whenever he likes,
and if anything goes wrong with the Company, his liability is
limited by the nominal amount of the shares held by him.
6. Nature of Corporate Personality and Immunity
A Company is a legal person having a residential status and
nationality. Since it has a residential status it has a domicile.
But a Company is not a citizen because the right to citizenship
is given to all natural persons, therefore, a Company cannot
have a right to franchise. A body corporate does not really
have a Corpus and therefore it cannot be subjected to corporeal
punishment like imprisonment in the event of an offence being
committed for and on behalf of it. It can be argued that a
Corpa Juris i.e., a juristic person cannot commit any unlawful
act, because that is antithesis to its legal existence. Besides no
one can empower or delegate another to commit an unlawful
act, therefore, it is not possible for a Company to authorise, ask
or delegate to any of its officials the right to commit an act
which is an offence. It is also not jurisprudentially valid to
criminalise any act of Corpa Juris. If any offence is committed
by any one even for the benefit of the Company, the Company
is not bound by such an act. A Corpa Juris cannot as a matter
of fact derive any benefit out of any such act because a Corpa
Juris is a neutral face, it can neither gain nor lose. If such an act
is benefited by anybody it would be the shareholders. But
since the shareholders are distinct personality and have nothing
to do with the day to day functions of the Company, shareholders
could not be put into the position of sufferance due to an unlawful
act of any employee or agent of the Company. For
civil wrongs, the Company is ofcourse liable to pay
compensation for an act of its official(s) if he discharges his
functions within its authority and in the process commits such
a civil wrong. The vicarious liability of a Company is sometimes
extended even to acts of a person ultravires to his authority
provided he does it bonafide and does it for the protection of
company’s interest. [Gobald Motors Services Vs. Veluswami
(AIR 1962 S.C.1)] Presently there is a tendency of criminalising
some of the activities done in the name of the Company,
attaching liability to the Company, This goes against the basic
philosophy of corporate system. Every person must be liable
personally for any of his act amounting to an offence. As such
non-payment of tax by window-dressing is to be considered as
personal liability and not a corporate liability. On this issue
there is a scope of debate.
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1.4 DIFFERENT MODES OF INCORPORATION especially confers incorporated
As stated earlier incorporation is the legal process by which an status on such associations, such
association or entity obtains the status of a ‘legal entity’ or ‘legal as RBI, SBI, LIC, GIC, etc.
person’. It is the exclusive prerogative of the state to determine (iii) Registered Companies: Here a general enactment
the policy and procedure with respect to incorporation. English empowers a state authority to
common law has provided for three different modes of incorporate certain associations,
incorporation. Based on this there are three kinds of companies on being satisfied that the
(i) Chartered Companies: These are associations requirements of the statute for
incorporated by a Royal Charter incorporation of such association
eg. The East India Company has been satisfied.
incorporated in 1600 AD.
(ii) Statutory Companies: They are associations 1.5 VARIOUS TYPES OF COMPANIES
incorporated by a statute which Companies can be divided into various categories on the basis
of different yardsticks or criteria as given in the following chart

Flow Chart - 2
Types of Companies

1 2 3 4 5 6 7 8 9
on the on the on the on the on the on the on the on the on the
basis of basis of basis of basis of basis of basis of basis of basis of basis of
liability nature of size & inter-Company listing in functions nationality capital aims
incorporation shareholding relation Stock Exchange

Unlimited Statutory Private Holding Co Manufacturing National Company without

Company Companies profit motive

Limited byRegistered Public Subsidiary Co Listed

shares Companies Mining Co Transnational Company Company with
Chartered Government Group Companies Companies having profit motive
Share Capital

Limited by Trading Co Multi-National

guarantee Deemed Public Joint Venture Unlisted Companies Companies
or Companies Service Co not having
Partnership Share Capital

The chart thereof shows that there are different ways of
categorising the Companies though the very identity on the basis
of categories make the distribution of Companies clear but still
the Companies Act has defined some of the above categories of
Companies. As for example Sec 4 of the Company Act has
defined ‘holding’ and ‘subsidiary’ relationship. A Company is
deemed to be a ‘subsidiary’ of another if the other controls the
composition of its board of directors or holds more than 50% of
the voting power of the Company or it is subsidiary to another
subsidiary of the other Company, then such other Company is
10
known as holding Company. A holding Company thus, may
have chain of subsidiaries, some of which are a direct subsidiary
of the holding Company and others are subsidiary to the
subsidiaries of the holding Company. All these Companies
together are known as Group Companies which essentially show
the group interest or group holding. Some of the definitions of
other types of Companies are given earlier under flow chart (1).
Others will be explained at appropriate places.

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1.6 WHY A COMPANY?
Relation between Corporate Personality and Industrial
Revolution:
Corporate personality with its legal character is perhaps the most
innovative step in the legal realm,in order to support and sustain
large scale production made possible through industrial
revolution.Science has resulted in the creation of industrial
civilization in 17th & 18th centuries,whereas law has innovated
corporate form of organisation to sustain and further the
industrial growth.The whole macro-economic situation during
this period did change on account of the operation of economy
on this scale. A large capital input became necessary for
economic operations on this scale.
Why is a big firm necessary?
A firm in this situation shall strive for reaching equilibrium in
order to earn maximum profits. This equilibrium is reached when
marginal cost of production cuts marginal revenue curve from
below. The level of output where marginal cost and marginal
revenue are equal is determined at the cutting point known as
‘point of equilibrium’or ‘point of maximum profit’. A rational
businessman in the industrialized civilization will expand only
so long as he thinks that he can increase his profits. Unlike small
scale operations the system in the industrial culture became mass-
production oriented due to internal and external economies.
Internal economies are the economies in production accruing to
the firm itself when it expands its output or enlarges its scale of
production. This type of economies operate due to technical,
managerial, commercial,financial,and risk-bearing reasons. As
for example, larger the production, higher is the efficient use of
capital equipment. If a machine produces 500 units per hour,
production of 100 units per hour will not reach a cost benefit
standard. Internal economies operate over and above the
technical reasons due to economy of specialised labour, better
and better utilisation of specialised management, economies in
buying and selling, utilisation of by products, etc. External
economics are those which accrue to each member firm as a
result of the expansion of the industry as a whole. Generally,
industrial civilisation has experienced localisation of industrial
activities both horizontal and vertical. This type of development
of horizontal and vertical concentration is advantageous to
skilled workers, credit facilities, better transport, etc. Besides
that, there are external economies arising out of group
advertisement, publication of trade and technical journals, R&D,
etc.
On account of this operational scale, a firm requires to raise its
production level atleast to a break-even point. In the following
figure the cost revenue equation of a hypothetical firm is shown,
where TC represents total cost curve and TR represents a total
revenue curve. In the figure, TC starts from point ‘A’ of the Y
axis because it is assumed that even if the firm is not put to
work (say when it is shut down or on strike) it has to bear certain
cost of production. These costs are fixed. It is clear from the
figure that any output smaller than OB would make the total
cost exceed the total revenue and the firm shall be at a loss.
But once the production reaches at OB the firm is able to raise
sufficient revenue to meet its cost. This is known as the earliest
break-even point. The firm is going to experience the break-
even point as well at a later stage, due to increasing total cost
and diminishing total revenue after sometime, provided, there
is no sudden change either in the demand factor or in the supply
factors like technology change, better and higher quality machine
being introduced, sudden change of demand on account of test
and selection variation in the consumers behaviour, etc. In the
figure, the firm reaches this point at OC when the production
level goes high to OC. Here again TC and TR shall interact.
The important point that one has to bear in mind that in the case
of production upto B level the TR will cut the TC from below
whereas at C level the TR will cut TC from above. The maximum
profit point in this diagram is pp' where the distance between
TR and TC (TR-TC) is the maximum. This point is reached at
point D. That means a firm will try to maximise its profit by
trying to produce at a level not below D.
Therefore one can easily understand that a large scale industry
shall strive for maximising its output through increasing its
marginal revenue or decreasing its marginal cost or by both. In
order to achieve this production level it is necessary to raise
huge capital for the purpose of investing in capital goods and
reducing per capita production cost. It, therefore becomes
impossible for proprietorship or partnership business to support
or further the cause of industrial growth, whereas in retail and
wholesale trading proprietorship and partnership continued to
play a vital role. A new form of business organisation emerged
which was known as corporations. A large amount of capital
was required to be raised from a large number of people. But
such a large body of capital holders could not run the business.
This necessitated the separation of ownership and management.
A major section of shareholders contributing a large amount of
share capital had to repose faith on a few persons with managerial
skills, in order to run the organisation for and on their behalf.
This resulted in the development of modern concept of
delegation and accountability. It has also resulted ultimately in
an assurance from the State about the limited liability of the
shareholders. Over the years big industrial houses like General
Motors dominated over the industrial world with their huge
corporate structures.
11
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In the last quarter of the 20th century the world is experiencing
another technological change with the change in the organisation
pattern. Consumerism has overtaken huge infrastructural
industries from the point of view of priority and importance.
As a result, service industries started dominating the whole globe.
Naturally fashion variation has become as popular as the product
variation. Investment and technology movement has started
becoming globalised. National character of organisation
obviously started being underplayed. Through a complicated
organisation structure of holding subsidiaries large industrial
empires have started coming up, de-emphasizing the role of
national jurisdiction and national laws. A new system of
economic logic has started building up. A new breed of
management professionals have started dominating the scene.
1.7 THE ORGANS OF A COMPANY
The registered company, which has a virtual monopoly of the
Commercial Corporations of our society, has two primary organs
viz. (i) the members in general meeting and (ii) the Board of
Directors. The division of power between the two organs, is
provided in the Articles of the Company. But there are certain
powers which can be exercised by the members in a general
meeting only. The management is usually vested in the Board.
The control over the managerial organ and the ultimate power
is legally vested in the members in general meeting. This topic
is discussed in detail in another module. As regards, small sized
Companies, the legal distinction between the two organs may
only be in theory. In most cases, the members of both the organs
are the same personnel. But the position is different with respect
to large size Companies. The Board of Directors of these
Corporations have emerged as the real power wielding organ.
The shareholders are relegated to the background. They have
neither the capacity nor the inclination to discharge the
supervisory or controlling function assigned to them by law.
Two major factors responsible for this position are :
a) Emergence of passive and institutionalized investors, who
have no inclination for entrepreneurship; and
b) Scattered shareholding.
This has resulted in the Board of Directors not being subject to
effective shareholder control.
Another factor to be noted is the emergence of Managing
Director, the administrative head of the Corporation as a pivotal
organ of the Company. Many of the powers of the Board are
now delegated to the Managing Director. Yet another
development is the growth of professional managers. Most of
the large size companies today have whole time or Executive
Directors, who are members of the Board by virtue of their
professional expertise, and not on account of their shareholding.
1.8 APPLICABILITY OF COMPANIES ACT, 1956
Sec.3(i) of the Companies Act 1956, provides that the term
‘company’, for the purposes of the Act, means a company
formed and registered under the Act, or an ‘existing company’
which is a company registered under any of the earlier
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Companies Act specified in the section. Thus, statutory
companies and other kinds of corporations are not governed by
the Act. Even in respect of registered companies the Act is not
exhaustive. As observed by L.C.B. Gower (‘The Principles of
Modern Company Law’) “Behind the Act is a general body of
law and equity applying to all companies irrespective of their
nature and it is there that most of the fundamental principles (of
company law) will be found”. Many of the cardinal principles
of company law, such as the doctrines of ‘ultra vires’ ‘indoor
management’, rules relating to the fiduciary position of
Directors, etc are founded on case laws.
In addition to the Companies Act, 1956, there are many special
statutes governing companies carrying on particular business
activities. For example, the Insurance Act, 1938 is applicable
to companies doing insurance business. Similarly the Banking
Companies Act, 1949, governs banking companies. Except in
so far as its provisions are inconsistent with those of the special
statutes, the Companies Act, is applicable to all companies
incorporated under the Act.
The following are the main types of associations governed by
the Act.
(1) Companies incorporated under the Act
(2) ‘Existing companies’ as defined under S3(i) (ii)
(3) ‘Foreign Companies’ within the meaning of S.591
(4) Unregistered companies for the purpose of winding up under
Part X of the Act.
(5) ‘Nidhis’ or ‘Mutual Benefit Societies’ declared as such by
the Central Government through notification in the official
gazette.
1.9 APPLICABILITY OF ENGLISH LAW
The Statute in force is the Companies Act, 1956. It is modelled
on the English Companies Act, 1948 which has since been
repealed. The Statute now in force in England is the Companies
Act 1985 which attempts to harmonize English law with the
continental law.
Though the Indian statute is not a verbatim copy of the English
Company Act 1948, and has developed its own lines, the English
decisions can profitably be referred to and relied upon especially
when the language used in both the statutes are identical. In
Hind Overseas (P.) Ltd. v. Raghunath Prasad [AIR 1976
S.C. 565] the petitioners and the other members of their family
held about 40% of the shares of a company. The remaining
shares were held by one VDJ and the members of his family.
Though the petitioners were appointed as Directors of the
Company, the business was always controlled by VDJ, who was
the majority shareholder. Differences of opinion developed
between the petitioners and VDJ, on many matters of
administration and management. The petitioners filed a petition
under Section 433(b) of Companies Act, 1956 for winding up
of the company. While examing the scope and ambit of the
section, the court adverted to the corresponding provisions in
the English Statute and relied upon the interpretation given to
those provisons.
“Although the Indian Companies Act is modelled on the English
Companies Act,the Indian law is developing on its own lines.
Our law is also making significant progress of its own as and
when necessary. Where the words used in both the Acts are
identical, the English decisions may throw good light and reasons
may be persuasive. But as the Privy Council observed long ago
in Ramanandi Kuer v. Kalawati Kuer,[ AIR 1928 PC 2] “It
has often been pointed out by this Board that where there is a
positive enactment of the Indian legislature, the proper course
is to examine the language of that statute and to ascertain its
proper meaning uninfluenced by any considerations derived from
the previous state of the law or of the English law upon which it
may have been founded”.
If it was true in the twenties it is more appropriate now. In view
of the background, conditions and circumstances of the Indian
society, the needs and requirements of our country calls for a
somewhat different treatment. We will have to adjust, adapt,
limit, or extend, the principles derived from English decisions,
entitled as they are to great respect, suiting the conditions of
our society and the country in general, always, however, with
one primary consideration in view that the general interests of
the shareholders may not be readily sacrificed at the altar of
squabbles of directors of powerful groups for power to manage
the company”.
1.10 PROBLEMS OF 20TH CENTURY : A
CONCLUDING REMARK
The modern corporation is the offshoot of industrial revolution.
When collective enterprise became a necessity, to work out the
business opportunities provided by science & technology, the
corporation emerged as a convenient instrumentality. During
the early days, the shareholders were mainly entrepreneurs who
took a keen interest in the affairs of their company. Very often
the Directors were appointed merely on the strength of their
shareholding. All these factors ensured proper shareholder
control over the Board. In fact the whole scheme of the
Companies Act is based on the assumption that the shareholders
can and will check corporate abuses. But the assumption has
proved to be wrong. In fact the members of the modern
corporation are a hapless lot, weak and vulnerable and in urgent
need of legal protection.
Apart from the shareholders, the other groups whose interests
have to be recognised by Corporate Law are the workers and
the consumers. The skill, efficiency and dedication of the
workers are as much a contributory factor to the growth and
prosperity of the enterprise as the managerial skill or the capital
employed. Another area of concern of corporate law should be
the social interest. The modern corporation is much more than a
mere business organisation. Because of its predominant position
in the economic frontier, having a significant impact on the
political and social arenas as well, it is widely recognised that
the modern corporation has a social responsibility. No society
can afford to permit a company to disregard its social
responsibility or the legitimate claims of the workers and
consumers. But at present company law has not properly
addressed itself to these vital issues.
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2. HISTORY OF COMPANY LAW
SUB-TOPICS
2.1 Introduction
2.2 Early History of Company Law in England
2.3 Modern history
2.4 History of Company Law in India
2.5 Administration of Companies
2.6 Jurisdiction of Courts
2.7 Concluding remarks
2.1 INTRODUCTION
Rapid scientific inventions and innovations in the 16th, 17th
and 18th centuries paved the way for industrial revolution, first
in England and then in Europe. Similarly the innovation of
Corporate personality concept during this time, resulted in the
form of business organisation which became the vehicle of rapid
industrial growth in 18th and 19th century. Initially this type of
Corporate personality started developing through the Royal
Charters. In fact the East India Company which was formed as
joint stock Company in order to carry on trade in India, obtained
the Charter from the British Sovereign in 1599.
2.2 EARLY HISTORY OF COMPANY LAW IN
ENGLAND
A registered Company in England is the youngest member in
the family of corporations. The statute which gave birth to it
was the Joint Stock Companies Act, 1844. Before that there
were only two types of corporations namely :
(1) the Chartered Company which came into being on the
issuance of a Royal Charter; and
(2) the statutory corporation which was created by a special
enactment. Incorporation through these devices was not
easily available. Further the cost was also prohibitive.
The Chartered Companies were incorporated mainly for the
purpose of overseas trade: The statutory corporations on the
other hand operated in the domestic field mainly in the railway
and other public utility sectors. Since it was very difficult to
obtain incorporation through the above two methods, most of
the business activities were carried out through large
unincorporated business associations which were often referred
to as ‘common law companies’ or 'deed of settlement
companies’. Legally these associations were only partnerships,
which set out the constitution of the company. The capital was
divided into shares of specific denominations and were made
transferable. The management of the business was entrusted
to a committee of directors or governors. The property of the
association was vested in another body of trustees. Many of
the trustees were also members of the Board, Thus we find that
these associations were having all the salient features of a
modern company. But the legal validity of many of the
provisions of the deed was doubtful. Whatever that be the deed
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of settlement company was the main vehicle through which
commercial activities were carried out. Being Partnerships they
were free from many of the regulations and restrictions to which
the Statutory Corporations and Chartered Companies were
subjected to.
By the beginning of 18th Century speculative activities reached
its zenith and paved the way for malpractices. Gower observes
that the period was marked by an almost frantic boom in
company floatation. Large unincorporated ‘companies’ with
transferable stock appeared on the commercial scene. Many of
them had only a short span of life and burst like the bubbles of
water. The story of the notorious South Sea bubble is a clear
illustration of the gambling mania of the period. The company
was incorporated in 1710, with the object of exploring the trade
with South Africa. It launched a scheme to acquire all the
national debt in exchange for the company’s shares. The scheme
turned out to be a failure. In 1720, the directors of the South
Sea Company were summoned before Parliament and fined for
their fraud. To control the prevailing speculative fever,
Parliament enacted a statute, known generally as the ‘Bubble
Act’, 1720. The statute which was the first attempt of English
law at framing of a Company Act, was clearly negative in its
approach. Section 18 of the Act provided that all those
undertakings as were therein described, ‘tending to the common
grievance prejudice and inconvenience of His Majesty’s subjects
should be illegal and void’. Associations purporting to act as
corporate bodies but without legal authority and the raising of
transferable stock by such bodies were manifestly to the
prejudice of the public trade and commerce of the Kingdom.
Broker dealings in illegal companies were also prohibited. But
companies and partnerships established before 1718 were
exempted from the purview of the Act. They could carry on
any local or foreign trade in such manner as ‘has hitherto been
done’. The full legal implication of the statute was not beyond
doubt.
Commenting on the effect of the Bubble Act, Holdsworth says;
“What was needed was an Act which made it easy for joint
stock societies to adopt a corporate form and at the same time,
safeguard both the shareholders in such societies and the public
against frauds and negligence in their promotion and
management. What was passed was an Act which deliberately
made it difficult for joint stock societies to assume a corporate
form and contained no rules at all for the conduct of such
societies, if and when they assumed it”.
The Repeal of Bubble Act
The Bubble Act 1720 had a restraining influence on the
commercial activities of the period following it. Gower observes
that the Statute was “ for long a sword of Damocles which
exercised a restraining influence as patent as the memory of the
great slump. Since the Bubble Act made it a criminal offence to
form any company ‘presuming to be a corporate body’ the
commercial community was forced to operate within the limits
of the unincorporated partnership. Though towards the end of
the century, Parliament showed willingness to incorporate by
special Acts, it was limited to activities such as banking,
insurance, and canal works. It was a negative policy in respect
of other trading associations. The only alternative available
was the unincorporated partnership. This resulted in the rebirth
of the ‘deed of settlement companies’ which the Bubble Act
attempted to suppress. As the Bubble Act expressly exempted
genuine partnerships from its ambit, it was thought that large
unincorporated bodies with joint stock were not hit by it,
provided that, some restrictions were imposed on the
transferability of shares.
In the latter half of the 18th century the unincorporated joint
stock company with a large number of shareholders, emerged
as the dominant type of trading association. In course of time,
many of them operated with transferable shares. The Bubble
Act was conveniently forgotten. At the turn of the century,
speculative activities and company promotion reached a height
comparable to that of the first two decades. In many cases
unscrupulous, company promoters could easily defraud the
investing public. This brought to light, the many disadvantages
of the unincorporated joint stock companies of the period. State
intervention to regulate the trading activities became inevitable.
The first step taken by the government was to initiate prosecution
against a few unincorporated associations with transferable
stock, for violation of the Bubble Act, though the statute was at
that time an almost forgotten one. In two cases the court took
the view that unincorporated joint stock companies with
transferable stock were illegal. But some other judges refused
to hold that all unincorporated bodies with transferable shares
were illegal. These conflicting decisions also contributed to
the confusion that prevailed in the succeeding decades, as to
the status of joint stock companies. It was increasingly felt that
active governmental intervention was essential to bring law in
tune with the commercial urge of the period. The first step
taken in this regard was the repeal of the Bubble Act in 1825.
2.3 MODERN HISTORY
The repeal of the Bubble Act was also followed by a slump.
But soon, the joint stock company appeared again and began to
dominate the industrial and commercial field. This made it clear
that it was an inevitable necessity of the period to have trading
associations through which capital could be readily raised for
commercial projects. Pressed by the urgent necessity of taking
some concrete steps to regulate trading associations, the Trading
Companies Act of 1834 was enacted. It empowered the Crown
to confer by letters patent all or any of the privileges of
incorporation without actually granting a charter. The Chartered
Companies Act of 1837 re-enacted the provisions of the Trading
Companies Act of 1834. It specifically provided that the liability
of the members could be limited by the letters patent.
The Companys’ Act of 1844-1862
In 1841, a Parliamentary Committee was appointed to study
and report on the functioning of joint stock companies. In 1843,
Gladstone the then President of the Board of Trade, became the
Chairman of the Committee. Based on the report of the
committee, The Joint Stock Companies Act, 1844 was passed.
The enactment is popularly known as Gladstone’s Act. The
statute which is still the foundation of our company law,
introduced three cardinal principles.
(1) Incorporation by mere registration
The Joint Stock Companies Act, 1844 provided a comparatively
easy and cheap method for the incorporation of commercial
associations. Hitherto, an association could be incorporated
only through the grant of a royal charter or by a special Act of
Parliament. But now every association satisfying the
requirements stipulated in the Act, was entitled to the
incorporated status.
(2) Compulsory Registration
The Act also provided that companies with membership above
25 or with shares transferable without the consent of all the
members could function only as incorporated bodies. The above
principle is incorporated in Section 11, of our Companies Act,
1956.
(3) Publicity
The Act is founded on the principle of disclosure. It insisted
that various information regarding the company and its affairs
should be periodically supplied to the Registrar of Companies.
It was thought that the mandatory provisions in the Act providing
for full publicity of the affairs of the company is an effective
guarantee against fraud and other malpractices.
The drawbacks of the Act
The Joint Stock Companies Act, 1844, is a landmark in the
history of commercial associations in England. Still the statute
had certain vital defects. The main drawbacks of the Act were:
(i) Provisions for Provisional and final registration
The Act provided for provisional and final registration of
companies. Final registration could be obtained only on the
fulfilment of certain stringent conditions.
(ii) Absence of limited liability to the members
Though the Act evolved a legal device for easy and cheap
incorporation of commercial associations, the most important
advantage of incorporation, namely limited liability of the
members, evaded them. Even after incorporation the members
remained fully liable for all the debts and liabilities of the
company, as if they were members of a partnership firm.
Limited Liability Act, 1855
The Joint Stock Companies Act, 1844 provided a cheap and
easy mode of incorporation. Then onwards incorporation was
no more a privilege of a few, who could influence the Crown or
the Parliament, but a legal right of all those who complied with
the requirements of the Act. But an anomalous position had
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arisen in so far as the statute fastened personal liability on the
members for the debts and liabilities of the Company. In this
respect Gladstone's Act put the registered company on par with
partnership, rather than with the other two types of corporations.
But limitation of personal liability was the most cherished goal
of the business community. And they clamoured for it,till
ultimately the Limited Liability Act, 1855, was enacted. But it
was a very cautious approach,and limited liability could be
claimed by the members of the registered company, only if the
following conditions were satisfied:
(a) The company had at least 25 members each holding a
minimum of shares of nominal value $10, paid upto 20
percent.
(b) Not less then three fourth of the authorised capital was
subscribed.
(c) The auditors of the company were approved by the Board
of Trade.
(d) The word ‘limited’ was added to the company’s name. It
was thought, that these provisions would, to some extent,
safeguard the interest of the creditors. But Limited Liability
Act 1855, had only a short span of life. Within a year of its
birth, the Joint Stock Companies Act, 1856 was enacted
which repealed both the earlier enactments, namely, Joint
Stock Companies Act 1844 and Limited Liability Act, 1855.
The Joint Stock Companies Act 1856
This statute revealed a complete reversal of the cautious policy
hitherto followed by the legislature. It did away with provisional
registration. All the safeguards provided by the limited liability
Act for the granting of limited liability to the members, except
the one requiring that the word ‘limited' should be added to the
company’s name were also thrown away. The deed of settlement
which was the constitutional document of the company, to be
registered with the Registrar for incorporation, was split up into
two viz : (a) the Memorandum of Association and (2) the Articles
of Association. The statute denotes the triumph of the champions
of ‘laissez-faire” doctrine, who pleaded: “If there was a rule
established by reason, authority and experience’ it is that the
interest of a community is best consulted by leaving to its
members, as far as possible, the unrestricted and unfettered
exercise of their talents and industry”( Lord Bramwell). The
effect of the statute is commented upon by Prof. Gower thus:
“Passed, as it was in the, hay day of laissez faire, it allowed
incorporation with limited liability to be obtained with a freedom
amounting almost to licence; all that was necessary was for seven
or more persons to sign and register a memorandum of
association."
Companies Act 1862
The next important statute was the Companies Act, 1962. This
was the first enactment to bear a short title ‘The Companies
Act’. According to Sir Francis Palmer, this statute was the
‘magna carta of corporate enterprise’. This was a consolidating
Act. It included a model form of Articles of Association which
the company could adopt instead of drafting its own articles.
The legislative policy reflected in the statute was one of granting
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maximum liberty to registered companies. With this enactment,
the pendulum of corporate enterprise reached the extreme end
of liberty. Then onwards, it had been a movement in the opposite
direction as subsequent Company law legislations have been
trying to impose more and more restrictions on companies and
corporate activities.
The Companies Act 1908
The next important English statute was “The Companies Act
1908” which also was a consolidating Act. It consolidated in
the main, the Companies Act 1862, and the Companies Act 1907.
The latter enactment introduced the concept of ‘private
company’, which was granted many privileges and concessions
including balance sheet secrecy.
The Companies Act 1928
The main contribution of this Act and the subsequent
consolidating Act of 1929 was that they recognised the special
authority relationship that existed in a group of companies
connected together by the holding- subsidiary relationship. The
Act also contained certain provisions aimed at the protection of
the minority.
The Companies Act 1948
This statute was based on the report of Cohen Committee which
recommended far reaching reforms in company law. The
suggested reforms were aimed mainly at two directions : (1) to
ensure that as much information as was reasonably required shall
be made available both to shareholders and creditors of the
company concerned and to the general public, (2) to ensure
effective shareholder control over the management. The Act
also conferred power on the members in a general meeting to
remove any director from office, even before the expiration of
his term of office. The investigatory power of the board of
trade was strengthened.
The Companies Act 1967
The statue was mainly a supplementary legislation attempting
to curb corporate abuses but by somewhat halfhearted steps
(Gower). It gave effect to some of the recommendations of the
Jenkins Committee and incorporated new stringent provisions
enhancing the fiduciary duties of the directors and further
strengthening the investigatory power of the board of trade.
The European Communities Act, 1972
In 1972, England became a member of European Economic
Community. Thereafter many legislative reforms were carried
out to comply with the EEC directives which aimed at
harmonisation of the company laws in the member states.
The Company Act 1985
The Companies Act 1985, consolidated all these legislations
and made suitable amendments to the law. In the next year, the
Insolvency Act, 1986 was enacted which removed from the
Company’s Act, all the provisions relating to winding up. There
are a few other supplemental legislations, such as the Company
Securities (Insider Dealing) Act, The Company Directors
Disqualification Act, 1986, The Financial Services Act, 1986.
The latest legislation is the Companies Act 1989 which was
necessary to implement the seventh and eight directives of
European Commission on consolidated accounts and audits of
group companies.
2.4 HISTORY OF COMPANY LAW IN INDIA
As noted earlier the Indian Company law was closely following
its English counter part. Even the language of most of the
statutory provisions was identical with the corresponding
provisions of the English Statute. Our Company Law is greatly
influenced by the English Law.
The history of Indian Company Law begins with the Joint Stock
Companies Act, 1850. It was modelled on the English Act of
1844. This was followed by the two Acts of 1857 and 1860
respectively. The Companies Act 1866 which repealed all the
earlier statutes remained in force till the Companies Act of 1882,
came into force. This statute was repealed by the Companies
Act of 1913. It was mainly based on the English Act of 1908,
though it also incorporated certain additional provisions taking
into account the peculiar conditions that prevailed in our country.
A drastic amendment to the 1913 Act was introduced by the
Amending Act of 1936. The statutes remained in the statute
book till the Companies Act 1954, came into force. The Act of
1956 which is the principal Company law statute in force is
mainly based on the English Act of 1948, though in certain
respects our statute is more progressive than the English Act of
1948 and contains many provisions, which are not found in the
English Law.
Amendments
The Act has been amended several times. Some of the
amendments have introduced drastic changes. Till date 16
amendments have been made. Of these, the Amendment Acts
of 1960, 1965, 1966, 1967, 1969, 1974, 1985 and 1988 are
very ‘significant’. A new Company' Bill of 1993 introduced in
the Parliament is expected to repeal and replace the 1956 Act
soon.
Other statutes
Though the Compay Act, 1956 is the principal legislation on
registered companies, there are a cluster of other laws having a
direct bearing on corporations. These statutes are supplementary
to the Companies Act, 1956. Some of the important legislations
are :
(1) The Securities Contract Regulation Act, 1956
(2) The Monopolies & Restrictive Trade Practices Act, 1969
(3) The Foreign Exchange Regulation Act 1973
(4) The Industries Development Regulation Act, 1951
(5) The Sick Industrial Companies Special Provisions Act, 1985
(6) The Securities Exchange Board of India Act, 1991.
2.5 ADMINISTRATION OF COMPANIES
We have noticed that the legal framework within which the
registered company operates was moulded about one and a half
centuries ago in an atmosphere of laissez faire. Subsequent
developments in the structure and character of corporators
(members) necessitated more state regulations. The regulatory
function of the state over corporations are now carried out mainly
by the Department of Company Affairs which is a wing of the
Ministry of Law, Justice and Company Affairs. Under the
Department there are four Regional Directors with their Head
Quarters at Delhi (North zone). Bombay (West Zone) Madras
(South Zone) and Calcutta (East zone). There are also Registrars
of companies, each Registrar having a specified territorial
jurisdiction. Most of the administrative and regulatory powers
vested in the Central Government under the Act are delegated
to the Regional Directors or the Registrar. Apart from the
delegated powers the Registrar is also vested with certain
statutory powers. The Registrar and the Regional Directors are
essentially administrative authorities under the control of the
Central Government.
Company Law Board
In addition to the above two there is also the Company Law
Board vested with vast powers mainly of quasi judicial nature.
The Board was first established by the Companies Amendment
Act, 1963 for a better and convenient administration of the
Companies Act. It was envisaged that most of the powers and
functions of the Central Government under the Companies Act
and allied statutes would be entrusted with the Board, but the
Board would function under the control of the Central
Government. Consequently many of the powers of the Central
Government were transferred to the Board, which functioned
as a delegate or agent of the Central Government.
Amendment Act 1974
But with the Amendment Act of 1974, a qualitative change in
the legal position of the Board took place. Certain powers which
were hitherto vested in the court were now transferred to the
Company Law Board.
The judicial powers which were so transferred to the Company
Law Board were:-
(1) power to sanction alteration of the registered office and
object clauses in the Memorandum of Association (Ss.17
to 19);
(2) power to sanction the issue of shares at a discount (S.79);
(3) the power to order rectification of the register of charges
(S. 141); and
(4) the power to convene any general meeting other than the
annual general meeting (S. 186).
Thus with the Amendment Act, 1974, the Company Law Board
was assigned a dual role, namely:-
(a) as a delegate of the Central Government; and
(b) as a quasi judicial organ vested with statutory powers.
Nevertheless, in the discharge of its powers and functions the
Board was subject to the control of the Central Government.
This was expressly provided by sub clause (6) of section 10 E
as it stood before the Amendment Act of 1988. At this stage
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the Board consisted of ex officio members only. Thus the Board
was ill equipped to discharge its quasi judicial function in an
independent and impartial manner.
The Amendment Act, 1988
This defect was rectified by the Amendment Act, 1988 which
provided for the Constitution of a truly independent body vested
with judicial and quasi judicial functions. It was freed from the
administrative control of the Central Government. In addition
to the statutory powers conferred on it the Board may also
exercise such other powers and functions as may be delegated
to it by the Central Government. [(Section 10E(1A)]. The
Company Law Board is also vested with powers under allied
statutes such as the Securities Contract Regulation Act, 1956.
The MRTP Act, 1969 etc. The Board is empowered to regulate
its own procedure [(See 10 E(6)]. Its decisions and orders are
appealable to the High Court. But the appeal is only on questions
of law (and not on questions of fact) arising out of such orders
(Section 10 F).
2.6 THE JURISDICTION OF COURTS
The Companies Act 1956, contains many provisions which are
penal in nature. For violation of those, the officers in default
and in certain cases the company also are fastened with criminal
liability. There are more than 170 sections in the Companies
Act, which are penal provisions. These offences may be tried
in the court of Judicial Magistrate First Class or Presidency
Magistrate, as the case may be [Section 2(11)(b)].
As regards civil matters under the Act, the jurisdiction is vested
with the High Court having territorial jurisdiction over the place
at which the registered office of the company concerned is
situated. But the Central Government may by notification in the
Official Gazette empower any District Court subordinate to such
High Court to exercise jurisdiction over all or any of the matters
over which the High Court has jurisdiction under the Act. A
District Court can be conferred jurisdiction only in respect of
companies having their registered office situate within its
territorial jurisdiction. (Sections 2(11) and 10 of Company Act).
Further restrictions on conferment of jurisdiction on District
Courts are:
(i) matters under Sections 391, 394 and 395 (Compromises
and arrangements reconstruction and amalgamation, and
takeovers) (ii) Winding up of companies with a paid up capital
of Rs.1 Lakh or more.
The jurisdiction of the High Court or the District Court as the
case may be, does not cover all cases where a company is a
party to a civil litigation. The provisions of the Company Act,
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dealing with civil jurisdiction are applicable only to those cases
where a right or liability arises out of the provisions in the
Company Act. As regards other civil matters, the company,
like any other person is within the jurisdiction of ordinary civil
court. Reference may also be made to Section 9 of the Civil
Procedure Code 1973, which provides that an ordinary civil
court shall have jurisdiction to entertain all suits of civil nature
except those which are expressly or by necessary implication
excluded. Even though the Company Act 1956 contains
elaborate provisions dealing with the management and conduct
of the affairs of the company and providing remedial measures
it does not always exclude the jurisdiction of civil court. On
certain matters the jurisdiction of the ordinary civil court and
the company court may be concurrent. The leading Indian case
on the topic is Nagappa Chettiyar v. Madras Race Club
[(1949) 19 Comp.cas.174]. The main object of the respondent
company was to carry on the business of a race club. At an
extraordinary general meeting of the club held on 7th November
1947 a special resolution was passed to amend some of the
provisions of the Articles of the company. Two members of the
club instituted a suit, for a declaration, that all the business
conducted at the meeting including the special resolution passed
was invalid, null and void. One of the issues in this case was
whether the civil court has jurisdiction to entertain the suit against
a company pertaining to a matter of internal management. It
was held that the court has jurisdiction. In Star Tile works v.
Govindan [AIR 1959 Ker 254], the dispute related to the
proceedings of the Annual General Meeting of the 1st defendant
company. The plaintiff were the shareholders of the company.
They alleged that their proxies were not allowed to exercise
their votes at the meeting. In this case Vaidialingam J held that
“there is also a considerable body of authority for the proposition
that many of the speedy remedies provided by the Act are equally
enforceable in the other courts by suits. That being so it is
impossible to regard the company court as having exclusive
jurisdiction in all matters pertaining to companies”.
2.7 CONCLUDING REMARKS
The present Industrial policy of the Govt of India will require a
thorough revision of the Companies Act. The new Company
Bill proposed in 1993 was withdrawn with a view to place a
comprehensive new Bill incorporating various new proposals
required for supporting the new economic policy. Some of the
important areas for new provisions to be incorporated are
corporate management, structure, capital formation,
accountability, standard of corporate accounts, winding up, etc.
3. FORMATION OF A COMPANY AND ITS
CONSTITUTIONAL DOCUMENTS
Sub-Topics
3.1 Steps of company formation at a glance
3.2 Company promotion & promoters’ role
3.3 Who can be the subscribers ?
3.4 Pre-incorporation Contract
3.5 Constitutional document : Memorandum
3.6 Constitutional document : Articles
3.7 Certificate of Incorporation
3.1 STEPS OF COMPANY FORMATION AT A
GLANCE
Formation of a company has several phases. These phases at a
glance are given below:
Formation of a Company
1 Planning Stage
........ Formulation of an idea
........ Design of the project outline
........ Viability study
........ Study of legal implications
2 Association of persons or Promotional State
........ Assemblage of Promoters [Sec. 12]
........ Applying for necessary licence/permit/discount
........ Making agreements for infra-structure
........ Pre-incorporation Contracts
........ Appointing Lawyers
3 Registration
........ Documentation [Sec. 13-15]
........ Application for registration [Sec. 33(1)]
........ A statutory declaration [Sec. 333(2)]
........ Certificate of incorporation [Sec. 34]
4 Commencement of business
........ Private limited company can start as soon as it
receives certificate of incorporation [Sec. 34]
........ Public Limited company :
........ (a) Invite public to subscribe by issue of
prospectus Sec 149(1) read with [Sec. 55]
........ (b) Raise Minimum subscription mentioned in
prospectus Sec 149A read with [Sec. 69]
........ (c) Allotment of share - [Sec 149(1)(a)]
........ (d) Certificate of allotment [Sec. 149(1)]
........ (e) Certificate to act as Directors [Sec. 266(1)(a)]
........ (f) Statutory declaration - [Sec. 149(1)(d) or Sec.
149(2)(c) or Sec. 149(2)A]
........ (g) Certificate to Commence business given <=>
then the Public Ltd company can commence
business [Sec. 149]
3.2 COMPANY PROMOTION AND PROMOTERS'
ROLE
According Sec 12 of the Companies Act any seven or more
persons, or where the Company to be formed is a private
company, any two or more persons associated for any lawful
purpose may, by subscribing their names to a memorandum of
associations form an incorporated company. Before they
subscribe to the memorandum of association they are called
promoters. They undertake all promotional activities which inter
alia includes planning activities, and pre-incorporation activities.
They are also called subscribers because they sign the
memorandum. In advanced countries there is a professional
class who undertake the job of promoting a company and after
taking all necessary steps of formation of a company leave the
company to the subscribers who become signatories of the
memorandum of the company. In our country such a promotional
class has not been professionally built up. As a result, the
promoters are those who themselves become subscriber by
directly participating in the formation of the company. The stage
of promotion is legally speaking a very intricate stage. At this
stage the company does not come into existence but many of
the important primary decisions and activities are to be
undertaken without which the company will never come into
existence. Many of these activities involve the undertaking of
liabilities. Intricate question arises as to the legal status of these
promoters.
What is Promotion? The word ‘promotion’ has not been
defined in the Companies Act, nor its area demarcated. The
best description of the term is found in the judgement of Bowell,
L.J., in Whaley Bridge Co Vs Green [(1879)Q.B.D. 111].
According to Bowell L.J, ‘promotion’ is not a term of law, but
of business operations familiar to the commercial world, by
which a company is generally brought into existence.
Promotional activities include the wide range of commercial
activities which include many technical and non-technical
operations. Amongst the technical activities include project
planning, feasibility study, looking for technical cooperation and
collaboration, and locational studies. Non-technical activities
include assembling required number of signatories, obtaining
advice on different legal requirements, appointing key people
like company lawyer who will make documentations and enter
into all types of pre-incorporation contracts . In spite of the fact
that at present many of the stringent conditions of the license
raj have been dispensed with, nevertheless, in most of the project
planning and company matters lot of infrastructural activities
are required to be done at the govt. level like arrangement for
industrial site, if it is an industrial concern, arranging for facilities
like water, electricity etc., talking with financial institutions, to
arrange for finances and the like.
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Position of a Promoter : Therefore, promoters play a very
important role. They undertake to form a company with
reference to a given object. It is difficult to identify a legal role
of a promoter. Promoters are not agents of a company because
there cannot be an existence of the agent in absence of the
principal itself. Therefore, a company cannot appoint an agent
even by application of fiction before the company receives the
certificate of incorporation. Promoters cannot also be called as
trustees, in absence of the company being their beneficiary. [See
Weeners Mills Ltd Vs. Bulkies Ammal AIR 1969 Mad 462]
Lord Blackburn, however observed “those who accept and use
such extensive power are not entitled to disregard the interest
of the corporation altogether. They must make reasonable use
of the power which they accept from the legislature, and,
consequently they do stand with regard to that corporation when
formed, in what is commonly called a fiduciary relation to some
extent” [Erlenger Vs. New Sombrero Porphate Co (1878)3
A.C 1280]. The principle was applied to Gluckstein Vs. Barnes
[(1900)A.C 240]. In this case a company owning the property
called ‘Olympia’ thereunder ‘Rough Weather’ and the
debentures charged on that property were worth very little.
Gluckstein and three others as trustees for the Syndicate formed
to buy Olympia and resell it to a company to be promoted by
them purchased the debentures for a sum much below the amount
they realised and made a profit of £ 20,000. The company went
into liquidation and the syndicate purchased Olympia for £
1,40,000 which they sold to Olympia Ltd, a company formed
by them, at £ 1,80,000. Gluckstein and three of his friends
involved in promoting the company also became the directors
of the company. They issued a prospectus for raising the capital
from the public wherein they disclosed that the property Olympia
was purchased by them at £ 1,40,000 and sold the same to the
company after registration at £ 1,80,000 but they did not disclose
the profit made on the dealings of the debenture of the old
company. The House of Lords decided that the promoters have
a fiduciary obligation to the company which they were to form,
from the moment they proposed to buy the property with a view
to resell it to the company. Therefore, the non disclosure of the
profit of £ 20,000 was a wrong in law, which was to be
compensated. Of course if the company does not come into
existence the relation does not arise. According to Ghickstein,
the fiduciary relation is created not from the day of incorporation
of the company but it arises from a prior date when the promoters
decide to gain by their promotional activity. Promoters are not
bound to refrain making any personal or individual gains but
they are bound to disclose that gain to the prospective
shareholders of the new company.
What makes a person a promoter? In Tiruvengadachariar
Vs. Vellumudaliar (1938 ILR Mad 192) the Madras High Court
decided that signing the memorandum or showing that the money
paid by him was utilised in paying of the expenses of the
formation of a company does not make a person promoter of a
company. In order to be a promoter a person has to be involved
in the process of conception, planning during the formative
stages of the company. Vendor of a property while selling it to
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a promoter of a company who took it for resale to the company
after promotion is not considered as a promoter if he joins other
promoters to promote the company after the sale of the company.
Liability of a Promoter: Promoter has a duty of disclosure
because he has a fiduciary obligation. A disclosure has to be
actual and express and it must be made to the body of persons
who act on behalf of the company after incorporation of the
company. Out of this obligation the liability of a promoter arises
to the company as soon as the company is formed. He is duty
bound to disclose the full account of all profits he may have
earned at the stage of formation of the company. His obligation
begins as soon as he sets out to act for or promote the company.
In Ladysoell Mining Co Vs. Brooks (35 Ch.D 400), five
persons purchased a mine for £ 500. At that time there was no
steps taken for forming a company. Afterwards four of these
persons with some other persons promoted a company to which
the mine was sold for £ 18,000. They did not disclose the profit
thus made. The Court held that there was no fiduciary obligations
to disclose this profit because the duty does not arise before the
promotional work begins. Promoters are not responsible to
account for the profit and return it to the company. They are
entitled to make such profit. The only responsibility that they
have a responsibility of disclosure failing which there shall be a
liability for account of non disclosure and breach of trust for
which they have to compensate. Promoters to take part in the
issue of prospectus are liable further to the shareholders on
statements made therein. In the event of winding up they will
be liable for misfeasance and breach of trust.
Renumeration: A promoter is entitled to a reasonable
remuneration. He may purchase the property and resell it to the
company at a profit subject ofcourse to disclosure. He may
also charge commission on properties acquired for the company.
Generally speaking such remuneration is stipulated in the
Articles of Association. Ofcourse in some cases like In Re
Englefield Colliery Co [1878 Ch.D 388], it was held that the
Board of Directors are duty bound to examine the reasonability
of the remuneration as stipulated in the Articles of Association,
payable to the promoters. Once the promoter signs the
Memorandum of Association he becomes a subscriber.
3.3 WHO CAN BE THE SUBSCRIBERS
Any person competent to contract is qualified to be a subscriber.
A subscriber need not be beneficially interested in the shares
for which he has ‘subscribed’.e.g. a trustee. A company or
corporation can be subscriber but not a ‘partnership firm’ or a
'minor'.
An agent can sign on behalf of his principal (refer to Circular
dated 27th July 1964, issued by C.L.B)
A HUF or a Partnership firm cannot be a subscriber because
these are not legal entity. Ofcourse if a Karta or a partner signs
a memorandum they are treated as individual subscriber's or
subscriber's in their own name. Ofcourse if it can be proved
that the Karta purchased the share as a subscriber out of the
HUF fund other members of the HUF can demand to be the
beneficiaries. But they are in no way under any obligation or
responsibility to share any loss. As regards Foreign Institutional
Investors (FII) or Non-Resident Indians (NRI) there is no
restriction imposed in the Company's Act. Foreign Exchange
Regulation Act of 1973, however, imposes certain restrictions
most of which are now in the process of withdrawl. As for
example, a FII subscriber does not require any clearance by the
RBI if the subscription limit is less than 24%. Similarly many
of the restrictions on NRI's are also not there at present. In
other cases a general or special permission of the RBI is needed.
Certificate of incorporation is considered as conclusive evidence
of birth of a company, as Pennigton puts it. This gives rise to
many of the issues relating to disability of the signatories. In
Mossa Gulam Arif Vs. Ibrahim Gulam Arif [ILR (1913) 40
Cal I(PC)] all but two of the subscribers of a company’s
memorandum were infants who had no legal capacity to sign it.
It was held that matter could not be reopened as the certificate
of incorporation was already issued.
How to become a subscriber
A person becomes a subscriber by signing the memorandum as
a subscriber, at the place intended for that purpose. If his name
does not appear in the place where the list of subscribers and
their addresses are specified in the memorandum, he cannot be
treated as a subscriber even if his name appears on all other
pages of the memorandum.
In Arthanari Transport Pvt. Ltd. v. K.P. Sami Gowaden [35
Comp.cases 930] the plaintiffs, signed the bottom of every page
of the memorandum of the company in pursuance of an
agreement with the defendants to form a transport company.
Disputes arose as to whether by such signature they became
subscribers to the company’s memorandum. Holding that they
did not, the court held “subscribers to a memorandum of
association means not merely signing at every one of its pages,
but signing their names as a token of entering into an agreement
both as signatories forming themselves into a company but also
as an undertaking to take the number of shares indicated against
their names. We do not think that the plaintiffs’ signature
elsewhere in the memorandum other than in token of being
parties to a declaration as to the formation of the association
and undertaking to accept the number of shares mentioned
therein can be regarded as subscribing to the memorandum for
they are not by their signature parties to the declaration which is
the vital part of the memorandum”.
3.4 PRE-INCORPORATION CONTRACT
Before a company commences business it has to enter into
several contracts and incur several initial expenses. These
contracts are known as preliminary contracts and the expenses
as preliminary expenses. Preliminary expenses can be either
expenses incurred before the company is incorporated or after
the company receives the certificate of incorporation but before
commencing business. Preliminary expenses are treated as
deferred revenue expenses and written off over a period of years.
In accounting language this is known as amortisation.
The conflict on the legal status of pre-incorporation contract is
very delicate to resolve. The general principle here is that no
one can authorise another to do an act on his behalf before he
himself comes into existence i.e., before the birth of the principal,
a principal cannot appoint an agent because he does not have an
existence. As such, promoters are not acting as agents of the
company which is not yet born. Therefore, promoters are
personally liable for all contracts entered into by the promoters
even though they declare in the contract that they are acting for
the prospective company. A company which is not yet born
cannot be represented. So such contracts binds the promoters
personally and not the company. Ofcourse if the promoters
specifically stipulate in the contract that they are not personally
bound, the contract infact becomes infructuous because nobody
is bound by that Contract. Persons entering into a contract with
promoters are required to be cautious about the role and status
of the promoters. Contracts entered into on behalf of the
company are required to be in writing signed by persons having
the authority express or implied, for or on behalf of the company
(Sec. 46). But such a contract can be made on behalf of the
company only after the company is registered. In Seth
Sobhagmal Lodha,Vs. Edward Mills Co. Ltd [(1972)42
Comp.Cas 1 (Raj)] the High Court of Rajasthan followed the
Common Law decisions of England and decided that contract
into on behalf of a company before its incorporation is not
binding on the company.
A Contract made on behalf of the prospective company cannot
be ratified by the company after its incorporation on the ground
that is possible. A company which is not in existence and hence
cannot delegate is not in a position to ratify that act after it is
incorporated. This principle is clearly enunciated In re English
& Colonial Produce Co Ltd [(1906)2 Ch. 435] nor can the
company claim any benefit under it [See NatalLand,
Colonisation & Co Ltd V. Pauling Colliery and Development
Syndicate Ltd (1904)A.C 120]
According to Pennignton, a pre-incorporation contract cannot
bind the company. It takes effect as a personal contract, and the
promoters themselves are personally liable. But under Sec.230
of the Indian Contract Act, an agent cannot personally enforce
a contract entered into by him on behalf of his principal nor is
he personally bound by them. An agent is personally liable
when his principal is undisclosed either both as to existence or
identity or as to his identity only. Therefore, if a promoter
enters into a contract with a landowner for purchasing a land
for an industry without mentioning that he is acting only as a
promoter the contract is personally binding on him. But if he
discloses that he is acting on behalf of a proposed company and
he is not personally liable for the contract no personal liability
can be attached.
Ofcourse, under the provision of Secs.15(h) and 19(e) of the
Specific Relief Act of 1963 there is a marked deviation of
Common Law principles on the matter of pre-incorporation
contract. According to Sec.19(e) of the Specific Relief Act,
specific performance can be enforced against a company where
its promoters have before its incorporations entered into a
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Contract for the purpose of the company and such contract is
warranted by terms of incorporation, as for example by inclusion
in the Articles of Association. Madras High Court has extended
the principle by its decision in Weavers Mills Ltd Vs. Balkies
Ammal [AIR 1969 Mad 462]. In this case promoters agreed to
purchase some properties for and on behalf of the company to
be promoted. On incorporation the company assumed
possession and built structures upon it. It was held that the
company adopted the benefit of the purchase as such the
company’s title over the property could not be set aside though
there was no conveyance by the promoter in favour of the
company after its incorporation. According to the Law
Commission “though a company cannot technically ratify a
contract made before its incorporation, there would appear to
be no reason why the company should not be entitled to take the
benefit or burden of a Contract made on its behalf by its
promoters by communicating its acceptance of the benefit or
the burden to the other party to the contract.
It is therefore clear that in Seth Subhogmal Lodha the provision
of the Specific Relief Act was not brought to the notice of the
Court. Ofcourse in some other cases the provisions of the
Specific Relief Act was taken into consideration in order to arrive
at a different conclusion. [Sec. Income Tax Officer Vs.
Bhurangiya Coal Co Ltd (AIR 1953 Pat 298)]
Pre-incorporation contracts are generally undertaken by the
company after its registration either by (a) incorporating the
contract in the terms of incorporation, as for example, by
inserting the contract into Articles of Association, or (b) by
entering into a fresh contract with the other party if the contract
is executory or with the promoters if the contract is executed
between the promoters and the other party. Ofcourse Weavers
Mills Ltd has extended the doctrine of equity and stipulated
that if the company accepts the benefit impliedly or expressly,
the order of specific performance can be given to the company
to perform the contract.
3.5 CONSTITUTIONAL DOCUMENT:
MEMORANDUM
Section 2(28) defines the memorandum thus : “Memorandum
means the memorandum of association’ of a company as
originally framed or as altered from time to time. The definition
does not throw any light as to the contents of the memorandum.
But being the basic document of the company it must contain
the fundamental provisions relating to its constitution. Section
13 to 15 contain the details with respect to the form and contents
of the memorandum.
The most important legal steps necessary in company formation
relates to the drafting of constitutional documents. Every
company has to prepare a memorandum of association.
According to Sec 13 of the Companies Act, memorandum
contains the following:
(a) Name Clause: The name of the company with the word
‘Ltd’ in case of Public Ltd company and with “Pvt Ltd” as
the last words in case of Private Ltd company.
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(b) State of the Registered office: The State in which the
registered office is to be situated.
It may be noted in this connection that at this stage the exact
address of the registered office is not necessary though in
most of the cases the practice is to specify the address of
the registered office. The company has to have a registered
office to which all communications and notices have to be
addressed, and this is to be notified to the Registrar within
30 days from the day of incorporation. [See Sec. 146]
(c) Object clause: The objects of the company as indicated
below:
(i) The main objects of the company to be pursued by the
company on its incorporation.
(ii) Objects incidental or ancillary to the attainment of the
main objects.
(iii) Other objects of the company not included above.
[N.B] : Company registered before 1965 were required to
state objects of the company without classification]
(d) Liability Clause :
(i) Company limited by shares or by guarantee shall also
specify the nature of liability of the members to be
limited
[N.B. Liability of the member may be either limited by share
or by guarantee]
(ii) A company to be limited by guarantee shall specify
that each subscriber undertakes or contributes to the
assets of the company in the event of its being wound
up while he is a member or within one year after he
ceases to be a member for payment of the debts and
liabilities of the company as well as other charges and
other expenses.
(e) Capital Clause : A company having a share capital shall
state the amount of the share capital with which the company
is registered (which is called as registered capital or nominal
capital or authorised capital upto which the company can
raise capital) and the division thereof in various classes of
shares (equity and preference) of a fixed amount.
(f) Subscribers Clause : Each subscriber shall sign the
memorandum specifying his address, description and
occupation and shall also specify opposite to his name the
number of shares that he proposes to subscribe. No
subscriber can take less than one share.
(g) Witness : The memorandum has to be signed by the
subscribers in the presence of atleast one witness who shall
attest the signature and shall likewise add his address,
description and occupation.
The above clauses are obligatory in nature which means that
the company must specify these clauses. According to Sec 16(2)
these provisions shall be deemed to be conditions contained in
the memorandum. It is often observed that memorandum of a
company contains various other issues including issues relating
to appointment of a Managing Director or a Manager or some
pre-incorporation contracts. These provisions are non-obligatory
in nature. According to Sec 16(3) these provisions are given
the same status as the provisions included in the Articles of
Associations and can be altered in the same manner as the
provisions in the Articles can be changed.
The memorandum should be divided into paragraphs numbered
consecutively and is required to be printed. Detailed discussion
about each of these clauses of the memorandum specifying all
related laws is discussed in the next topic. The Company Act
contains draft forms of memorandum of association of various
types of Companies in Table B,C,D & E of Schedule 1.
3.6 CONSTITUTIONAL DOCUMENT : ARTICLES
According to Sec 2(2) Articles of a company means its Articles
of Association as originally framed or altered from time to time
in pursuance of the Company's Act. The regulation contained
in Table A of Schedule 1 of the Companies Act, 1956 which is
given in Annexure II in this volume is also to be included in the
term Articles. Articles provide internal regulation and
administration, distribution of the powers among the various
agents and organs of the company. It provides for matters such
as (1) conduct of the general meeting (2) the appointment of
the Directors, their powers and conduct of its business by the
Board (3) borrowing (4) issue of shares (5) transfer and
transmission of shares (6) dividend (7) alteration of capital etc.
All matters other than those required to be included in the
memorandum under section 13 are the proper subject matter of
the Articles.
Articles optional in certain cases
In the case of Public company limited by shares, the preparation
and presentation of the Articles, along with the memorandum
of association with the Registrar for registration is optional. In
all other cases, the Articles shall be prepared, signed by the
subscribers and presented to the Registrar along with the
memorandum [Secs.26&27] If a public company limited by
shares has not prepared its own articles, the model Articles in
Schedule I, Table A, will be deemd to be the Articles of the
company. [S.28(i)] Table A articles shall be read as part of the
articles of all companies limited by shares in so far as they are
not excluded or modified by the articles if any of the company
concerned. [Sec.28]
In Prayan Prasad and others v. Gaya Bank and Trades
Association Ltd [(1931) 1 Comp.Cas 85] the shares of the
appellant were forfeited for non payment of the amount due on
those shares. The forfeiture was effected after giving notice to
the appellants. But the notice served was not in compliance
with Article 24 of table A of Company's Act, 1913. Holding
that non compliance of the requirement under Art.24 of Table
A rendered the forfeiture invalid . The court held “in case of a
company limited by shares, if articles are not registered or in so
far as the articles do not exclude or modify the regulations in
Table A in Schedule I those regulations shall, so far as applicable,
be the regulation of the company in the same manner and to the
same extent as if, they were contained in the duly registered
articles”.
Articles must be written into paragraphs consecutively numbered
and signed by the subscribers specifying their respective address,
description and occupation. Atleast one witness must attest the
signature of the subscribers. He shall also specify his address,
description and occupation. Articles shall be printed [See Sec.
30] A company limited by shares may adopt all or any of the
shares contained in Table A of Schedule 1. Other types of
Companies may draft an article in a form specified for various
types of Companies in Table C,D & E of Schedule 1 of the
Companies Act [See, Sec. 28 & 29] (Annexure I).
3.7 CERTIFICATE OF INCORPORATION
1. Application of Registration
After preparation of the Constitutional documents , ie. Articles
of Association and Memorandum of Association an application
has to be made for registration of the company to the Registrar
in the State in which the company is going to have its registered
office. The application shall be accompanied with:
(a) the Memorandum of the company
(b) Its Articles if any
(c) An agreement if any, which the company proposes to enter
into with any individual for appointment as its Managing
or whole time Director or Manager.
(d) A Statutory declaration by an Advocate or a practising
Chartered Accountant or Director or Manager or Secretary
of the company certifying that all the requirements of this
Act and the rules thereunder have been complied with in
respect of registration, and
(e) The registration fee
If the Registrar is satisfied that all the requirements have been
complied with he shall register the memorandum, the articles if
any and other agreements and shall certify under his hand that
the company is incorporated [See Sec 33 and 34(1)]. This
certificate is known as certificate of incorporation.
2. Effect of Certificate of Incorporation :
The certificate of incorporation is conclusive evidence that all
the requirements of the companies Act, 1956, in respect of
registration and matters precedent and incidental thereto have
been duly complied with and that the company is a company
authorised to be registered and duly registered under the Act
(Section 35). Thus the certificate is not only proof of the
company’s birth, but also of its legitimate birth. ‘It is also
conclusive evidence that the company was rightfully born after
the proper ante-natal procedure had been followed’.
(Pennington). In the result all registered companies are
corporation de-jure.
Since the certificate is conclusive evidence evidence of the
company’s rightful birth, any irregularity in connection with
the incorporation of the company or matters precedent and
incidental to it cannot affect the company’s position as an
incorporated body. The plea that the formation of the company
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is vitiated by viertal irregularities, or that the requirements of
the Act have not been complied with, cannot be sufficient
grounds to annal the incorporation. Thus in Mossa Gulam Arif
v. Ibrahim Gulam Arif (ILF 40 Cal.1) all but two of the
subscribers of a company’s memorandum were infants who had
no legal capacity to sign it. Held that the matter could not be
reopened after the issue of the certificate of incorporation. The
certificate of incorporation was conclusive proof of the fact that
memorandum was duly signed by the required number of
subscribers. In Oeel’s case [(1867) .2 Ch. App.674], the
memorandum was altered so materially by a person after it had
been subscribed by seven persons, but before registration, that
the document could not be regarded as signed by the required
number of subscribers. Though the ‘alteration entirely
neutralised and annihilated the original execution and signature
of the document’, it was held that the irregularity did not affect
the birth and existence of the company as a legal person. Lord
Cairns observed in this case: “The certificate of incorporation
is not merely a prima facie answer, but a conclusive answer to
such objections. When once the certificate of incorporation is
given, nothing is to be enquired into as to the regularity of prior
proceedings”.
The conclusiveness of the certificate of incorporation prevents
the reopening of matters prior and contemporaneous to the
registration and essential to it. So even when the signatures of
all the subscribers were forged, the certificate of incorporation
is conclusive proof that the company was rightfully born. As a
logical corollary, a subscriber cannot after the issue of the
certificate of incorporation repudiate his subscription on any
ground, though he may have a remedy against the wrongdoer.
In Cotman v. Brougham [(1918-19) All E.R. Rep. 265]it was
argued that the object clause of a company containing inflated
objects was not in accordance with the requirements of the act.
Though the contention was factually correct, Lord Wrenbury
held that the matter cannot be reopened, as the certificate of
incorporation was conclusive that the requirement of the Act
had been duly complied with.
Exception to the conclusiveness of certificate of
incorporation
It is true that the certificate of incorporation is conclusive
evidence of the legitimate birth of the company and also of the
due compliance of all matters precedent and incidental to the
formation of the company. But there are two exceptions to the
conclusive nature of the certificate of any result of a formal
application, like an application for seire facias to repeal a charter,
the company can be got rid of unless by winding up.
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But a contrary view is taken by the House of Lords in Bowman
v. Secular Society [(1917) AC 406]. It was held therein that
proceedings could be instituted by the Attorney General to get
the registration of a company formed for an illegal object
cancelled. In the above case Lord Parker of Waddington
observed- “only by misconduct, or great carelessness on the
part of the Registrar could a company with objects wholly illegal
obtain registration. If such a case did occur it would be open to
the court to stay its hand until an opportunity had been given for
taking appropriate steps for the cancellation of the certificate of
registration. It should be observed that - the Attorney General
on behalf of the Crown could institute proceedings by way of
certiorari to cancel a registration which the Registrar had
improperly or erroneously allowed”.
In a recent case R.V. Registrar [(1991) BCLC 476], a prostitute
managed to get her business registered as a company under the
name of Lindi St Claire (Personal Services) Ltd. The main object
as stated in the memorandum was to carry on the business of
prostitution. On a petition filed by the Attorney General, the
court cancelled the registration on the ground that the objects of
the company were unlawful.
3. Date of Incorporation
The company comes into existence as a legal person on the date
mentioned in the certificate of incorporation as the date of
incorporation.(Section 34(2)). Because of the conclusiveness
of the certificate of incorporation, the matter cannot be reopened.
In Jubilee Cotton Mills Ltd v. Lewis (1924 AC 958), the
memorandum and other documents of a company was presented
to the Registrar on 6th. The Registrar issued the certificate of
incorporation on 8th, but put the date as 6th. Held that the
company was incorporated on 6th and not on 8th as the certificate
is also conclusive that the company came into existence on the
date of the certificate. Accordingly the allotment of shares by
the company on 6th was valid as the company was in existence
on that date.
4. Commencement of Business
A private Ltd company can straightway commence business on
receiving the certificate of incorporation. It does not require
any further ‘trading certificate’ or ‘certificate of incorporation’.
The main reason is that a Private Limited company does not
require public subscription and it collects share capital from the
subscribers and their friends and relations.
4. DETAIL PROVISIONS OF CONSTITUTIONAL DOCUMENTS:
MEMORANDUM
SUB TOPICS legislative policy as regards the amendment of the provisions in
4.1 Introduction the memorandum reads :-
4.2 Name Clause “A company shall not alter the conditions contained in its
(a) Choosing of name memorandum, except in the cases in the mode and to the extent
for which express provision is made in the Act”. On the other
(b) Publicity need hand, section 31(1) dealing with amendment of the provisions
(c) Dispensation with ‘Ltd’ in the articles reads :-
(d) Alteration of the name “Subject to the provisions of this Act and to the conditions
(e) Procedure of alteration contained in the memorandum a company may by special
4.3 Registered office resolution alter its articles”.
(a) General Provisions When the Joint Stock Companies Act, 1856 (U.K.) split the
(b) Change of Registered office 'deed of settlement’ into the memorandum of association and
articles of association the obvious purpose was to separate the
4.4 Object Clause basic provisions of the constitution from those dealing with
(a) General Principles matters of internal regulation and to place the former beyond
(b) Doctrine of ultra vires the amending process (Palmer). Though the statute of 1856,
(c) Indian Law did not expressly prohibit amendment of the provisions in the
memorandum, the Companies Act, 1862 made explicit that
(d) Alteration except in two cases ‘no alteration shall be made by any company
4.5 Liability Clause in the conditions contained in its memorandum of association’.
(a) General provisions The legislative intention was to provide a rigid constitution for
(b) Alteration the registered company.
4.6 Capital Clause But later, it was realised that business organisations cannot
function effectively with an absolutely rigid constitution.
(a) General provisions
Business exigencies and commercial needs may require a
(b) Alteration company to change the provisions in its memorandum from time
4.7 Association Clause to time. Hence rigidity was gradually relaxed. Now the
4.8 Annexures Company’s Act has incorporated many provisions which
empower the company to amend all the provisions in the
memorandum except the ‘liability clause’ and ‘association
4.1 INTRODUCTION
clause’. The grounds on which such alterations are permitted
Memorandum of Association is the fundamental document of cover almost all exigencies for alteration. Thus a strictly rigid
registration of the Company. It overrides all other regulations constitution under the 1962 Act (England) has been transformed
including provisions of Articles of Associations. Any person today into a constitution of utmost flexibility. It is true that the
entering into contract with the Company is supposed to have alteration must be carried out in the mode stipulated by the Act
knowledge about this instrument. The Court has to interpret and only for the purposes specified therein. [Secton 16(i)]. But
about the provisions of Articles of Association in consistency even in respect of the obligatory clauses in the memorandum
with the memorandum of Association. In case any provision of the company enjoys wide powers of alteration. On account of
Articles is irreconciliable with the Memorandum, the all these “there is today no meaningful distinction between the
memorandum prevails. Once corporate lawyers used to argue memorandum and the articles” (Gower). Still from the
about the status of memorandum vis-a-vis the Company as if it procedural angle the distinction between the two documents is
was the same as a Constitution to the State. substantial. The procedure for alteration of the provisions in
Naturally the Legislative policies with respect to the amendment the articles is comparatively simple. But the statute has stipulated
of the two constitutional documents viz.(1) the memorandum different and sometimes cumbersome procedures for the
and (2) articles of association are entirely different. The amendment of the different obligatory clauses in the
provisions in the memorandum being the essential and memorandum. A strict compliance of those procedural steps
fundamental conditions of incorporation are treated as normally are insisted upon.
unalterable. The Articles being a document dealing with matters
of internal regulation and administration are made freely 4.1 NAME CLAUSE
alterable. These conflicting policies are evident from the The first paragraph in the memorandum is the name clause. It
following provisions. Section 16(i) which embodies the states the name of the company. The identity of the company
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as a separate legal person can be established only through its
name. In the case of a limited company, whether limited by
shares or by guarantee the last component of the company’s
name shall be ‘limited’ or ‘private limited’ (private company)
or any abbreviation of such word (eg., ‘Ltd’., Pvt. Ltd., (P)Ltd.)
Sec.13(1) the purpose of insisting on the use of the word limited
as a component of the company’s name is to give a constant
notice to third parties that unlike in the case of a partnership
firm the liability of the members is limited.
(a) Choosing the name
There is no legal requirement as to what shall be the name of a
company. It may be indicative of the name of the controlling
shareholder or of the business activities of the company or
neither. Usually the name is choosen by the company’s
promoters, whose freedom in doing so is curtailed in two ways:-
(1) The power of the Central Government under Section 20.
(2) The common law restrictions.
(1) The Central Government’s Power:
Though the company’s name is choosen by the promoters, it is
subject to the previous approval of the Central Government.
Section 20(1) provides that no company shall be registered with
a name which in the opinion of the Central Government is
undesirable. Any name which is identical with or too nearly
resembling the name of mother company will be deemed to be
an undesirable name. [Section 20(2)]
The Central Governments power under the section is
discretionary and not confined to the cases specified in section
20(2).
But difficulties and hardships may be caused to company
promoters if the Registrar refuses registration on the ground
that the name of the proposed company is undesirable. To avoid
this facilities are available for consultation before hand about
the acceptability of a proposed name. Now an application can
be made by the company promoters to the Registrar in the
prescribed form (Form 1A) seeking the availability of the
proposed name. If permission is granted, the name will be
reserved for the use of the proposed company, for a period of
90 days. The company may be formed within this period.
In 1962, the department of Company Affairs have issued a
circular containing the guidelines to be followed in deciding
whether a name is desirable or not. If the proposed name is not
in consonance with the principal objects of the company as stated
in the memorandum or if it has a close phonetic resemblance to
the name of an existing company or it is likely to produce a
misleading impression regarding the scope or scale of is
activities, it will be an undesirable name in the opinion of the
Central Government.
(2) Common law restrictions:
In addition the law restrains a proposed company from using
an undesirable name under The Emblems and Names
(Prevention of Improper use) Act,1950. Further in choosing
the name of the company the Promotors should ensure that they
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are not guilty of the tort of “passing off”. If they choose a business
name which cause the public to confuse the company with some
other existing business, the company may be prevented from
using such name. This right is independent of and unconnected
with the power of the Central Government under the Act. The
legal basis of a ‘passing off’ action is on the proprietary right of
the plaintiff which is the ‘goodwill’ of the business rather than
the business name.
(b) Publicity in respect of the name
On incorporation a company must give due publicity of its name.
It must be exhibited at the outside of every office or place where
its business is carried on. Its name shall also be engraved on its
seal. The name and address of its registered office shall be
mentioned in all its business letters, bill heads, letter papers
notices and other official publications, failing which the company
and the officers in default may be penally liable (Section 147).
(c) Dispensation with the requirement of ‘limited’. as a
component of the name
Section 25 contains an exception to the rule that the word
‘limited’ shall be the last component of the name of a limited
company. It is with respect to non commercial association
incorporated as companies. The Central Government may by
licence exempt such companies from the requirement of ‘limited’
added as a component of the company’s name on being satisfied
that :
(1) The association to be formed as a limited company is for
the promotion of commerce, art, science, religion, charity
or any other useful object.
(2) Such company intends to apply its profits and other name
in promoting its objects.
(3) Payment of dividend to the members is prohibited.
The licence may be granted on such conditions and subject to
such regulations as the Central Government may think fit.
(d) Alteration of the Name
Section 21 and 22 deal with the alteration of the name clause.
The alteration may be optional or obligatory.
(i) Obligatory Change:
Section 22(1)(b) empowers the Central Government to issue
directives to a company to change its name. The company shall
comply with such direction within 3 months of the receipt of
such direction or such extended time as the Central Government
may allow. The Central Government’s power under this section
is subject to the following conditions.
(1) It is available only when the registered name of the company
is, in the opinion of the Central Government, identical with
or too nearly resembles the name of an existing company
registered under the present Act or any of the previous Acts.
(The Central Government’s power is now delegated to the
Regional Director). This type of alteration is known as
alteration by rectification.
(2) The direction is issued within 12 months of the registration
of the present name of the company.
Failure to comply with the direction issued under the section
will fasten penal liability on the company as well as the officers
in default. [S..22(2)].
An alteration under this section can be carried out by passing an
ordinary resolution.
(ii) Optional change:
A company may ‘suo moto’, change the name by amending the
name clause in two situation.
(1) When the name is identical with or too closely resembling
the name of another company in existence [Sec.22(i)(a)].
(2) In any case where the company decides to change the name
(Sec.21).
(e) Procedure of Alteration
The following are the procedures of alteration :
(1) In all cases of change of name, the previous approval of the
Central Government is necessary. The power of the Central
Government has now been delegated to the Registrar of
companies.
(2) Obligatory alteration may be carried out by passing an
'ordinary resolution’, but optional alteration warrants a
‘special resolution’. (An ordinary resolution requires only
a simple majority, whereas a special resolution requires a
3/4th majority).
(3) A certificate copy of the resolution effecting the change of
name along with certified copies of the memorandum and
articles along with some other documents are filed with the
Registrar for the issue of a fresh certificate of incorporation
incorporating the change of name. On the issue of the fresh
certificate the change takes effect. The fresh certificate
issued in consequence of the change of name does not affect
the rights and liabilities of the company which continues as
the same legal entity [Sec.23(3)]. In this connection the
Supreme Court held that the Legal proceedings commenced
prior to the change of name may be continued after the
change. Even the proceedings commenced in the old name
after the alteration are treated as instances of misdescription
only, rectification of name will be allowed.
4.3 REGISTERED OFFICE
(a) General Provisions
The second paragraph in the memorandum is the registered office
clause which merely states the State in which the registered office
of the company is situated. The registered office clause merely
states the State within which the registered office is situated and
not the address of the company or the place where it is situated.
The situation of the registered office of the company is a matter
of vital legal significance, as it determines which Registrar and
High Court are having jurisdiction over it. It also determines
the domicile and nationality of the company, though not its
residence.
Within thirty days of its incorporation or on the day on which it
commences business whichever is earlier, the company shall
have a registered office [Section 146(i)]. Notice of the situation
of the registered office shall be given to the Registrar within 30
days of incorporation. If the situation of the registered office is
changed at any time, notice of such change shall also be given
to the Registrar within 30 days of the change. [Section 140(2)].
Since the memorandum only indicates the State wherein the
registered office of the company is situated, the location of the
registered office may be changed from time to time within the
State without amending the registered office clause. But notice
of such change shall be given to the Registrar. All notices and
other communications to the company are sent to its registered
office. Many important records and registers have to be kept at
the registered office. The following are some of them:-
(1) Registered of members [Section 163(1)]
(2) Register of Debenture holders [Section 163(1)]
(3) Register of Directors [Section 303]
(4) Register of changes [Section 143]
(5) Books of account. [Section 209]
(b) Change of Registered Office Clause [Ss.17 to 19]
A company may change its Registered Office:-
(1) from one place to another in the same city, town or village,
or
(2) from one city, town, or village to another city, town or village
in the same State, or
(3) from one city town or village in one State to another city,
town or village in another State.
As the registered office clause merely states the State wherein
the Registered Office is situated, alteration of the Registered
office clause is required only in the last case. In the first case
change may be effected by a Board resolution. The second
case requires permission of the general meeting by a special
resolution [Section 146(2)]. The procedure for amendment of
the Registered office clause is the same as that for the object
clause.
Procedure of Alteration
(a) The Company has to pass a special resolution so as to change
its registered office from one place to another.
(b) Apply to the Company Law Board (i.e., CLB) for
confirmation of the alteration.
(c) Notice to be given to every debenture holder and every other
person whose interest may be affected by the alteration.
(d) The consent of every creditor who is entitled to object the
change of the registered office must be obtained or his claim
be secured to the satisfaction of CLB.
(e) The CLB shall cause notice of the petition for confirmation
of alteration to be seen on the registrar who may also state
his objections or suggestions.
The CLB generally consider the following matters before
approving the Change.
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 1) the interest of the company and its members;
2) public interest;
3) interest of the creditors; and
4) bonafides of the company in seeking the amendment.
Can the State object to the Change of the Registered Office?
The question whether the State in which the Registered Office
of the company is presently situated has any ‘locus standi’ to
object to the change of the registered office to another State
was considered by many High Courts. The decisions are
conflicting.
In Re Orissa Chemicals and Distillers Ltd., [AIR 1961 Ori
162 or (1962)32 Comp, cas.497].the Company which was
engaged in the business of manufacturing the dealing in Sugar
and allied products had its registered office in Tharsuguda
(Orissa). A special resolution was passed to change its
Registered office to the Masulipatnam (Andhra Pradesh). The
Company presented an application to the company court for
confirmation of the resolution. (Before the Amendment Act,
1958 the jurisdiction was vested with the court and not Company
Law Board). The issue for the consideration of the court in this
case was whether the State of Orissa had any locus standi to
oppose the application. The objection was mainly based on the
plea that the proposed alteration would seriously affect the State
of Orissa and deprive it of a considerable source of revenue.
The company argued that these matters are irrelevant for deciding
an application under Section 17 and the confirmation of the
court should be based on consideration of grounds specified in
grounds (a) to (g) of section 17(i) only. Other considerations
should not be allowed to prevail. Rejecting the contention of
the company [S. Burman J. held: “It is clear from section 17(3)(a)
that the State of Orissa is a person whose interest, in the opinion
of the court be affected by the alteration]. But in Mackinnon
Mackenzia & Co Pvt,Ltd. In re [(1967)37 Comp.cas.516] a
contrary view was taken by the Calcutta High Court. The
Registered office of the petitioner company was situate in
Calcutta (West Bengal). The company passed a special
resolution substituting the existing clause 2 of the memorandum
by the following clause:
“The Registered office of the company will be situated in the
State of Maharashtra”. The application filed by the company
under Section 17 for confirmation of the alteration was contested
by the State of West Bengal, on the ground that it would result
in a loss of revenue to the State. To the question whether the
State has any locus standi to object the application filed under
S.17, A.N. Ray. J. (as he then was) held that the State has no
right of its own to be heard. Section 17 does not treat the State
as an entity entitled to notice or to be heard. To the argument
that since the change of registered office would affect the revenue
of the affected State, it must be treated as an interested person,
his Lordship observed:
“The question of revenue if it falls for consideration is to be
considered on the basis of the integrity of the Republic of India
and not in a sectional and parochial manner. To hold that the
possibility of loss of revenue is not only relevant but of
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persuasive force in regard to change of office from one State to
another is to rob section 17 of the Companies Act of the statutory
power conferred on a company to change its registered office
and also to impose upon the statute a limitation with regard to
change of registered office."
In Minerva Mills Ltd. v.Govt.of Maharashtra [(1975) 45
comp. cases 1]the petitioner company,the registered office of
which was situate in the State of Maharashtra, passed a special
resolution amending clause 2 of the memorandum to change its
registered office to to the State of Karnataka and filed a petition
under section 17 for confirmation of the resolution . The State
of Maharashtra opposed the petition on the following among
other grounds.(i) the amendment was not in the interest of the
company (ii) the sanctioning of special resolution would affect
adversely the general economy of the State. On the various
issues which come up for consideration the court held:-
(i) though there is no express provision in the Companies Act
which requires that notice of a petition to shift the registered
office of a company from one State to another State must be
given to the former State, the court has the power to direct notice
of the petition be given to any person other than those mentioned
in clauses (3) and (4) of Section 17.
(ii) A State from which the registered office is to be transferred
and which is served with a notice under section 17(3)(a) can
oppose the petition only on the ground on which it is entitled to
be served with that notice viz., on the ground of its adverse
effect on some specific pecuniary or proprietary interest of that
particular State and not on regional considerations or on the
vague ground of the effect of the shifting of the registered office
on the general economy of the State which must necessarily be
involved in every case... The State is not entitled to assume the
role of the protector of the interests of the share holders of the
company or its workmen or the public at large”. In the instant
case the court held that the State could object to the alteration in
its capacity as a creditor of the company in respect of arrears of
Sales Tax.
4.4 OBJECT CLAUSE
(a) General Principles:
The basic philosophy of Corporate identity in so far as reflected
in object clause has undergone a sea change. The traditional
idea and purpose of the object clause is given in Cotman V.
Brougham [(1918)A.C. 514], Lord Parker of Waddington has
stated the purpose of the object clause to be this. “It is intended
to serve a double purpose. In the first place it gives protection
to subscribers who learn from it the purposes to which their
money can be applied. In the second place it gives protection
to persons who deal with the company and who can infer from
it the extent of the company’s powers”. In other words the
object clause ‘enables the shareholders creditors and those
dealing with the company to know what is its permitted range
of enterprise. The object clause operates in a two fold way: (i) it
affirmatively determines the powers of the company. The
company has power to indulge in all activities which are
reasonably necessary or ancillary to the attainment of the objects
pursued by the company. (2) it restricts the powers of the
company to those which are reasonably necessary or incidental
to the objects pursued by the company. Any activity which
transgresses the limits so set out has no legal validity. Such an
act is an ultra vires transaction.
Palmer points out that the subscribers not only initiate the
creation of the company but also determine the purposes for
which it is formed. Subject to the following limitations, the
object clause of a company may contain any business purpose
as its objects. The limitations are :-
(1) The object clause must not contain anything in contravention
of the Companies Act or allied statutes.
(2) The objects stated must not be in contravention of the
general law. For example, a company cannot have its
objects, the promotion of untouchability.
(3) The objects shall not have the effect of rendering the
company to trade union.
The conservative and traditional British Courts followed a
positive theory of prescription. According to the Common Law
judiciary the object laid down in the memorandum stipulates
the character of personality and strictly delimits the Corporate
existence. British Courts strictly interpreted the object clause
and used to consistently follow the decision in Eastern
Countries Railway Vs. Hawkes [(1855)5 HLC 331], in which
it was laid down that “it must therefore be now considered as a
well settled doctrine that a Company incorporated by an act of
Parliament for a special purpose cannot devote any part of its
funds to object unauthorised by the terms of its incorporation,
however desirable such an application may appear to be”.
Similarly in Ashbury Rly Carriage & Iron Co Ltd Vs. Riche
[(1875)L.R 7 HL 653] explaining the same principle that an act
done not strictly included in the object clause of the
memorandum was ultra vires the Company and therefore
altogether void, Lord Cairnes held : “objects for which the
proposed Company is to be established, and the existence, the
coming into existence, of the Company is to be an existence
and to be a coming into existence for those existence alone”.
Therefore, in laying down the objects in memorandum it is
always necessary to be extremely careful while drafting the
memorandum. The British Cours did not allow an act
permissible because the memorandum "contained all other acts
what the Board deems it necessary”. According to the Court
other clauses only include those acts which were necessary and
essentially for the purpose of conducting the main object. This
type of strict interpretation give rise to the doctrine of ultra
vires.
(b) Doctrine of Ultra Vires :
Palmer has given the following reasons for the development of
rule of ultra vires:
(i) as a matter of Constitutional Law, Parliament as a sovereign
power in the country does not grant more power to delegated
bodies than it has authorised; and
(ii) as a practical consideration it was thought that the rule would
protect investors in the company and creditors of it against
the unauthorised use of funds.
According to Bullantine on Corporation, the theoretical
justifications for the principle of Ultra Vires are :
(i) that the intending shareholders who contemplate an
investment in business enterprise should know within what
lines of business in monies to be put at risk. Prof. Gower
puts this as ensuring an investor in a gold mining Company
not suddenly finding himself holding shares in a fried fish
shop ;
(ii) that the Directors and Management may know within what
lines of business they are authorised to act; and
(iii) that anyone who shall deal with the Company may ascertain
if he is able to read and construe the charter whether a
Contract or transaction into which he contemplates entering
is one within the general authority of the management.
Ultra vires may either be substantive or procedural. Where the
object clause does not provide an act, the Company is not bound
by the act because ‘there is a lack of legal capacity to incur
responsibility for the action’. This is a substantive ultra vires.
A procedural ultra vires is one where there is no lack of power
or capacity of the Company but the organ of the Company which
has done the act does not have the power or has exceeded the
power. A procedural ultra vires act nevertheless binds the
Company because an outsider is not always expected to know
the power arrangement unless such power arrangement is
provided in the memorandum or articles. [See Royal British
Bank Vs. Tarkunde (1856)6 E.B. 627] Substantive ultra vires
however is decisive and a Company is not bound by such an
act. Every person entering into a Contract by the Company is
presumed to have the knowledge about the Constitutional
documents of the Company. An act may be ultra vires per se as
well. As for example, a Company purchasing its own share was
held to be doing an act which is ultra vires per se even though
the articles empowered the Company to do so. [Trevor Vs.
Whitworth (1887)12 A.C 409] Similarly a Company paying
dividend out of its Capital is per se ultra vires even though
empowered by the articles. [Guiness Vs. Land Corporation
of Ireland (1882)22Ch.D 349].
During the middle of the 20th century many authors as well as
judges of England and America started questioning the validity
of the principle of ultra vires. The movement started slowly
with Belhouse Ltd Vs. City Wall Properties Ltd [(1966)36
Comp. Cases 779] In this case the object clause included the
power to carry on any other trade or business whatsoever, which
can, in the opinion of Board of Directors, be advantageously
carried on by the Company. The Court held that the object is
quite in order. Many disadvantages of the principle of ultra
vires and its impracticability were noticed. A presumption of
notice often becomes very difficult to sustain if a contract is
afterwards avoided on interpretation. That is not covered by
the object if the Company puts an innocent party into difficulty.
No except every person who deals with a Company or uses a
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Company’s products to have knowledge of the Memorandum is
not a practical proposition as the judge observed in Re John
Banforte (London) Ltd [(1953)Ch. 131] . It also creates
difficulties for the management for interpreting objects at every
stage. Many of the authors in USA empirically tried to prove
that the shareholders invest in the Company not liking or disliking
the business of the Company. In most of the times most of the
shareholders are ignorant about the range of activities that their
company is against to. Empricially it is established that investing
public primarily invest trusting the management. And therefore,
they like the management to earn profit efficiently if necessary,
with product variation. They do not mind their management to
run fried fish shop if gold mining becomes uneconomic. Cohen
Committee in its report very rightly suggested doctrine of ultra
vires as illusory protection to the shareholders which the
shareholders themselves discarded long back.
In fact the rigid approach of the Common Law Court induced
the Corporate Lawyers to include a very large number of
unnecessary powers to the object clause which Lord Werenbury
condemned though not unlawful. In recent times the principle
of ultra vires has become teethless, due to circumventing
commercial practice. Further comments on the issue shall be
made later.
(c) Indian Law :
The pernicious practice of writing the object clause of a
Company including all possible activities is very much in practice
in India. This is an outcome of right application of ultra vires.
In order to curb the above practice of inflating the object clause
Section 13 was amended by the Amendment Act 1965. Now it
is required to divide the object clause into two parts viz.,
(i) the main objects along with objects (powers) incidental or
ancillary to the main objects (each to be stated separately);
and
(ii) the other objects of the company.
Thus, after 1965, the powers of the company if included in the
object clause has to be stated separately.
But Indian Courts are still greatly influenced by the British Courts
in this matter. Supreme Court in Dr. Lakshmanaswami
Mudaliar Vs. LIC [(1963)33 Comp.Cases 420(S.C)] held that
acts incidental must have reasonable proximity with the main
object specified. An object is required to be differentiated from
power. Powers are necessary ingredient to attain objects.
For example, the objects of a textile manufacturing company is
to manufacture and sell textile goods. For this it may have to
enter into various transactions such as service contracts with
technical personnel, colloboration agreements, purchase of
landed property and materials, operation of bank accounts, etc.
These transactions are not the objects, but only powers which
may be necessary or incidental to the objects. Similarly
borrowing money cannot be an object of the company, it is only
a power which a company may exercise in the pursuit of its
object.
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In the strict sense powers shall not be included in the
memorandum of a company as its objects. But in practice it has
become customary to include in the object clause a catalogue of
powers also. In the result it has become difficult to find out by a
perusal of the object clause the real objects of the Company. In
the words of Lord Wrenbury in Cotman Vs. Brougham [(1918)
AC 514] ‘ the function of the memorandum is taken to be, not
to specify, not to disclose, but to bury beneath a mass of words
the real object or objects of the company with the extent that
every conceivable form of activity shall be found included
somewhere within its terms’.
(d) Alteration :
The object clause being the most fundamental provision in the
company’s constitution was originally thought to be unalterable.
The Companies Acts, 1862 (U.K) and Company Act 1866
(India) explicitly prohibited alteration of all the provisions in
the memorandum except the capital clause. But realising that
the regidity of the object clause is an obstacle in the way of
legitimate expansion of a company’s business, subsequent
statutes permitted alteration for certain specified purpose. The
purposes for which alteration was permitted were extended from
time to time. Now amendment of the object clause is permissible
under the Companies Act, 1956 for the seven purposes specified
in section 17(1). The grounds specified therein are so wide that
almost all alterations would be covered by one or more of them.
Palmer says, “It is extremely unusual to find an alteration of
objects which cannot be brought under one head or another (24th
edn. par.9-40). Gower observes that, “the rigidity of the
memorandum has long since been relaxed” (Gower’s principles
of Modern Company Law. 4th Edn.) Thus within a period of
less than hundred years the legislative policy has completely
reversed regards amendment of the object clause.
Grounds for alteration of the object clause: Section 17(1)
has laid down seven grounds which may be invoked by a
company to amend its object clause. The grounds are :
(a) to carry on its business more economically or more
efficiently;
(b) to attain its main purposes by new or improved means;
(c) to enlarge or change the area of its operations;
(d) to carry on some business which under existing
circumstances many conveniently or advantageously be
combined with the business of the company;
(e) to restrict or abandon any of the objects specified in the
memorandum;
(f) to sell or dispose of the whole, or any part of the undertaking
or any of the undertakings of the company;
(g) to amalgamate with any other company or body of persons.
Since the company’s powers are positively and negatively
determined by the object clause, its amendment may be necessary
if the company has to enter into transactions which at present
are not warranted by the object clause.
Now let us examine these provisions:
(i) carrying on the business more economically or more
efficiently
The amending power under this clause is a very limited one.
An alteration on this ground does not contemplate change of
business. The original busines must remain the same as before.
The amendment must only affect the mode of conducting the
business. A company which had suspended its business of
interior decorators and house furnishers altered the object clause
to embark upon the business of financiers. Held, the alteration
could not be permitted under this head [In Re Drages (1942)1
All ER 194].
This clause permits an alteration which would enable the
company to carry on its existing business with greater economy
and efficiency. In re scientific poultry breeder’s Association
[(1933) CR.413] the company was formed to encourage poultry
breeding without any profit motive, altered its object clause to
empower the company to pay equitable remuneration to its
governing body members, was held to be permissible under
clause (a).
(ii) to attain its main purpose by new or improved means
If an industry is to survive, it has to keep pace with scientific
and technological advancement. Adoption of new and improved
means of production and distribution may necessitate the
alteration of its object clause. But alteration under this head is
permissible only for attaining the “main purpose” of the
company. The word “purpose” has a more restricted meaning
than the term “object”. The alteration to be valid under this
head must be to carry out the mainpurpose of the company more
effectively and efficiently. In re Government Stock Investment
Co. [(1891) 1 Ch. 649] the object clause as originally drafted
provided that the object was to make investment in government
securities. The alteration of the object clause to enable the
company make investment in other kinds of securities also was
held to be not within the ambit of this head.
(iii) To enlarge or change the local area of operation.
A company may want to change or enlarge the area of its
business operation. For example suppose the object of a
company is to trade in a particular commodity in the State of
Tamilnadu. Due to adverse market conditions in Tamilnadu,
the company may desire to change the area of operation to
Karnataka. For this, amendment of the object clause is necessary.
Similarly, for expansion of the ‘area of operation’ amendment
of the object clause may be required. All these alterations can
be done under S.17(1)(c).
(iv) Additional business:
Sec.17(1)(d) gives powers to the company to amend the object
clause for the purpose of carrying on any new or additional
business. The power of the company under this clause is very
wide. Though the language of sec. 17 (1)(d) is somewhat
restricted as it envisages only those additional or new business
which can be "conveniently or advantageously combined with
the existing business”, but the courts have interpreted, this
provision liberally. In many cases it has been held that the new
business need not be connected with or similar to the existing
business. A business which is wholly different from the existing
business can be undertaken provided the new business is capable
of being conveniently or advantageously combined with the
existing business. In Re Ambala Electric Supply Co. ltd.
[(1963)33 Comp. Cas. 583] a company which was engaged in
the business of generating power was allowed to alter the object
clause for the purpose of carrying on ‘cold storage and other
allied business’. Similarly in Re Parent Tyre Co.ltd. [(1923)2
Ch.222] the existing business consisted of holding large
investments in two other companies. The object clause of the
company was altered with a view to carry on the business of
bankers, financiers, underwriters and dealers in secdsurities.
Though the new business was not similar to the existing business,
it was held that the alteration was within the purview of
S.17(1)(4).
A company formed to manufacture textile goods was allowed
to amend the object clause under s.17(1)(d) to enable it to carry
on the business of alcohol production. [See Straw Products v.
Registrar, AIR 1969 Orissa 91]
Whose discretionary power:
As seen above, amendment of the object clause under section
17(i)(d) is ‘conveniently or advantageously combined with the
existing business. But who is to decide this ? Theoritically it is
within the power of the court (now CLB) to take the ultimate
decision; for the alteration becomes operative only if the sanction
of the court is given to it. But the matter being a business
proposition the courts are generally reluctant to substitute their
wisdon to the foresight of the business community.
In Re Parent Tyre Co. [(1923)2 Ch 222] Lawrence.J. observes:-
“It is essentially a business proposition, whether an additional
business can or cannot be conveniently or advantageously carried
on under the existing circumstances with the business of the
company. The additional business may be one which is different
from the original business and yet may well be capable of being
conveniently and advantageously combined with the business
which is being carried on”. In Straw Products Ltd. v. Registrar
of Companies [AIR 2969 Orissa 91] the petitioner company
amended its object clause in the memorandum by inserting new
provisions to enable the company to embark upon many new
business activities which were not akin to the existing business
of the company. The amendment also sought to empower the
company to make donations. Holding the amendments to be
valid ,B.K.Mohanty J.observed: “The proposed step can be
justified on the basis of section 17(1)(a)which is of very wide
import and it can be said that the company by contributing to
the funds to political parties would be carrying on business more
efficiently.True it is that the court,has a discretion to confirm or
not to confirm an alteration even if the conditions laid down in
section 17 are satisfied.But it has to be borne in mind that it is
primarily for the company to decide whether it is for its good
that it should make such contributions and it is not for the court
to tell the company as to how it is to carry on its business.”
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NOTE: Now certain companies are prohibited from making
political contributions. As regards others, ceiling is imposed
(Refer sec.293-A). Similarly in Re Dalmia Cements
(Bharath)Ltd.[(1964) 34 Comp. Cases 729], the petitioner
company was engaged in the manufacturing cement and allied
products. The petition was filed for confirmation of a special
resolution passed by the company to amend the object clause
with a view to embark upon the business of exporters. Holiding
that the alteration falls within the purview of section 17,
Rangasamy Iyengar J. of the Madras High Court held:-
“Section 17(1)(a) and (d) has employed language of wide
amplitude and it is difficult to confine its scope by a statement
that it will be applicable to this or that situation. Whether a
company can carry on its business more economically or more
efficiently is a matter for the judgment of the Directors. They
alone are best fitted by reason of their experience in the particular
business to decide whether the business can be carried on more
economically or more efficiently by adding fresh objects. The
Court of course, on given facts may apply its mind and see
whether the Directors may reasonably and fairly form that
opinion. I consider that the court can do no more about it.”
Limitation on the power of alteration:
The Company’s power to embark upon ‘new business’ under
s.17(i)(d) though very wide, is subject to certain limitation. The
most important one is that ‘new business’ shall not be prejudicial
to or destructive of the existing business of the company.
Similarly no new busines can be embarked upon the suspending
or terminating the existing business.
(iv) Amalgamation:
Amalgamation is the process of fusion of two or more companies
into one. If such a power is not given by the object clause Section
394 gives jurisdiction to the court to sanction an amalgamation
or arrangement. [Marybong and Kyel Tea Estate Ltd. Re
(1977) 47 Comp. cas. 802].
Procedural requirements:
The first step to be taken for the alteration of the object clause
or registered office clause is the passing of a special resolution
at a general meeting. Within 30 days of the passing of the special
resolution a copy of the same has to be filed with the Registrar
(s.192). The next step is to file a petition before the Company
Law Board for confirmation of the alteration. Atleast one month
before the filing of the petition a general notice about the
amendment shall be given by publication in two newspapers,
one in English and the other in the principal language of the
District where the registered office of the company is situate.
Individual notice of the petition shall be given to all the debenture
holders and other creditors of the company.
The petition before the Company Law Board shall be
accompanied with copies of the memorandum, articles, notice
calling the meeting, special resolution, etc. Wide power is given
to the Company Law Board either to confirm the alteration or
to reject it. Alteration may be confirmed either wholly or in
part and on such terms and conditions as it may think fit.
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Though the concerned Registrar shall be given a reasonable
opportunity to be heard, the state where the registered office of
the company is situate has not statutory right to be heard on a
petition under section 17. But the CLB regulation provides that
where the registered office is changed from one state to another
notice of the petition shall be served on the concerned states. If
the Company Law Board has confirmed the alteration, a certified
copy of the order together with a printed copy of the
memorandum as altered shall be filed with the Registrar. This
shall be done by the company within a period of 3 months from
the date of the order of the Company Law Board. The Registrar
will issue a fresh certificate within one month from the filing of
the documents [S.18(1)]. The certificate is conclusive evidence
that all the requirements with respect to the alteration and
confirmation thereto have been duly complied with.
Consequences of failure to file the order of CLB within the
stipulated period
If the company fails to file the order of the Company Law Board
within the period as specified in sec.18(1) the order becomes
voide and inoperative [sec.19(2)]. But before the expiry of 3
months from the date of the order of CLB, the Company Law
Board may extend the period for filing of the order with Registrar.
In such a case the order can be filed within the expected period
[s.18(4]. An order which has become null and void may be
revived by the Company Law Board on sufficient grounds, if
application for the same is made within a period of 1 month
from the date on which the order became void [proviso to
s.19(2)].
Sections 18(4) and Proviso to section 19(2) compared
The power of the CLB under S.18(4) to extend the period for
filing its order with Registrar, only when it is alive. The power
under section 19 arises when the order has become null and
void on grounds of failure to file with the Registrar within the
stipulated period.
Amendment Act, 1974:
Before the Companies Amendment Act, 1974, the application
for confirmation of the alteration had to be made to the court.
The jurisdiction was transferred to CLB by the Amendment Act,
1974, to give effect to the recommendation of the Administrative
Reform Commission.
Differences between the English Law and Indian Law:
The English Law on the topic is entirely different. Though the
grounds for the alteration of the object clause were the same as
in our Law, the Companies Act, 1948, dispensed with
requirement of confirmation by the court to give effect to the
alteration. On the other hand the English statute conferred a
right to the dissenting minority to apply to the court for
cancellation of the alteration. The Companies Act, 1985 retained
the same provision. But the Companies Act, 1989 effected
radical changes as regards the amendment of the object clause.
Under the new provision (sec.4) ‘a company may by special
resolution alter its memorandum with respect to the statement
of the company’s objects’. The power is not fettered by any
restriction or condition, though the dissenting minority of
members (holding not less than 15% voting rights) or debenture
holders holding not less than 15% of the companies’ debentures
may apply to the court for cancellation of the alteration.
4.5 LIABILITY CLAUSE
(a) General Provision :
The memorandum of a company limited by shares or guarantee
must state that the liability of its members is limited.
The limited liability clause, whether of a company limited by
guarantee, or by shares, merely states that ‘liability of the
members is limited. It does not indicate either the nature or
extent of their liability.
In the case of a company limited by guarantee, the next paragraph
will be guarantee clause. It contains the undertaking by the
subscribers that in the event of the company being wound up
while he is a member or within one year after he ceases to be a
manner, for payment of the debts and liabilities of the company
incurred before he ceased to be a member. The undertaking is
to pay such sum as may be required to discharge such debts and
liabilities but not exceeding the amount specified therein. It is
this clause which determines the nature and extent of the liability
of the members in a guarantee company.
A company registered under sec 25 obtaining a licence from
the Central Govt exempting the use of the word ‘Ltd’ or ‘Pvt
Ltd’ as the case may be, in its name must also specify in the
memorandum that the liability of its members is limited.
(b) Alteration :
The Companies Act does not include any amending or alteration
provision in so far as liability clause is concerned. Though it is
theoritically possible to alter the liability limited by shares to
the liability limited by guarantee or vice-versa. Sec 32(1)(a)
provides for a fresh registration of an unlimited Company into a
limited Company or re-registration of a limited Company into
an unlimited Company. Such a re-registration will necessarily
involve amendment of a Constitution and re-submission of the
Constitutional documents and undertaking other registration
formalities. Ofcourse, such registration of an unlimited
Company into a limited Company shall not affect any existing
debts and liabilities before the Company is thus registered.
4.6 CAPITAL CLAUSE
(a) General Provisions
The memorandum of a company limited by shares or of a
company limited by guarantee and having a share capital will
also contain a capital clause. This clause states the ‘authorised
capital’ of the company. Authorised capital is the nominal value
of the maximum number of shares which which the company is
authorised to issue to the members at any time. It does not
include the ‘premium’ if any collected on the shares. The
‘premium’ does not constitute part of the capital though for
many purposes it is treated on a par with capital. Under Indian
law shares should have a specified nominal value. But many
other legal systems permit the issue of shares with no nominal
value. If the company intends to issue more than one class of
shares the capital clause must divide the authorised capital into
shares of different classes and fix the nominal value of each
class. As regards companies, whose shares are not dealt with
on recognised stock exchanges the nominal value should be in
accordance with the listing agreements. The modern practice is
to fix the nominal value of the shares at a small amount so as to
attract maximum number of people to apply for and subscribe
in the shares.
While fixing this authorised Capital a Company has to carefully
analyse its future needs because if it prescribes a lower amount
it will not be able to raise further capital from the people in the
event of need for future expansion or growth. There are
professionally competent persons who give appropriate advice.
One has to keep in mind therefore, the possibility of future
growth, expansion, diversification and product variation in order
to prescribe the authorised capital. But at the same time it is
also necessary not to prescribe an unrealistic quantum of
authorised capital mainly for two reasons - (i) it may enable the
management to over-capitalise the Company for covering up
managerial inefficiency, (ii) it may attract registration charges.
(b) Alteration
Change of nominal capital may mean either increase of share
capital or decrease of share capital. The relevant sections of
such alteration are Ss.94A, 97 and 100. These provisions were
discussed in the Module on share capital.
4.7 ASSOCIATION CLAUSE
(a) General Provision
The last clause in the memorandum is the association clause.
This is unnumbered and the memorandum concludes with the
association clause. It states that the persons subscribing their
signatures to the memorandum (‘We the several persons whose
names are subscribed’) are desirious of being formed into a
company in pursuance of the memorandum.
The association clause is followed by the Names, Addresses,
and occupation of the subscribers and the number of shares each
subscriber has agreed to take in a tabular form. The
memorandum is signed by each subscriber in the presence of at
least one witness who will atteast the signature of the subscriber.
The minimum number of subscribers required for a public
company is seven and that for a private company is two [Section
12(1)]. The term ‘subscribing’ as used in section 12 means the
signing in the memorandum and articles by those persons on
their attorneys, who have agreed to be associated with the
company.
The subscribers are the first members of the company. On
incorporation they, ipso facto become members of the company
[sec.41(1)]. A Subscriber need not be beneficially interested in
the shares for which he has subscribed. A subscriber need not
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be a natural person. A body corporate being a legal person can 4th. - The liability of the members is limited.
be subscriber. But a partnership firm or a Joint Hindu Family, 5th. - The share capital of the company is two hundred
as such, cannot be a subscriber, as they are not persons. So also thousand rupees, divided into one thousand shares of
a minor cannot be a subscriber to the memorandum. If a guardian two hundred rupees each.
has subscribed to the memorandum on behalf of the minor, he
will be deemed to have subscribed in his personal capacity We, the several persons whose names and addresses are
[Palniappa V. Official liquidator AIR 1942 Mad.470]. But a subscribed, are desirous of being formed into a company in
Partner of the firm or the Kartha of of the family can be pursuance of this memorandum of association, and we
subscribers. As regards foreign nationals and NRIs, the Foreign respectively agree to take the number of shares in the capital of
Exchange Regulation Act, 1973, has imposed certain restrictions. the company set opposite our respective names.
Irregularity in connection with Subscription Names, addresses, descriptions and Number of
occupations of subscribers shares taken by
If an irregularity has crept in connection with subscription to a each subscriber
memorandum can the aggrieved party have any remedy ? For
example, suppose a person was fradulently induced to subscribe 1. A.B. of Merchant .. 200
to the memorandum. Can he claim any relief ? The answer 2. C.D. of ‘’ .. 25
depends upon whether the relief was claimed before or after the
issue of the certificate of incorporation. In the former case he is 3. E.F. of ‘’ .. 30
entitled to the usual remedies. But after the issue of the certificate 4. G.H. of ‘’ .. 15
of incorporation the irregularity cannot affect the existence of
5. I.J.of ‘’ .. 5
the company. This is because the certificate of incorporation is
conclusive proof of the fact matters. It is assumed that all matters 6. K.L of ‘’ .. 5
incidental to incorporation have been duly complied with. [Sec. 7. M.N. of “ .. 10
350]. But Conclusiveness of the certificate of incorporation is
Total shares taken .. 325
not a bar for the aggrieved person to claim relief against others.
Dated the.......................day..............................of 19
4.8 ANNEXURES
Witness to the above signatures.
Following are the Forms of Memorandum for various kinds of
X.Y. of.......................................
company's as specified in Table B,C,D & E in Schedule I of the
Company Act, 1956. Memorandum of a Company Limited by Guarantee and not
having a share Capital
Memorandum of Association of a Company Limited by
Shares Memorandum of Association
Ist - The name of the company is “The Eastern Steam Packet Ist.- The name of the company is “The Mutual Calcutta
Company Limited.” Marine Association Limited”.
2nd. - The registered office of the company will be situated in 2nd.- The Registered office of the company will be situate in
the State of Bombay, the State of West Bengal.
3rd - (a) The main objects to be pursued by the company on 3rd.- (a) The main objects to be pursued by the company on
its incorporation are the conveyance of passengers and its incorporation are “the mutual insurance to ships
goods in ships or boats between such places as the belonging to members of the company”.
company may from time to time determine.” (b) The objects incidental or ancillary to the attainment
(b) The objects incidental or ancillary to the attainment of the above main objects are “providing for the
of the above main objects are the acquisition, welfare of employees or ex-employees of the company
construction, building, setting-up and provision of and the making, drawing, accepting, endorsing,
establishments for repairing ships or boats, for the executing and issuing of any negotiable or transferable
training of personnel required for the running of ships documents and the doing of such other things as are
or boats and the doing of all such other things as are conducive to the attainment of the foregoing main
conducive to the attainment of the foregoing main objects”.
objects.” (c) The other objects for which the company is established
(c) The other objects for which the company is are “building, equipping and maintaining charitable
established are “carrying on the business of carriers by hospitals, running of schools and undertaking any
land and air and the running of hotels for tourists.” other social service”.
4th.- The liability of the members is limited.
5th.- Every member of the company undertakes to contribute to
the assets of the company in the event of its being wound-up
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while he is a member, or within one year after he ceases to be a
member, for payment of the debts and liabilities of the company
contracted before he ceases to be a member, and the costs,
charges and expenses of winding-up and for the adjustment of
the rights of the contributors among themselves, such amount
as may be required, not exceeding one hundred rupees.
We, the several persons whose names and addresses are
subscribed, are desirous of being formed into a company, in
pursuance of this memorandum of association.
Names, address, descriptions and occupations of subscribers.
1. A.B. of ------------------------------ Merchant.
2. C.D. of ------------------------------ "
3. E.F. of ------------------------------- "
4. G.H. of ------------------------------ "
5. I.J. of -------------------------------- "
6. K.L. of ------------------------------ "
7. M.N. of ----------------------------- "
Dated the.............................day of ....................19 .
Witness to the above signatures
X,Y, of.....................
Memorandum of a Company Limited by Guarantee and
having a share Capital
Memorandum of Association
Ist. - The name of the company is “The Snowy Range Hotel
Company Limited”.
2nd. - The Registered office of the company will be situate in
the State of West Bengal.
3rd. - (a) The main objects to be pursued by the company on
its incorporation are “the facilitating of travelling in
the Showy Range, by providing hotels and
conveyances by sea and by land for the
accommodation of travellers".
(b) The objects incidental or ancillary to the attainment
of the above main objects are “conducting coaching
classes in catering, hotel management etc., and the
doing of such other things as are conducive to the
attainment of the foregoing main objects".
(c) The other objects for which the company is
established are “running a publsihing house and the
publishing of peridocials/magazines/newspapers
catering to various interest pertaining to the objects
aforesaid".
4th.- The liability of the members is limited.
5th.- Every member of the company undertakes to contribute to
the assets of the company in the event of its being wound-up
while he is a member, or within one year after he ceases to be a
member, for payment of the debts and liabilities of the company
contracted before he ceases to be a member, and the costs,
charges and expenses of winding-up and for the adjustment of
the rights of the contributors among themselves, such amount
as may be required, not exceeding fifty rupees.
We, the several persons whose names and addresses are
subscribed, are desirous of being formed into a company, in
pursuance of this memorandum of association, and we
respectively agree to take the number of shares in the capital of
the company set opposite our respective names.
Number of
Names, addresses, descriptions and
occupations of subscribers shares taken by
each subscriber
1 A.B. of .................. Merchant ... 200
2 C.D. of .................. Merchant ... 25
3 E.F. of .................. Merchant ... 30
4 G.H. of .................. Merchant ... 40
5 I.J. of .................. Merchant ... 15
6 K.L. of .................. Merchant ... 5
7 M.N. of .................. Merchant ... 10
Total shares taken ... 325
Dated the ............................. day......................... of 19
Witness to the above signatures.
X.Y. of ....................................................................
Memorandum of Association of an Unlimited Company
Memorandum of Association
Ist. - The name of the company is “The Patent Stereotype
Company”.
2nd. - The registered office of the company will be situated in
the State of West Bengal.
3rd. -(a) The main objects to be pursued by the company on
its incorporation are “the working of a patent method
of founding and casting stereotype plates of which
method P.Q. of Bombay, is the sole patentee”,
(b) The objects incidental or ancillary to the attainment
of the above main objects are “purchasing, taking on
lease or licence or concession or otherwise, lands,
buildings, works and any rights and privileges or
interest therein for establishing the necessary
workshops/factories and the doing of such other
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 things as are conducive to the attainment of the Names, address, description and Number of
foregoing main objects”. occupation of subscribers shares taken by
each subscriber
(c) The other objects for which the company is established
are ‘conducting research in any fields pertaining to 1. A.B. of ----------------------- Merchant 3
the science of metallurgy and turning to account the
results of the same’. 2. C.D. of ----------------------- " 2

We, the several persons whose names are subscribed, are desirous 3. E.F. of ------------------------ ,, 1
of being formed into a company in pursuance of this 4. G.H. of ----------------------- ,, 2
memorandum of association, and we respectively agree to take 5. I.J. of ------------------------- ,, 2
the number of shares in the capital of the company set opposite
our respective names. 6. K.L. of ------------------------ ,, 1
7. M.N. of ----------------------- ,, 1
Total shares taken 12
Date of the .........................day of ....................19
Witness to the above signatures
X.Y. of ...........................

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5. CONSTITUTIONAL DOCUMENT: ARTICLES
SUB TOPICS
5.1 Contents of the Articles
5.2 Status of Constitutional documents
5.3 Memorandum Versus Articles
5.4 Alteration
5.5 Annexure
5.1 CONTENTS OF THE ARTICLES
It has been already pointed out that Articles of Association
which contains detail regulations as to the functioning of the
Company, is one of the two constitutional documents that a
Company must have. It has also been stated that a private limited
Company must prepare its own articles of association specifying
therein:
(a) restriction on transferability of shares:
(b) limiting the number of members to fifty not including persons
who are employed in the Company and persons who have
been in the employment when they became members and
continued to be so; and
(c) prohibiting invitations to the public to subscribe for any
shares or debentures of the company.
A public Company limited by shares may adopt all or any of the
regulations contained in Table A of Schedule I of the Companies
Act. Similarly a Public Company limited by guarantee and not
having a share capital may adopt one laid down in Table C. A
Public Company limited by guarantee and having a share capital
may prepare its regulations in the form specified in Table D.
Unlimited Company’s articles of association is given in Table E
of Schedule I. If a public company limited by shares does not
have articles at the time of registration, the regulation specified
in Table A of Schedule I shall be considered as the duly registered
Articles.
According to Sec 30 the Articles shall be (a) printed (b) divided
into paragraphs consecutively numbered and (c) signed by each
subscribers of the memorandum of association in the presence
of atleast one witness who shall attest the signature and shall
also specify his name, address and occupation. If one examines
the content of Table A of Schedule I one can understand the
contents of articles of association. A list of these contents can
be specified as under
(i) interpretation of various terminologies;
(ii) Regulation regarding share capital, various types of share
capital, rights of the share holders, procedure of issuing
share certificate, variation of the rights, etc ;
(iii) Right of lien of the Company and its extent and character;
(iv) Calls on all shares;
(v) Procedure of transfer of shares;
(vi) Transmission of shares;
(vii) Right of forfeiture of shares;
(viii) Conversion of share into stock;
(ix) Share warrants and the procedure of issuing share
warrant;
(x) Alteration of capital;
(xi) Various types of meeting and proceedings in those
meetings;
(xii) Voting and Proxies;
(xiii) Board of Directors, their powers and proceedings of the
meetings of the Board of Directors;
(xiv) Manager and Secretary and their powers;
(xv) Provisions regarding the Corporate Seal;
(xvi) Dividends and reserves;
(xvii) Procedure of accounts;
(xviii) Capitalisation of profits;
(xix) Regulation relating to winding up; and
(xx) Idemnity
A Public Company having a share capital may adopt these
regulations or may amend or omit some of the regulations.
5.2 STATUS OF CONSTITUTIONAL DOCUMENTS
The registered company being an association of persons as it is,
is founded on the agreement or contract between its members.
But it also has a legal existence distinct and separate from that
of its members. Its relationship with the members is also based
on an agreement or contract which is supposed to exist between
them. This principle is embodied in section 36 which read as
follows:
“(1) Subject to the provisions of this Act the memorandum
and articles shall when registered bind the company and
the members thereof, to the same extent as if they
respectively had been signed by the company and each
memeber and contained covenants on its and his part to
observe all the provisions of the memorandum and of the
articles.
(2) All the money payable by any member to the company
under the memorandum or articles shall be a debt due from
him to the company”.
The history of the section can be traced back to the Joint Stock
Companies Act, 1844 which for the first time provided the legal
framework for the formation of registered companies. The
statute made it obligatory on existing partnerships with
membership above 25 to be incorporated. This was done by
registering the partnership deed (the deed of settlement) with
the Registrar of companies. Thus the “deed” which originally
was only a contract between the members of an unincorporated
body, became the constitution of the registered company.
Though the “deed” was subsequently split into and substituted
by the memorandum and articles, they were continued to be
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treated as contractual documents by the subsequent statutes also.
Section 36 embodies this.
2. How far a contract?
Read literally sec.36 implies that the provisions in the
memorandum and articles are contractual terms between the
company and its members in respect of all matters stated therein.
But judicial interpretation to the provision has curtailed its ambit
considerably. Now it is settled law that they are contractual
terms between the company and its members in respect of maters
relating to ‘membership rights’ only. Thus provisions dealing
with voting rights, rights to dividend, calls on shares,lien, transfer
of shares proceedings of General meeting,etc. are contractual
terms. But provisions dealing with matters, such as appointment
and removal of Directors, Auditors, Solicitors, etc. are outside
the ambit of section 36 as they do not affect the rights or liabilties
of members as members. In Eley v. Positive Life Assurance
Co. Ltd. [(1876)1 EX.D 88] the articles of a company provided
that one ‘E’ should be the solicitor of the company. The company
refused to appoint him. Held, he could not claim damages for
breach of contract for the following reasons:
(1) There was no specific contract between the parties, express
or implied.
(2) ‘E’ could not rely upon the relevant provisions in the articles
because those provisions did not affect him in his capacity
as a member.
3. Special features of the Contract:
The contract embodies in the memorandum and articles has many
special features. In the words of Ross. J. ‘it is a contract of the
most sacred character’ [Clark v Workman (1920)1 1r.R.107].
The shareholders advance money and become members relying
mainly on the provisions contained in these documents. Some
of the special features of this most important statutory contracts
are:-
(1) Its terms can be unilaterally altered by one of the contracting
parties namely the company. We have seen that the
provisions in the memorandum and articles are liable to
amendment. (Sec. 36 expressly provides that it is subject
to the provisions of this Act.)
(2) Normal contractual remedies are available only to the
company. Courts have consistently shown reluctance to a
member against the company for breach of the contractual
provision contained in the memorandum or articles. In
Houldsworth v City of Glasgow Bank [(1880)5 App.
Cas. 317], the plaintiff was fraudulently induced by the
company to take shares. The House of Lords refused to
award damages to him, while he remained a member. The
jurisprudential basis of this rule was never satisfactorily
explained. (Sealey: Cases and materials in company law,
5th edn. p.335). Remedies like rectification of instrument
are also not available.
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4. Binding force of the contract in the articles:
(a) Company and members:
As regards the provisions in the memorandum and articles which
deal with ‘membership rights’, it is well settled that both the
company and members are bound to each other as if they had
entered into an express contract incorporating all those terms.
In Hickman v Kent or Romney Marsh Sheep Breeders’
Association [(1915)1 Ch.881] the defendant was a non profit
making association registered as a company, the object being to
maintain the purity of a particular breed of sheep. Art. 49 of the
articles of association provided that disputes between the
associations and any of its members should be referred to
arbitrator. Hickman, a member instituted a suit against the
association, pertaining to his membership rights. The court
upheld the objection of the company that the civil court has no
jurisdiction, as Art.49 is to be treated as an agreement between
the company and the members that disputes shall be referred to
arbitration.
Can a member restrain the company from breach of articles?
It is settled law that provisions in the memorandum and articles
do not constitute a contract between a company and its members
in respect of matters relating to outsiders’ right. But Prof.
Wedderburn (1957 CL.J.193) argues that a member in his
capacity as a member has the right to restrain the company from
committing any breach of the articles even though this may
amount to enforcing ‘outsiders' right’ indirectly. For example,
if the articles provide that certain transactions may be entered
into by the Company with the consent of the General meeting a
member may sue the company to prevent it from entering into
the transactions without such consent. [See Quinn and Axtens
Ltd. v. Salmon, (1909 A.C.442]. But the learned author’s view
‘involves disregarding innumerable weighty dicta and overruling
a number of leading cases’ [Gower, p.319). Goldberge (35
M.L.R. 362) suggests that Wedderburn’s proposition can be
narrowed and reformulated thus : “A member of a company has
under section 20(1) of the Act (This corresponds to section 36
of the Companies Act, 1956) a contractual right to have any of
the affairs of the company conducted by the particular organ of
the company specified in the act or the company’s memorandum
or articles”.
(b) Between members inter-se
Are the provisions of the memorandum and articles contractual
terms between an individual member and another ? Section 36
says that these provisions shall ‘ bind the company and the
members thereof to the same extent as if they respectively had
been signed by the company and by each member and contained
covenants on its and his part to observe all the provisions’.
The section is ambiguous as to whether a member is to be treated
as impliedly covenanting with another. The preponderant view
now is that the provisions of the memorandum and articles are
contractual terms between the members inter se. Each member
impliedly covenants with every other to obey those provisions
so far as they relate to their rights and duties as members. In
Shiv Omkar Maheswari v Bansidhar Jaganath (AIR 1956
Bom. 459), the Bombay High Court reivewed the case law on
the point and held that the memorandum and articles have
contractual force between the members inter se.
Between the company and outsiders:
As noticed earlier, the memorandum and articles have contractual
effect only in respect of matters pertaining to membership rights
and not in respect of outsider rights. So section 36 will not
imply a contract between the company and an outsider, on the
ground of the provisions of these constitutional documents. But
in many cases, both the company and other party might have
transacted business on the basis of the articles. In those cases,
the relevant provisions of the articles shall be treated as
contractual terms between the company and the other party. For
example the article of a company may fix the salary of the
managing director at Rs.5,00,000/- per annum. If ‘A’ is
appointed as the managing director without any express term as
to his salary, the particular provision of the articles providing
for the salary of the managing director will be treated as a term
of the contract between ‘A’ and the company. But as the company
has a statutory right to alter all the provisions of the articles, if it
has unilaterally altered a provision which was an implied
contractual term between it and an outsider, the alteration cannot
be pleaded by the other party as a breach of contract. He must
be presumed to have consented to the power of the company to
alter the terms of the articles which are read into the contract
between them. In the above illustration, if the company has
altered the salary clause and reduced the salary of the managing
director to Rs.2,50,000/- per annum, ‘A’ cannot plead that the
company has committed breach of contract. If he wanted sanctity
to the provisions of the articles which are read into the contract
between him and the company, those provisions should have
been expressly incorporated into the contract. Otherwise he
will have no remedy if the company varies those provisions.
But this does not mean that the accrued rights of the other party
can be prejudicially affected by varying the terms impliedly read
into the contract. Thus, if ‘A’ was appointed as the managing
director in 1978 and the salary clause in the articles was altered
in 1980 reducing the salary of Managing Director with
retrospective effect, the alteration cannot affect the right of ‘A’
to claim remunaeration at the previous rate, from the date of his
appointment till the date of alteration.
5.3 MEMORANDUM VERSUS ARTICLES
Articles of Association is a subordinate document to the
memorandum which is treated as the general constitution of the
Company. The memorandum is fundamental and therefore can
be altered as prescribed in the Act. Articles of Associationns
on the other hand regulates internal relations within the company
as also distributes the power. It can be altered according to
what the members think fit. The distinction between these two
documents is highlighted by Lord Aciras in Ashbury Rly
Carriage & Iron Company Ltd v. Riche [(1875) L.R.
7H.L.653] thus :-
“I will ask your Lordships to observe the marked and entire
difference between the two documents - I mean the
memorandum of association on the one hand and articles of
association, those articles play a part subsidiary to the
memorandum of association. They accept the memorandum of
association, as the charter of incorporation of the company, and
so accepting it, the articles proceed to define the duties, the
rights and the powers of the governing body as between
themselves and the company at large, and the mode and form in
which the business of the company is to be carried on”.
Thus the basic or fundamental provisions relating to the
constitution of a company are set out in its memorandum of
association. Being the fundamental document of the company
which specifies its business activities and powers the early
Companies Acts did not contain any provision for amendment
of provisions in the memorandum. The articles on the other
hand deal with matters of internal regulation, such as, the
distribution of powers among the various agents of the company,
conduct of meetings, appointment of Directors, etc..
Any provisions in the articles of association is to be interpreted
in consonance with all the provisions of the memorandum or
in other words no part of the articles can be construed in such a
way that it intervenes or contradicts any provision of the
memorandum. Ofcourse, the principle of construction does not
apply where the words are clear and unambiguous, and are in
consonence with the provisions of the memorandum.
Memorandum delimits the boundary of the comapny. Every
one entering into the contract with the company is bound to
have constructive notice of the provisions of the memorandum.
Articles on the other hand provides regulation for internal
management. Any internal regulation of power application can
be presumed to have been accomplished according to internal
regulations. This principle of indoor management is discussed
elsewhere along with the principle of constructive notice.
5.4 ALTERATION
1. Unfettered Power to alter:
Unlike the provisions in the memorandum the legislative policy
with regard to amendment of the articles had always been to
grant maximum liberty to the company. As the articles deal
with the composition and powers of its organs and other matters
for the smooth and efficient operation of its administrative
machinery it was recognised from the early days of company
law that companies should have the unfettered freedom to alter
its articles. How and in what manner shall the business be carried
on is essentially a business proposition to be determined
primarily by the company itself. This policy is reflected in
section 31(i), which reads :-
“Subject to the provisions of this Act and the conditions
contained in its memorandum a company may, by special
resolution alter its articles”.
The company’s power to alter the articles is a statutory one and
cannot be curtailed by a restrictive provision in the articles. It
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cannot also stipulate in section 31(1)namely the passing of a
special resolution. For example,suppose it is provided in the
articles of a company that the alteration of any provision in the
articles shall be effective only if such alteration is assented to
by ‘X’, the promoter of the company. Such a provision is invalid,
as it is inconsistent with section 31(1) which provides that the
alteration can be carried out by passing a special resolution.
A contrary view is expressed in Palmer’s Company Law. (24th
Edn.page 180). It is stated therein : “A provision in the articles
that any specific article may not only be altered with the consent
of a named person is valid and without such consent any
attempted alteration would be ineffective. But this is on the
assumption that the shares held by that person is of a separate
class. In India, public companies and private companies which
are subsidiaries of public companies can issue only two classes
of shares viz. equity shares and preference shares. The terms of
issue of such preference shares contain the rights attached to
them. But in England any number of classes of shares, even
with disproportionate voting rights can be issued. In England it
is also possible to incorporate a protective provision in the
memorandum and provide therein that it is unalterable.
Though section 31(1) provides that the company’s power to alter
the articles are ‘subject to the conditions contained in the
memorandum’ it is not possible to curtail the amending power
of the company by a restrictive provision in the memorandum
for the following reason. By virtue of sec.16(2) the non
obligatory clauses in the memorandum shall be treated as if they
are provisions in the articles only. The phrase ‘subject to the
provisions in the memorandum’ only means that the altered
provision shall not be inconsistent with the obligatory clauses
in the memorandum.
In Andrews v Gas Metre Co. [(1897)1 Ch.361] the original
articles did not contain any provision for the issue of preference
shares. The articles were altered to enable the company to issue
such shares. The court held that the alteration was valid.
2. Can alteration lead to breach of Contract?
Another question to be considered is whether the company can
amend any provision in the articles or incorporate a new
provision, if such amendment would empower the company to
commit a breach of contract. This interesting question was
finally settled by the House of Lords in Southern Foundries
Ltd. v. Shirlaw [(1940)2 All ER 445]. In 1933 the defendant
company (‘Southern’) by a written agreement appointed the
plaintiff as its Managing Director for a period of 10 years. In
1936, Federated founderies Ltd. (‘Federated’) became its
controlling shareholder. Consequently Southern altered its
articles so as to include a new provision which empowered
‘Federated’ to remove any Director of Southern. Exercising
the power conferred by the new article, ‘Federated’ removed
the plaintiff from his directorship in 1937. The plaintiff
contented that the alteration was invalid as the effect of the
amendment was to empower the company to break its contract
with him.
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Rejecting the contention of the plaintiff Lord Porter observed -
“A company cannot be precluded from altering its articles
thereby giving itself power to act upon the provisions of the
altered articles”. But this does not mean that the company can
construe a breach of contract with impunity by altering its
articles. As pointed out by Lord Porter in the above case to act
upon the provisions of the altered articles may nevertheless be
a breach of contract, if it is contrary to a contractual term validly
made before the alteration. Gower says: “If, the company has
entered into contracts it will be liable if at the behest of those in
control it breaks the contract and it cannot justify a breach by
alleging that its constitution justified or required it so to act”.
(Principles of modern Company Law). Articles will not relieve
the company from its liability to pay damages for breach of the
express terms of contract. On the other hand in the absence of
an express contract if the parties proceeded on the assumption
that, the existing provisions in the article would be the basis of
the service terms, it must be presumed that both the parties have
tacitly agreed that the company shall have the power to alter
those provisions. But this cannot prejudicially affect the accrued
rights of the parties. Let us take an illustration. Suppose ‘A’ is
appointed as Managing Director of the company. The articles
at the time of appointment of `A’ specified the tenure of the
Managing Director. If no express service contract was entered
into between the company and `A’ the provisions in the the
Article would govern the contract between them. But the
company can alter those terms without being liable for breach
of contract, though by such alteration the accrued rights of the
other party cannot be affected. In strict legal theory the plea
that the company shall not be permitted to alter its articles, if
such alteration would empower it to commit breach of contract,
is not valid. Barring the exceptional cases where specific relief
or injunction will be granted there is no rule of law, that a
contracting party shall not breach the contract. It only provides
for damages to be paid to the aggrieved party.
3. Retrospective alteration:
The statutory power of the company to alter the provisions in
its articles is wide enough to include a alteration with
retrospective effect. In Allen v. Gold Reefs of West Africa
[(1909)1 Ch. 656] regulation 29 of the Company’s articles
provided that the ‘company shall have a first and paramount
lien for debts owing by a member to the company upon all
shares (not being fully paid up) held by such member’. The
company altered the articles by deleting the words ‘not being
fully up’ and giving it retrospective effect. The alteration
prejudicially affected the plaintiff who was the owner of certain
fully paid shares and also a debtor of the company. Rejecting
his contention that the retorspective operation was invalid it
was held that “the power thus conferred on companies to alter
the regulations contained in their articles is limited only by the
provisions contained in the statute and the conditions contained
in the company’s memorandum of assocaition”. In Sidebotton
v Kershaw Lees & Co. Ltd [(1920)1 Ch. 154] the defendant
company incorporated a new provision in its articles to
empower the Directors to buy out at a fair price the shares of
any member who carried on any business in competition with
the company. The plaintiff who challenged the alteration, was
at the time of alteration carrying on a competing business. Held,
the alteration was valid.
In State of Karnataka v. Mysore Coffee Curing Works Ltd.
[(1984)55 Comp. cas.70]. The petitioner was a company
incorporated in 1938. Arts. 70(a) and 97 of Articles of
Association of the Company that the State Government, which
was a member of the company has the pwoer to nominate three
Directors, and another as Chairman of the Board. Subsequent
to the further issue of shares the shareholding of the petitioner
State was reduced to 20%. The company proposed to amend
Articles 70(a) and 97, with a view to take away the special rights
conferred on the petitioner. The move was attempted to be
thwarted by the petitioner by moving petition to restrain the
company from amending the provisions. Rejecting the
contentions of the petitioner, the Karnataka High Court held
that “the only restriction on the unfettered power under
subsection (1) of section S.31 of the act is the restriction imposed
by the proviso to that section."
4. Retrospective Operation of amendment and accrued
rights:
Though the company enjoys wide pwoers to alter the provisions
in the articles will such alteration affected accrued rights ? The
issue has much practical significance with respect to transfer of
shares. As regards the company transferee becomes a member
only on his name being entered in the register of members.
Suppose ‘A’, the holder of a block of shares transfers the same
to ‘B’, the transfer is strictly in consonance with the articles of
association as they are on the date of transfer. Can the company
susbsequently alter the articles, so as to prejudice the rights of
the transferee to get his name entered in the Register of Members
as a member.
The issue came up for the consideration of the Kerala High
Court in Vardhaman Publishing Ltd. v. Mathrubhoomi Ltd
[(1991)71 Comp. cas.1]. The petitioner purchased a block of
shares of the respondent company from a registered bolder and
applied for registration of the same. Subsequent to the
presentation of the relevant documents for registration the
company altered the articles by incorporating a new provision
therein. The purpose of the amendment was to confer on the
Board of Directors a discretionary power to refuse any transfer
of shares on the ground that the transferee is not a desirable
person in the opinion of the Board. A single judge of the Kerala
High Court held that the amendment of the articles could not
deprive the petitioner of his right to have the transfer registered,
as it was accrued prior to the alteration. He held that alteration
of articles cannot affect concluded transactions. As per original
articles there was a subsisting contract that the shares were freely
transferable and there was no power in the Board to reject the
transfer, so as to take away a right already accrued. Referring
to section 31(2) which provides that ‘any alteration of the articles
shall be as valid as if originally contained in the articles, the
learned judge observed that the provision can only relate to the
procedural validity of the altered articles....
On appeal the Division Bench [(1992))73 Comp.cas]) agreed
that accured rights cannot be upset by retrospective alteration
of the articles. But the transferees’ rights become accrued only
on lodgment of the proper instruments of transfer and no other
obstacle remain in enforcement of the right of transfer.
5. Procedure for alteration:
The company may alter any of the provisions in the articles by
a special resolution. But an alteration which has the effect of
converting a public company into a private company, the consent
of the Central Government is necessary [proviso to section
31(1)]. This is to ensure that the attempted conversion is not
for the purpose of avoiding the regulations and restrictions
applicable to public companies only. The power of the Central
Government has been delegated to the Regional Director.
(Notification dated:31-5-1991).
The alteration to be effective must be filed with the Registrar
within 30 days of the passing of the special resolution.
6. The Power of the CLB to alter the articles
Apart from the company at its General Meeting the Company
Law Board is empowered to order alteration of the articles.
(S.404). This is to provide relief against oppression and
mismanagement.
7. Limitation on the power of Alteration:
The general rule that the company in General Meeting can alter
any of the provisions in its articles is subject to certain
exceptions. They are :-
(i) The alteration must be bonafide:
The statutory power under section 31 must be exercised ‘not
only in the manner required by law but also bonafide for the
benefit of the company as a whole’. (per Lindley M.R. in Allen
v Gold Reef of West Afica (1900)1 Ch. 656) The obvious
purpose of this limitation is to safeguard the interest of the
minority. But on challenging the validity of the alteration on
this ground the plaintiff must adduce clear proof of ‘mala fides’
or discrimination on the part of the company or the majority
who amended the articles. If he fails to establish this the courts
would be inclined to hold that the alteration was valid.'
(ii) Class rights:
If the company has issued different classes of shares, and the
special rights of particular class of shareholders are embodied
in the articles, those rights cannot be varied by mere alteration
of the articles. The class rights embodied in the articles are
entrenched provisions which are subject to the limitations
contained in section 106. If the variation of the rights of any
particular class of shares are prohibited by the terms of issue of
those shares, the alteration is ineffective. The same is the
position when the memorandum of articles contain provisions
prohibiting variation. The variation of class rights can be
effected only by strictly complying with the requirements of
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section 106. The variation contemplated here is one which
detrimentally affect the interests of the holders of the special
class of shares.
(iii) Increase in members’ liability:
A fundamental term of the contract between a company limited
by shares or guarantee and its members is that the liability of
each member is limited to the amount agreed by him to pay or
contribute at the time of his becoming a member. By altering
the memorandum or articles, the company cannot impose on
him an increased liability. But if a member agrees to be bound
by the alteration effecting the increased liability, he will be bound
by the terms of the alteration. (Section 38).
(iv) Restriction for the protection of minority:
In a petition filed under section 397 or 398, the court has power
to alter the memorandum or articles of a company, in any manner
it thinks fit (S.404). When the court has thus amended the
memorandum or articles, they cannot be further amended by
the company so as to effect the amendments already made by
the court.
5.5 ANNEXURE
Schedule I of the Company Act, 1956 provides a model for
Articles of Association of a Company limited by shares. For
other types of companies the model is provided in Schedule I -
tables' C, D, and E.
[See Section 2(2), 14, 28(1), 29 and 223]
Table A
Regulations for Management of a Company Limited by
Shares
Interpretation
1. (1) In the regulations-
(a) “the Act” means the Companies Act, 1956.
Memorandum of Association of a Company Limited
by Shares,
(b) “the Seal” means the common seal of the company.
(2) Unless the context otherwise requires, words or
expressions contained in these regulations shall bear
the same meaning as in the Act or any statutory
modifications thereof in force at the date at which these
regulations became binding on the company.
Share Capital and Variation of Rights
2. Subject to the provisions of section 80, any preference
shares may, with the sanction of an ordinary resolution, be
issued on the terms that they are, or at the option of the
company are liable, to be redeemed on such terms and such
manner as the company before the issue of the shares may,
by special resolution, determine.
3. (1) If at any time the share capital is divided into different
classes of shares, the rights attached to any class (unless
otherwise provided by the terms of issue of the shares of
that class) may, subject to the provisions of sections 106
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and 107, and whether or not the company is being would-
up, be varies with the consent in writing of the holders of
three-fourths of the issued shares of that class or with the
sanction of a special resolution passed at a separate meeting
of the holders of the shares of that class.
(2) To every such separate meeting, the provisions of these
regulations relating to general meetings shall mutatis
muntandis apply, but so that necessary quorum shall be two
persons at least holding or representing by proxy one-third
of the issued shares of the class in question.
4. The rights conferred upon the holders of the shares of any
class issued with preferred or other rights shall not, unless
otherwise expressly provided by the terms of issue of the
shares of that class, be deemed to be varied by the creation
of issue of further shares ranking pari passu therewith.
5. (1) The company may exercise the powers of paying
commissions conferred by section 76, provided that the rate
per cent, or the amount of the commission paid or agreed to
be paid shall be disclosed in the manner required by that
section.
(2) The rate of commission shall not exceed the rate of five
per cent of the price at which the shares in respect whereof
the same is paid are issued or an amount equal to five per
cent of such price, as the case may be.
(3) The commission may be satisfied by the payment of
cash or the allotment of fully or partly paid shares or partly
in one way and partly in the other.
(4) The company may also, on any issue of shares, pay such
brokerage as may be lawful.
6. Except as required by law, no person shall be recognized
by the company as holding any shares upon any trust, and
the company shall not be bound by, or be compelled in any
way to recognize (even when having notice thereof), any
equitable, contingent, future or partial interest in any share,
or any interest in any fractional part of a share of (except
only as by these regulations or by law otherwise provided)
any other rights in respect of any share except an absolute
right to the entirety thereof in the registered holder.
7. (1) Every person whose names is entered as a member in
the register of members shall be entitles to receive within
three months after allotment or [within two months after
the application for the] registration of transfer (or within
such other period as the conditions of issue shall provide)-
(a) one certificate for all his shares without payment; or
(b) several certificates, each for one or more of his shares,
upon payment of one rupee for every certificate after
the first;
(2) Every certificate shall be under the seal and shall specify
the shares to which it relates, and the amount paid up thereon.
(3) In respect of any share or shares held jointly by several
persons, the company shall not be bound to issue more than
one certificate, and delivery of a certificate for a share to
one of several joint holders shall be sufficient delivery to
all such holders.
8. If a share certificate is defaced, lost or destroyed, it may be
renewed on payment of such fee, if any, not exceeding [two
rupees] and on such terms, if any, as to evidence and
indemnity and the payment of out-of-pocket expenses
incurred by the company in investigating evidence, as the
directors think fit.
Lien
9. (1) The Company shall have a first and paramount lien-
(a) on every share (not being a fully-paid share), for all
moneys (whether presently payable or not) called, or
payable at a fixed time, in respect of that share; and
(b) on all shares (not being fully-paid shares) standing
registered in the name of a single person, for all
moneys presently payable by him or his estate to the
company:
Provided that the Board of Directors may at any time declare
any share to be wholly or in part exempt from the provisions
of this case.
(2) The company’s lien, if any, on a share shall extend to
all dividends payable thereon.
10. The company may sell, in such manner as the Board thinks
fit, any shares on which the company has a lien:
Provided that no sale shall be made-
(a) unless a sum in respect of which the lien exists is
presently payable, or
(b) until the expiration of fourteen days after a notice in
writing stating and demanding payment of such part
of the amount in respect of which the lien exists as in
presently payable, has been given to the registered
holder for the time being of the share or the person
entitled thereto by reason of his death or insolvency.
11. (1) To give effect to any such sale, the Board may authorise
some person to transfer the shares sold to the purchaser
thereof.
(2) The purchaser shall be registered as the holder of the
shares comprised in any such transfer.
(3) The purchaser shall not be bound to see to the application
of the purchase money, nor shall his title to the shares be
affected by any irregularity or invalidity in the proceedings
in reference to the \sale.
12. (1) The proceeds of the sale shall be received by the
company and applied in payment of such part of the amount
in respect of which the lien exists as is presently payable.
(2) The residue, if any, shall subject to a like lien for sums
not presently payable as existed upon the shares before the
sale, be paid to the person entitled to the shares at the date
of the sale.
Calls of Shares
13. (1) The Board may, from time to time, make calls upon
the members in respect of any moneys unpaid on their
shares (whether on account of the nominal value of the
share or by way of premium) and not by the conditions of
allotment thereof made payable at fixed times:
Provided that no call shall exceed one-fourth of the nominal
value of the share or be payable at less than one month
from the date fixed for the payment of the last proceeding
call.
(2) Each member shall, subject to receiving at least fourteen
days’ notice specifying the time or times and place of
payment, pay to the company, at the time or times and place
so specified, the amount called on his shares.
(3) A call may be revoked or postponed a the discretion of
the Board.
14. A call shall be deemed to have been made at the time when
the resolution of the Board authorising the call was passed
and may be required to be paid by installments.
15. The joint holders of a share shall be jointly and severally
liable to pay all calls in respect thereof.
16. (1) If a sum called in respect of a share is not paid before or
on the day appointed for the payment thereof, the person
from whom the sum is due shall pay interest thereon from
the day appointed for payment thereof to the time of actual
payment at five per cent per annum or at such rate, if any,
as the Board may determine.
(2) The Board shall be at liberty to waive payment of any
such interest wholly or in part.
17. (1) Any sum which by the terms of issue of a share becomes
payable on allotment or any fixed date, whether on account
of the nominal value of the share or by way of premium,
shall, for the purpose of these regulations, be deemed to be
a call duly made and payable on the date on which by the
terms of issue such sum becomes payable.
(2) In case of non-payment of such sum, all the relevant
provisions of these regulations as to payment of interest
and expenses, forfeiture or otherwise shall apply as if such
sum had become payable by virtue of a call duly made and
notified.
18. The Board
(a) may, if it thinks fit, receive from any member willing
to advance \the same, all or any part of the moneys
uncalled and unpaid upon any shares held by him,
and
(b) upon all or any of the moneies so advanced, may (until
the same would, but for such advance, become
presently payable) pay interest at such rate not
exceeding, unless the company in general meeting
shall otherwise direct, six per cent per annum, as may
be agreed upon between the Board and the member
paying the sum in advance.
Transfer Shares
19. (1) The instrument of transfer of any share in the company
shall be executed by or on behalf of both the transferor and
transferee.
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(2) The transferor shall be deemed to remain a holder of the [20. subject to the provisions of section 108, the shares in the
share until the name of the transferee is entered in the register company shall be transferred in the following form, namely:-]
of members in respect thereof.
Form No &B
Date of presentation to
the prescribed authority ..................................

Share Transfer Form

[Pursuant to section 108 (1-A) of the Companies Act, 1956]
For the consideration state below the “Transferor(s)” named do hereby transfer to the “Transferee(s)” named
the same the shares specified below subject to the conditions on which the said shares are now held by the
Transferors(s) and the Transferee(s) do hereby agree to accept and hold the said shares subject to the
conditions aforesaid.
___________________________________________________________________________________
Full name of company Name of the recognised stock exchange where dealt in, if any
___________________________________________________________________________________
Description of Equity/Preference Shares
___________________________________________________________________________________
No. in figures Number in Words Consideration (in figures) Consideration in (words)
___________________________________________________________________________________
Distinctive from
___________________________________________________________
numbers To
Corresponding
Certificate Nos.
___________________________________________________________________________________
Transferors(s) Seller(s) Particulars Regd. Folio No. Signature(s)

Names (s) in full 1. _____________________________ 1. _____________________________

2. _____________________________ 2. _____________________________
3. _____________________________ 3. _____________________________
4. _____________________________ 4. _____________________________

Signature of Witness
Attestation ______________________________
I, hereby attest the Signature of the Transferors(s) herein Name and Address of Witness
mentioned ______________________________
______________________________
Signature ______________________________
Name ______________________________
Address/Seal ______________________________
* Please see overleaf for instructions PIN

subs. vide Notfn. No. GSR 480 (E) dated 22-4-88, (See Chartered Secretary issue May 1988, p 427).

*Instructions For Attestion:

Attestation, where required (thumb impressions, marks, signature difference, etc,) should be done by a Magistrate, Notary
Public or Special Executive Magistrate or a similar authority holding a Public Office and authorised to use the Seal of his office
or a member of a recognised Stock Exchange through whom the shares are introduced or a manager of the transferor’s bank.

Note: Names must be rubber stamped preferably in a straight line. Chronological order should be maintained. Broker’s Clearing
Number should be stated when delivery is given by a Clearing Member Bank.

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Transferee(s) (Buyer(s) Particulars Signature(s)

Names(s) in full 1. _______________________________ 1. ____________________________

2. _______________________________ 2. ____________________________

3. _______________________________ 3. ____________________________
___________________________________________________________________________________
Occupation Address Father’s/Husband’s Name

___________________________________________________________________________________
1
___________________________________________________________________________________
2
___________________________________________________________________________________
3
___________________________________________________________________________________
Transferee(s) existing Folio, Value of
if any, in same Order of Names Stamps affixed Rs.
Dated this .................... day of ................. ‘One Thousand Nine Hundred .......... Place ...............................

Folio Company Code

For office use only

Checked by ______________________________ 1. ________________________

Signature(s) of
Transferee(s)

Specimen

signature tallied by ________________________ 2. ________________________

Entered in Register of Transfer No. ___________ 3. ________________________

Approval Date ___________________________

Continuation of front page (herein enter the Distinctive numbers when the space on the front page is found to
be insufficient)

___________________________________________________________________________________
Distinctive From
____________________________________________________________________
Number To
___________________________________________________________________________________

Corresponding
Certificate Nos.

___________________________________________________________________________________

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 ___________________________ _________ ______________________________________

Name of delivery Broker or Date Power of Attorney Probate Death Certificate

Clearing Number ______________________________________
___________________________ ________ Letters of Administration
Registered with the Company
No. ______________ Date ________________
______________________________________
Signature (not initials) of Broker, Bank,
Company or Stock Exchange Clearing House)
______________________________________
______________________________________
Lodged by _____________________________
full Address ____________________________
___________________________________
___________________________________
___________________________________
______________________________________
______________________________________
Share Certificates to be returned to
(Full in the name and address to which the
Certificates are required to be returned)
NAME & ADDRESS ____________________
___________________________________
___________________________________
___________________________________

SHARE TRANSFER STAMPS

___________________________________________________________________________________

* To be filled only if the documents are lodged by a person other than the transferee.

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21. The Board may, subject to the right of appeal conferred by
section 111, decline to register -
(a) the transfer of a share, not being a fully-paid share, to
a person of whom they do not approve; or
(b) any transfer of shares on which the company has a
lien.
22. The Board may also decline to recognise any instrument of
transfer unless-
(a) a fee of two rupees is paid to the company in respect
thereof;
(b) the instrument of transfer is accompanied by the
certificate of the shares to which it relates, and such
other evidence as the Board may reasonably require
to show the right of the transferor to make the transfer;
and
(c) the instrument of transfer is in respect of only one
class of shares.
23. Subject to the provisions of section 154, the registration of
transfers may be suspended at such times and for such
periods as the Board may from time to determine:
Provided that such registration shall not be suspended for
more than thirty days at any one time or for more than forty-
five days in the aggregate in any year.)
24. The Company shall be entitled to charge a fee not exceeding
two rupees on the registration of every probate, letters of
administration, certificate of death or marriage, power-of-
attorney or other instrument.
Transmission of Shares
25. (1) On the death of a member, the survivor or survivors
where the member was a joint holder, and his legal
representatives where he was a sole holder, shall be the only
persons recognised by the company as having any title to
his interest in the shares.
(2) Nothing in clause (1) shall release the estate of a deceased
joint holder from any liability in respect of any share which
had been jointly held by him with other persons.
26. (1) Any person becoming entitled to a share in consequence
of the death or insolvency of a member may, upon such
evidence being produced as may from time to time properly
be required by the Board and subject as hereinafter provided,
elect, either:
(a) to be registered himself as holder of the share; or
(b) to make such transfer of the share as the deceased or
insolvent member could have made.
(2) The Board shall, in either case, have the same right to
decline or suspend registration as it would have had, if the
deceased or insolvent member had transferred the share
before his death or insolvency.
27. (1) If the person so becoming entitled shall elect to be
registered as holder of the share himself, he shall deliver or
send to the company a notice in writing signed by him
stating that he so elects.
(2) If the person aforesaid shall elect to transfer the share,
he shall testify his election by executing a transfer of the
share.
(3) All the limitations, restrictions and provisions of these
regulations relating to the right to transfer and the registration
of transfers of shares shall be applicable to any such notice
or transfer as aforesaid as if the death or insolvency of the
member had not occurred and the notice or transfer were a
transfer signed by that member.
28. A person becoming entitled to a share by reason of the death
or insolvency of the holder shall be entitled to the same
dividends and other advantages to which he would be
entitled if he were the registered holder of the share, except
that he shall not, before being registered as a member in
respect of the share, be entitled in respect of it to exercise
any right conferred by membership in relation to meetings
of the company:
Provided that the Board may, at any time, give notice
requiring any such person to elect either to be registered
himself or to transfer the share, and if the notice is not
complied with within ninety days, the Board may thereafter
withhold payment of all dividends, bonuses or other moneys
payable in respect of the share, until the requirements of
the notice have been complied with.
Forfeiture of Shares
29. If a member fails to pay any call, or instalment of a call, on
the day appointed for payment thereof, the Board may, at
any time thereafter during such time as any part of the call
or instalment remains unpaid, serve a notice on him requiring
payment of so much of the call or instalment as is unpaid,
together with any interest which may have accrued.
30. The notice aforesaid shall -
(a) name a further day (not being earlier than the expiry
of fourteen days from the date of service of the notice)
on or before which the payment required by the notice
is to be made; and
(b) State that, in the event of non-payment on or before
the day so named, the shares in respect of which the
call was made will be liable to be forfeited.
31. If the requirements of any such notice as aforesaid are not
complied with, any share in respect of which the notice has
been given may, at any time thereafter, before the payment
required by the notice has been made, be forfeited by a
resolution of the Board to that effect.
32. (1) A forfeited share may be sold or otherwise disposed of
on such terms and in such manner as the Board thinks fit.
(2) At any time before a sale or disposal as aforesaid, the
Board may cancel the forfeiture on such terms as it thinks
fit.
33. (1) A person whose shares have been forfeited shall cease
to be a member in respect of the forfeited shares, but shall,
notwithstanding the forfeiture, remain liable to pay to the
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 company all moneys which, at the date of forfeiture, were
presently payable by him to the company in respect of the
shares.’
(2) The liability of such person shall cease if and when the
company shall have received payment in full of all such
moneys in respect of the shares.
34 (1) A duly verified declaration in writing that the declarant
is a director the manager or the secretary, of the company,
and that a share in the company has been duly forfeited on
a date stated in the declaration, shall be conclusive evidence
of the facts therein sated as against all persons claiming to
be entitled to the share.
(2) The company may receive the consideration, if any, given
for the share on any sale or disposal thereof and may execute
a transfer of the share in favour of the person to whom t he
share is sold or disposed of.
(3) The transfer shall thereupon be registered as the holder
of the share.
(4) The transferee shall not be bound to see to the application
of the purchase money, if any, nor shall his title to the share
be affected by any irregularity or invalidity in the
proceedings in reference to the forfeiture, sale or disposal
of the share.
35. The provisions of these regulations as to forfeiture shall
apply in the case of non-payment of any sum which, by the
terms of issue of a share, becomes payable at a fixed time,
whether on account of the nominal value of the share or by
way of premium, as if the same had been payable by virtue
of a call duly made and notified.
Conversion of Shares into Stock
36. The company may, by ordinary resolution,-
(a) convert any paid-up shares into stock; and
(b) reconvert any stock into paid-up shares of any
denomination.
37. The holders of stock may transfer the same or any part
thereof in he same manner as, and subject to the same
regulations under which, the shares from which the stock
arose might before the conversion have been transferred,
or as near thereto as circumstances admit:
Provided that the Board may, from time to time, fix the
minimum amount of stock transferable, so , however, that
such minimum shall not exceed the nominal amount of the
shares from which the stock arose.
38. The holders of stock shall, according to the amount of stock
held by the, have the same rights, privileges and advantages
as regards dividends, voting at meetings of the company,
and other matters, as if they held the shares from which the
stock arose; but no such privilege or advantage (except
participation in the dividends and profits of the company
and in the assets on winding-up) shall be conferred by an
amount of stock which would not, if existing in shares, have
conferred that privilege or advantage.
39. Such of the regulations of the company (other than those
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relating to share warrants), as are applicable to paid-up
shares shall apply to stock and the words, “share” and
“shareholder” in those regulations shall include “stock” and
“stockholder” respectively.
Share Warrants
40. The company may issue share warrants subject to, and in
accordance with, the provisions of sections 114 and 115;
and accordingly the Board may in its discretion, with respect
to any share which is fully paid-up, on application in writing
signed by the person registered as holder of the share, and
authenticated by such evidence (if any) as the Board may,
from time to time, require as to the identity of the person
signing the application, and on receiving the certificate (if
any) of the share, and the amount of the stamp duty on the
warrant and such fee as the Board may from time to time
require, issue a share warrant.
41. (1) The bearer of a share warrant may at any time deposit
the warrant at the office of the company, and so long as the
warrant remains so deposited, the depositor shall have the
same right of signing a requisition for calling a meeting of
the company, and of attending, and voting and exercising
the other privileges of a member at any meeting held after
the expiry of two clear days from the time of deposit, as if
his name were inserted in the register of members as the
holder of the shares included in the deposited warrant.
(2) Not more that one person shall be recognised as depositor
of the share warrant.
(3) The company shall, on two days’ written notice, return
the deposited share warrant to the depositor.
42. (1) Subject as herein otherwise expressly provided, no
person shall, as bearer of a share warrant, sign a requisition
for calling a meeting of the company, or attend, or vote or
exercise any other privilege of a member at a meeting of
the company, or be entitled to receive any notices from the
company.
(2) The bearer of a share warrant shall be entitled in all
other respects to the same privileges and advantages as if
he were named in the register of members as the holder of
the shares included in warrant, and he shall be a member of
the company.
43. The Board may, from time to time, make rules as to the
terms on which (if it shall think fit) a new share warrant or
coupon may be issued of by way of renewal in case of
defacement, loss or destruction.
Alteration of capital
44. The company may, from time to time, by ordinary resolution
increase the share capital by such sum, to be divided into
shares of such amount, as may be specified in the resolution.
45. The company may, by ordinary resolution,-
(a) consolidate and divide all or any of its share capital
into shares of larger amount that its existing shares;
(b) sub-divide its existing shares or any of them into
shares of smaller amount that is fixed by the
 memorandum, subject, nevertheless, to the provisions
of clause (d) of sub-section (1) of section 94;
(c) cancel any shares which, at the date of the passing of
the resolution, have not been taken or agreed to be
taken by any person.
46. The company may, by special resolution, reduce in any
manner and with, and subject to, any incident authorized
and consent required by law, -
(a) its share capital;
(b) any capital redemption reserve account; or)
(c) any share premium account
General Meetings
47. All general meetings other than annual general meetings
shall be called extraordinary general meetings.
48. (1) The Board may, whenever it thinks fit, call an
extraordinary general meeting.
(2) If at any time there are not within India directors capable
of acting who are sufficient in number to form a quorum,
any director or any two members of the company may call
an extraordinary general meeting in the same manner, as
nearly as possible, as that in which such a meeting may be
called by the Board.
49. (1) No business shall be transacted at any general meeting
unless a quorum of members is present at the time when the
meeting proceeds to business.
(2) Save as herein otherwise provided, five members present
in person, (in the case of a public company) - two members
present in person, (in the case of a private company) shall
be a quorum.
50. The chairman, if any, of the Board shall preside as chairman
at every general meeting of the company.
51. If there is no such chairman, or if he is not present within
fifteen minutes after the time appointed for holding the
meeting, or is unwilling to act as chairman of the meeting,
the directors present shall elect one of their number to be
chairman of the meeting.
52. If at any meeting no director is willing to act as chairman or
if no director is present within fifteen minutes after the time
appointed for holding the meeting, the members present
shall choose one of their number to be chairman of the
meeting.
53. (1) The chairman may, with the consent of any meeting at
which a quorum is present, and shall, if so directed by the
meeting, adjourn the meeting from time to time and from
place to place.
(2) No business shall be transacted at any adjourned for
thirty days or more, notice of the adjourned meeting shall
be given as in the case of an original meeting.
(3) When a meeting is adjourned for thirty days or more,
notice of an adjournment or of the business to be transacted
at an adjourned meeting.
(4) Save as aforesaid, it shall not be necessary to give any
notice of an adjournment or of the business to be transacted
at an adjourned meeting.
54. In the case of an equality of votes, whether on a show of
hands or on a poll, the chairman of the meeting at which
the show of hands takes place, or at which the poll is
demanded, shall be entitled to a second or casting vote.
55. Any business other than that upon which a poll has been
demanded may be proceeded with, pending the taking of
the poll.
Votes of Members
56. Subject to any rights or restrictions for the time being attached
to any class or classes of shares,-
(a) On a show of hands, every member present in person
shall have one vote; and
(b) on a poll, the voting rights of members shall be as
laid down in section 87.
57. In the case of joint holders, the vote of the senior who tenders
a vote, whether in person or by proxy, shall be accepted to
the exclusion of the votes of the other joint holders.
For this purpose, seniority shall be determined by the order
in which the names stand in the register of members.
58. A member of unsound mind, or in respect of whom an order
has been made by any Court having jurisdiction in lunacy,
may vote, whether on a show of hands or on a poll, by his
committee or other legal guardian, and any such committee
or guardian may, on a poll, vote by proxy.
59. No member shall be entitled to vote at any general meeting
unless all calls or other sums presently payable by him in
respect of shares in the company have been paid.
60. (1) objection shall be raised to the qualification of any voter
except at the meeting or adjourned meeting at which the
vote objected to is given or tendered, and every vote not
disallowed at such meeting shall be valid for all purposes.
(2) Any such objection made in due time shall be referred
to the chairman of the meeting; whose decision shall be
final and conclusive.
61. The instrument appointing a proxy and the power of attorney
or other authority under which the proxy was executed, or
the transfer of the shares in respect of which the proxy is
given:
Provided that no intimation in writing of such death, insanity,
revocation or transfer shall have been received by the
company is its office before the commencement of the
meeting or adjourned meeting at which the proxy is used.
Board of Directors
64. The number of the directors and the names of the first
directors shall be determined in writing by the subscribers
of the memorandum or a majority of them.
65. (1) In addition to the remuneration payable to them in
pursuance of the Act, the directors may be paid all travelling,
hotel and other expenses properly incurred by them -
(a) in attending and returning from meetings of the Board
of Directors or any committee thereof or general
meetings of the company; or
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 (b) in connection with the business of the company.
66. This qualification of a director shall be the holding of at
least one share in the company.
67. The Board may pay all expenses incurred in getting up and
registering the company.
68. The company may exercise the powers conferred by section
50 with regard to having an official seal for use abroad, and
such powers shall be vested in the Board.
69. The company may exercise the powers conferred on it by
sections 157 and 158 with regard to the keeping of a foreign
register; and the Board may (subject to the provisions of
those sections) make and vary such regulations as it may
think fit respecting the keeping of any such register.
70. All cheques, promissory notes, drafts, hundies, bills of
exchanged and other negotiable instruments, and all receipts
for moneys paid to the company, shall be signed, drawn,
accepted, endorsed, or otherwise executed, as the case may
be, by such person and in such manner as the Board shall
from time to time by resolution determine.
71. Every director present at any meeting of the Board or of a
committee thereof shall sign his name in a book to be kept
for that purpose.
72 (1) The Board shall have power at any time, and from time
to time, to appoint a person as an additional director,
provided the number of the directors and additional directors
together shall not at any time exceed the maximum strength
fixed for the Board by the articles.
(2) Such person shall hold office only up to the date of the
next annual general meeting of the company but shall be
eligible for appointment by the company as a director at
that meeting subject to the provisions of the Act.)
Proceedings of Board
73. (1) The Board of directors may meet for the despatch of
business, adjourn and otherwise regulate its meetings, as it
thinks fit.
(2) A director may, and the manager or secretary on the
requisition of a director shall, at any time summon a meeting
of the Board.
74. (1) Save as otherwise expressly provided in the Act,
questions arising at any meeting of the Board shall be
decided by a majority of votes.
(2) In case of an equality of votes, the chairman of the
Board, if any, shall have a second or casting vote.
75. The continuing directors may act not withstanding any
vacancy in the Board; but, if and so long as their number is
reduced below the quorum fixed by the Act for a meeting
of the Board, the continuing directors to that fixed for the
quorum, or of summoning a general meeting of the company,
but for no other purpose.
76 (1) The Board may elect a chairman of its meetings and
determine the period for which he is to hold office.
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(2) If no such chairman is elected, or if at any meeting
the chairman is not present within five minutes after
the time appointed for holding the meeting, the
directors present may choose one of their number to
be chairman of the meeting.
77. (1) The Board may, subject to the provisions of the Act,
delegate any of its powers to committees consisting of such
member or members of its body as it think fit.
(2) Any committee so formed shall, in the exercise of the powers
so delegated, conform to any regulations that may be
imposed on it by the Board.
78 (1) A committee may elect a chairman of its meetings.
(2) If no such chairman is elected, or if at any meeting the
chairman is not present within five minutes after the time
appointed for holding the meeting, the members present
may choose one of their number to be chairman of the
meeting.
79. (1) A committee may meet and adjourn as it thinks proper.
(2) Questions arising at any meeting of a committee shall be
determined by a majority of votes of the members present,
and in case of an equality of votes, the chairman shall have
a second or casting vote.
80. All acts done by any meeting of the Board or of a committee
thereof or by any person acting as a director, shall,
notwithstanding that it may be afterwards discovered that
there was some defect in the appointment of any one or
more of such directors or of any person acting as aforesaid,
or that they or any of them were disqualified, be as valid as
if every such director or such person had been duly
appointed and was qualified to be a director.
81. Save as otherwise expressly provided in the Act, a resolution
in writing, signed by all the members of the Board or of a
committee thereof, for the time being entitled to receive
notice of a meeting of the Board or committee, shall be as
valid and effectual as if it had been passed at a meeting of
the Board or committee, duly convened and held.
Manager or Secretary
82. Subject to the provisions of the Act,-
(1) a manger or secretary may be appointed by the Board
for such term, at such remuneration and upon such
conditions as it may think fit; and any manager or secretary
so appoint may be removed by the Board,
(2) a director may be appointed as manager or secretary.)
83. A provision of the Act, or these regulations requiring or
authorising a thing to be done by or to a director and the
manager or secretary shall not be satisfied by its being done
by or to the same person acting both as director and as or in
place of, the manager or secretary.
The Seal
84. (1) The Board shall provide for the safe custody of the
seal.
(2) The seal of the company shall not be affixed to any
instrument except by the authority of a resolution of the
Board or of a committee of the Board authorised by it in
that behalf, and except in the presence of at least two
directors and of the secretary or such other person as the
Board may appoint for the purpose; and those two directors
and the secretary or other person as aforesaid shall sign
every instrument to which the seal of the company is so
affixed in their presence.
85. The company is general meeting may declare dividends,
but no dividend shall exceed the amount recommended by
the Board.
86. The Board may from time to time pay to the members such
interim dividends as appear to it to be justified by the profits
of the company.
87. (1) The Board may, before recommending any dividend,
set aside out of the profits of the company such sums as it
thinks proper as a reserve or reserves which shall, at the
discretion of the Board, be applicable, for any purpose to
which the profits of the company may be properly applied,
including provision for meeting contingencies or for
equalising dividends; and pending such application, may,
at the like discretion, either be employed in the business of
the company or be invested in such investment (other than
shares of the company) as the Board may, from time to time
think fit.
(2) The Board may also carry forward any profits which it
may think prudent not to divide, without setting them aside
as a reserve.
88. (1) Subject to the rights of persons, if any, entitled to shares
with special rights as to dividends, all dividends shall be
declared and paid according to the amounts paid or credited
as paid on t he shares in respect whereof, the dividend is
paid, but if and so long as nothing is paid upon any of the
shares in the company, dividends may be declared and paid
according to the amounts of the shares.
(2) No amount paid or credited as paid on a share in advance
of calls shall be treated for the purposes of this regulations
as paid on the share.
(3)All dividends shall be apportioned and paid
proportionately to the amounts paid or credited as paid on
the shares during any portion or portions of the period in
respect of which the dividend is paid; but if any share is
issued on terms providing that it shall rank for dividend as
from a particular date such shares shall rank for dividend
accordingly.
89. The Board may deduct from any dividend payable to any
member all sums of money, if any, presently payable by
him to the company on account of calls or otherwise in
relation to the shares of the company.
90 [Omitted]
91 (1) Any dividend, interest or other moneys payable in cash
in respect of shares may be paid by cheque or warrant sent
through the post directed to the registered address of the
holder or, in the case of joint holders, to the register of
members, or to such person and to such address as the holder
or joint holders may in writing direct.
(2) Every such cheque or warrant shall be made payable to the
order of the person to whom it is sent.
92. Any one of two or more joint holders of a share may give
effectual receipts for any dividends, bonuses or other
moneys payable in respect of such share.
93. Notice of any dividend that may have been declared shall
be given to the persons entitled to share therein the manner
mentioned in the Act.
94. No dividend shall bear nearest against the company.
Accounts
95. (1) The Board shall from time to time determine whether
and to what extent and at what times and places and under
what conditions or regulations, the accounts and books of
the company, or any of them, shall be open to the inspection
of members not being directors.
(2) No member (not being a director) shall have any right of
inspecting any accounts or books or document of the
company except as conferred by law or authorised by the
Board or by the company in general meeting.
Capitalisation of Profits
96. (1) The company in general meeting may, upon the
recommendation of the Board, resolve-
(a) that it is desirable to capitalise any part of the amount
for the time being standing to the credit of any of the
company’s reserve accounts, or to the credit of the
profit and loss account, or otherwise available for
distribution; and
(b) that such sum be accordingly set free for distribution
in the manner specified in clause (2) amongst the
members who would have been entitled thereto if
distributed by way of dividend and in the same
proportions.
(2) The sum aforesaid shall not be paid in cash but shall be
applied, subject to the provision contained in clause (3),
either in or towards -
(i) paying up any amounts for the time being unpaid on
any shares held by such members respectively;
(ii) paying up in full, unissued shares of the company to
be allotted and distributed, credited as fully paid up,
to and amongst such members in the proportions
aforesaid; or
(iii) partly in the way specified in sub-clause (i) and partly
in that specified in sub-clause (ii).
(3) A share premium account and a capital redemption reserve
account may, for the purposes of this regulation, only be
applied in the paying up of unissued shares to be issued to
members of the company as fully paid bonus shares.
(4) The Board shall give effect to the resolution passed by the
company in pursuance of this regulation.
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97. (1) Whenever such a resolution as aforesaid shall have been
passed, the Board shall -
(a) make all appropriations and applications of the
undivided profits resolved to be capitalised thereby,
and all allotments and issues of fully paid shares if
any; and
(b) generally do all acts and things required to give effect
thereto.
(2) The Board shall have full power -
(a) to make such provision, by the issue of fractional
certificates or by payment in cash or otherwise, as t
thinks fit, for the case of shares or debentures
becoming distributable in fractions; and also;
(b) to authorise any person to enter, on behalf of all the
members entitled thereto into an agreement with the
company providing for the allotment to them
respectively, credited as fully paid-up, of any further
shares to which they may be entitled upon such
capitalisation or (as the case may require) for the
payment up by the company on their behalf, by the
application thereto their respective proportions of the
profits resolved to be capitalised, of the amounts or
any part of the amounts remaining unpaid in their
existing shares.
(3) Any agreement made under such authority shall be effective
and binding in all such members.
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Winding-Up
98. (1) If the company shall be wound-up, the liquidator may,
with the sanction of a special resolution of the company
and any other sanction required by the Act, divide among
the members, in special or kind, the whole or any part of
the assets of the company, whether they shall consist of
property of the same kind or not.
(2) For the purpose aforesaid, the liquidator may set such value
as he deems fair upon any property to be divided as aforesaid
and may determine how such division shall be carried out
as between the members or different classes of members.
(3) The liquidator may, with the like sanction, vest the whole
or any part of such assets in trustees upon such trusts for
the benefit of the contributories as the liquidators, with the
like sanction shall think fit, but so that no member shall be
compelled to accept any shares or other securities whereon
there is any liability.
Indemnity
99. Every officer or agent for the time being of the company
shall be indemnified out of the assets of the company against
any liability incurred by him in defending any proceedings,
whether civil or criminal, in which judgement is given in
his favour or in which he is acquitted or in connection with
any application under section 633 in which relief is granted
to him by the Court.
6. COMMENCEMENT OF BUSINESS
SUB - TOPICS
6.1. Formal procedures for commencing business at a glance.
6.2. Restriction on commencement of business.
6.3. Issue of prospectus or statement in lieu of prospectus.
6.4. A few other issues.
6.5. Certificate to commence business and its effect.
6.6 Annexure
6.1. FORMAL PROCEDURES FOR COMMENCING
BUSINESS AT A GLANCE
At a glance:
1. A public company having a share capital has to issue a
prospectus inviting public to subscribe for shares; and
2. The prospectus thus issued must be delivered to the Registrar
for registration on or before the date of publication.
OR
A company not requiring to call for public subscription is
required to issue a statement in llieu of prospectus, and the
statement in lieu of prospectus is required to be registered with
the Registrar in the same manner as the prospectus is required
to be registered.
3. Shares are to be allotted to the applicants.
4. A return of allotment is to be filed with the Registrar within
30 days.
5. Certificate from every Director is to be procurred, stating
that he has paid to the company the money for shares taken
by him or promises to pay the money for shares contracted
to be taken by him.
6. A duly verified declaration by one of the Directors or the
Secretary in the prescribed form stating that :
(a) a minimum subscription has been raised;
(b) Directors have paid for the shares or agree to pay for
them; and that
(c) no money is repaid to applicants by reason of failure
to apply for or to obtain permission for listing in a
recognised stock exchange (when the company issued
the prospectus), has to be filed with the Registrar.
7. Every Director has to give a certificate that he is agreeable
to act as such.
8. A Registrar shall on filing of a duly verified declaration as
stated above certify that the company is entitled to commence
business.
(Refer to Sections 44(1), 56, 61,70 and 149)
6.2. RESTRICTION ON COMMENCEMENT OF
BUSINESS
A public limited company after receiving the certificate of
incorporation cannot commence business unless it receives the
trading certificate. This public company after receiving the
certificate of incorporation may be required to raise capital from
the public. In that case it has to issue a prospectus as laid down
in Sec.56 read with part-I and II of Schedule II of the Company
Act. If the company does not raise capital from the public it is
not to issue a prospectus inviting a public to susbcribe but it has
to file with the Registrar a statement in lieu of prospectus as
stipulated under Sec. 70(1) read with Schedule III of the
Company Act.
The law relating to obtaining trading certificate is specified in
Sec.69 and Sec.149. Both these sections stipulate negative
conditions that may stand in the way of issuing a certificate to
commence business. According to Sec. 69(1) company cannot
allot shares unless the amount stated in the prospectus as
minimum subscription has been raised and the application money
thereon has been received by the company. According to Sec.
149 a company cannot commence business unless:
(a) shares held subject to the payment of the whole amount
thereof in cash has been allotted to an amount not
less than the minimum subscription;
(b) every Director of the company has paid to the company
for the shares taken or contracted to be taken by him
for which he is liable to pay in cash;
(c) no money is or may become liable to be paid to the
applicants by reason of any failure to apply for or to
obtain permission for listing in any recognised stock
exchange; and
(d) there has been filed with the Registrar a duly verified
declaration by one of the Directors or the Secretary,
in the prescribed form, that the previous conditions
in (a),(b) and (c) have been complied with.
According to Sec.149(3) the Registrar shall, on filing of a duly
verified declaration as stated above certify that the company is
entitled to commence business and that certificate shall be
conclusive evidence that the company is so entitled. If any
company commences business in contravention of Sec.149 every
person who is responsible for the contravention shall be
punishable with fine upto Rs.500/- for every day during which
the contravention continues.
A company which has issued statement in lieu of prospectus
shall also submit a duly verified declaration by one of its
Directors or the Secretary that the Directors have paid to the
company for each of the shares taken or contracted for. On
receiving the verified declaration the Registrar shall issue the
certificate for commencing business. An existing company
which has to start a business falling in the subsidiary or ancilliary
issues or other issues in the object clause cannot start a business
under that clause unless a special resolution is passed on that
behalf in the Annual General Meeting, and a verified declaration
by one of the Directors or Secretary to that effect is filed with
the Registrar.
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6.3. ISSUE OF PROSPECTUS OR STATEMENT IN
LIEU OF PROSPECTUS
A prospectus has been defined as any document, notice or
circular inviting deposits from the public or offers from the public
for the subscription or purchase of any shares in or debentures
of a body corporate. [Sec. 2(36)] A prospectus issued by or on
behalf of the company shall be dated which shall be its date of
publication. The prospectus shall contain the matters as provided
in Schedule II of the Company Act. Some of these are as follows:
1) Main objects of the company;
2) Name, address, description and occupation of the
signatories;
3) Number and class of shares;
4) Number of redeemable shares with the date of redemption;
5) Number of qualification shares of Directors, if any;
6) Remuneration of Directors;
7) Main address, description and occupation of Director,
Managing Director, Secretary and Manager;
8) Shares offered to the public for subscription;
9) Minimum subscription required for purchase of property,
preliminary expenses, repayment of money borrowed,
working capital and other expenses;
10) Time of the opening of the subscription list;
11) Substance of important contracts;
12) Share premium payable if any;
13) Names and addresses of underwriters and their obligations;
14) Name, address, description and occupation of the vendors;
15) Particulars of the nature and interest of the promoters of
the company or property acquired of every Director or
Promoter;
16) A report of the auditor in respect of profit and loss and
excess of liabilities, rates of dividends, if any, etc;
17) If proceeds of the issue is to be applied directly or indirectly
towards purchase of the business a financial report about
the business as certified by the auditor.
The prospectus is to be signed by the Directors, Secretary and
the Manager.
A statement in lieu of prospectus as specified in Sec.70 includes:
i) nominal share capital of the company;
ii) names, addresses, description and occupation of Director,
Managing Director, Secretary and Manager;
iii) Number and amount of shares, debentures agreed to be
issued as fully or partly paid up;
iv) amount payable to each vendor;
v) amount to be paid to the promoter;
vi) amount payable as commission;
vii) the statement is to be signed by the Directors or their agents
authorised in writing.
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Legal status of Prospectus:
A prospectus is not a mere statement but it contains absolute
disclosure of the company. The matter shall be discussed in
detail in the module on protection of investor’s interest. No
application form is valid for the share capital unless it is
accompanied by a prospectus. The prospectus is required to be
registered with the Registrar on or before the day of publication.
Since this is the document on which the prospective
sharesholders apply for entering into the contract with the
company the statements made in the prospectus are treated as
conditions and terms of contract. Any misstatement in the
prospectus therefore may either become a fraud or a
misrepresentation thereby making the contract voidable. Of
course one may argue that since the Act has criminalized the
untrue statement in a prospectus the act is an unlawful one and
therefore the agreement is void. In between these two
probabilities the nature of the untrue statement shall determine
the position. An untrue statement which is immaterial or is
reasonably believed as true at the time of issue of the statement
shall create only civil liability of damages.
An untrue statement whether it is a fraud or misrepresentation
makes the contract voidable only at the option of the shareholder.
Contracts made before receiving the trading certificate .
Section 149 (4) provides that a contract made by a public
company before obtaining the trading certificate is provisional
only. Palmer states that the words of the section are very wide
and would appear to extend to all contracts including contracts
of membership constituted by application for shares and
allotment. (22nd ed., p.273). But Pennington takes a different
view. He says:- “Since the purpose of the section is to prevent
the company from commencing to carry on its business until it
obtains the trading certificate, contracts which are not directly
concerned with carrying on its business are outside the ambit of
the section and are binding immediately they are entered into”
(15th Edn. p.92). According to this view, contracts for the
allotment of shares, underwriting contracts etc. being contracts
not directly concerned with the carrying on of the company’s
business are outside the ambit of Section 149(4). This view
seems to be preferable.
6.4. A FEW OTHER ISSUES
1. Can a Trading Certificate be avoided ?
Though a public company having a share capital can commence
its business only on obtaining the trading certificate, in practice
this is avoided by incorporating the company initially as a private
company and later converting it into a public company.
2. Legal effect of transactions entered into before obtaining
the trading certificate
Before 1985 the English Law was the same as that under the
Indian Company Act, 1985, i.e., transactions entered into by
companies before obtaining the trading certificate are valid and
binding on the company as well as the other party.[Section
117(8)]. But if a public company commences business before
obtaining the trading certificate the company and the officers in
default will incur penal liability [Section 117(7)].
3. What happens if Trading Certificate is not or cannot be
obtained ?
A public company which fails to obtain the trading certificate
within one year of its incorporation is liable to be wound
up.(Sec.433(c))
6.5 CERTIFICATE TO COMMENCE BUSINESS AND
ITS EFFECT
Once the Registrar issues the certificate of commencing the
business all contracts made against the company become
operative.According to Sec. 149(4) contracts made after the date
of incorporation, but before it is entitled to commence business
shall be provisional only. These shall become binding on the
day of receiving the trading certificate.Contract made during
this time by the Directors or the promoters will ordinarily bind
the company,if the position of the company is disclosed (if the
company is stipulated as the principal).
6.6 ANNEXURE
A draft prospectus is given in Schedule II as follows:
Matters to be specified in Prospectus and Reports to be
set out therein
[See sections 44(2) (a) and 56]
Part I
Matters to be Specified
1. (1) Save as hereinafter provided in clause 27, the main
objects of the company, with the names, addresses,
descriptions and occupations of the signatories of the
memorandum and the number of shares subscribed for by
them.
(2) The number and classes of shares, if any, and the nature
and extent of the interest of the holders in the property and
profits of the company.
(3) The number of redeemable preference shares intended
to be issued, with the date of redemption or, where no date
is fixed the period of notice required for redeeming the
shares and the proposed method of redemption.
2. (1) The number of shares, if any, fixed by the articles as the
qualification of a director.
(2) Any provision in the articles as to the remuneration of
the directors whether for their services to the company as
directors, managing directors or otherwise.
3. (1) The names, addresses, description and occupations of-
(a) the directors or proposed directors;
(b) the managing director or proposed managing director,
if any;
(c) [ * * * * ]
(d) [ * * * * ]
(d) the manger or proposed manger, if any:
Provided that
(i) where any such person is already a director, managing
director or manager of any other company or
(ii) where any such person (including a firm or a body
corporate) is already a managing agent or secretaries
and treasurers of any other company,
the matters to be specified under this clause shall include the
names of all the companies in which such person is a director,
managing director or manger and, where, any such person is a
firm or a body corporate the said particulars shall be given in
respect of every partner of the firm or, as the case may be, in
respect of every director of the body corporate.]
(2) Any provision in the articles or in any contract which
has been entered into as to the appointment of a managing
director, or manager, the remuneration payable to him or
them, and the compensation, if any, payable to him or them
for loss of office.
4. [ * * * * ]
5. Where shares are offered to the public for subscription,
particulars to -
(a) the minimum amount which, in the opinion of the directors
or of the signatories of the memorandum arrived at after
due inquiry, must be raised by the issue of those shares in
order to provide the sums, or, if any part thereof is to be
defrayed in any other manner, the balance of the sums
required to be provided in respect of each of the following
heads and distinguishing the amount required under each
head:-
(i) the purchase price of any property purchased or to be
purchased which is to be defrayed in whole or in part
out of the proceeds of the issue;
(ii) any preliminary expenses payable by the company,
and any commission so payable to any person in
consideration of his agreeing to subscribe for, or of
his procuring or agreeing to procure subscriptions for,
any shares in the company;
(iii) the repayment of any moneys borrowed by the
company in respect of any of the foregoing matters;
(iv) working capital;
(v) any other expenditure, stating the nature and purpose
thereof and the estimated amount in each case; and
(b) the amounts to be provided in respect of the matters
aforesaid otherwise than out of the proceeds of the issue
and the sources out of which those amounts are to be
provided.
6. The time of the opening of the subscription lists.
7. The amount payable on application and allotment on each
share, and in the case of a second or subsequent offer of shares,
the amount offered for subscription on each previous allotment
made within the two proceeding years, the amount actually
allotted, and the amount, if any, paid on the share so allotted.
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8. The substance of any contract or arrangement or proposed
contract or arrangement, whereby any option or preferential right
of any kind has been or is proposed to be given to any person to
subscribe for any shares in or debentures of, a company, giving
the number, description and amount of any such shares or
debentures and including the following particulars of the option
or right:—
a) the period during which the option or right is
exercisable;
b) the price to be paid for shares or debentures subscribed
for under the option or right;
c) the consideration, if any, given or to be given for the
option or right or for the right thereto;
d) the names, addresses, descriptions and occupations,
of the persons to whom the option or right or the rights
thereto has been given or is proposed to be given or,
if given to existing share-holders or debenture-holders
as such, the description and numbers of the relevant
shares or debentures;
e) any other material fact or circumstances relevant to
the grant of the option or right.
Explanation– Subscribing for shares or debentures shall, for the
purposes of this clause, include acquiring them from a person
to whom they have been allotted or agreed to be allotted with a
view to his offering them for sale.
9. The number, description and amount of shares and debentures
which within the two preceding years have been issued or agreed
to be issued, as fully or partly paid-up otherwise than in cash
and in the latter case the extent to which they are so paid-up,
and in either case the consideration for which those shares or
debentures have been issued or agreed to be issued.
10. The amount paid or payable by way of premium, if any, on
each share which had been issued within the two years preceding
the date of the prospectus or is to be issued, stating the dates or
proposed dates of issue and, where some shares have been or
are to be issued at a premium and other shares of the same class
at a lower premium, or at par or at a discount, the reasons for
the differentiation and how any premiums received have been
or are to be disposed of.
11. Where any issue of shares or debentures is underwritten, the
names of the underwriters and the opinion of the directors that
the resources of the underwriters are sufficient to discharge their
obligations.
12. (1) As respects any property to which this clause applies–
a) the names, addresses, descriptions and occupations
of the vendors;
b) the amount paid or payable in cash, shares or
debentures to the vendor and, where there is more
than one separate vendor, or the company is a sub-
purchase, the amount so paid or payable to each
vendor, specifying separately the amount, if any, paid
or payable for goodwill;
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c) the nature of the title or interest in such property
acquired or to be acquired by the company;
d) short particulars of every transaction relating to the
property completed within the two preceding years,
in which any vendor of the property to the company
or any person who is, or was at the time of the
transaction, a promoters, or a director, or proposed
director of the company or any person who is, or was
at the time of the transaction, a promoters, or a director
or proposed director of the company had any interest,
director or indirect, specifying the date of the
transaction and the name of such promoter, director
or proposed director and stating the amount payable
by or to such vendor, promoter, director or proposed
director in respect of the transaction.
(2) The property to which sub-clause (1) applies is property
purchased or acquired by the company or proposed so to
be purchased or acquired, which is to be paid for wholly or
partly out of the proceeds of the issue offered for
subscription by the prospectus or the purchase or acquisition
of which has not been completed at the date of the issue of
the prospectus, other than property-
(a) the contract for the purchase or acquisition whereof
was entered into in the ordinary course of the
company's business, the contract not being made in
contemplation of the issue nor the issue in
consequence of the contract; or
(b) as respects which the amount of the purchase money
is not material.
(3) For the purposes of this clause, where any of the vendors is
a firm, the members of the firm shall not be treated as
separate vendors.
13. The amount, if any, or the nature and extent of any
consideration, paid within the two preceding years, or payable,
as commission to any person (including commission so paid or
payable to any sub-underwriter, who is a promoter or officer of
the company) for subscribing or agreeing to subscribe, or
procuring or agreeing to procure subscriptions for any shares
in, or debentures of the company; and giving also the following
particulars, namely:-
(a) the name, address, description and occupation of each
such person;
(b) particulars of the amounts which each has underwritten
or sub-underwritten as aforesaid;
(c) the rate of the commission payable to each for such
underwriting or sub-underwriting;
(d) any other material term or condition of the
underwriting or sub-under-writing contract with each
such person; and
(e) when any such person is a company or a firm, the
nature of any interest direct or indirect, in such
company or firm of any promoter or officer of the
company in respect of which the prospectors is issued.
14. (1) Save as hereinafter provided in clause 27, the amount
or estimated amount of preliminary expenses and the persons
by whom any of those expenses have been paid or are
payable.
(2) Save as aforesaid, the amount or estimated amount of
the expenses of the issue and the persons by whom any of
those expenses have been paid or are payable.
15. Any amount or benefit paid or given within the two preceding
years or intended to be paid or given to any promoter or officer
and the consideration for the payment or the giving of the benefit.
16. (1) The dates of, parties to, and general nature of—
(a) every contract appointing or fixing the remuneration
of a managing director [ * * * * * * ] or manager
whenever entered into, that is to say, whether within
or more than, two years before the date of the
prospectors;
(b) every other material contract, not being a contract
entered into in the ordinary course of the business
carried on or intended to be carried on by the company
or a contract entered into more than two years before
the date of the prospectus.
(2) A reasonable time and place at which any such contract
or a copy thereof may be inspected.
17. The names and addresses of the auditors, if any, of the
company.
18. (1) Full particulars of the nature and extent of the interest if
any, of every director or promoter —
(a) in the promotion of the company; or
(b) in any property acquired by the company within two
years of the date of the prospectus or proposed to be
acquired by it.
(2) Where the interest of such a director or promoter consists
in being a member of a firm or company, the nature and
extent of the interest of the firm or company, with a statement
of all sums paid or agreed to be paid to him or to the firm or
company in cash or shares or otherwise by any person either
to induce him to become, or to qualify him as, a director,
or otherwise for services rendered by him or by the firm or
company, in connection with the promotion or formation of
the company.
19. If the share capital of the company is divided into different
classes of shares, the right of voting at meetings of the company
conferred by, and the rights in respect of capital and dividends
attached to, the several classes of shares respectively.
20. Where the articles of the company impose any restriction
upon the members of the company in respect of the right to
attend, speak or vote at meeting of the company or of the right
to transfer shares, or upon the directors of the company in respect
of their powers of management, the nature and extent of those
restrictions.
21. (1) In the case of the company which has been carrying on
business, the length of time during which the business of
the company has been carried on.
(2) If the company proposes to acquire a business which
has been carried on for less than three years, the length of
time during which the business has been carried on.
22. (1) If any reserves or profits of the company or any of its
subsidiaries have been capitalized, particulars of the
capitalization.
(2) Particulars of the surplus arising from any revaluation
of the assets of the company or any of its subsidiaries during
the two years preceding the date of the prospectus and the
manner in which such surplus has been deal with.
23. A reasonable time and place at which copies of all balance-
sheets and profit and loss accounts, if any, on which the report
of the auditors under Part II of this Schedule is based may be
inspected.
PART II
Reports to be set out
24. (1) A report by the auditors of the company with respect
to—
(a) profits and losses and assets and liabilities, in
accordance with sub-clause (2) or (3) of this clause,
as the case may require; and
(b) the rates of the dividends, if any, paid by the company
in respect of each class of shares in the company for
each of the five financial years immediately preceding
the issue of the prospectus, giving particulars of each
class of shares on which sub dividends have been paid
and particulars of the case in which no dividends have
been paid in respect of any class of shares for any of
those years;
and, if no accounts have been made up in respect of any part of
the period of five years ending on a date three months before
the issue of the prospectus, containing a statement of that fact
[and accompanied by a statement of the accounts of the company
in respect of that part of the said period up to a date not earlier
than six months of the date of issue of the prospectus indicating
the profit or loss for that period and the assets and liabilities
position as at the end of that period together with a certificate
from the auditors that such accounts have been examined and
found correct by them. The said statement may indicate the
nature of provision or adjustments made or are yet to be made.]
(2) If the company has no subsidiaries, the report shall—
(a) so far as regards profits and losses, deal with the profits
or losses of the company (distinguishing items of a
non-recurring nature) for each of the five financial
years immediately preceding the issue of the
prospectus; and
(b) so far as regards assets and liabilities, deal with the
assets and liabilities of the company at the last date to
which the accounts of the company were made up.
(3) If the company has subsidiaries the report shall—
(a) so far as regards profits and losses, deal separately
with the company's profits or losses as provided by
sub-clause (2) and in addition deal either—
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 (i) as a whole with the combined profits or losses of its
subsidiaries, so far as they concern members of the
company; or
(ii) individually with the profits or losses of each
subsidiary, so far as they concern members of the
company;
or, instead of dealing separately with the company's
profits or losses, deal as a whole with the profits or
losses of the company, and, so far as they concern
members of the company, with the combined profits
or losses of its subsidiaries; and
(b) so far as regards assets and liabilities, deal separately
with the company's assets and liabilities provided by
sub-clause (2) and in addition, deal either:—
(i) as a whole with the combined assets and liabilities of
its subsidiaries, with or without the company's assets
and liabilities, or
(ii) individually with the assets and liabilities of each
subsidiary;
and shall indicate as respects the assets and liabilities
of the subsidiaries, the allowance to be made for
persons other than members of the company.
25. If the proceeds, or any part of the proceeds, of the issue of
the shares or debentures are or is to be applied directly or
indirectly—
(i) in the purchase of any business; or
(ii) in the purchase of an interest in any business and by
reason of that purchase or, anything to be done in
consequence thereof, or in connection therewith, the
company will become entitled to an interest as respect
either the capital or profits and losses or both, in such
business exceeding fifty per cent, thereof;
a report made by accountants (who shall be named in the
prospectus) upon—
(a) the profits or losses of the business for each of the
five financial years immediately preceding the issue
of the prospectus; and
(b) the assets and liabilities of the business at the last date
to which the accounts of the business were made up,
being a date not more than one hundred and twenty
days before the date of the issue of the prospectus.
26. (1) If—
(a) the proceeds, or any part of the proceeds, of the issue
of the share or debentures are or is to be applied
directly or indirectly in any manner resulting in the
acquisition by the company of shares in any other body
corporate; and
(b) by reason of that acquisition or anything to be done in
consequence thereof or in connection therewith, that
body corporate will become a subsidiary of the
company;
a report made by accountants (who shall be named in the
prospectus) upon—
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(i) the profits or losses of the other body corporate for
each of the five financial years immediately preceding
the issue of the prospectus; and
(ii) the assets and liabilities of the other body corporate
at the last date to which its accounts were made up.
(2) The said report shall—
(a) indicate how the profits or losses of the other body
corporate dealt with by the report would, in respect
of the shares to be acquired, have concerned members
of the company and what allowance would have fallen
to be made, in relation to assets and liabilities so dealt
with, for holders of other shares, if the company had
at all material times held the shares to be acquired;
and
(b) where the other body corporate has subsidiaries, deal
with the profits or losses and the assets and liabilities
of the body corporate and its subsidiaries in the manner
provided by sub-clause (3) of clause 24 of this
Schedule in relation to the company and its
subsidiaries.
PART III
Provisions Applying to Parts I and II of Schedule
27. Clause 1 (sofar as it relates to particulars of the signatories
of the memorandum and the shares subscribed for by them) and
clause 14 (so far as it relates to preliminary expenses) of this
Schedule shall not apply in the case of a prospectus issue more
than two years after the date at which the company is entitled to
commences business.
28. Every person shall for the purposes of this Schedule, be
deemed to be a vendor who had entered into any contract,
absolute or conditional, for the sale or purchase, or for any option
of purchase, of any property to be acquired by the company, in
any case where —
(a) the purchase money is not fully paid at the date of the
issue of the prospectus;
(b) the purchase money is to be paid or satisfied, wholly
or in part, out of the proceeds of the issue offered for
subscription by the prospectus;
(c) the contract depends for its validity or fulfilment on
the result of that issue.
29. Where any property to be acquired by the company is to be
taken on lease, this Schedule shall have effect as if the expression
"vendor" included the lessor, the expression "purchase money"
included the consideration for the lease, and the expression "sub-
purchaser" included a sub-lessee.
30. If in the case of a company which has been carrying on
business, or of a business which has been carried on for less
than five financial years, the accounts of the company or business
have only been made up in respect of four such years, three
such years, two such years or one such year, Part II of this
Schedule shall have effect as if references to four financial years,
three financial years, two financial years or one financial year,
as the case may be, were substituted for references to five (b) make those adjustments and indicate that adjustments
financial years. have been made.
31. Where the five financial years immediately preceding the 33. Any report by accounts required by Part II of this Schedule—
issue of the prospectus which are referred to in Part II of this (a) shall be made by accountants qualified under this Act
Schedule or in this Part cover a period of less than five years, for appointment as auditors of the company; and
references to the said five financial years in either Part shall
(b) shall not be made by any accountant who is an officer
have effect as if references to a number of financial years the
or servant, or a partner or in the employment of an
aggregate period covered by which is not less than five years
officer or servant, of the company or of the company's
immediately preceding the issue of the prospectus were
subsidiary or holding company or of a subsidiary of
substituted for references to the five financial years aforesaid.
the company's holding company.
32. Any report required by Part II of this Schedule shall either—
For the purposes of this clause, the expression "officer" shall
(a) Indicate by way of note any adjustments as respects include a proposed director but not an auditor.
the figures of any profits or losses or assets and
liabilities dealt with by the report which appear to the
persons making the report necessary; or

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7. CASE LAW
T.V. Krishnan v. Andhra Prabha (p) Ltd. (AIR 1960 A.P.
123.)
By virtue of the powers conferred by Act IXXX of 1958 the
Union Government appointed a wage committee for fixing and
determining the rates of wages of the working Journalists. The
committee classified newspapers into five categories (A to E)
on the basis of their gross income. Separate pay scales were
recommended for journalists working in the different classes
of newspapers. In the classification the Express Newspapers
Ltd. was assigned to Group ‘A’. As a result of the
recommendations, ‘The express Newspapers Ltd.’ had to pay
an additional sum of Rs.2.00 lakhs per month as wages. At an
extraordinary meeting of the Company held in February 1959,
it was resolved that the company should cease to do business
as proprietors and Publishers of newspapers dailies.
Consequently the Board of Directors of Express Newspapers
Ltd., sold to the Andhra Prabha (P) Ltd. a company
incorporated in April, 1959, the proprietary rights of printing
and publishing of ‘Andhra Prabha’ and ‘Andhra Prabha
Illustrated Weekly’ as a going concern. The petitioners alleged
that the Andhra Prabha (P) Ltd. was not promoted for any
bonafide purpose. The motive was to circumvent the
recommendation of the wage committee and to defeat the
lawful claims of the employees. Petitioner pleaded for
cancelling or revoking the incorporation of a company.
The court held that Under Sec. 12 of the Companys Act the
essence of a validly incorporated company is that it should
consist of a particular number of persons and that it should be
asociated for a lawful purpose. It is not the petitioner’s case.
The only point that is stressed is that the company was not
started for any lawful purpose but to circumvent the rights of
the employees.
The fact that this company is calculated to affect the future
interests of its workers would not nullify the selling of property
rights to another Prabhu (P) Ltd.. It is not suggested that any
attempts are being made to carry on the business by illegal
methods. So the objectives and the means are good. Even if
this tends to jeopardize the interests of the petitioners, it cannot
enter the determination of the character of the object of the
association since it is a collateral consequence.
Moosa Goolam Ariff v. Ebrahim Baolam Ariff [ILR (1913)
40 Cal.1 (P.C.)]
All but two of the subscribers of the company’s memorandum
were infants who had no legal capacity to sign it. Holding that
the matter could not be reopened after the issue of the certificate
of incorporation, LORD MACNAGHTEN observed: “Their
Lordship will assume that the conditions of registration
prescribed by the Indian Companies Act were not duly complied
with”, that there were not seven subscribers to the memorandum
and that the Registrar ought not to have granted the certificate.
But the certificate is conclusive for all purposes.
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Seth Mohanlal and another v. Grain Chambers Ltd. [(1968)
38Comp. Cas.543 S.C.]
The respondent company was engaged in the business of an
exchange in grains, cotton, sugar, gur and other commodities.
Under its articles no person could remain a member of the
company for a continuous period of six months. In March 1949
the Board of Directors of the company sanctioning transactions
of business in futures in gur for March 1950, settlement. One
of the issues in this case was about the validity of the resolution.
The Supreme Court held that the resolution could not be
challenged in view of Regulation 94 of Table A of Companies
Act, 1913. Speaking for the court, Shah.J. observed, “the
respondent company is limited by shares and was registered
after the commencement of the Indian Companies Act, 1913.
The company has adopted special articles of association, but
there is no article which excludes or modifies Regulation 94 of
Table A and by operation of section 18 of the Act (section 2 of
1956 Act) that regulation must be deemed to apply in the same
manner and to the same extent as if it was contained in the
registered articles of the company. We are unable to hold that
because the company has not incorporated regulation 94 of
Table A in its articles of association, an intention to exclude the
applicability of the regulation to the company may be inferred”.
His Lordship pointed out that in order to exclude any regulation
Table A by implication, it must be inconsistent with any express
provision in the memorandum or the articles of association of
the company.
Kishangarh Electric Supply Company Ltd. v. United State
of Rajasthan. [AIR 1960 Raj.49.]
In 1942, the State of Kishangarh, which subsequently was
merged with the State of Rajasthan, granted a licence to one
Lohawala for the supply of Electricity to the State, on certain
condition. It was agreed that a company would be formed to
take over the business of supplying electricity with equity
participation by the State. The plaintiff company alleged that it
was incorporated for the purpose of taking over the business of
Lohawalla and the Co., (the business name of the licensee), which
transferred all its rights in favour of the company in 1946.
Thereafter the business was being carried out by the plaintiff
company. In September 1946, the then Kishangarh state forcibly
and unlawfully took possession of the building of the Power-
House plants and machinery and records of the company.
The contention of the Respondent State was that the plaintiff
company was not formed in accordance with the terms of the
agreement between the State and the licensee (Mr. Lohawalla).
The shares allotted to the State were not accepted by the State,
and the certificate of commencement of business was not issued
to the palintiff company by the Registrar. As such, the company
had no locus standi to carry on business or even to institute the
suit. On the above issues, the Court observed that the argument
advanced on behalf of the plaintiff is that the Company was
entitled to commence business, but the certificate had been
wrongly refused to the company by the Registrar, who was an
employee of the Kishangarh State. One of the conditions when
a company can commence business is that the shares held subject
to the payment of the whole amount thereof in cash have been
allotted to an amount not less in the whole than the minimum
subscription, vide Section 103(1)(a) of the Indian Companies
Act then in force in Kishangarh. The minimum subscription,
according to the statement in lieu of prospectus was
Rs.50,000-, vide document Ex.P.7. Now the total of issued
capital was Rs. 1,00,000/- of which Rs.50,000/- was to be
counted in lieu of fully paid shares to H.H. the Darbar of
Kishangarh State, and the remaining amount of 50,000/-, which
was to be subscribed in cash was the minimum subscription
fixed by the Directors, according to the Statement in lieu of
prospectus. Of this minimum subscription at least 1000 shares
were such on which no amount had been paid to the company.
Under clause 8 of the Articles of Association, the amount payable
on application on each of the shares so offered was not to be
less than 25% of the nominal amount of the shares. In respect
of the allotment of these 1000 shares, therefore there must have
been paid to the company Rs.2500/- before allotment could be
made. Under Section 101 of the Indian Companies Act, no
allotment can be made unless the amount mentioned, as
minimum subscription has been applied for, and at least 5%
thereof has been paid to or received in cash by the company.
Admittedly in respect of 100 shares no amount had been received
by the company. The provision as to minimum subscription
having been applied for had not been fulfilled. The company,
therefore, was rightly held by the Registrar not to be entitled to
commence business unless the allotment has been made of shares
for not less than the minimum subscription. In the present case
the allotment of requisite shares could not have been made as
shown above and the company consequently was not entitled to
commence any business. Now, the section does not say that it
shall not commence its business. It says that it shall not
commence, which means that it cannot enter into any agreement
for sale or purchase of any property also. As stated earlier,
there was no sale of the property by the Kishangarh State to the
company, and, therefore, if the State took back into its possession
all that handed over to Lohawalla and Co., the Company had no
cause of action against the former Kishangarh State.
In the absence of the right to commence business the company
had no right even to file a suit. Section 103 sub-section (3) of
Company Act 1913 corresponding to Section 149 of Company
Act 1956, is provisional only and shall not bind on the company
until that date and on that date it shall become binding.”
Query: (1) Do you agree with the observation of the learned
judge that the company has no right even to file a suit before
obtaining the certificate of commencement of business? What
is the true scope of section 149 ?
Query: (2) Will the carrying on of preliminary steps such as
issue of prospectus or the allotment of shares, be activities within
the purview of Section 149 ?
Beattie v. Beattie (E&F) Ltd. [(1938)3 All ER 214]
A provision in the articles provided that the disputes between
the members and the company should be settled by arbitration.
The defendant was a Director of the plaintiff company, he was
sued by the company for return of certain sums which was alleged
to be improperly paid to him. He tried to invoke the arbitration
clause. Held, the arbitration clause was not applicable to the
present dispute as it did not relate to the rights or liabilities of a
member in his capacity as member. As stated by Astbury J, in
Hickman’s case [1915-1 Ch.881] “No right merely purporting
to be given by an article to a person whether a member or not in
a capacity other than that of a member, as for instance, as
solicitor, promoter, director, etc. can be enforced against the
company’. Nor can the company base its claim upon the Articles
or memorandum to enforce a provision therein, which does not
deal with membership rights.
Johnson v Lyttle’s Iron Agency (1877)5 Ch.D.687
The steps taken by a company to forfeit the shares of a member
in violation of the provisions in the articles were held invalid on
the ground that the company “did not comply strictly with the
provisions of the contract between the company and the
shareholders which is contained in the regulations”. A
shareholder may enforce the contract contained in the articles
and compel the company to allow him to vote at general meeting
or to enter his name on the register of members, or to obtain the
fiancncial benefits. Similarly the company may also enforce its
rights conferred by the articles, against the members.
[Also see: Borland Trustees v. Steel Bors (1901)1 Ch.279]
Re Cyclist’s Touring Club [(1907)1 ch.269]
The object of the company was to promote cycling and to protect
pedal cyclists. The company sought to expand its objects so as
to permit motorists also become members. Held that alteration
is not permissible under S.17(1)(d) as the interests of cyclists
(present objects), and those of motorists (new objects) were to
some extent, antithetical.
In re Drages Ltd.
The company which was incorporated to do the business of house
furnishers and interior decorators temporarily suspended its
business. Later on the object clause was altered to enable the
company to carry on the business of financiers. Held, the
alteration was invalid. The new business cannot be carried on
by closing down the original business. It can only be combined
with the existing business which must remain intact even after
the commencement of the additional business.
In re Motilal Hirabhai Spinning & Weaving Co. Ltd. [(1970)
40 Comp.cas. 1215]
A company was formed to carry on the business of manufacturing
and trading textile goods. After about 52 years, it closed down
the business in 1949 due to financial difficulty and let out the
premises. In 1969 it amended the object clause by passing a
special resolution, the purpose being to indulge in the business
of manufacturing photographic materials and pharamaceuticals.
In an application for confirmation of the petition, D.A. Desai.J
of the Gujarat High Court held:-
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“When the court is called upon to confirm the proposed alteration
in the object clause, not- withstanding fact that the same has
been approved by a special resolution, and not- withstanding
the fact, that no member or creditor has appeared to contest the
petition, the court should examine the petition to find out whether
it is open to the company to alter the object clause and if so
whether the proposed alteration falls within one or the other
clauses of sub-section(1) of section 17.... The language of claims
(a) and (d) unmistakably indicate that before any alteration in
the object clause is sanctioned which enable the company to
start or undertake a new business activity, the company must
invariably be doing some business at the relevant date. If on
that date the company is virtually a defunct company the court
will have no jurisdiction to sanction the proposed alteration in
the object clause. This is implicit in the language used in clauses
(a) and (d).
[See also Eastern Wollen Mills Ltd. In re (1958)60 Bom.LR
1121]
Strathspay Public Assembly Hall Co. Ltd. v. Anderson
trustees, [1934 S.C. 385.]
The original objects of a company were to build and let a public
hall with shops and cellars. When the building was destroyed
by fire the company altered its object clause by susbstituting a
new one which provided for the erection and letting of shops
and houses and warehouses. Held, the alteration could nto be
permitted [under S.17(1)(e)] as it sought to effect a fundamental
change in the character of the main objects. But it is doubtful
whether at present such a restrictive attitude would be taken by
the courts.
Geo Rubber Exports Ltd. In re [(1991)72 Comp.Cas. 713]
The petitioner company was incorporated with the object of
carrying on the business of dealing in latex rubber gloves and
other rubber products. As the market conditions turned
unfavourable it was forced to abandon its project. Subsequently
a special resolution was unanimously passed for alteration of
the object clause. This was to enable the company to do the
business of aqua farming and dealing in marine products. The
company’s assets exceeded its liabilities. Further, there was no
objection from any shareholder or creditor to the proposed
alteration. On a petition filed before the Company Law Board
it was observed (Per K.K. Dhar, Member):-
“As the company is not carrying on any business at present the
point arising for determination is whether the alteration of the
object clause of the memorandum of association as prayed for
in the petition is in accordance with the provisions of section
17(1) of the Act......
The scope of alteration covered by clauses (a) and (d) came up
for consideration before the Court/C.L.B. from time to time. It
has been held that if a company wants to add some new objects
so as to carry on its existing business more economically or
more efficiently, such an amendment should be allowed under
clause (a). In so far as clause (d) is concerned, the Court/ C.L.B.
has allowed alteration of the object clause for inclusion of new
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objects after being satisfied that, under existing circumstances,
the company can conveniently combine the new business with
the existing business, and new business is not inconsistent with
or destructive of the business being carried on by the company.
In this case however, the company has not been carrying on any
business either on the date when the special resolution was
passed or when the petition is heard by CLB, it is for
consideration whether the company can be allowed to alter the
object clause as there is no existing business with which the
new business can be combined as provided in clause (d) of
section 17(1). It has been held in Motilal Hirabai Spinning
and Weaving Co. Ltd. [40 comp.cas. 1216] that, the language
of clauses (a) and (d) of sec. 17(1) unmistakably indicates that
before any alteration in the object clause is sanctioned, which
enables the company to start or undertake a new business activity,
the company must invariably be doing some business. In many
other cases the court/CLB held that the object clause of the
memorandum of association can be allowed for carrying on some
new business even if the company is not carrying on any
business”...
The CLB then referred to a few cases which held so, but admitted
that in all those cases, the companies were compelled by process
of law to part with their existing business, but not voluntarily.
But these cases were strong enough according to the Board to
hold that the combination of new business with the existing
business is not to be considered essential for alteration under
section 17(1)(d).
Querry: Do you think this case can be reconciled with other
cases?
[See also: Mahalakshmi Bank Ltd. v. Registrar AIR 1961
Cal.666]
All India Railway Men’s Benefit Fund Ltd. v. Jamedar
Beheswarnath Bali [(1945) 15 Comp.cas. 142]
The appellant was an association of railway employees registered
under the Companies Act, 1913 with the object of affording
relief to the members on their retirement from service. The
respondent was enrolled as a member of the appellant asociation
in 1932. Dispute arose between the parties as to the quantum of
amount payable to him on his retirement from service in 1940.
The main issue was whether the respondent was bound by the
amendment made to the original articles by a special resolution
passed in 1939. His contention was that he was only bound by
the articles as they existed on the date of his becoming a member
of the association. Holding that the respondent was bound by
the amendment articles and quoting with approval the statement
of Lindley M.R. in Allen v. Gold Reef of West Africa,Nijogi.J.
of the Nagpur H.C. held “section 31 of Companies Act, 1956
authorises a company to alter or add to its articles by a special
resolution and declares that any alteration or addition so made
shall be as valid as originally contained in the articles and be
subjected in like manner to alteration by special resolution. It
has been held that a company cannot deprive itself of the statutory
power to alter its articles of association either by a statement in
the articles or by a contract that they shall not be altered.”.
Shuttleworth v Cox Bros & Co. (Maiden head) Ltd. [(1927)2
KB.9]
Article 18 of the company provided that the plaintiff shall be a
permanent Director of the company. A new provisions was
incorporated in the articles to the effect that any Director shall
vacate his office, if he shall be requested in writing by all the
other Directors to resign his office. Invoking the power under
the new provision, the plaintiff was asked by his fellow Directors
to resign. The plaintiff contented that the new article was invalid.
The court held that it was valid as the plaintiff failed to prove
that the majority acted malafide. In Greenhalh v. Arderne
Cinema Ltd. [(1950)2 All ER 1120]. Evershed M.R. said “I
think the matter can, in practice, be stated... by saying that a
special resolution of this kind is liable to be impeached if the
effect of it were to discriminate between the majority share
holders and the minority shareholders so as to give the former
an advantage of which the latter were deprived”. In the above
case, an alteration of the articles sought to empower the company
to relieve any member from the liability under the pre-emption
clause by passing an ordinary resolution to that effect. Held,
the alteration was valid.
Jayantilal Ranchoddas v. Tata Iron & Steel Ltd [(1957) 27
Comp. cas. 604; AIR 1958 Bom.155]
Before confirming the alteration the C.L. Board should ensure
that sufficient notice has been given to every debenture holder
and to every other person or class of persons whose interest
would be affected by the alteration. The interests of ordinary
creditors and members also shall be taken into consideration.
Every creditor who in the opinion of the Company Law Board
is entitled to object to the alteration must either consent to the
alteration or must be paid off or secured.
Oriental Paper Mills Ltd. In re [(1958)28 Comp.cas.523; AIR
1957 Orissa 232]
The Petitioner company, by a special resolution amended the
Registered office clause to change the Registered office from
Orissa to West Bengal. The State of Orissa objected to the
change. The company argued that the State had no locus standi
to oppose the petition. Rejecting the contention the Orissa High
Court held that the expression “any person” or “class of persons”
in section 12(3)(a) of Companies Act, 1913 (coorsponding to
section 17(3)(a), of Companies act, 1956) were very general
and were applicable not only to creditors or debenture holders
of a company but also to every person whose interest might be
affected. It was also held that as the proposed alteration would
affect the revenue of the State of Orissa, the court while deciding
whether the special resolution should be confirmed must also
take into account the interest of the affected State.
[See Company Law Boards Regulations regarding alteration
of Registration Office Clause.]
17. Fertiliser Corporation of India v Workman : AIR 1970
SC 867
The appellant was a government company registered under the
Companies Act, 1956. The articles of association of the
company gave power to the President of India to appoint the
members of the Board of Directors and also to issue directive to
the Board from time to time in regard to the conduct of the
business of the company. Held: “The exercise of the powers of
the Board of directors of the company is apart from other
restrictions, subject to the directives if any, issued by the
President from time to time with regard to the conduct of the
business of the company or Directors".
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8. PROBLEMS
1.(a) If you are asked to frame an Articles of Association of a
Private Limited Company, what ten items you will require
to include in it as the most important ones ?
(b) X Co. Ltd. is a public limited Company having its object
clauses like the following :
Main object :
a) Manufacturing, branding, selling, etc., cigarettes and other
tobacco products.
b) Purchasing all materials needed to manufacture, brand,
patent of the above products and all assets including plants
and machineries needed.
Ancillary objects:
a) Enter into any contracts, lease agreement etc., for the
purpose of the main objects.
b) Manufacture, sale and otherwise disposal of any by-
products.
Other objects :
a) Manufacturing consumable food stuffs and selling the same.
b) Doing any other business that the Company deems it
profitable and beneficial to the Company.
(i) Directors of the Board of the said Company ask for
your advice on the proposal of starting a Hotel
business at Bangalore. Give a detailed advice to the
Company.
(ii) Suppose any change in the object clause is necessary,
Can the Company change and how?
(iii) How can the Company change its name?
2. Mr. Anil Desai is engaged in trading activities as a grocer.
The business at present is a sole proprietory concern. He wants
to expand the business by entering into the food processing
industry, for which a minimum investment of Rs.200 lakhs as
capital is required. His existing business is worth Rs.25 lakhs.
He may be able to invest another 50 lakhs. Two of his friends
are prepared to invest a total amount of Rs.120 lakhs provided
the business is run as a Corporation. There are a few others
who are prepared to be associated in the new venture of Anil
Desai. But he is apprehensive. He wants to be quite sure that
inspite of the association of his two friends and few others in
the capital, the control over the business concern shall always
remain with him.
1. Which type of company is suitable to achieve the purpose?
Explain how this would ensure Anil Desai’s perpetual
control.
2. Assume that the company may require another 300 lakhs in
the near future for its expansion. The present members of
the company are not in a position to make further
investments. But, the members of the public and a few
other friends of Anil Desai, will be inclined to take shares
of the company. What would be the device to be resorted
to ?
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b) Assuming that Mr. Anil Desai is agreeable to form a
company, advise him as to the steps to be taken for
the purpose.
c) Assume that the company was formed with an initial
membership of six persons. Of these, two persons
were minors at the time when they subscribed to the
constitutional documents of the company, but they
attained majority within three months of incorporation
of the company. One of the members pleads that the
company is not legally incorporated. Advise.
3. Mr. Karan Singh is the kartha of a Mitakshara Hindu Family,
engaged in the traditional business of dealing in Silk and other
textile items. He has four adult sons and three daughters. The
four adult sons have altogether 15 issues, (10 males and 5
females, all minors). With the implied consent of all his sons,
Mr. Karan Singh entered into an agreement with the kartha of
another joint family, with a membership of 15 (4 males and 11
females, all adults), to carry on the business jointly as a
partnership firm.
a) The two karthas are prosecuted on the ground that
the business organisation which they have formed is
legally prohibited. Decide, stating the reasons.
b) Assume that ‘A’ Co. Pvt. Ltd., with a membership of
30, is carrying on the business of travel agency. ‘B’
Co. Pvt. Ltd., with a membership of 25 is also engaged
in the same business. The managements of both the
companies with the unanimous consent of all their
members have decided to merge the business activities
of both the companies. The legal device contemplated
is the formation of a third company as a private
company. Is it possible ? If so how ? Examine the
legal issues involved.
c) As association with a membership of 25 is carrying
on the business of grocers as an unincorporated body.
Due to differences among the members, some of them
decided to withdraw from the joint venture. They
have instituted a suit for dissolution of the association.
Others object. Decide.
d) Assume that in situation (c) above, the association
has business dealings with M/s. ‘P’ & Co. Ltd. It has
instituted a suit against the company (‘P’ & Co. Ltd’)
for realisation of the amount due from them. ‘P & Co.
Ltd’. pleads that the suit is not maintainable. Decide.
4. Prepare the memorandum of association of a company limited
by guarantee and having a share capital. The object of the
company is to promote cultural activities.
5.a) Rajaram & company is engaged in the business of money
lending. Mr.Rajaram, the Proprietor of the business concern
wanted to convert it into a private limited company. Advise
him as to the procedural steps to be taken to achieve this.
b) What are the essential documents to be filed for registration
of the company?
c) The Memorandum of Association of the Company presented
to the Registrar for registration, contain, inter alia, the
following clauses :
i) “All the directors of the Company shall be appointed
by Mr. Rajaram, the promoter”;
ii) “The Articles embodied in Table A, of Schedule I of
Companies Act, 1956 shall be deemed to be the
Articles of the Company”.
The Registrar objects to the incorporation of these
Provisions in the Memorandum. Decide.
d) Assume that the Company now wants to embark upon the
business of manufacturing consumer durables. Advise the
secretary as to the steps necessary to achieve this.
6. Forty years ago Mr. Rajaram started his career as a good
grains dealer in Palani. Though there was no one else associated
with him in the venture, the business was started under the name
and style “Raja & Company”. In course of time, “Raja &
Company” embarked upon many other areas of trading and
manufacturing activities. More than 5000 employees took
shelter under its umbrella. When Rajaram died recently, his
two sons ‘Pramod’ and ‘Pradeep’ inherited the business.
a) The two brothers decided to convert the business into an
incorporated body. They also want to enter the new pastures of
‘oil drilling’. For this they have negotiated with M/s. Name
Inc., USA for technical collaboration. The latter are willing to
provide the technical assistance and other facilities, if, but only
if they are permitted equity participation in the oil drilling
business. The brothers are prepared, provided that they are quite
sure that the management and control of the business will always
remain with them.
Assume that the brothers are prepared to make a cash investment
of Rs.5 crores in the oil drilling business, which they have in
their personal accounts with M/s. Deena Bank, Palani Branch.
A few friends of the brothers are also willing to make investments
upto Rs.5 crores in the oil drilling venture. The foreign
collaborators want a minimum of 15% of equity participation.
The project cost of the oil drilling venture is assessed at Rs.60
crores. This amount is to be raised by equity and term loan.
The IDBI is prepared to provide the loan on condition that the
Debt-Equity ratio does not exceed 2:1.
The brothers seek your opinion. Give a detailed legal opinion,
explaining the legal provisions and modus operandi for the same.
It must be specifically explained how your advice when
implemented would ensure that the brothers together can always
retain control over the management of the new company.
b) Specify the contents of the essential matters to be included
in the Articles of the Company or Companies formed under
Clause (a).
c) Assume that after the death of Rajaram, the proprietory
business run by him was converted by his legal heirs into a
company under the name and style ‘Mayil Vahana Enterprises
Pvt. Ltd.’ in May 1991 with its registered office at Palani. On
receipt of a petition from one Mr. Murugan that he had been
carrying on the business of grocers and dealers in foodgrains
for the last 25 years under the trade name “Mayil Vahana
Enterprises” at Dindigal at about 100 Km. from Palani, the
Regional Director, Department of Company Law Affairs, has
issued notice to the company on 2nd July 1992 to change its
name immediately. On the company failing to comply with the
directive issued by the Regional Director, Criminal Proceedings
were launched against the following :
a) the company
b) Mr. Pramod, the Managing Director
c) Mr. Janaki Ram, an advocate practicing in Madras, and who
is a Director of the Company.
Advise each one of the accused as to defences (if any) available
to them.
d) What would be your advice to the three accused in situation
(c) above, if the Regional Director did not receive any petition
complaining about the name of the company. But he acted suo
moto, on coming to know that there is an existing company in
the same field of business and operating for the last ten years
under the name “Mayil Vahana Enterprises Ltd”. What would
be your advice to the three accused.
e) Assume that the Registrar did not issue any notice for change
of name of the company. But it was brought to the notice of the
Board in August 1992, that there is an existing company
functioning under the same name in Dindigal. Immediately they
got an ordinary resolution passed at a general meeting in early
September and changed the name to “Palani Andavan Enterprises
Pvt. Ltd”. The Company’s application to the Registrar for
registration of the new name, is pending.
The Registrar seeks your advice as to whether he can refuse to
register the change of name. Decide
f) Assume that in situation (c) above, the Company, i.e. Mayil
Vahana (P) Ltd., was formed with a membership of ten. All the
members of the Company are the members of the family of
‘Pramod’ and ‘Pradeep’. Immediately after the formation of
the Company, Pramod, his wife and two children died in a road
traffic accident. The legal heir of the deceaseds is Pradeep.
The accident was in July 1991.
7. Fortune seems to play a ‘hide and seek’ game with him.
a) After having seen her protean face at glances in many and
varied business activities, ‘Pramod’ thought that she had come
to stay with him permanently in his beverage business, which
consisted of running a ‘coffee house’ and sale of coffee powder
under the brand name ‘Ruchi coffee’. He started the business
as a Private limited company under the name and style ‘Ruchi
Coffee Works (P.) Ltd. The Company was incorporated in April
1990. On the first anniversary of the coffee business, when he
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examined the accounts, Pramod thought that he had at last
conquerred her. His modest investment has grown three-fold.
But the joy was soon shadowed by the clouds of threatened
legal proceedings. In June 1991 along with the dark, gloomy
monsoon days came an unusual visitor to him in the form of a
notice from the Regional Director (MADRAS), of the
Department of Company Affairs, asking to change the name of
the company within three months. The reason adduced was
that the name of the company closely resembles the name of
another business firm ‘Ruchi & Company’, engaged in the
business of manufacturing coffee powder and having business
activities in the locality, for the last four or five years. The
notice was served on the company as well as on Pramod, its
Chairman-cum-Managing Director. It warned them, that if the
directive is not complied with within the stipulated time, they
will be prosecuted. Advise Pramod and the Company, pointing
out the possible contentions of the other party and your defences
to them.
b) Assume that the Regional Director did not serve any notice.
But Pramod wants to change the name of the company as he felt
that the customers are a bit confused about the two brands
[NOTE: Specify your name, ID No, and address while sending answer papers]
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of coffee powder in the market. Advise him in detail, the steps
to be taken to change the name of his business to ‘Kudak Coffee
(P) Ltd.
c) Assume that Pramod wants to enter into the field of film
distribution also. The object clause of the company as it exists
today, does not permit this. Advise the company as to the steps
to be taken to achieve this.
d) The company has four members, Mr. Pramod, holds 9000
out of the 10000 issued shares of nominal value of Rs.10 each,
the remaining shares are held by his wife, father-in-law, and
brother-in-law. Pramod’s idea of entering the film business was
not cherished by other members. But they did not oppose him.
The object clause got altered. Now he wants the issued capital
to be raised to 30 lakhs. His father-in-law objected to this. A
general meeting was convened, to alter the Articles of association
by inserting a new provision, wherein it is provided that in any
fresh issue of shares duly decided by the Board of Directors,
the shares shall be offered to the existing shareholders
proportionately and the shareholders are bound to purchase the
shares so offered. Mr. Janardhan, the father-in-law of Pramod
questions the validity of the new article.
Give your legal opinion.
 9. SUPPLEMENTARY READINGS
1. Companies Act, 1956, Sections 52 to 56, 90, 149
2. Ramaiya, A Guide to the Companies Act, 10th Edn, Wadhwa & Co Pvt Ltd, Nagpur, pp. 1-170
3. S.C. Sen, New Frontiers of Company Law, 1971, Eastern Law House,Lucknowk, pp. 1-59
4. S.M Shah, Lectures on Company Law, N.M. Tripathi, Bombay, pp. 1-74

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 Master in Business Laws

Coporate Law

Course No: III

Module No: II

Characteristics of Corporate Personality

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in

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Materials Prepared by :
1. Ms. Sudha Peri
2. Dr. N. L. Mitra

Materials Checked by :
Ms. Archana Kaul, B.Sc., LL.M.

Materials Edited by :
Dr. P. C. Bedwa

© National Law School of India University

Published by :
Distance Education Department
National Law School of India University
Post Bag No. 7201
Nagarbhavi, Bangalore - 560 072

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 INSTRUCTIONS

Corporate Personality is the most ingenious invention in the Anglo-American Jurisprudence in the
sixteenth century. The large scale production system and the individualism required a legal vehicle.
Corporate personality met that demand. It is not that the corporate personality was not known in
earlier legal systems but no body earlier thought that such a device would be necessary to be the
vehicle of progress in industrial civilization. The corporate personality is unique in several senses.
As for example, it has a distinct personality separate from its shareholders, on which law confers
rights and impose duties; it has a perpetual life unlike a person in fact and in the absence of its
members it does not automatically die. In the Second World War all the shareholders of several
companies were killed. It was held in one such a case that the company was still alive and could
lawfully function. In this module we have discussed various special characters of a corporate body
and its functions.
In the I module you have understood as to how different type of companies can be floated,
registered and commence business. You have also understood the various documents that could
be required to incorporate such companies. Once these companies are incorporated the company
gets a distinct, separate, perpetual life. It can sue and can be sued in its own name. One very
important character of almost entire corporate sector (barring unlimited companies) is that the
liability of the members is limited. That does not mean that the liability of the company is limited.
Of course if the company has more liability than assets the company cannot continue any longer
and has to go in for winding up. The limited liability concept was invented in the middle of the
nineteenth century in Joint Stock Companies to give a phillip to rapid industrialisation and capitalism
at the centres of imperialism. Therefore companies formed with capitalists in England but having
business in India would ensure the shareholders profits but assured them that they would not
suffer any loss exceeding the capital that they have contributed. As a result common people started
buying shares and stocks of these companies. In this new form of legal personality the capitalism
carried out with glorious success until it found stiff resistance from trade cycles specially in the
nineteenth and twentieth centuries. It is interesting to note here adaptability of the judicial
system to the need of the corporate structure and economic growth. Judiciary served as a faithful
servant to the growth of capitalism, but it is also true that judiciary formed the basis of public
interest from which the theoretical format of welfare economics ultimately came into being. It is
therefore necessary for every student of Corporate Law to carefully examine the extent and
limitation of characters of corporate being.
N. L. MITRA
Course Coordinator

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 CHARACTERISTICS OF CORPORATE PERSONALITY

TOPICS

1. Kinds of Companies ...................................................................................................... 72

2. Legal Personality ................................................................................................................ 82

3. Lifting of the veil ................................................................................................................. 86

4. Principle of ultra vires ....................................................................................................... 100

5. Constructive Notice & Indoor management ................................................................... 108

6. Legal Institutions under Company Law .......................................................................... 114

7. Case Law ............................................................................................................................. 117

8. Problems .............................................................................................................................. 119

9. Supplementary Readings ................................................................................................... 120

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 1. KINDS OF COMPANIES
SUB TOPICS Note: Despite the fact that the basic reason as to why people go
in for incorporation rather than partnership is that, of limited
1.1 Introduction
liability of members [i.e., their personal assets cannot be utilized
1.2 Flow Chart for paying off company debts]. There are some companies which
1.3 Private Companies provide for unlimited liability of the members [i.e., their personal
1.4 Deemed Public Company assets can be utilized for satisfaction of company debts]. These
are known as unlimited companies. But normally the liability
1.5 Public Company
of members is limited either by shares or by guarantee. In such
1.6 Government Company & Public Corporations companies, the liability of the members is limited to the face
1.7 Foreign Companies value of the shares in their hands or the amount guaranteed by
1.8 Holding and Subsidiary Companies them. In a limited company, the members cannot be asked to
1.9 Multinational and Transnational Companies pay even a single rupee more than what they have agreed to be
liable for regardless of the liability of the company. A company
1.10 Illegal Associations is required to add the words Ltd. or Unlimited after its name to
1.11 Conclusion indicate to the public in general the nature of its liability.

1.1 INTRODUCTION 1.3 PRIVATE COMPANY

In the first module of the corporate law, we have briefly studied
the nature of a corporation, its evolution from a sole-corporation
to the present day giant holdings and have also dealt with various
modes of classification of companies. To recapitulate, a
company is an organization registered under the Companies Act.
Though a company is normally incorporated for business
purpose we do have companies which have been incorporated
for various non-profit purposes, for example, Stock Exchange,
Federation of Chamber of Commerce etc. In India, we have
two modes of incorporation viz., — (1) by a statute [for ex. Life
Insurance Corporation] and (2) under a Statute [for ex. TATA,
TELCO. Kirloskar etc]. Though we have already dealt with
various modes of classification in the first module, we would
now classify the companies in a manner more relevant to our
present module.
1.2 KINDS OF COMPANIES
Given below is a flow chart, depicting the various kinds of
companies presently operating in India.
Kinds of Companies
Limited Unlimited
By Shares By Guarantee
Private Public
National Multinational Transnational
Holding Subsidiary
Initially the most popular form of business enterprise was the
'partnership firm', where two or more persons joined together to
carry out a business with an intention of earning and sharing
profits [Sec. 4, Indian Partnership Act]. Though a partnership
had certain distinct advantages over other forms of business, it
was saddled with one very big disadvantage - the unlimited
liability of the partners. Slowly people found it more convenient
to turn a business into a limited company by forming a private
company and selling the existing business to the company [as in
Salomon v. Salomon & Co. Ltd., (1897) AC 22]. The sale
consideration usually being the allotment of shares to the sellers
of the business, the shares credited as being fully paid. The
result of such transactions is to limit the liability of the business
owners in case of loss, and to make a division of profits and
interests in the business easier to accomplish. In general, the
shares of a private company are held by a very few persons all
belonging to either the same family or being close friends. The
basis on which these companies are formed is the close
interrelation and mutual trust shared by the parties concerned.
For all practical purposes a 'private company' is merely a
partnership firm in the guise of a company. S. 28(1) of the
Companies Act defines a private company as one which by its
articles of association --
(a) restricts the right to transfer its shares;
(b) limits the number of members (exclusive of persons who
are or have been in the employment of the company) to
fifty; and
(c) prohibits any invitation to the public to subscribe for any
shares or debentures of the company.
Several joint holders of a share are for the purpose of this
definition treated as one member.
There are two basic conditions to be satisfied for it to be said
that the company has issued an invitation to the public”, namely
that the invitation must have been issued -

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1) by the company itself -- In Booth v. New Afrikander Gold
Mining Co Ltd [(1903) 1 Ch 295], it was held that an offer
by the liquidator of an old company, of shares in a new
company, was not an offer to the public; and
2) to any person who chose to apply for the shares, or to a
considerable class of persons selected as being the most
likely subscribers -- In Nash v. Lynde [(1929) AC 158],
the directors of a private company prepared a document,
which was in the form of an offer for shares to persons
generally. The document was not, however, advertised, but
a copy was shown to one person only with a view to his
joining the company and becoming a director. It was held
that, though the document was an offer of shares made to
the' public' it had not been issued as a prospectus.
In the matter of further issue of capital, a private limited company
is not bound by the provision of sec 81 of the Companies Act.
It is bound by the provisions of its Articles, or in the absence of
it, by the general power conferred on the Board by sec.291. In
case of further issue offered to the existing shareholders pro-
rata the members of the private company cannot renounce the
right in favour of any outsiders [Needle Industries Ltd. v.
Needle Industries (Newly) Holdings Ltd. (1981)51 Comp.Cas
743].
"Public" includes any section of the public whether selected as
members or debenture holders of the company or as clients of
the person issuing the prospectus or in any other manner, but
the offer is not a public offer if it can in all the circumstances
be properly regarded only as a domestic concern of the persons
making and receiving it.
Legally, the position of a private company is in most respects
the same as that of a public company, and even if one member
holds practically all the shares [ex: Solomon's case], the
company is still a distinct 'being' or 'person', and the company
is not bound by notice of matters which are in the knowledge of
this person.
If a private company fails to comply with any of the provisions
of sec. 28(1), it ceases to be entitled to some of the privileges of
a private company (ex: carrying on business with less than two
members). In such cases, the court may grant relief, if the default
was due to accident, inadvertence or other sufficient cause.
Special provisions relating to Private Companies
1) A Private company consist of upto 50 members excluding
employee members [sec. 3(iii)].
2) It must along with its 'Annual Return' send a certificate
signed by a director and the secretary that the company has
not issued any invitation to the public to subscribe for shares
or debentures, and, if the number of members exceeds fifty,
a certificate that the excess consists of employees or past
employees of the company [sec. 161(2)(b)].
3) The company need not hold a statutory meeting [sec.
165(10)].
4) Directors need not deliver to the Registrar a consent to act
nor need they sign the memorandum or a contract for their
qualification shares [sec. 264(3)].
5) A statement in lieu of prospectus need not be registered
even though no prospectus is issued [sec. 70(3)].
6) The provisions relating to minimum subscription” do not
apply, and shares can therefore be allotted irrespective of
the number of shares subscribed [sec. 69].
7) A private company may start business immediately on its
incorporation -- it need not wait for a special certificate
from the Registrar as in the case of public companies.
8) There is no fixed retirement age of directors under the Act,
unless the company is a subsidiary of a public company;
nor is there any restrictions on their remuneration.
9) Sec. 81 of the Act, providing for issue of new shares of a
public company to already existing members in certain cases
is not applicable to private companies, which are therefore
free to allot new issues to outsiders.
10) According to sec. 416 if any agent of a company makes a
contract on behalf of the company but keeping the company
as an undischarged principal, he has to make a memorandum
in writing of the terms of the contract & specifying the other
party to the contract. He has also to deliver the
memorandum to the company and send copies to each of
the directors so that it may be laid before the board at its
next meeting. Private companies are exempted from these
requirements.
11) Under sec. 300, an interested director cannot participate in
voting at board's proceedings. This section is not applicable
to a private company, and an interested director of such a
company is under no obligation to retire from a meeting of
the board at which the subject-matter of his interest is
discussed. He may not only participate in the meeting but
may also exercise his vote.
1.4 DEEMED PUBLIC COMPANY & COMPULSORY
CONVERSION OF PRIVATE COMPANY INTO
PUBLIC COMPANY
Popularly speaking sections 43,43A and 44 are treated as
provisions for a deemed public company. But correctly speaking
only section 43 deals with a private limited company deemed
in law as a public limited company though structurally and
apparently it looks as if it is a private limited company. When
a private limited company fails to include in its article any or
all restrictions to be stipulated under section 3(1)(iii), the
company is in the eye of law treated as a public limited company.
As has been stated earlier a private limited company has to
stipulate in its articles (1) higher limits of its members so long
as they are in employment, and (2) prohibiting invitation to be
made to the public to subscribe for any shares in or debentures
of the company. It is not enough that a company to be a private
limited company has not issued shares to the public. It is
incumbent on the company to declare by its articles that it cannot
invite public to subscribe to the shares or debentures of the
company. If default is made in this respect the company shall
not be entitled to the privileges or exemptions conferred on
private companies. For all purposes in the eye of law the
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company shall be deemed to be a public limited company as
per the provisions of section 43. Of course if the Company
Law Board is satisfied that the failure is due to an inadvertence
or due to some sufficiently valid cause the CLB may by an
order relieve the company from such consequences of law on
the ground of just and equitable relief. So the CLB can restore
the status quo ante if it is convinced that it is just and equitable
for not treating the company as public limited in the eye of law.
Section 43A and 44 deals with a private limited company
becoming public limited in certain cases and the consequences
arising out of that. According to section 43A a private company
becomes public company if
(a) 25% or more of its capital is held by one or more public
companies, however excluding shares held by a bank
forming part of the subject matter of a trust or for the benefit
of the body corporate or as a trustee either in its own name
or on behalf of the trustee. This company shall become a
public limited company from the date on which the aforesaid
percentage was held before the commencement of
Companies Amendment Act 1960, on the expirty of three
months from the date of such commencement unless the
percentage holding drops down during the meantime below
this statutory prescription.
(b) According to section 43A(1A) where the annual average
turnover of the company during the relevant period is not
less than such amount as may be prescribed, the private
company shall become the public company from the expirty
of the period of three months from the last day of relevant
period during which the private company had the said
average turnover. The ceiling is prescribed by way of rules.
According to rule 4(c) of the general rules and forms if the
average annual turnover of a private company for three
consecutive years exceeds ten crores per annum the
company shall become a public limited company. The
conversion takes effect after the expirty of three months
from the period at the close of which the accounts show the
amount of the turnover.
(c) Where a private company holds 25% of the paid up share
capital of the public company, the private company becomes
a public company on and from the date on which the
aforesaid percentage is first held. However since this
provision is included by Companies(Amendment) Act,
1974, a private company holding such percentage of shares
of public company from a date prior to 1974, the private
company shall become public company on and from the
expiry of three months from the commencement date of the
Amendment Act, unless during the time the percentage drops
down.
(d) A private company becomes a public company after the
commencement of Amendment Act, 1988, if it accepts
public deposits from the public after an invitation made by
advertisement. The private company becomes a public
company on and from the date on which such acceptance
or renewal is first made after the commencement of
Amendment Act 1988.
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In case the private company becomes a public company in any
one of the above ways the company shall inform the Registrar
within three months from the date on which the private company
becomes public by operation of law, that it has become a public
company according to any one of the aforesaid grounds. On
receiving the information the Registrar shall delete the word
'private' before the word 'limited' in the name of the company
and shall also make necessary alterations in the certificate of
incorporation issued to the company and in its memorandum of
association. Company shall continue to be public company until
with the approval of the Central Government and in accordance
with the provisions of this Act becomes a private company again.
The company which has thus become public company by
operation of law and under compulsive situation of
transformation of its organizational pattern may continue to
include provisions for the 'cap' on number of membership and
limitation on shares and debentures to be issued to the public by
advertisements as well as on transfer of shares, in its articles of
association, so that its membership may fall below seven, without
its incurring any penal liabilities.
If the company makes a default in informing the Registrar about
the change of status the company and every officer of the
company who is in default shall be punishable with fine up to
Rs.500/- for every day for which the default continues. A private
limited company has to file along with its annual return under
section 161 two additional certificates as per section 43A (8) &
(9). In the first certificate it has to certify that no body or bodies
corporate holds or hold 25% of the share capital or more (if the
private company has a share capital) and the annual turnover is
not more than ten crores and the company has not accepted or
renewed public deposits. In the second certificate to be filed
with the Registrar it is to be specified that the concerned private
company does not hold 25% or more of the paid up share capital
of one or more companies.
The basic objective of such automatic conversion of private
limited company into public limited company is the protection
against the abuse of exemptions and privileges available to
private companies. Section 43 A has been inserted by
Amendment Act 1960 on the recommendation of Shastri
Committee and thereafter several amendments remodified the
legal regime. It has been the intention that once the private
company indirectly uses public money it forfeits the
characteristic of a private company and should be made liable
like a public company. According to law private company is
required to be limited to an optimal size. The general
presumption is that a very big company becomes publicly
accountable due to the sheer volume of its turnover. So when a
private company crosses that optimal limit it is statutorily
responsible as a public company. Section 43A therefore, is
interpreted on the public policy design and it compulsorily alters
the character of the company, both in structural form as well as
from the context of liabilities.
1.5 PUBLIC COMPANY
Any company which does not fall within the definition of 'private
company' is a 'public company'. These are generally large trading
or manufacturing concerns. The shareholders are members of
the public and the shares are in general freely transferable. A
public company cannot start business till a certificate of
'commencement of business' is issued by the Registrar. As these
companies function after raising public money, they have been
saddled with more liability and responsibility under the Act.
For example, specific provisions have been laid down for the
mode of appointment of the directors, auditors etc, their term of
office, removal etc., so also provisions for first issue of shares,
further issue of shares, raising & reducing of capital etc., have
also been made. In general, public companies are levied with a
high level of accountability and their mode of operation is
seemingly more restricted as compared to the private companies.
It is also to be noted that public companies demarcate the division
between ownership [which is with the shareholders] and control
or management [which is with the board of directors]. A public
company can also be converted into a private company, by (i)
passing of a special resolution, and (ii) incorporating the limiting
provisions in the Articles as prescribed under sec. 3(1)(iii). But
sec. 31(1) provides that no alteration made in the articles which
has the effect of converting a public into a private company
shall have effect unless such alteration has been approved by
the Central Government.
1.6 GOVERNMENT COMPANY AND PUBLIC
CORPORATIONS
Section 617 of the Act defines a Government Company as
follows:
"Government company means any company in which not
less than fifty-one percent of the paid-up share capital is
held by the Central Government, or by any State
Government or Governments or partly by one or more State
Governments and includes a company which is the
subsidiary of a company thus defined".
The obvious advantage of forming a Govt. Company is that
it gives the State activities some of the freedom enjoyed by
private corporations and the Government escaped the rules and
principles which hampered action when it was done by a
government department instead of a government corporation.
In other words, it gave the Govt. some of the robes of the
individual [Thurman W. Arnold, 193]. And in order to ensure
this freedom the Supreme Court has reiterated in a number of
cases that a Government Company is not a department or an
extension of the State. It is not an agent of the State. Accordingly
its employees are not Civil servants and prerogative writs [under
Arts 32 & 226 of Constitution] cannot be issued against it. In
Tamlin v. Mannaford [(1950) 1 KB 18] it was held that a
Government Company will be regarded as an agent of the State
only when it is basically performing governmental or sovereign
and not merely commercial functions.
A public company which is wholly owned & controlled by the
State is known as a public corporation. In contra-distinction to
a government company a public corporation is totally under the
control and management of the State and for all practical
purposes is an instrumentality of the State. The question then
arises, as to whether such corporations can be deemed to be
'State' for the purposes of Art. 12 of the Constitution. This
question was answered affirmatively by Krishna Iyer, J., in Som
Prakash Rekhi v. Union of India [(1981) 1 SCC 449]. Here,
the company in question arose out of the acquisition and vesting
in the Central Government of the assets and business of Burmah
shell. The employee, who had certain rights as to provident
fund etc., against the former company, claimed them against the
Government by means of a writ. His claim was resisted on the
ground that the undertaking had been vested in a company
registered under the Companies Act and the question of a writ
against a private company could not arise. Krishna Iyer J.,
brushed aside this contention. He laid emphasis upon the fact
that the whole undertaking had been vested in the Central
Government and, therefore it became a State undertaking. The
learned judge also stressed the fact that the law should not go
by the fact whether the company is registered under the
Companies Act or otherwise, but by the nature of the functions
that the unit was performing. Here the statement of reasons
stated that the company was being acquired in public interest
and thus the new company was created to perform a function of
public nature. The court noted the fact that the reason why the
State chose to function through companies was not to frustrate
employees, but to assure commercial flexibility and freedom
from departmental rigidity, slow motion procedures and
hierarchy of officers. The learned judge cited the following
remark of President Roosevelt:
"Concentration of economic power in all embracing
corporations... represents private enterprise become a kind
of private Government which is a power unto itself-a
regimentation of other peoples' money and other peoples'
lives".
Hitting at the reality of the situation, Iyer, J., remarked:
"The true owner is the State, the real operator is the State
and the effective collectorate is the State and the
accountability for action to the community and the
parliament is of the State. Nevertheless a distinct juristic
person with a corporate structure conducts the business. Be
it remembered though that while the formal ownership is
cast in the corporate mould, the reality reaches down to
State control.... What we wish to emphasize is that merely
because a company or other legal person has functional and
jural individuality for certain purposes, it does not
necessarily follow that for the effective enforcement of
fundamental rights, we should not scan the real character
of that entity; and if it is found to be a mere agent or surrogate
of the State, in fact owned by the State, in truth controlled
by the State and in effect an incarnation of the State,
Constitutional lawyers must not blink at these facts and
frustrate enforcement of fundamental rights despite the
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 inclusive definition of Article 12 that any authority
controlled by the Government of India is itself State" [Avtar
Singh, pp.16-17].
Sec. 620 gives the Central Government power to declare by
notification in the Official Gazette that any of the provisions of
the Act shall not apply to any Government Company or what
provisionsshall apply to such a company. The notification shall
be effective only to the extent to which it is approved by the
Parliament, and the absence of any such notification the whole
Act applies to such Government Companies. The only special
provision relating to these companies is given in Sec. 619,
relating to the appointment, powers and functions of the auditor
of a Government Company. In all other matters a Government
company is treated as any other company.
1.7 FOREIGN COMPANIES
A foreign company means a company incorporated outside India.
But for the purposes of sec. 591, it means a company, which,
though incorporated outside India, has a 'place of business' in
India. The meaning of the expression 'place of business' has
been judicially construed in A/s Dampskib 'Hercules' v. Grand
Trunk Pacific Rly. Co [(1912) 1 KB 222]. Here, four directors
of a Canadian railway company, were in England to form a
London Committee for the purpose of raising loans for the
construction of the railway 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 defendants were carrying on their business in the office
used by the London Committee and would therefore be properly
served with a writ. As per Buckley L. J.,
"We have only to see whether the corporation is "here", if it
is, if it can be severed. 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, and also a
subsidiary object; its paramount object is to make and run a
railway in Canada, to do which a great many things must
first happen: it has a subsidiary object, namely, the raising
of money to carry out its paramount object. The raising of
this loan capital is part of the company's business, and it is
done here by a London Committee constituted of directors
resident in England".
Such a company has to furnish to the Registrar the following
documents within thirty days.
(i) A certified copy of the Charter, Statutes, or Memorandum
and Articles or any instrument containing the constitution
of the company.
(ii) The full address of the registered or principal office of the
company abroad.
(iii) A list of the directors of the company, along with their
nationality, residential address etc.
(iv) A similar information about the secretary of the company.
(v) The name(s) and address(es) of one or more persons resident
in India, authorized to accept on behalf of the company
service of processes, notices, etc.
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(vi) The full address of the office of the company in India which
is to be deemed its principal place of business in India.
A foreign company is further bound by the following obligations:
a) The company should conspicuously exhibit on the outside
of every office or place of business its name and the country
of incorporation in English and in the regional language.
The statement should also show the nature of liability of
members.
b) The name and the country of incorporation should also
appear in English on all business letters, bill-heads and letter
papers and on all notices and other official publications of
the company. This statement should also include the nature
of liability of members.
A failure to comply with these provisions does not affect the
validity of any contract made by the foreign company, but the
"company shall not be entitled to bring any suit, claim any set-
off, make any counter-claim, or institute any legal proceedings
in respect of any such contract until it has complied with all the
provisions of the Act relating to foreign companies" [sec. 599].
1.8 HOLDING AND SUBSIDIARY COMPANIES
When a company has control over another, it is known as the
'holding or parent company' and the company over which it
exercises the control is known as the 'subsidiary company'. This
control may be exercised in any one of the following three ways,
viz.,
(i) When one company controls the composition of the board
of directors of another, the later becomes the subsidiary of
the former. This type of control is deemed to have been
exercised when, one company has the power, to appoint or
remove the holders of all or a majority of the directors of
another company without the consent or concurrence of any
other person. A company is further deemed to have the
power to appoint to a directorship in the following three
cases--
a) If a person cannot be appointed to a directorship
without the exercise in his favour of the power of
appointment held by the company 'A' in company 'B'
b) If a person's appointment to directorship in company
'B' follows necessarily from his appointment as
director, managing agent, secretaries and treasurers
or manager or to any other office or employment in
the company 'A'.
c) If the directorship of company 'B' is held by an
individual nominated by the company 'A' or by any of
its subsidiaries.
[In all these cases company 'A' is the holding company and
Company 'B' is the subsidiary].
(ii) Where one company 'A' holds the majority of shares
in another company 'B', the latter becomes the
subsidiary of the former.
(iii) Where one company 'A' is subsidiary to another
company 'B' which is itself a subsidiary of company
 'C', then company 'A' also becomes a subsidiary of
company 'C'.
The above conditions will be deemed to have been satisfied,
even if the majority of the shares are held or the power of
appointment to directorship is exercisable by any person as a
nominee either of the holding company or of any of its
subsidiaries.
Merely because a company is a subsidiary of another does not
make it an 'agent' of the holding company, nor does it destroy
the separate legal identity of the subsidiary company. In the
words of Cohen, L. J.,
"Under the ordinary rules of a law, a parent company and a
subsidiary company, even a 100 percent subsidiary
company, are distinct legal entities, and in the absence of
an agency contract between the two companies one cannot
be said to be the agent of the other” [Avtar Singh, p. 18].
One of the leading cases in this regard is the Smith Stone
& Knight Ltd v. Birmingham Corpn. [(1938) 4 KB 116].
Here, a company acquired a partnership concern, registered
it as a company, and then continued its existence as its own
subsidiary company. The parent company held most of the
shares of the subsidiary, treated its profits as its own,
appointed managers for it and exercised effectual and
constant control. When the business of the subsidiary was
acquired by the defendant corporation the court allowed
the parent company to claim compensation in respect of
removal and disturbance because the subsidiary company
was not operating on its own behalf but on behalf of the
parent company. Atkinson J., after referring to the basic
rule that "....... the mere fact that a man holds all the shares
in a company does not make the business carried on by the
company his business. It is also well settled that there may
be such an arrangement between the shareholders and the
company as will constitute the company the shareholders'
agent for the purpose of carrying on the business and make
it the business of the shareholders", laid down a six point
test for ascertaining the person actually carrying on the
business of the subsidiary company, viz.,
(i) were the profits (of the subsidiary) treated as profits of the
parent company?
(ii) were the persons conducting the business appointed by the
parent company?
(iii) Was the (parent) company the head and the brain of the
trading company?
(iv) Did the company govern the adventure, decide what should
be done and what capital should be embarked on the
venture?
(v) Did the (subsidiary) company make the profit by its own
skill and direction?
(vi) Was the (parent) company in constant and effectual control?
The answers to these questions would decide whether the
subsidiary was an agent of the parent company or whether it
had a distinct legal personality of its own. Total and exclusive
control in all respects is the surest indication of agency or trust.
In Wallersteiner v. Moir [(1974) 1 All E R 217(CA)], Lord
Denning, M. R., gave a picturesque description of a situation
where the company was nothing but the controller himself under
another hat. He observed that,
"It is plain that W used many companies, trusts or other
legal entities as if they belonged to him. He was in control of
them as much as any "one-man company" is under the control
of one who owns all the shares and is the chairman and managing
director. He made contracts of enormous magnitude on their
behalf on a sheet of note paper without reference to anyone
else. I am prepared to accept that the companies ...... were
distinct legal entities .... even so they were just the puppets of
W. He controlled their every movement. Each danced to his
bidding. He pulled the strings. No one else got within the reach
of them. Transformed into legal language, they were his agents
to do as he commanded. He was the principal behind them. I
am of the opinion that the court should put aside the corporate
veil and treat these concerns as being his creatures for whose
doings he should be, and is responsible".
Shares in the Parent Company
The concept of a subsidiary company being the agent of the
parent company has another major implication. When such an
agent subsidiary company becomes insolvent, the parent
company is held liable for its debts. In USA, this principle was
evolved in, Taylor v. Std. Gas & Electric Co [306 US 307
(1939)]. Here, the parent company undercapitalized its
subsidiary, heavily indebting the subsidiary to the parent
company. Mismanagement of the subsidiary led to insolvency.
During reorganization proceedings, the parent company declared
its claim to be superior to claims of other creditors. The court
rejected this argument and subordinated the claims of the parent
company, not only to claims of other creditors of the subsidiary
but also to those of its 'preferred shareholders'. This resulted in
the 'Deep Rock doctrine' which states that: 'The claims of
creditors who are also shareholders may be subordinated to the
claims of other creditors in insolvency or reorganization
proceedings, when the court finds that the shareholder/creditor
has violated certain properties necessary to the maintenance of
separate corporate identity. When the subsidiary is not an agent
of the parent company, the creditors of the subsidiary cannot
hold the parent company liable for their debts'.
Subsidiary of a multinationl company
Unlike subsidiaries of national companies, the subsidiaries of
multinational companies have more autonomy in the host
country. The extent of power which such parent ocmpanies
have on their subsidiaries was debated in Lonrho Ltd v. Shell
Petroleum Co Ltd [(1980) 2 WLR 367, CA]. Here, a group of
oil companies in UK owned & controlled certain oil companies
in Rhodesia. The English parent company was called upon to
produce certain documents relating to a pipe line contract which
were in the possession of its subsidiaries. The court rules
empowered it to order the disclosure of all documents in the
possession, custody or power” of a party. The question was,
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‘whether the documents in the possession of a foreign subsidiary
could be deemed to be in possession of the parent? The Court
of Appeal answered the question in the negative. Lord Denning,
while emphasizing on the position of the company in the
jurisdiction of local laws applicable to it and the available degree
of freedom from interference by the parent, observed: These
South Asian and Rhodesian companies were very much self-
controlled. Their directors were local directors - running their
own show, operating it, with comparatively little interference
from London. They were subject, of course, to all local laws &
ordinances. That seems to the a different position from the
concept of a one-man-company or a 100 percent subsidiary
company which is operating in this country with self-same
directors, or a 100 percent parent with various subsidiaries. It
is important to realize that subsidiaries of multinational
companies have great deal of autonomy in the countries
concerned".
Schimitthoff [Lifting the corporate veil, 1980 JBL p. 158]
explains the importance of this decision to the international
community, as follows: 'The importance of this case lies in the
fact that for the first time an English court has held that, if a
multinational finds itself in a conflict between the interest of the
home and host country, the interests of the host country will
prevail. This rule which was also adopted in France in Frenhauf
case should now be regarded as an established principle of
international law'.
Though a holding company may and in general, and also does
acquire the shares of a subsidiary company, the subsidiary is
not allowed to acquire membership of its holding company [sec.
42]. Consequently, 'any allotment or transfer of shares by a
company to its subsidiary shall be void'. This prohibition does
not apply to the case of a subsidiary company which already
held shares of its holding company at the commencement of the
Act or before becoming a subsidiary of the said holding company.
The section also does not apply in the following cases:
(i) Where the subsidiary is considered as a legal representative
of a deceased member of the holding company; and
(ii) Where the subsidiary is considered as a trustee.
This exception wont apply where the holding company itself or
any of its other subsidiaries is beneficially interested under the
trust, except when its interest is only for the purpose of a security
for a transaction, (including lending of money) entered into in
the ordinary course of its business.
1.9 MULTINATIONAL AND TRANSNATIONAL
CORPORATIONS
Multinational corporations (MNCs) or Transnational
Corporations (TNCs) have been attracting a lot of attention and
publicity, both nationally as well as internationally. Public
awareness of MNCs & TNCs has grown in the past twenty five
years. The reasons for the stupendous growth in the number of
MNCs & TNCs is not difficult to trace. Firstly, the rapid advance
of industrialization made smaller units non-viable and thus
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causing an increase in the size of industrial units. Secondly,
industrial enterprises earned huge profits in the inflationary
period of the late sixties and seventies and they wanted to invest
these profits in further business expansion. These enterprises
found starting new units in different overseas countries as a useful
proposition because of the availability of cheap labour and new
markets, their home countries in most cases encouraging them
to go abroad. Placing in general historical perspective the
phenomenon of USA's initial "lead"and the corresponding lag”
of the other industrial countries in the race of multinational
enterprises, Mr. B.N. Ganguli said "there was, therefore, no need,
according to the Eisenhower Administration's assessment, for
adventitious governmental aid, because the crisis situation had
been resolved. What was needed was an expansion of economic
development and trade through the flow of U.S. private capital,
management and technique to areas that need them most and
could use them to the best advantage. Major attention was
focused on direct investment by which private enterprises would
start subsidiaries in branch plants, thus retaining a degree of
control as well as ownership over the assets in the host countries
.....".[B. N. Ganguli, Multinational Corporations, pp.12-14].
This explains the growth of MNCs, now more commonly known
as TNCs. Transnational Corporations are those enterprises
which own or control production or services outside the country
in which they are based. Thus, MNCs or TNCs are national
companies for the country of their origin/incorporation, but with
extensions overseas.
A 1978 United Nations study revealed, that in their search for
continued growth, TNCs have been increasing their use of cross-
border agreements which are not tied to equity investments.
Many host countries, especially developing ones, favour such
arrangements as they provide a means of acquiring the skills &
products developed by TNCs without the establishment of a
long-staying foreign owned entity within their borders. These
so-called alternatives to the TNCs have, in fact, been used for
many years among OECD countries. These alternatives come
in a wide spectra of forms and extend from relatively simple
and straight forward licensing, franchising or management
agreements to highly complicated combinations of a wide variety
of provisions that are collectively referred to as 'industrial
cooperation'. Thus TNCs are not only the giant conglomerates
with subsidiaries in dozens of countries; they also include small
foreign companies and enterprises engaged in various non-equity
forms of collaboration with local firms and companies, such as
agreements for providing technical services, marketing
assistance and managerial expertise. It is not essential for a
TNC to own assets in the host country; what is essential is for it
to control them.
Despite the malpractices of some of the MNCs & TNCs, we
cannot deny the fact, that, they have been agents of international
division of labour and internationalization of capital. In the
words of Mr. L. K. Jha, "essentially a multinational or
transnational enterprise is one which carries on its productive
operations in more than one country. Prima facie it reflects a
healthier trend in regard to the location of industries globally
than the earlier pattern of enterprises concerning manufacturing
activities in their own country and only exporting their goods
and services to others" [L. K. Jha, Economic Strategy for the
80s, p.144]. Furthermore, MNCs are responsible for augmenting
international trade and may help the developing countries in
pushing up their exports.
In India, MNCs mainly operate in two ways.
Salient Features of Organisations
i) Through the establishment of a mere place of business, i.e., a
branch in India, and (ii) through an Indian subsidiary i.e., a
company incorporated in India under the Companies Act, 1956
but controlled by the MNC. In general, the MNCs here dominate
the manufacture of consumer goods, because even if they charge
nominal profits for them, the profits are bound to be large because
of the large consumer market in this country.
Some salient features of different types of global players have
been tabulated by Bartlett and Ghoshal as follows :

Organisational Multinational Global International Transnational

Characteristics Companies Companies Companies Companies

Configuration Decentralized Centralized Source of core Dispersed,

of assets and and nationally and globally competences interdepend-
capabilities sufficient operated centralized ant and
and others specialised
decentralised

Role of Sensing and Implementing Adopting and Differentiated

overseas exploiting parent company leveraging contribution
operation local strategies parent company by
opportunities competenace national units
to world wide
integrated
operations.

Developments Knowledge Knowledge Knowledge Knowledge

and diffusion developed developed development at developed
of knowledge and retained and retained the centre and jointly and
within at centre transferred to shared
each unit. overseas units worldwide

Organisational Federal Country wide Country wide Confederal

structure subsidiaries Branching representatives subsidiaries.
and agencies

with the rapid development of market economy organisation
structures are given an extra emphasis for the purpose of
increasing operational efficiency. In order to facilitate transfer
of technology and technical know how different forms of
organisational structure of global operations, have been devised.
Multinational and transnationals generally operate through
holding subsidiary relationships either in federal form or in a
confederal form. In MNC's self sufficient national units operate
and constitute the central unit. In TNC's national units are not
only self sufficient but operate independently on product lines,
but they have interdependence on global policy formulation. In
the case of global and international companies the operation is
principally done through either a country agent or a country
susbidiary which is entirely dependent on the policy dictates.
These mostly operate as clearing houses.
1.10 ILLEGAL ASSOCIATIONS
One of the basic objectives of the Companies Act is to eliminate
the evils caused by large partnerships trading in unincorporated
form. A business association consisting of a large number of
persons, unless incorporated, leads to inevitable confusion and
uncertainty concerning both the rights and liabilities of members
inter se, as also their relations with others. sec. 11(2) of the
Act, thus provides that no company, association or partnership
consisting of more than twenty persons (10 in case of banking
business) shall be formed for the purpose of carrying on any
business that has for its objects the acquisition of gain for itself
or for its members unless it is registered as a company under the
Companies Act, or is formed in pursuance of some other Indian
law. If it is not so registered it becomes an 'illegal association'.
This section does not apply to a Hindu unindividual family
[HUF] doing some business, and if a business is carried on by
two or more HUFs, in computing the number of members for
the purposes of this section, minor members are excluded. Some
of the consequences of forming an illegal association are:
(i) According to sec. 11(4), every member of such an
association shall be personally liable for all liabilities
incurred in the business, apart from imposition of fine which
may extend to Rs.1000/-.
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(ii) The members of such an association cannot sue in respect
of any contract entered into by the association. For example,
price of goods sold by association cannot be recovered by
filing of a suit.
(iii) It cannot be wound up under the Act even under provisions
relating to winding up of unregistered companies.
(iv) Lastly, there can be no suit between the members inter se
for partition, dissolution or taking of accounts.
In Badri Prasad v. Nagarmal [AIR 1959 SC 559], the case
arose out of a suit for recovering the contribution made to an
illegal association, and also for accounts. It was contended that
the objects of the association not being illegal, recovery on
dissolution should be allowed in the manner of realization of
assets of a dissolved firm. The Supreme Court held that such a
claim is clearly untenable. The only course for the courts to
pursue is to say that he is not entitled to any relief as the courts
cannot adjudicate in respect of contracts which the law declares
to be illegal".
1.11 CONCLUSION
The later part of 20th century beginning from the end of First
world war can be called the era of the corporation. The industrial
revolution as it spread over the 20th century, life required
collective organization of man and things. To bring its human
structure and physical plan into existence, to carry out its
operations, to distribute its products, to meet the growing
demands made on it in peace and war, proved wholly beyond
the capacity of individual entrepreneurs. The modern
corporation is an organic growth and a natural development of
the industrial revolution in modern society [S. C. Sen, pp.1-2].
In the words of W. T. Gossett, Vice-president in the General
Council of the Ford Motor Company, "The modern corporation
is a social and economic institution that touches every aspect of
our lives, in many ways it is an institutionalized expression of
our way of life. During the past 50 years industry in corporate
form has moved from the periphery to the very centre of our
social and economic existence. Indeed it is not inaccurate to
say that we live in a corporate society". There have been
fundamental changes in the nature of corporations over a period
of time, in the nature of stock-holders, directors, management,
and of various other concepts which at one time were considered
to be the fundamental concepts in company law jurisprudence.
Though judicial recognition of these changes is slow, it has been
there and in certain cases such recognition is imminent.
Corporations in their most primitive form can be traced to a
period as early as the 14th century, where people formed guilds
to hold property and perpetuate the guild beyond the lives of
the members. The main function of these guilds was regulation
of the conduct of its members in their trading and for that purpose
they had certain amount of rule making powers for regulation
of economic activities. The journey from these guilds to the
giant multinational corporations of the 20th century has been a
long road with every bend resulting in some new development
and every step fought with difficulties. It has been
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an unbelievable process of evolution through out and it can be
honestly said that no other business association has undergone
such metamorphosis or changed so drastically.
According to Berle and Means in their study - Modern
corporation and private property, as property was gathered under
the corporate system, and as control became increasingly
concentrated, the power of this control steadily widened. Briefly,
the past century has seen the corporate mechanism evolve from
an arrangement under which an association of owners controlled
their property on terms closely supervised by the state to an
arrangement by which many men delivered contributions of
capital into the hands of a centralized control, accompanied by
grants of power permitting such control almost unexplored
permission to deprive the grantors at will of the beneficial interest
in the capital thus contributed. The stock holder in the modern
corporation surrendered a set of definite rights in exchange for
a set of definite expectations. The growth of power of control
steadily diminished the number of things which shareholders
could control, and a shareholder today is in no actual position
to demand anything or enforce anything on the control. The
shareholder today occupies a subservient position to that of the
control of the controlling group of managers. In addition to
shareholders and directors, "control" was recognized by Berle
and Means as one of the important constituent parts of the
modern corporate structure. The same recognition was also
given to the management which has now become a very
important part in modern corporations. Workers also were given
a due recognition by them, but Berle being a legalist preferred
not to recognize them as part of the corporate structure, as such
recognition would interfere with both legality of the source of
power and the legal controlling power in a corporation.
Further study of the American corporation was made by Prof.
Galraith in the New Industrial State (1967). By then it was
clear that the trend relating to dispersion of shareholdings had
become an accepted part of corporations and that this trend
was continuing and intensifying. He divided corporations into
two groups for the purpose of the study of structures. The
orthodox type of smaller companies were termed as
entrepreneurial corporation" and the second as "mature
corporation". The former he felt had maintained the same
structure as the classic company and there was not been much
change. The mature corporation he said is the giant corporations
of modern days dominating the modern economy, and he felt
that it was the study of its structure which was more important.
In his graphic description of this structure, he said "It is more
useful to think of the mature corporation as a series of concentric
circles. The band within each pair of circles represents a group
of participants with a different motivational system. In the more
spacious with bands at the outer reaches are the most numerous
groups. Such in general is their motivational system that they
are the most loosely attached. At the centre is what is now
called the top management. Theirs is the firmest attachment.
Between are the others.....". According to him, in the outermost
circle are the ‘ordinary shareholders' whose only relation to the
corporation is a ‘pure case of pecuniary motivation'. He does
not identify himself with the goals of the enterprise nor does he
expect to influence these goals. The next circle is occupied by
the ‘production workers' - their motivation is more complex.
Pecuniary compensation to them is definitely important, but there
is also a sense of identification with the corporation arising due
to his daily association with the corporation as opposed to an
ordinary shareholder. The combination will vary greatly with
the circumstances of the industry and firm. Increased
Share & Stock
Holders
Production Workers
Supervisors
Technicians
Executives
'Galbraith Circle' portrays the realities of a modern corporate
structure. The technocrats & the workers in various stages of
corporation are now permanent features of a company, much
more so than the shareholders who have become mere suppliers
of capital. In ascertaining whether in the matters of corporation
the workers and management should have a say in addition to
the say of the shareholders, the new structure of the modern
corporation should always be borne in mind. An assessment of
the rights of the different ingredients constituting the corporation
would be defective unless this modern corporate structure is
given due weightage.
The realities of modern corporation were reassessed by Adolf
Berle in his book "The 20th Century Capitalist Revolution".
He said that, the actualities of modern corporation demonstrate
the gradual erosion of even directors' powers and the rise of the
power of what he termed as the techno-structure. In modern
business, the board of directors are unable to take any decision
identification with the corporation, narrows the opportunities
for trade union. As one moves inwards, next come the foreman,
supervisory personnel and other white collar personnel, who at
the inner perimeter merge with technicians, engineers, and other
specialists who comprise the techno structure. Beyond these, at
the centre are the executives or management. As one moves
progressively inwards, identification and adaptation become
increasingly important. Given below is a pictorial representation
of "Galbraith Circle".
unless there is a thorough study of the market and a proper
planning by this techno-structure. Shareholder as a prominent
figure is now receding to the background. As he puts it
graphically, capitalism remains and is galloping but the vanishing
figure is the capitalist himself.
Peter Drucker made a brilliant study of the modern corporation
in "The concept of the corporation". He says that, ‘the structure
of the modern corporation has become "an essay in federalism"
and on the whole an exceedingly successful one. It attempts to
combine the greatest corporate unity with the greatest divisional
autonomy and responsibilities; and like every true federation it
aims at realizing unity through local self-government and vice-
versa. This is the result of the policy of decentralization which
is the accepted pattern of modern large corporations. The
concept of decentralization of modern corporations has
developed into a philosophy of industrial management and into
a system of local self government. It is not a mere technique of
management but an outline of social order'.
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2. LEGAL PERSONALITY
SUB TOPICS
2.1 Nature and Scope
2.2 Advantages of incorporation
2.1 NATURE AND SCOPE
"Although company law is a well recognized subject in the legal
curriculum and voluminous literature, its exact scope is vague
since the word company has no strictly legal meaning". In legal
theory, it implies an association of a number of people for some
common object or objects. The purposes for which men and
women may wish to associate are multifarious, ranging from
those as basic as marriage and mutual protection against
elements to those as sophisticated as the objects of the
confederation of British Industry or the Atomic Energy
Authority. But in common parlance the word 'company' is
normally reserved for those associations for economic purposes
i.e., to carry on a business for gain"[Gower, p.3].
In the terms of the Indian Companies Act, 1956, a company
means a company formed and registered under the Companies
Act. A company is not merely a legal institution, but is a legal
device for the attainment of any social or economic end and to
a large extent publicly and socially responsible. It is, therefore,
a combined political, social, economic and legal institution. Thus
the term has been variously described. [It] is a means of co-
operation in the conduct of an enterprise...." "Corporate device
is one form of associated enterprise". It is an intricate,
centralized, economic, administrative structure run by
professional managers who hire capital from the investor". [Avtar
Singh, p.1].
Depending on the availability of resources and size & nature of
the (planned) enterprise, persons wanting to do business may
go in for either a 'partnership firm' or a 'company'. For a small
business it is convenient to go in for a firm or even if they want
to go in for incorporation they can go in for a 'private company'.
Since the liability of the partners of a firm is unlimited people
prefer to go in for incorporation of company with limited liability.
Accordingly the Joint Stock Company has become the most
dominant form of business organization. In the words of Mahlo,
Companies abound in the national economy ranging from the
small family or partnership concern to the faceless multinational
corporations, they provide the structural framework of the
modern industrial society [Avtar Singh, p.2]. It would now be
proper to recapitulate in brief, the history of company law. In
England, during the 17th and 18th century, a body corporate
could be brought into existence either by a Royal Charter or a
special Act of Parliament. Both the methods were highly
expensive and very time consuming. As a result of which a
very large number of huge unincorporated associations came
into existence, trading in the corporate form. Though the
membership of these associations was large the actual trading
and management was left to a few select persons [here is the
seed of division between ownership and control which is very
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evident in the present day public companies]. This led to
corruption and mismanagement at a very large scale, resulting
in the passing of the 'Bubbles Act of 1720' which instead of
making trading by unincorporated associations illegal, made the
very business of promoting companies illegal. Though it acted
as a major set-back to the growing trade and commerce, the Act
remained in force for over a century till it was replaced in 1825.
In 1844, the Joint Stock Companies Act, (788 Vict c110) made
registration and incorporation of large partnerships compulsory,
though the principle of unlimited liability was still left intact.
The right to trade with limited liability was granted in 1855 and
the Joint Stock Companies Act of 1856, consolidated the whole
law relating to such companies. Since then, the Act has been
amended a number of times.
In India, the first law in this field is the Joint Stock Companies
Act, 1850. Since then, after a series of amendments we have
the final comprehensive piece of legislation in the form of
Companies Act of 1956. Though comprehensive, it is not
exhaustive of either the modes of incorporation (we can still
have business organizations incorporated by Acts of Parliament,
for ex: LIC, RBI etc.) or the whole of company law. It only
consolidates certain portions of the Act and common law still
has a large role to play in this field, especially in the area of
duties of corporate directors and their social responsibilities.
2.2 ADVANTAGES OF INCORPORATION
An incorporated company has several characters and advantages.
Most of the advantages emanate from the separate legal entity
and corporate liability. In this chapter we will discuss the basic
outcome of the corporate personality and the resultant insulation
of functionaries acting for and on behalf of the company with
exceptions. The following chapter is the module will contain
other characters and advantages.
(i) Separate Legal Identity
As stated earlier, the fundamental attribute of corporate
personality from which all other consequences and advantages
flow is a 'separate legal identity' distinct from its members. It
is thus able to enjoy rights and be subjected to duties and
liabilities, differing from those being enjoyed or borne by its
members. In short, it has a legal personality” and is often
described as an 'artificial person' as opposed to a 'natural person'.
Though joint stock companies legally came into existence from
1844, it was not till the end of 19th century that the implications
of 'Corporate personality' were fully grasped by the courts. It
was in Salomon v. Salomon & Co [(1897) AC 22, HL] that
for the first time the exact meaning of the term 'company' was
clearly elucidated in England. Salomon had for many years
carried on a prosperous business as a leather merchant, earning
healthy profits and having a substantial surplus of assets over
liabilities. In 1892, he decided to convert his business into a
limited company called Salomon & Co. Ltd., with Salomon,
his wife and five of his children as members and Salomon as
the MD. The business was purchased by the company for about
£ 40,000. This price was satisfied by £ 10,000 debentures
conferring a charge over the assets of the company in favour of
Salomon, £ 20,000 in fully paid £1 shares to Salomon and the
rest given partly in cash and partly in shares to the other members
who held them as nominees of Salomon. Within a year of
incorporation, the company went into liquidation, with assets
worth £ 6,000 and liabilities of about £ 17,000 of which £
10,000 was to Salomon who was a secured creditor and
remaining £ 7,000 to unsecured creditors. Thus after paying
off Salomon, nothing would have been left for the satisfaction
of debt of the secured creditors. They therefore contended, that,
though incorporated... the company never had an independent
existence; it was simply Salomon under a different name ......
The business was solely his, conducted solely for and by him
and the company was mere sham and fraud, in effect entirely
contrary to the intent and meaning of the Act. Rejecting this
contention, the House of Lords observed:
When the memorandum is duly signed and registered, though
there be only seven shares taken, the subscribers are a body
corporate capable forthwith of exercising all the functions of
an incorporated company. It is difficult to understand how a
body corporate thus created by statue can lose its individuality
by issuing the bulk of its capital to one person. The company is
at law a different person altogether from the subscribers of the
memorandum; and though it may be that after incorporation the
business is precisely the same as before, the same persons are
managers, and the same hands receive the profits, the company
is not in law their agent or trustee. The statute enacts nothing as
to the extent or degree of interest which may be held by each of
the seven or as to the proportion of interest, or influence
possessed by one or majority of the shareholders over others.
There is nothing in the independent or unconnected, or that they
should have a mind or will or their own, or that there should be
anything like a balance of power in the constitution of the
company.
Long before the Salomon's case was decided, this principle
had already been established in India in re Kondali Tea Co
Ltd [(1886) ILR 13 Cal 43]. Here, certain persons transferred
a 'tea estate' to a company, and claimed exemptions from ad
valorem duty on the ground that, they themselves were the
shareholders in the company and, therefore, it was nothing but
a transfer from them in one name to themselves under another
name. Rejecting this, the Court observed: "The company was
separate person, a separate body altogether from the shareholders
and the transfer was as much a conveyance, a transfer of the
property, as if the shareholders were totally different persons".
This does not mean, that persons like Salomon can with impunity
and openly defraud the company they form or swindle their
existing creditors. In Salomon's case it was argued that the
company was entitled to rescind in view of the willful
overvaluation of the business sold to it. But the House held
that, there was actually no fraud at all since the shareholders
were fully conversant with what was being done. Had Salomon
made a profit which he concealed from his fellow shareholders
the position would have been different [this point will be dealt
in greater detail in our module on board of directors]. Nor was
there any fraud on Salomon's pre-incorporation creditors, all of
whom were fully paid. The case was decided in Salomon's favour
because in law the company is a different person from the persons
forming it, and the courts do not willingly negate this separate
identity unless there are extenuating circumstances warranting
their interference. The consequences of this separate identity
phenomena are not always beneficial to the members. For
example, in Macaura v. Northern Assurance Co [(1925) AC
619, HL), a trader incorporated his timber business, and
transferred all his assets to the company. Unfortunately he forgot
to assign the insurance policies in favour of the company. There
was an incident of fire, and the company assets perished in the
fire. When he went to claim the insurance money for those
assets, the insurance company refused to pay. He was denied
relief by the House of Lords, who reiterating the Salomon case
principle held that, on incorporation the company acquired a
legal personality distinct from its members and an insurance
policy in the name of the founder-member could not be said to
have been in the name of the company. In Kahn-Freund's striking
phrase "sometimes corporate entity works like a boomerang and
hits the man who was trying to use it" [Gower, p. 88].
This theory of corporate entity is still the basic principle on
which the whole law of corporations is based. But the theory
cannot be pushed to unnatural limits. There are certain situations,
where the courts are compelled to identify a company with its
members. A company cannot, for example, be convicted of
conspiring with its sole director, as held in R V McDonnel
[(1966) 1 All ER 193]. The court herein observed, "where the
sole responsible person in the company is the defendant himself,
it would not be right to say that there were two persons or two
minds". The corporate veil is said to be lifted or pierced, when
the court ignores the company and concerns itself directly with
the members or managers.
The principle behind this doctrine is abuse of the concept of
separate legal identity of corporation. Where the corporate entity
is being abused for an unjust or inequitable purpose, the courts
lift the veil to look at the realities and hold the guilty persons
liable. Inroads in the 'legal entity' of a corporation have been
done both by the courts and the legislature. Where the courts
have done it, the doctrine has often been described as 'lifting or
piercing of corporate veil', and where the legislature has done
it, the doctrine is more properly known as 'cracking the corporate
shell'. We have discussed this exception in chapter III of this
module.
(ii) Limited Liability
As the corporation is a separate person, its members are not as
such liable for its debts. A company under the Act can be
registered either as an unlimited company or a limited company
[limited either by shares or by guarantee]. Thus, when
obligations are incurred on behalf of a company, the company
is liable and not its members, though the company may
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ultimately be able to recover a contribution from them to cover
its obligations. If the company is an unlimited one their liability
to contribute will be unlimited, if limited by shares - their liability
will be limited to the nominal value of the shares held by them
and if the company is limited by guarantee, the liability of
members will not arise till the company is wound-up, and then,
in practice, only for a derisory sum.
In case of small private limited companies, the members' freedom
from personal liability may, in practice, proves to be largely
illusory. Banks and others who grant the company formal credit
facilities, in general require the members/directors to personally
guarantee the debt. If then the company goes into liquidation,
these members/directors may face personal liability which may
bankrupt them. In these cases, the limited liability clause protects
them only from small traders who have been unable to get a
personal guarantee from them. Speaking of the advantages of
trading with limited liability, Buckley, J., in re London & Globe
finance Corpn [(1903) 1 Ch 728] observed:
"The statutes relating to limited liability have probably done
more than any legislation in the last fifty years to further
the commercial prosperity of the country. They have, to
the advantage as well of the investor as of the public, allowed
an encouraged aggregation of small sums into large capitals
which have been employed in undertakings of great public
utility largely increasing the wealth of the country".
(iii) Right to Deal in Property
Being a distinct legal person, a company has the right of
acquiring, holding, enjoying and disposing off property in its
own name. It is the sole owner of all assets in its name, and the
shareholders are not the private or joint owners of this property.
As Lord Buckmaster observed in the Macuara's case, no
shareholder has any right to any item of property owned by the
company, for he has no legal or equitable interest therein". In
Waton, J.'s simple truism: the property of the company is not
the property of the shareholders. It is the property of the
company”. [Avtar Singh, p. 8]. This kind of a clear distinction
between company assets and assets of the members is impossible
to make in case of a partnership firm.
(iv) Rights to take Legal Actions
Closely allied to questions of property are those relating to legal
actions. Before the Joint Stock Companies Act came into force
unincorporated associations faced great difficulties in either
suing or being sued. These difficulties were in part overcome
by the use of the trust device but more satisfactorily by means
of statutory intervention. A company being a person in its own
right can sue or be sued in its own name.
(v) Perpetual Succession
One of the obvious advantages of an artificial person is that it is
not susceptible to the thousand natural shocks that flesh is heir
to”. It cannot become incapacitated by illness, mental or
physical, and it has not (or need not have) an allotted span of
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life [Gower, p.92]. This does not mean that the death or
incapacity of the human beings running the company would not
embarrass/effect it, obviously it will especially if all/majority
of the members die or are incapacitated. But generally speaking,
the vicissitudes of the flesh have no direct effect on the
disembodied company, ‘members may come and members may
go but the company goes on for ever'. For example, during the
second world war, all the members of a private company, while
in general meeting were killed by a bomb, but the company
survived; not even a hydrogen bomb could destroy it. The
insanity of the managing director will be calamitous to the
company provided that he is removed promptly; he may be the
company's brains but lobectomy is a simpler operation on a
company and has less drastic effects on it than on a natural
person.
The continuing existence of the company irrespective of changes
in membership, is helpful in other directions also. When an
individual sells his business to another, difficult questions may
arise, regarding, the performance of existing contracts by new
owners, the assignment of rights of a personal nature, and the
validity of agreements made with customers ignorant of the
change of proprietorship. Similar problems may arise on a
change in the constitution of a partnership. Where the business
is incorporated and the sale is merely of the shares, none of
these difficulties arise. The company remains the proprietor of
the business, performs the existing contracts and retains the
benefit of them, and enters into future agreements. The
difficulties attending vicarious performance, assignments and
mistaken identity do not arise [Gower, p.94]. Some of these
problems will arise when the company as a whole either merges
with or is taken-over by another company, the consequences of
which we will deal later at an appropriate time.
Disadvantage of perpetual succession
As mentioned earlier, the fact that all/most of the directors and
or members of the company die or become incapacitated does
not result in an automatic end of the company i.e., 'the company
does not reach its death along with its members'. This concept
of 'perpetual succession' has a great advantage in the commercial
world. It leads to stability and certainty in the uncertain and
fluid scenario of an industrial society. Shareholders can invest
in a company and the creditors can give loan to it, not on the
basis of the management but on the basis of past performance
and future opportunities of the company. There is no needless
panic or crisis at the stock exchange simply because the chairman
or managing director has expired [though the sensex may show
a drop of few points, it is usually temporary and the price is
stabilized in a comparatively short time]. In short, a company
continues to function smoothly, regardless of any upheaval in
its management.
But, this very advantage of continuity and perpetuity may turn
to a major disadvantage, when the members and management
want the company to 'cease functioning'. Being a 'legal person'
the company cannot die a natural death, its end has to come
through legal means alone. To provide for this eventuality, the
Companies Act has elaborate provisions given under Ss. 433
to (about) 481. Thus, not only the promoters etc have to undergo
a lot of expense in terms of time money and convenience for
'incorporation of a company', but they have also to invest equally
heavily (and sometimes much more heavily) for bringing the
existence of the company to an end by following the complicated
procedure for winding-up [we will be dealing with winding up
in a later module]. Even if the company has been running in a
loss for a long time or has accumulated enormous debts, this
procedure can not be escaped from. So also, it may happen that
the main purpose for which the company was incorporated has
failed, i.e., there is no reason for the company to exist, even
then the members cannot simply 'down the shutter' of the
company, but will have to proceed with winding up. Thus for
example in re German Date Coffee Co [(1882) 20 Ch D 169].
Here, the memorandum of a company stated that it was formed
for working a German patent which would be granted for
manufacturing coffee from dates; for obtaining other patents
for improvements and extension of the said invention; and to
acquire and purchase any other invention for similar purposes.
The intended German patent was never granted, but the company
purchased a Swedish patent, and also established works in
Hamburg where they made and sold coffee from dates without
any patent. A petition having been presented by two
shareholders, it was held that the main object for which the
company was formed had become impossible, and therefore, it
was just and equitable that the company should be wound up.
We may thus safely conclude, that not only does a company
enjoy an expensive birth - but thanks to the concept of perpetual
succession it also gest an expensive funeral - regardless of the
hardships caused to the members.
(vi) Transferability of Shares
Incorporation resulting in giving the business a separate identity
apart from its members, has facilitated the easy transferability
of a member's interest in it. Previously this result was achieved
through the use of 'trust' coupled with an agreement for
transferability in the deed of settlement. But this arrangement
was only partially successful, since the member even after the
transfer, remained liable for the firm's debts incurred during the
time he was a member. Moreover, in the absence of limited
liability clause, his opportunity to transfer was in practice much
restricted. Similarly, in case of partnership, though a partner
may transfer his share, his right to do so is subject to the terms
and conditions of the partnership deed as well as the Partnership
Act.
Section 82 of the Companies Act provides that, "the shares or
other interest of any member in a company shall be movable
property, transferable in the manner provided by the articles of
the company". Thus incorporation enables the member to sell
his shares in the open market and get back his investment without
having to withdraw the money from the company. This provides
for ‘liquidity to the investor and stability to the company'.
Does this mean that there is absolutely no restriction on the
members right to transfer shares? No - the scope for restriction
is given in sec. 82 itself -- '.... in the manner provided in the
articles'. Thus, the articles of a company, may impose any
condition/restriction on this right to transfer shares. These
restrictions are in general more stringent in case of private
companies than in case of public companies, in order to allow
the former to retain its strictly private character. As observed
by Lord Greene M.R. in re Smith & Fawcett Ltd [(1942) Ch
304], "private companies are (no doubt) in law separate entities
just as much as are public companies, but from the business and
personal point of view they are much more analogous to
partnerships than to public corporations". Accordingly, it is to
be expected that in the articles of such a company the control of
the directors over the members may be very strict indeed.
(vii) Borrowing
It would be natural to presume that sole traders or proprietors
being personally liable would be more capable of borrowing
capital from the market but in reality that is not so. Creditors
find it easier and safer to lend money to companies rather than
to individuals. The reasons are varied: larger number of assets,
greater chances of return, better investment with great stability
etc. In order to facilitate the borrowing by companies, equity
practitioners have come up with an ingenious device known as
'floating charge' over the assets of the company, i.e., a charge
which floats like a cloud over the whole assets from time to
time falling within a generic description, but without preventing
the mortgagor from disposing of those assets in the usual course
of business until something occurs (for ex: winding-up) to cause
the charge to become crystallized or fixed. By virtue of it the
lender can obtain an effective security on all the undertaking
and assets of the company both present and future" either alone
or in conjunction with a fixed charge on its land. If, in addition,
the lender requires some personal security he can insist on the
members, or some of them, joining as guarantors. By this he
places himself in a stronger position, than if he merely had the
personal security of the individual traders. Frequently therefore,
a proprietor-business is converted into a company solely for the
purpose of raising further capital.
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3. LIFTING OF THE VEIL
SUB-TOPICS
3.1 Doctrine of lifting the veil - general meaning
3.2 Circumstances of lifting the veil
3.3 Personal liability in Companies Act
(a) Criminal Liability
(b) Civil Liability
3.1 DOCTRINE OF LIFTING THE VEIL
It is true as Avtar Singh observes that in question of property
and capacity of acts done and rights acquired or, liability assumed
thereby .... personalities of the natural persons who are the
company's corporations is to be ignored" (Singh , p.9). But this
theory cannot be extended to an unlimited extent. During the
nineteenth and early twelveth century several corporate lawyer's
and economists argued that a blanket legal personality may be
used as a shield for defrauding consumers in particular and public
in general. A corporate personality being an attribute by law
can show in the way of criminialization and fixation of corporate
criminal liabilty. The whole range of taxation laws may in that
case become non piercing. Some corporate lawyers could argue
that corporate personality being a legal personality, even fine
cannot be imposed against the corporations. This is an extension
of the logic of corporate personality to a very unreasonable extent
because in that case legal personality would conflict with the
sovereign function of the State. The resolution of this legal
puzzle has been attempted in the twentieth century in two ways
: and what goes on behind it is concealed from the public gaze -
(a) Through the means of legislative process, the corporate shell
has been broken a number of times to affix individual
liability specially in the matter of tax laws. Since the
legislature confers the personality and this constitutes the
personality shell it can only break it or puncture it. Based
on this principle, both the common law legislatures and civil
law legislatures have broken the corporate shell.
(b) In innumerable instances of fraud and abuse of corporate
structure, common law courts and civil law courts lifted
Lifting the veil
By the Legislature (Cracking the corporate Shell)
Reduction of No. of Fraudulent or wrongful
members trading
Misdescription of company name
Determination of character For the benefit of revenue or
taxation purpose
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the corporate veil in order to identify the responsible person
and affix proportionate liability. The basic philosophy
behind this is that the legislature attributes the corporate
veil with which individual functioning within the corporate
structure are insulated against personal liability. The
anology can be brought from the sovereign function of state
as a corporate body, in which state functionaries do not incur
any personal liability for making the state function. In many
countries having constitutional form of governance, the
secondary rule of the constitution empowers the state to
make primary rules for cracking the corporate identify of
the state and exposing the functionaries to individual
liabilities. In corporate law itself instances of such personal
liabilities are immovable in every country. This is therefore,
a very strong exception to the rule of corporate liability in
which individuals are absolutely insulated from liability
arising out of their function in the representative capacity
in the corporation. These exceptions on cracking the shell
or lifting the veil require further elucidation.
It should be emphasized here that the use of the term 'veil' does
not mean that the affairs of the company are completely
concealed from the view. On the contrary, it is an essential
condition of law of corporate personality with limited liability
that it should be accompanied by wide publicity. Normally
however, third parties are neither bound nor entitled to look
behind such information as the law provides shall be made
public, in addition to the veil of incorporation, there is something
in the nature of a curtain formed by the compay's public file,
but under certain situations, even this curtain may be raised. So
the phrase 'veil' basically denotes the cut-off line beyond which
the general public is not allowed to go for further information.
Though in general even the courts prefer to maintain this sanctity
and privacy of a corporate personality, under exceptional
circumstances they ignore this veil and go behind to ascertain
the true circumstances of the given case. The following flow
chart shows the various circumstances under which corporate
veil may be pierced or the shell cracked open.
3.2 CIRCUMSTANCES OF LIFTING THE VEIL
By the Judiciary (Lifting of the veil)
Premature Trading Company groups
Fraud or improper Agency or trust and Government
conduct companies
Now we will try to look at each of these situations briefly.
A] By the Legislature => Cracking of Shell
Though, this doctrine owes much to the judiciary for both its
evolution and development, the statute itself provides for certain
situations where the courts may go behind the corporate veil.
Though not as important as the judicial lifting of veil, even these
situations merit a brief description. So now we will study each
situation in detail where the corporate veil can be lifted.
(i) Reduction of number of members
Under S. 45 of the Act, if a company carries a business for more
than 6 months with less than two members, any person who is a
member after the lapse of the 6 month period may become liable,
jointly and severally with the company, for the payment of its
debts. This section does not operate to destroy the separate
personality of the company - it still remains an existing entity
even though there may be only one member or more. A creditor's
rights under the section are severely limited. It is only a member
who remains after the end of 6 months who can be sued, and
then also only if he knows that the company is carrying on
business with only member, and he is further liable for only
those debts contracted after the 6 month period and while he
was still a member. A director does not become automatically
liable unless he is a member also. Due to these limitations the
rule is more of theoretical interest rather than of practical
importance.
(ii) Fraudulent or wrongful trading
Of a far greater importance is S.542 of the Act, creating a specific
but widely defined criminal offence of carrying on business with
intent to defraud creditors of the company or any other persons
or for any fraudulent purpose. Once this fact is established during
a winding-up the court may, on the application of the liquidator,
creditor or contributory of the company, declare that the persons
who were parties to such business shall be personally responsible
for such debts of the company as the court may direct. Besides,
every person who is knowingly a party to such conduct of
business, is punishable with imprisonment, or fine, or both [sec.
543(3)]. This liability arises only when the company is in
winding up and for offences committed before or during winding
up. Fraudulent trading connotes real dishonesty according to
current notions of fair trading among commercial men, i.e., real
moral blame. The basis for decisions under this section have
been explained in re White & Osmond (Parkstone) Ltd
[unreported, cited in Avtar Singh, p.516] as: "There is nothing
wrong in the fact that the directors incur credit at a time when,
to their knowledge, the company is not liable to meet all its
liabilities as they fall due. What is manifestly wrong is if directors
allow a company to incur credit at a time when the business is
being carried on in such circumstances that it is clear that the
company will never be able to satisfy its creditors. However,
there is nothing wrong to say that directors who genuinely believe
that the clouds may roll away and the sunshine of prosperity
will shine upon them again and disperse the fog of their
depression are not entitled to incur credit to help them to get
over the bad time".
(iii) Misdescription of company name
If in any act or contract of a company, its name is not fully or
properly indicated as required under S. 147 of the Act, every
person who is involved in the doing of the act or making of the
contract shall be personally liable for it. Thus, in re William C
Leitch Bros. Ltd [(1932) All ER 892], the directors were held
personally liable on a cheque signed by them in the name of the
company stating the company's name as L.R. Agencies Ltd.--
the real name being L. & R. Agencies Ltd.”
(iv) Premature trading
Under S. 149 of the Act, a public company cannot commence
business immediately after incorporation, but has to obtain a
further certificate of 'commencement of business' from the
Registrar. Any contract entered into before the obtaining of
this certificate is merely provisional and not binding on the
company. If after the certificate is obtained, the company refuses
to be bound by the contract, the persons involved in the making
of the contract will be held personally liable. Technically
speaking, this is not really a case of lifting of the veil, the effect
of court intervention is to hold the director's etc., personally
liable. This provision is once again of academic interest, since
no public company would really enter into a contract before
obtaining the requisite certificate.
(v) Company groups
As seen earlier, even a 100% subsidiary company, is a separate
legal entity and its creator and controller is not to be held liable
for its acts merely because he is the creator and controller. Nor
is the subsidiary to be held as an asset of the holding company.
A subsidiary may however lose its separate identity to a certain
extent in two cases, firstly due to legislative intervention and
secondly by judicial intervention (this we will discuss later).
Thus secs. 212-214 contain provisions Designed primarily to
give better information of the accounts and financial position of
the group as a whole to the creditors, shareholders and public"
Similarly, the prohibition on financial assistance for the purchase
of company's own shares extends to financial assistance by any
of its subsidiaries. These provisions relating to group disclosures
have in some respects made matters worse rather than better for
they are calculated to lead those who had group annual reports
to assume that there is a group liability which is not really true.
So people unaware of intricacies in company law, are more likely
to be misled by these disclosures. Though, we have given certain
specific instances, there are many other miscellaneous provisions
spread through out the Act, which make it possible for the courts
to disregard the corporate identity and to fix the liability on the
person(s) responsible for the breach of such statutory provisions.
B] By the Judiciary => Lifting of the veil
As stated earlier this entire doctrine of 'lifting of corporate veil'
though of paramount importance does not owe its existence to
legislative draftsmanship, but is a prime example of judicial
ingenuity. Time and again, the courts have gone behind the
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facade of corporate identity in their search for truth, though again,
many are the instances when the courts have refused to look
behind this veil of legal personality. Thus, whether the court
would be willing to pierce the corporate veil or not, would rather
depend on the gravity and need of the particular situation, but
for the following purposes the courts have been very willing to
lift the veil.
(i) Determination of character
It may in certain situations become necessary for the courts to
determine the character of a company to check if it is an enemy”.
In such cases, it goes behind the legal identity, to examine the
character of the persons actually in control of it. One of the
leading cases on this point is Daimler Co. Ltd v. Continental
Tyre & Rubber Co. [(1916) 2 AC 307: (1916-17) All ER 191].
Here, a company was incorporated in England for the purpose
of selling tyres manufactured in Germany by a German
Company. The German Company held the bulk of the shares in
the English company. The holders of the remaining shares (save
one) and all the directors were Germans, residing in Germany.
Thus the real control of the English company was in German
hands. During the first world war, the English company
commenced an action to recover a trade debt. And the question
was whether the company had become an enemy company and
should, therefore, be barred from maintaining the action. House
of Lords held that, "a company incorporated in the UK is a
legal entity, a creation of law with the status and capacity which
the law confers. It is not a natural person with mind or
conscience. It can be neither loyal nor disloyal. It can be neither
a friend nor enemy. But it may assume an enemy character
when persons in defacto control of its affairs, are residents in an
enemy country or, wherever resident, are acting under the control
of enemies". Accordingly the company was not allowed to
proceed with the action. But where no such monumental
questions of public policy or national importance are involved,
the courts refuse to look behind the corporate entity to ascertain
the nature of persons controlling it [Refer to, People's Pleasure
Park Co. v. Rohleder, [61 SE 794].
(ii) For the benefit of the revenue
The courts have given to themselves the power to disregard the
corporate entity, to reach the person controlling it, if it feels
that the company is being used for purposes of tax evasion or
to circumvent tax obligation. One of the early cases on this
issue is in re Sir Dinshaw Maneckjee Petit, [AIR 1927 Bom
371]. Here, the assessee was a wealthy man enjoying huge
dividends and interest income. He formed four private
companies and agreed with each to hold a block of investments
as an agent for it. Income received was credited in the accounts
of the company, but the company handed back the amount to
him as a pretended loan. This way he divided his income into
four parts in a bid to reduce his tax liability. But it was held
that, "the company was formed by the assessee purely and
simply as a means of avoiding super-tax and the company was
nothing more than the assessee himself. It did no business, but
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was created simply as a legal entity to ostensibly receive the
dividends and interests and to hand them over to the assessee as
pretended loans". This does not mean, that in all cases, courts
will tend to equate the income of the company with the income
of the assessee. This is done only in cases, where there is an
express intention to deceive. Where such an intention is lacking,
the courts refuse to pierce the corporate veil, as is evident from
the case of Bacha F. Guzdar v. Commissioner of Income Tax,
Bombay [AIR 1955, SC 74]. Here, the income of a Tea
company was exempt up to 60% as agricultural income and
40% income was taxed as income from manufacture & sale of
tea. The plaintiff was a member of a tea company. She received
a certain amount as dividend in respect of shares held by her in
the company and claimed that this income should also be
regarded as agricultural income upto 60% and be non taxable.
It was held that, ‘although the income in the hands of the
company was partly agricultural, yet the same income when
received by the shareholders as a dividend could not be regarded
as agricultural income".
(iii) Fraud or improper conduct
The corporate entity as such is wholly incapable of being
strained to an illegal or fraudulent purposes. Where a company
is formed with an express intention to defraud creditors or for
improper purposes, the courts will refuse to uphold the corporate
identity and hold the controlling person personally liable. One
clear illustration is, Gilford Motor Co. v. Horne [(1933) 1 Ch
935]. Horne was appointed as MD of the plaintiff company on
condition that "he shall not at any time while he shall hold the
office of MD or afterwards, solicit or entice away the customers
of the company". His employment came to an end under an
agreement. Shortly afterwards he started a company which
solicited the plaintiff's customers. It was held that , "the company
was mere cloak or sham for the purpose of enabling the defendant
to commit a breach of his covenant against solicitation. Evidence
as to the formation of the company and as to the position of its
shareholders and directors lead to that inference. The defendant
company was a mere channel used by the defendant Horne for
the purpose of enabling his own benefit, for the advantage of
the customers of the plaintiff company and that the defendant
company ought to be restrained along with the defendant Horne".
(iv) Agency or trust and Government Companies
A company may be sometimes deemed to be the agent or trustee
of another company or of its principal. In India, earlier, this
question used to arise frequently in connection with Government
companies. As already discussed earlier, forming of a company,
allowed the government to be clothed in the robes of an
individual and allowed it to escape the rules and regulations
which hampered its actions if it were to act through a government
department. Initially, the Supreme Court did everything in its
powers to ensure the continuity of this freedom, and it was not
till 1981 that Krishna Iyer, J., in Somprakash Rekhi's case
imposed the liability of a 'state' even on government companies.
As a general rule it is very difficult to ascertain whether a
corporate body is really independent or is being used as the
agent or instrumentality of the state or of some other corporation,
and unless it becomes really essential, courts are generally
reluctant to look into this question. In 1939, in Smith Stone &
Knight Ltd v. Birmingham Corpn [(1939) 4 KB 116],
Atkinson, J., laid down a six point test to ascertain whether a
given company was the agent or instrumentality of another.
This test has made the job of the courts easier, in determining
this issue. The same test has also been used in taxation cases to
see whether a company is an agent or trustee of another. As
Lord Denning, M.R. said in Littlewoods Mail Order Stores
Ltd v. I R C [(1969) 3 All ER 855 (CA)]: The doctrine laid
down in Salomon v. Salomon & Co Ltd has to be watched
very carefully. It has often been supposed to cast a veil over
the personality of a limited company through which the courts
cannot see. But that is not true. The courts can and often do
draw aside the veil. They can, and often do, pull off the mask.
They look to see what really lies behind. The legislature has
shown the way with group accounts and the rest. And the courts
should also follow suit. We should also look at the Fork
company and see it as it really is - the wholly owned subsidiary
of the tax payers in point of fact, and it should be so regarded in
point of law". Despite all these advantages which make the
idea of doing business in the ‘company form' really lucrative,
there a some major disadvantage of incorporation which cannot
be overlooked. Apart from the fact that it is very expensive to
go in for incorporation, it is time consuming and often
inconvenient, one cannot get away from the fact that this shield
PERSONAL CRIMINAL LIABILITY OF OFFICERS IN DEFAULT
(Instances of cracking the shell)
of legal personality has been given by the law is the form of
judicial pronouncement, and this shield can be removed or
disregarded whenever the need arises. ‘Lifting of corporate veil
doctrine' evolved by the courts has thus turned into a major
disadvantage of incorporation, whereby the privacy of this legal
person, called a company can be invaded by the courts to ferret
out its innermost secrets. But still, weighing the advantages
and disadvantages of incorporation in a balance, the advantages
far outweigh the disadvantages.
3.3 INSTANCES OF PERSONAL LIABILITY
IN THE COMPANIES ACT
Over and above the company being liable, the Companies Act
itself provides the following circumstances in which each officer
of the company committing default shall be personally liable
unless he/she can prove that 1) the decision for the action has
been taken or not taken on the bonafide belief that such an action
or inaction is for the interest of the institution; 2) the default is
not a default in law and 3) as soon as the mistake is perceived
the officer concerned has taken a proper action. For the purposes
of the Act an officer (in default) shall mean all the following
officers of the company (a) Managing Director, (b) Whole
time director, (c) the manager, (d) the secretary (e) Any person
in accordance with whole company is accustomed to act, (f)
Any person charged by the responsibility attributed by the board
(sec. 5).
An officer shall not be covered by the corporate responsibility
and shall be exposed to his personal liability in the following
cases:

Sl. Section Ground of Offence Punishment

No. No. Imprisonment Fine

1. 22(2) Failure to change the name when - 100/- per day

directed by the Central
Government.
2. 39 Copies of constitutional documents - 50/- per day
not given to members.
3. 40 Alteration in constitutional - 10/- per copy
document not noted in copies.
4. 43/A/(5) Grounds of private company
becoming public not notified - 500/- per day
to Registrar within 3 months.
5. 44(3) Untrue statement in a prospectus upto 2 years and/or upto
or statement in lieu of 500/- per day
Prospectus.
6. 49 Investments not kept in the name - upto 5000/-
of company.

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7. 56(3) Statutory matters not disclosed - upto 5000/-
in prospectus.
8. 58(A) Public deposits accepted without upto 5 years and/or fine
(5)(6) public advertisement
9. 58(10) Safeguards directed to depositors upto 3 years and/or
not taken care of 50/- per day.
10. 60(5) Failure to Register Prospectus - upto 5000/-
11. 63(1) Misstatement in the Prospectus upto 2 years and/or upto
12. 68 Fraudulent or reckless statement upto 5 years and/or upto
in the prospectus 10000/-
13. 69 Minimum subscription not raised - upto 5000
but shares issued
14. 70 Allotment of shares or debentures upto 2 years and/or
violating statutory conditions upto 5000
15. 72 Allotment of shares or debentures - upto 5000/-
violating provision of S. 72
16. 73 Allotment violating conditions - upto 5000/-
in S. 73
17. 75(4) Failure to submit returns as - upto 500/-
to allotment per day
18. 76 Prohibition of paying - upto 500/-
commission and discount
19. 77 Violation of prohibition on - upto 1000/-
purchasing own shares.
20. 79 Issuing shares at a discount - upto 50/-
in violation of the provision
21. 80 & 80A Violating provisions for issuing - upto 1000/-
redeemable preference shares
22. 95 Notice to Registrar for consolidation - upto 50/-
of share capital not given per day
23. 97 Notice of increase of share - upto 50/- per day
capital or of members not given
24. 105 Concealing the names of creditors upto 1 year and/or fine
and others requiring discloser.
25. 108-I Penalty for acquisition & transfer
of shares in contravention of
section 108 A-D
a. Violation of condition 108A 3 years and/or 5000/-
b. Violation of condition 108B 3 years and/or 3000/-
c. Violation of condition 108C 3 years and/or 5000/-
d. Violation of condition 108D 5 years and/or also fine
26. 111 Violation of power to refuse - upto 50/- per day
registration and appeal against
refusal

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27. 113(1) Violation in the application for
the registration of transfer of - upto 500/- per day
shares and debentures or
debenture stock in accordance with
the provisions of Sec.53
28. 115 Violation of provision of not
entering the names in the register - upto 50/- per day
of members on the issue of share
warrants.
29. 116 Deceitful personation of an owner upto 3 years and fine
of any share or interest in the
company.
30. 118 Refusal of copies and inspection - upto 50/- and
of trust deed further fine
which may
extend to
20/- for
every day
of default
31. 137 Violating the provision for
maintaining Register of - upto 50/- per day
Charges etc.
32. 142 Default made in filing with the - uto 500/- per day
Registrar particulars regarding
charges etc.
33. 143 Non keeping of Register of charges - upto 500/-
34. 144 Refusal to inspect Register - upto 20/- per day
of charges
35. 146 Default in notifying Registered - upto 50/- per day
office
36. 147(3) Name of the Company not properly
published in commercial upto 500/-
documents
37. 147(4) Name of the company not properly upto 500/-
affixed or painted
38. 148 Authorised,subscription or paidup
capital not properly published. upto 2000/-
39. 149(2A)&6 Improperly commenced business upto 500/- per day
violating sec.149
40. 150 Register of members not properly upto 50/- per day
kept
41. 151 Index of members not kept upto 50/-
42. 152 Not keeping Register of debentures upto 50/-
43. 153-B(3a) Shares & Debentures held in trust upto 100/- per day
44. 153-B False statement made by the trustees 2 years and fine
45. 154 Register closed without giving upto 500/- per day
notice

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46. 157 Register of foreign members and - upto 50/- per day
debentures holders not properly
kept.
47. 158 Foreign register does not - upto 50/- per day
disclose the required
information.
48. 163 Register not kept in proper
place for inspection - upto 50/- per day
49. 165 Statutory meeting not properly - upto 500/-
held
50. 168 Annual General meeting not - upto 250/-
properly held.
51. 176(4) Notice given for invitation - upto 1000/-
to appoint proxy at the company
expenses.
52. 187-C Not declaring persons holding - upto 100 per day
beneficial interest
53. 188(8) Not circulating members - upto 5000/-
resolution as required
54. 192 Non registration of certain - upto 10/- per copy
resolutions & agreements to distributed
be registered
55. 193 Minutes of proceedings of General - upto 50/-
Meetings of board not properly
kept.
56. 196(3) Not allowing inspection of minutes - upto 500/- for
books of general body meeting each offence
as required.
57. 197 Improper publication of reports
of the proceedings of General - upto 500/-
Meeting.
58. 205A Unpaid dividend not treated as - upto 500/-per day
per Sec.205-A.
59. 207 Penalty for failure to distribute upto 7 days and fine
dividends within 42 days
60. 209(5) Failure to keep books of account. upto 1 year and/or
Default in keeping open books of upto 1000/-
account for inspection.
61. 209A Default upto 1 year and/or
upto 1000/-
61(a) 210(5) Failure to lay annual accounts upto 6 months upto 1000/- or
and balance sheet before the both
company.
61(b) 211(7) Failure to comply with the 6 months and/ or
provisions of Sec.211 upto 1000/-
62. 212 Disclosure in the balance sheet upto 6 months upto 1000/-
not made properly

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63. 217 Improper report by the board upto 6 months and/or
upto 2000/-
64. 218 Improper issue of final account - upto 500/-
65. 219 Members not supplied with financial - upto 500/-
and audited report
65(a) 220 Not filing copy of Balance Sheet upto 6 months upto 500/-
with Registrar
66. 221 Disclosures not properly made in 6 months and/or
the annual account upto 5000/-
67. 223 Banking or insurance company not - upto 50/- per day
publishing statements in the
appropriate table specified
in Schedule-I
68. 224 Violation in the appointment of - upto 500/-
auditors
69. 224A Appointment of Auditor without the
approval of company by special - upto 500/-
resolution.
70. 232 Non compliance of provision on - upto 500/-
annual audit accounts.
71. 233 Auditor's non-compliance with - upto 1000/-
Ss.227 & 229
72. 233A Non-compliance of government for - upto 500/-
special audit
73. 233B Non-compliance on cost audit upto 3 years and/or
requirement. upto 5000/-
74. 234 Non furnishing information or - upto 500/-
explanation sought by th and if con-
Registrar tinuing 50/-
every day.
75. 240 Failure or refusal to sign the notes 6 months and/or upto
of examination in investigation 2000/- and
also 200/-
per day when
the failure
continues.
76. 248 Furnishing false statement in a upto 6 months and/or upto
material particular 5000/-
77. 250(8) Change in the composition of
Board of Directors resulting upto 6 months and/or upto
from transfer of shares which 5000/-
is prejudicial to public interest.
78. 250(10) Issuance of shares involution - upto 5000/-
of restrictions.
79. 269(6) Want of approval of central - upto 500/-
government in the matter of for every day till
appointment of whole time he vacates office
Director or Manager
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80. 269(10) Violation of CLB restrictions in the matter
(a)(b)(c) appointing whole time Director, Manager or
Officer
(a) Company - upto 5000/-
(b) Every Officer - upto 10000/-
(c) Concerned appointee - upto 10000/- and
refund of
entire amount
of salaries,
commissions,
perquisites
enjoyed till
date of order
81. 269(11) Contravention of the Company Law upto 3 years and upto 50/-every
Board Order day of default
82. 272 Person acting as director for - upto 50/- every
want of share qualification day between
after the expiry of 2 months expiry date
and the last
day of acting
as such.
83. 279 Person acting as director of more - upto 5000
than 20 companies inrespect of
each of those
companies
after the
first twenty
84. 283 Disqualified person acting as - upto 500/- for
Director each day he
function as
director
85. 294 Violation of furnishing or refusing - upto 5000/-
to furnish information regarding the with a fur-
terms and conditions of appointment ther fine of
of the selling agent to the Central 50/- for
Government. every day of
default.
86. 298 Grant of Loan security or guarantee simple or fine
to directors without prior approval imprisonment upto 5000/-
of Central Government. upto 6 months
87. 299 Non disclosure of personal interest - upto 5000/-
by director.
88. 300 Interested Director knowing partici- - upto 5000/-
pation in Board's proceedings
89. 301 Default in not maintaining properly - upto 500/-
register of Contracts for each default
90. 302 Non disclosure of Director's interest - upto 1000/-
in contract appointing Manager etc.
91. 303 Default in non-keeping register of - upto 50/- per
directors, manager and secretary at day during
its registered office. default
continues
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92. 304 Refusal of inspection of Register - upto 50/-
of Directors to any member
93. 305 Violation of duty to disclose - upto 500/-
appointment or relinquishment of office
of director, managing director, manager or
secretary within 20 days of such happening.
94. 307(7) Non production of register of
director's share holding etc. - upto 500/-
at the commencement of every general
meeting of company.
95. 307(8) Non maintenance of register of - upto 5000/-
director's shareholdings, with further
debentures etc. fine upto
20/- everyday
during
default
96. 308 Default of directors to upto and/or
make disclosures of shareholdings 2 years 5000/-
97. 320(3) Director securing payment by way of - upto 250/-
compensation for loss of office etc.
with the transfer of undertaking
from the transferee
98. 322 Failure to add statement to - upto 1000/-
the proposal of appointment of a and damages
person to the office of director, which the
that his liability will be person so
unlimited. appointed may
sustain from
default
99. 332(5) Acting as managing agent of more - upto 1000/-
than 10 companies in respect of
each company
in excess of
ten
100. 343 Transfer of office by managing upto and/or upto
agent without approval of the 6 months 5000/-
company in general meeting and
central government
101. 347 Managing agents default in respect - upto 50/- for
to matters where schedule VIII applies everyday
during which
default
continues
102. 370(1-E) Non keeping of register showing the - upto 500/-
names of all body corporates unde the and further upto
same management and particulars of 50/- per day
all loans, guarantee or security during fault
continues
103. 371 Violation of section 369,370 or simple upto 5000/-
370-A (regarding loss to imprisonment
managing agent, to companies upto 6 months
under same management)
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104. 372(8) Non maintenance of register of - upto 500 and
investments with all particulars also 50/- for
every day
during fault
continues
105. 374 Non compliance of provision u/s 373 - upto 5000/-
regarding purchase of shares by
company.
106.391(4) Failure to annex court order - upto 10/- for
concerning compromise or each copy of
arrangement with creditors to which default
every copy of memorandum is made.
107. 394(3) Non filing of certified copy with - upto 50/-
Registrar within 30 days of
making an order regarding facili-
tating reconstruction and
amalgamation of companies.
108.404(3) Default in not filing with the - upto 5000/-
Registrar certified copy of
alteration of memorandum or
alteration of company within
30 days
109. 407 Termination or modification of upto one and/or upto
agreement by the officials year 5000/-
without the leave of CLB
110. 416 Violation of requirements of filing - upto 200/-
memorandum in the office of company
for placing in the next meeting of
Board of Directors concerning the
contract by agents in which company
is undisclosed principal
111. 420 Contravention of provisions concerning upto 6 or fine upto
provident funds of employees months 1000/-
112. 423 Non filing accounts of receivers as - upto 200/-
as per requirements u/Ss. 421 and 422
113. 454 Default in the statement of affairs upto 2 and/or upto 100/-
made to the liquidator years per day during
the period of
default continues
114. 481 Non filing a copy of order of - upto 50/-
dissolution of a company within per day
30 days by the liquidator to during which
the Registrar default
continues
115. 485 Default in the publication of the - upto 50/-
resolution of voluntary winding up every day
in the official gazette during which
default
continues

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116. 488 Default in the declaration of upto 6 and/or upto
solvency in the proposal of months 5000/-
voluntary winding up.
117. 493 Failure to give notice of - upto 100/-
appointment of liquidator to per day
Registrar within 10 days of during which
the event to which it makes defaults
continue
118. 495 Failure to call creditor's - upto 500/-
meeting in case of insolvency
by the liquidator
119. 496 Failure on the part of liquidator - upto 100/-
to call general meeting at the end
of each year.
120. 497 Failure to furnish the return within - upto 50/-
one week to the Registrar after the per day
meeting on fully winding up of the during which
company the default
continues
121. 497 Failure to call general meeting - upto 500/-
by the liquidator
122. 500 Default in holding the creditor's - upto 1000/-
meeting
123. 501 Default in giving notice of - upto 50/- per
resolution passed by creditor's day during
meeting to the Registrar which default
continues
124. 508 Failure to call meeting of - upto 100/-
company and creditors at for each
the end of each year failure
125. 509(3) Failure to send a copy of accounts - upto 50/- for
to Registrar about final meeting everyday fault
and dissolution continues
126. 509(7) Failure of liquidators to call a - upto 500/-
general meeting of the company or for each
creditors failure
127. 516 Failure to give notice of his - upto 50/-
appointment as liquidator within every day of
30 days to Registrar default
128. 538(1) Officer guilty of any false repre- upto 5 and/or fine
sentation or fraud for obtaining years
the consent of the creditors to
agreement relating to affairs of
company
129. 538(2) Where an officer pawns, pledges or upto 3 and/or fine
disposes profit of the company years
130. 539 Falsification of books upto 7 years and fine
131. 540 Frauds of Officers upto 2 years and fine
132. 541 Failure to keep proper accounts upto 1 year -
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133. 542 Persons fraudulent conduct upto 2 years and/or
of business upto 5000/-
134. 547 Failure to notify that company - upto 500/-
is in liquidation
135. 550 Disposal of books and papers upto 6 months and/or upto
of a wound up company in violiation 5000/-
of requirement
136. 551(5) Failure to furnish information - upto 500/-
as to pending liquidation everyday of

136(a) If liquidator makes wilful default upto 6 and or/

months upto 1000/-
137. 559 Failure to file certified copy - upto 50/-
within 30 days on whose appli- everyday
cation of winding up is ordered of default
by the court.
138. 598 Penalties in default of companies - upto 1000/- in
incorporated outside India case of continuing
offence and upto
100/- for every
day of default
139. 606 Violation concerning issue of upto 6 and/or 5000/-
prospectus months
140. 614-A Failure to comply with orders upto 6 months and/or 5000
of court
141. 615 Furnishing a wrong information upto 3 and/or upto
to central government months 1000/-
142. 621-A Failure to comply with the order upto 6 and/or upto
of Company Law Board months 5000/-
143. 625(4) Default in the payment of simple imprisonment -
compensation in cases of upto 2 months
frivolous prosecution
144. 628 Penalty for false statement upto 2 years and fine
145. 629 Penalty for false evidence upto 7 years and fine
146. 629-A Contravention of any of the - upto 500/-
provisions for which no and for
punishment is provided for continuing default
default upto 50/- per day
147. 630 Penalty for wrongful withholding upto 2 years upto 1000/-
property.

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 (b) PERSONAL CIVIL LIABILITY OF OFFICERS IN DEFAULT
(Instances of cracking the shell)

Sl.No. Section Grounds of Liability Extent of liability

1. 62(1) Misstatement in prospectus Compensation to suffering
member
2. 69 Return of application money Money with interest at
when allotment cannot be made the rate of 6% p.a. from
the expiry of 30th day
3. 71 Irregular allotment Compensating the share-
holder of the company
4. 73 Default in listing of shares Repayment of money of
and debentures u/s 73 investor plus 15%
interest
5. 111 Wrongful refusal of registration Damages
and unnecessary delay for
registration

6. 607 Statutory civil liability Compensation to suffering

member.

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4 PRINCIPLE OF ULTRA VIRES
SUB TOPICS
4.1 Introduction
4.2 Ultra Vires transaction
4.3 History of ultra vires rule
4.4 Effects of Ultra Vires transaction
(A) Rights of the company and shareholders
(B) Rights of other party
4.5 The Organ theory
4.6 Present status of the principle
4.7 Conclusion
4.1 INTRODUCTION
In our first module of corporate law, we have seen that for the
purposes of incorporation, the promoters of a company have to
file with the Registrar certain essential documents along with
their application for registration. Two of the main documents
required to be so filed are the memorandum and articles of
association. The memorandum consists of five major clauses,
namely, the name clause, the registered office clause, the object
clause, the capital clause, and the liability clause. The
memorandum in fact is required to give all the information which
a third party may reasonably want to have regarding the company.
The articles on the other hand, consist of rules and regulations
meant for internal governance of the company. We had further
seen though briefly, what was meant by the object clause and
what was ultra vires transaction. In this chapter, we will be
dealing with this principle in slightly more detail.
4.2 ULTRA VIRES TRANSACTIONS
Before going in depth to what ultra vires transactions really are,
it would be proper to study the reasons for inclusion of the 'object
clause' in the memorandum. There are basically three reasons
for this inclusion, viz.:
(i) The capital of the company is contributed by the
shareholders and held by the company as though in trust
for them. Such a fund must be dedicated to some defined
objects so that the contributors may know the purposes to
which it can be lawfully applied. The statement of objects,
therefore, gives a very important protection to the
shareholders by ensuring that the funds raised for one
undertaking are not going to be risked in another.
(ii) It affords a certain degree of protection to the creditors also.
The creditors trust the corporation & not the shareholders,
and they have to seek their repayment only out of the
company's assets. The fact that the corporate capital cannot
be spent on any project not directly within the terms of the
company's objects gives the creditors a feeling of security.
(iii) By confining the corporate activities within a defined field,
the statement of object serves the public interest also. It
presents diversification of a company's activities in
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directions not closely connected with the business for which
the company may have been initially established. It also
prevents concentration of economic power [Avtar Singh, p.
43].
These very reasons, require the company to adhere strictly to
the objectives stated in the object clause. The function of the
memorandum is, to delimit and identify the objects in such plain
and unambiguous manner as that the reader can identify the field
of industry within which the corporate activities are to be
confined” [Per Lord Wrenbury in Cotman v. Brougham, (1918)
AC 514]. The function of the courts is to see that the company
does not move in a direction away from that field - and it was
for this purpose that the principle or ‘doctrine of ultra vires' was
evolved. Ultra- means beyond and vires- means power, so the
phrase ‘ultra vires' literally means ‘beyond power'. Any action
of the company which falls outside the scope of the object clause
is ultra vires the company.
According to Palmer, there are two reasons why the ultra vires
doctrine has been developed by the courts: first, as a matter of
constitutional law, parliament, as the sovereign power in the
country, does not grant more power to delegated bodies than it
has authorized, and, secondly, as a practical consideration, it
was thought that the rule would protect investors in the company
and creditors of it against the unauthorized use of the company's
funds. In the words of Prof. Gower, the purpose of the ultra
vires rule was to ensure that an investor in a gold mining company
did not find himself holding shares in a fried-fish shop, and [to
give] those who allowed credit to a limited company some
assurance that its assets would not be dissipated in unauthorized
enterprises” [Palmer, p.73].
The application of this doctrine was first demonstrated in
Ashbury Railway Carriage and Iron Co Ltd v. Richean
[(1874-80) All ER Rep Ext 2219]. Here, the memorandum of
a company stated its objects as the objects for which the
company is established are to make and sell, or lend on hire,
railway carriages and wagons and all kinds of railway plants,
etc., to carry on the business of mechanical engineers, and
general contractors ....". The company entered into a contract
with Riche, a firm of railway contractors to finance the
construction of a railway line in Belgium. The company
however repudiated the contract as being ultra vires, and Riche
brought an action for breach of contract - because according to
him the contract came well within the meaning of the words
general contractors” and was, therefore, within the powers of
the company, and, secondly, that the contract was ratified by a
majority of the shareholders, but the House of Lords held the
contract ultra vires and hence null & void. Lord Cairn observed,
The subscribers are to state the objects for which the proposed
company is to be established and then the company comes into
existence for those objects and those only. Such a statement of
objects has two-fold operation. It states affirmatively the ambit
and extent of powers of the company and it states negatively
that nothing shall be done beyond that ambit, and that no attempt
shall be made to use the corporate life for any other purpose
than that which is so specified. The terms general contractors”
must be taken to indicate the making generally of such contracts
as are connected with the business of mechanical engineers. If
the term general contractors” is not so interpreted, it would
authorize the making of contracts of any and every description,
such as, for instance, of fire and marine insurance and the
memorandum in place of specifying the particular kind of
business, would virtually point to the carrying on of the business
of any kind whatsoever and would, therefore, be altogether
unmeaning. Hence the contract was entirely beyond the objects
in the memorandum of association. If so, it was thereby placed
beyond the powers of the company to make the contract. If the
company could not make it, much less could it be ratified. If
every shareholder of the company had been in the room and
had said: That is a contract which we desire to make, which we
authorize the directors to make” the case would not have stood
in any different position from that in which it stands now. The
shareholders would thereby, by unanimous consent, have been
attempting to do the very thing which by Act of Parliament they
where prohibited from doing” [Avtar Singh, pp.43-44].
In India, the first case on this principle seems to be Jahangir
Rastamji Modi v. Shamji Ladha [4 Bom. H.C.R. 185 (1866-
67)]. Here, the plaintiff was the registered shareholder of 601
shares in a company of which the defendants were the directors.
The plaintiff alleged that the object clause under the
memorandum, did not include dealing in shares, nor did it include
the purchase by the company's of its own shares; yet the directors
not only dealt in shares thereby incurring losses on behalf of the
company, but also also purchased 1,422 shares of the company.
Two of the issues framed were (1) Whether the purchase of its
own shares by the company was ultra vires and (2) Whether
purchase of shares in a joint stock company was ultra vires.
Delivering the judgment, Sargent, J., observed,
"A long series of decisions of the courts of law and equity
in England has decided that an incorporated joint stock
company can do no act which is not expressly or impliedly
authorized by...the deed of settlement of the company... It
is therefore to the memorandum and articles of association
that we must turn to determine whether those transactions
are expressly or impliedly authorized; or as it has been
sometimes expressed, whether they fall within the scope
of the objects for which the company was established.
While holding that the purchase by the company of its own
shares was ultra vires, the learned Judge remarked: I have
not arrived at this decision without some regret, as I cannot
but be aware of a fact perfectly notorious, that it has been
the practice not only of companies similar to this, but for
other companies, to purchase their own shares, and that
this decision may press somewhat harshly upon individuals;
but at the same time if the joint stock companies are to
flourish, more specially in a country like this, it can only
be by the public feeling assured that the courts of law while
refusing to interfere with directors in carrying out the
objects of these associations into full and complete activity,
will prevent the application of the funds of the company to
other than legitimate purposes and objects of the
association" [Sangal, pp 8. 9 & 10].
Slowly, a strict interpretation of the objects stated in the
memorandum gave way to a slightly more liberal interpretation.
In Attorney General v. The Great Eastern Railway Co
[(1874-80) All ER Rep Ext 1459], the House of Lords observed
that 'the doctrine of ultra vires, as it was explained in the Ashbury
case, should be maintained. But it ought to be reasonably and
not unreasonably understood and applied and that whatever may
be fairly regarded as incidental to the objects authorized ought
not to be held as ultra vires, unless it is expressly prohibited'.
Thus, a company may do an act which is: (a) necessary for, or
(b) incidental to, the attainment of its objects, or (c) which is
otherwise authorized by the Act. Applying this rule of
construction, a chemical manufacturer was allowed to distribute
1,00,000 Pounds to universities and scientific institutions for
the furtherance of scientific education and research as it was
conductive to the continued progress of the company as chemical
manufacturers [Evans v. Brunner, Mond & Co Ltd, (1921) 1
Ch 359]. But where the money is paid by the company for a
good purpose but not one useful to it, the courts refused to hold
the payment as valid. For example in A. L. Mudaliar v. LIC
[AIR 1963 SC 1185], the directors of a company were authorized
to make payments towards any charitable or benevolent object,
or for any general public, general or useful object. Accordingly,
the directors being permitted by the shareholders, paid two lakh
rupees to a trust formed for the purpose of promoting technical
and business knowledge. Holding the payment ultra vires, the
Supreme Court observed, the directors could not spend the
company's money on any charitable or general object which
they might choose. They could spend for the promotion of only
such charitable objects as would be useful for the attainment of
the company's own object. The company business having been
taken over by the LIC, it had no business left to promote". This
decision is an authority on two points, namely:
(i) A company's funds cannot be diverted to every kind of
charity even if there is an unrestricted power to that effect
in the company's memorandum; and
(ii) The objects of the company must be distinguished from
powers. Objects have to be stated in the memorandum not
the powers. Even if the powers are stated, they have to be
used only to effectuate the objects of the company. They
do not become independent objects themselves [Avtar
Singh, p. 46].
Thus, a power to make charitable contributions cannot be acted
upon to make grants of any or every kind. In the famous words
of Bowmen, L. J., in Hutton v. West Cork Rly Co [(1883) 23
Ch D 654], charity has no business to sit at boards of directors
qua charity. There is, however, a kind of charitable dealing
which is for the interest of those who practice it, and to that
extent and in that garb charity may sit at the board, but for no
other purpose".
The ultimate test to decide whether a transaction is ultra vires
or not, is to see whether it is beneficial to the company or not.
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If it does not benefit the company, then the transaction becomes
ultra vires however praiseworthy the object may be.
Disadvantages of the rule
The ultra vires rule suffers from two short comings. In practice,
it creates difficulties for both the management and the persons
dealing with the company. For the management, their powers
of doing business are restricted because at every step, they have
to check whether their acts come within the purview or scope of
the articles and memorandum. If they dont then the
memorandum has to be altered, which is not very convenient.
Outsiders dealing with the company are placed at an unnecessary
disadvantage, because under law, they are deemed to have
knowledge of the provisions of the memorandum and articles.
So, if a transaction is not covered by the 'object clause' even a
bonafide transaction with a company can be invalidated and as
a result an outsider very often finds himself in difficulty. Gower
has called the ultra vires rule a great trap for the unwary third
party. According to Cohen Committee Report, the doctrine of
ultra vires is an illusory protection for the shareholders and yet
may be pitfall for third parties dealing with the company".
4.3 HISTORY OF THE ULTRA VIRES RULE
In the words of Gower "The ultra vires rule has a long and
somewhat tangled history". Chartered corporations were
considered as possessing all the powers of a natural person to
the extent an artificial entity was physically capable of exercising
them. If these powers were misused by exceeding the objects
stated in the charter, a writ in the nature of 'Quo Warranto', could
be taken, to restrain such action or proceeding, or in the nature
of 'Ciare Facias' could be taken to forfeit the charger, but the
actions were not null and void.
By the English Companies Act of 1844, incorporation became
possible by registration under the Act and charters of
incorporation became infructuous. The constitution of such
companies still followed the existing practice of having a
document in the nature of a deed of settlement with no clear
exposition of the different objects of the company.
Effect of ultra vires transaction
On Rights of the company & shareholders
Injunction Personal Repudiation
Liability of contract
of the
Directors
Right to a
tracing
order
We will now discuss each of these categories in detail.
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With the passage of time, however, a feeling grew that the
unlimited and unrestricted powers of directors ought to be
curtailed or should be so construed that investors and creditors
were protected. Investors were considered in need of protection
against wrongful application of the assets of the company to
ventures not in their contemplation and creditors were expected
to be protected against wrongful utilization of assets which might
result in insolvency of the company, and reaching a position
where the creditors could not be paid. A direct result of growth
of this feeling was development of a theory that if the directors
sought to enter into forbidden or unauthorized transactions they
could be restrained by the action of a shareholder, and that a,
unauthorized contract could be regarded as ultra vires and
unenforceable as against the company.
In 1855 in Eastern Counties Railway Co v. Hawkes, [(1855)
5 H L C 331], Lord Cranworth declared, "it must therefore be
now considered as a well-settled doctrine that a company
incorporated by act of Parliament for special purpose cannot
devote any part of its funds to objects unauthorized by the terms
of its incorporation, however desirable such an application may
appear to be".
The companies position was finally settled in 1875 in Ashbury
Railway Carriage & Iron Co. v. Riche [(1875) LR 7 HL 653]
and further reiterated and clarified in Attorney General v. Great
Eastern Railway [(1874-80) All ER Rep Ext 1459]. In London
County Council v. Attorney General [(1902) AC 165] Lord
Hallsbury L. C. referring to the two above cases said: I think
now it cannot be doubted that these two cases do constitute the
law upon the subject".
4.4 EFFECT OF ULTRA VIRES TRANSACTIONS
As can be easily foreseen, effects of ultra vires transactions are
usually grave, influencing the rights of both the company and
also the third party to the contract. The flow chart given below
shows the various consequences of an ultra vires transaction at
a glance.
On Rights of the other party
Right to Right to sue
retain directors
security for breach
once of warranty
obtained of an
authority
4.4 (A)ON RIGHTS OF THE COMPANY AND
SHAREHOLDERS
It is the fundamental right of both the company and the
shareholders to expect that the funds of the company will be
spent only on the objects specified in the memorandum, and
that the directors should limit the activities of the company to
the objects given in the memorandum. But in cases, where the
directors enter into ultra vires transactions, the company and
the shareholders can exercise the following rights:
1] Injunction
Even a single member of the company can seek an injunction
order to restrain the company if he fears that the company has
or is about to enter into an ultra vires transaction. Thus for
example, in London County Council v. Attorney General
[(1902) AC 165], the council had statutory power to work
tramways and wanted to run omnibuses in connection with the
tramways. The court found that the omnibus business was in no
way incidental to the business of working tramways, and,
therefore, restrained the company from undertaking it, although
it might have materially contributed to the success of the council's
tramway business.
2] Personal liability of Directors
One of the basic duties of the directors is to see that the corporate
capital is used only for the legitimate business of the company.
If the funds of the company are diverted for a purpose other
than that specified in the memorandum, the directors will be
personally liable to replace the funds. This liability of a director
does not come to an end on his death, but attaches to his estate
in the hands of his legal representatives. Thus in Peoples' Bank
of Northern India Ltd v. Hargopal [(1935) 5 Comp. Cas 305],
a suit for damages by the Peoples' Bank against the directors of
a local branch on the ground of loss caused to the company
owning to the wilful breach by the directors of their obligation
as directors in granting loans was decreed against the legal
representatives of a deceased director.
3] Repudiation of contract
So far this discussion has centred around the rights which the
company & shareholders have against the responsible directors.
But the most fundamental right of the company in such cases,
from which the remaining rights flow is the right to 'repudiate
the contract'. The general rule is, that, an ultra vires contract is
completely null and void and devoid of any legal effect. A very
interesting point to note in this regard is that, if the company
has executed its part of the ultra vires contract, courts by hook
or by crook manage to ensure that the third party is bound by
the ultra vires contract. But, where the third party has executed
his part of the contract, then alone does the rule of ultra vires
transactions being completely void holds good in rem are made
available to the third party. For example, in Ahmad Sait v.
Bank of Mysore [(1930) 59 M.L.J.R 28], though it was ultra
vires for the Bank of Mysore to advance money on mortgage, it
did do so. But still the Madras High Court held, that, the Bank
had the right to sue on the basis of the mortgage & thus to
enforce the mortgage. The court justified its decision by holding
that, 'according to Brice on the Doctrine of ultra vires, property
legally and by formal transfer or conveyance transferred to a
company in law duly vested in such a company, even though the
company was not empowered to acquire such property, and in
India, a mortgage was a transfer of interest in immovable
property'.
This outlook is similar to the device invented by the courts to
circumvent the rule of invalidity of a minor's contract only when
it suited the minor to evade the rule but not otherwise. Pollock
& Mulla in their book on contract have given a good explanation
of this rule, by stating:
"Section 7 of the Transfer of Property Act, 1882, provided
that every person competent to contract an entitled to
transferable property was competent to transfer such
property. But it was not provided anywhere in the Act that
a person not competent to contract was incapable of
becoming a transferee of property. This circumstance was
pressed into service and it was held that though a sale or
mortgage of his property by a minor was void, duly executed
transfer by way of sale or mortgage in favour of a minor
who had paid the consideration money was not void, and it
was enforceable by him or any other person on his behalf.
A minor, therefore, in whose favour a deed of sale was
executed was competent to sue for possession of the property
conveyed thereby [Sangal, p.57].
Thus we find that the Indian courts are inclined to treat the
companies on par with minors so far as protection of their interest
goes. To give a minor certain one-sided privileges because of
his infancy is both reasonable and understandable but to give a
company also similar one-sided protection does not stand to
reason today when companies because of their resources can
utilize and do utilize the services of the best legal brains in the
country, and hence are not as defenceless as the minors are.
4.4 (B) RIGHTS OF THE OTHER PARTY
We have already discussed in detail the rights which a company
or shareholders have in case of ultra vires transactions, we have
now to study the rights which the other party to the transaction
has against those officers of the company responsible for entering
into the contract. These rights briefly are as follows:
1] Right to a tracing order
If the other party has advanced an ultra vires loan to a company,
then the party does not have a right to recover the money so
advanced because an ultra vires loan cannot create any liability
on the company. It would be unfair, on the other hand to deprive
the lender of the money so advanced. Therefore, the third party
has been given the right to follow his money and to recover it
in specie from the possession of the company, provided the
money can be identified. This right is known as the 'right to a
tracing order'. This right was recognized & enforced under the
common law, if the money could be identified as such or any
asset of the company could be identified as having been
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purchased out of this money. But, if the money got so mixed up
with the company's money that it became incapable of
identification then it could not be traced.
To rectify this major flaw, equity looked upon such money as
being held by the directors in trust for the benefit of the lender.
Thus, equity found no difficulty in regarding a 'mixed or
composite fund' separate for certain purposes. This approach
coupled with and encouraged by the far-reaching remedy of a
declaration of charge enabled equity to identify money in a mixed
fund. In India, this principle has been applied as early as in
1931, in the case of re Madras Native Permanent Fund Ltd
[60 M L J R, 270 (1931)]. The company was started in 1878
under the name of the Madras Native Permanent Fund Ltd.,
with a capital of rupees two lakhs. The objects of the company
as stated in the memorandum of association were to make
advances to shareholders upon security of movable or
immovable property for enabling them to purchase, build and
repair houses and to grant to them simple loans to a limited
extent and to do such things as were incidental to the attainment
of the above objects. In 1887, a new branch was started and
was called the Deposit Branch, to distinguish it from the Loan
Branch, the name adopted to designate the company's original
activities. The capital of the company was raised and the newly
raised shares were allotted to the Deposit Branch.
While the Loan Branch was confined to the original objects, the
Deposit Branch developed into an ordinary bank and carried on
banking business. In the Deposit branch there were deposits
and advances, customers depositing money and loans being
advanced on pledges of jewels. The customers of the bank
included both members and strangers. This went on for about
forty years and it was then found that the Company's affairs
were not being conducted satisfactorily. The Company having
sustained a loss, the depositors were unable to get back their
moneys. A liquidation petition was filed and a compulsory order
was made in May, 1927. Some of the depositors in the bank
were the applicants in this misfeasance summons. Dismissing
the application, Venkasubba Rao, J., made the following
observations:
"The short question I have to decide is, are the amounts
due to them debts? In otherwords, are the lenders in the
eye of the law, creditors and is the borrowing company,
debtor? This point is now well settled by authority. Where
the carrying on of a business by the company was ultra vires,
it was held that the ultra vires transaction created no debt,
either legal or equitable. This was held in re Birkbeck
Permanent Benefit Building Society [(1912) 2 Ch 183].
The facts of that case resemble those of the present. A
building society carried on banking business altogether
beyond what was authorized. Cozens-Hardy M.R. observes
that the so-called contracts of loan, though not illegal, are
void and in truth have no existence. This is treated as the
doctrine as to ultra vires borrowing. The case went up to
the House of Lords and this view was affirmed, although
on another point the decision of the Court of Appeal was
varied [Sinclair v. Brougham (1914) A.C. 399]. The
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relation between the depositor and the company is not that
of debtor and creditor and the only possible remedy for the
person who has paid the money is one in rem and not in
personam. This is a most unequivocal declaration, that ultra
vires transactions do not create the relationship of debtor
and creditor. The preliminary objection, therefore, must be
upheld and on this short ground the application is
dismissed".
The learned judge went on to say: from this it does not follow
that the lenders can, in no circumstances, recover their deposits.
The very case I have cited, Sinclaire v. Brougham, decides
what their rights are and how and to what extent they can be
enforced". The depositors to whom moneys were due from the
Deposit Branch, had already under orders of the Court been
paid sums amounting to over a lakh. The learned Judge further
indicated certain sums of money which he directed the liquidators
to distribute among the depositors of the Deposit Branch.
In this manner, the depositors were repaid only about 75 per
cent of their deposits. They suffered losses of about 25 per cent
of their deposits for, practically speaking, no fault of theirs but
due to the technical rule of ultra vires [Sangal, pp.19-20].
2] Right to retain security once obtained
This right of an ultra vires lender was recognized in Deonarayan
Parasad Bhadani v. Bank of Baroda, Ltd [(1957) 27 Comp
Cas 223]. The plaintiffs sought a declaration that a prior first
English mortgage on its properties & assets created by Deft. no.
2 (the mill), in favour of the deft. no. 1 bank, to secure repayment
of a sum of Rs.25,00,000 advanced to the mills by the bank was
ultra vires and of no effect. They also sought the consequential
relief that the bank might be ordered to deliver up the mortgage
to be canceled and for a permanent injunction restraining the
bank from taking any action under the mortgage or any steps to
enforce and realize the mortgage. After going through a series
of arguments, Desai, J., held .... I have reached the comforting
conclusion that even if I were to take the view that the whole
transaction of mortgage in favour of deft. no. 1 bank was ultra
vires and a nullity, I would yet hold that there is an equity arising
in favour of the bank which entitles it to retain possession of the
property given to it in the purported performance of the contract
between the parties and to claim restitution before it can be
compelled to part with the possession of that property. Therefore,
in that view of the matter also the plaintiffs are not entitled to
the relief they seek in this suit".
3] Right to sue the directors
The directors of the company are its agents, and as such they
are duty bound to keep within the limits of the company's
powers. If they, induce, however innocently, an outsider to
contract with the company in a matter in which the company
does not have the power to act, they will be personally liable to
such a person, for the loss caused to him. For example, in
Weeks v. Propert [(1873) LR 8 CP 427], a railway company
invited proposals for a loan on debentures. At the time the
advertisement was published, the company had already issued
debentures to the extent of £ 60,000 being the full amount which
it was authorized by its constitution to issue. It had, thus
exhausted its borrowing powers. The plaintiff offered a loan of
£ 500 based on the advertisement. The directors accepted it
and issued to him a debenture of the company. The loan being
ultra vires was held to be void. In an action by the plaintiff
against the directors, it was held that the directors by inserting
the advertisement had warranted that they had the power to
borrow which they did not in fact possess. Their warranty
consequently was breached, and hence they were personally
liable.
It must be remembered, that, the representation held out by the
directors must be of fact & not of law. Thus, whether a company
is authorized by its memorandum to borrow at all is a question
of law which every person dealing with the company is presumed
to know, but, whether the company had already borrowed the
entire amount authorized by the memorandum, is a question of
fact, which an outsider cannot under normal circumstances be
presumed to know. A representation of the former kind will not
render the director personally liable, but a representation of the
latter will render him so.
4] Ultra vires torts
The rule of constructive notice of memorandum and articles
explains why a company is not liable for an ultra vires contract,
but that does not solve the problem of injustice involved.
Moreover, the rule altogether fails to hold ground when a
company is sought to be made liable for a tort committed by a
servant of the company while acting beyond the company's
powers. Any one dealing with a company may, at the pain of
losing the bargain, be required to acquaint himself with the
company's memorandum. But that can hardly be expected of a
person who has been the victim of an ultra vires tort. For
example, a company is operating omnibuses - a venture entirely
alien to its objects as described in the memorandum. The driver
of one such bus negligently injures the plaintiff who sues the
company for the tort. It can, no doubt, be contended against
him that the driver was not a servant of the company. The
company, having no existence outside its corporate sphere, could
not have appointed him. But can it be said that the plaintiff
ought to have know this fact. Doubtless the plaintiff deserves
to be compensated. But the law has not yet clearly declared the
justice of his demand. As the law seems to stand at present, to
make a company liable for any tort it must be shown that-
(1) that the activity in the course of which it has been committed
falls within the scope of the memorandum, and
(2) that the servant committed the tort within the course of his
employment [Avtar Singh, p. 55].
4.5 THE ORGAN THEORY
It is a central feature of incorporation, that the company acquires
a new and separate legal identity capable of enjoying rights,
exercising powers, and incurring duties and obligations. It is
traditional to describe any subject possessing rights and duties
as a 'person' But it is one thing to attribute legal capacities and
characteristics to a company, and quite another to treat it as
having human characteristics and qualities. It is unnecessary
and unreasonable to suppose that the latter step follows directly
from the former - yet the courts have now taken this analogy
with a physical person to its utmost limits; ascribing to a company
human attributes such as 'reputation' 'character'; or an 'intention
to defraud' etc. This kind of attribution has been made in order
to make it difficult for the companies to escape liability for acts
undertaken on their behalf - because there are some types of
liability which demand actual fault of the principal/master i.e.,
the company itself. For the purpose of attributing such liability
the English judiciary started distinguishing between "organs"”
and "agents"” of the company and attributed the acts of the
former to the company. For example, in Bolto (Engineering)
Co Ltd v. Graham & Sons [(1957) 1 QB 159, CA], the question
which arose was, whether the landlord company had effectively
terminated a business tenancy, because it had the intention to
occupy the premises for its own business. There was no formal
general or board meeting to decide on such intention but the
executive directors of the company had clearly manifested such
an intention and such manifestation was held to be sufficient
intention of the company's mind. Lord Denning, L.J., observed:
"A company may in many ways be likened to a human body. It
has a brain and nerve centre which controls what it does. It also
has hands which holds tools and act an accordance with
directions from the centre. Some of the people in the company
are mere servants and agents who are nothing more than hands
— and cannot be said to represent the mind and will. Others
are directors and managers who represent the directing mind
and will of the company and control what it does. The state of
mind of these managers is the state of mind of the company and
is treated by the law as such".
However, it is in the sphere of criminal law that the organic
theory made a major impact. Except where the crime is one in
which the 'actus reus' (or the act) is such that an artificial person
is either physically incapable to commit it, or, the punishment
for the act is such that it cannot be imposed on an artificial
person (say imprisonment), or where it is a statutory offence is
and corporate liability is clearly excluded by the statute itself,
the corporation is made liable for the acts of its 'organs'. Though
extremely useful, this theory has thankfully not been carried
over to absurd extremes. For example, if persons who constitute
the head and brains are imbibed in defrauding the company,
they cannot successfully defend either a civil action or a criminal
prosecution by the company by saying, "we were the controlling
organs of the company and accordingly the company knew all
about it and consented" [Belmont Finance Corp v. Williams
Furniture Ltd (1979) Ch 250 CA; R V Phillipon (1989) 89 Cr
App R 290, CA]. To allow such a defence, would mean that
the duties which the organs owe to the company, would be wholly
negated.
4.6 PRESENT STATUS OF THE PRINCIPLE
The ultra vires doctrine confines corporate action within fixed
limits. While it handicaps the ambitious manager, it lays a trap
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for the unwary creditor. That is why there has been a revolt
against it almost ever since its inception. The businessman has
always endeavoured to evade the limitations imposed by the
doctrine. One of the methods of by-passing ultra vires is the
practice of registering memoranda containing a profusion of
objects and powers.
For example, in Cotman v. Brougham [(1918) AC 514], the
House of Lords had to consider a memorandum which contained
an objects clause with thirty sub-clauses enabling the company
to carry on almost every conceivable kind of business which a
company could adopt. Such an object clause naturally defeats
the very purpose for which it is there. In a bid to control this
tendency the courts adopted the "main objects rule" of
construction. The rule owes its origin to the decision in the
Ashbury case where it was held that the words "general
contractors" must be read in connection with the company's main
business. German Date Coffee Co. In re Failure of
Substratum, [(1973) 47 Aust LJ 718] is another illustration of
its application. The memorandum of a company stated that it
was formed for working a German patent which would be
granted for manufacturing coffee from dates ; for obtaining other
patents for improvements and extension of the said invention;
and to acquire and purchase any other invention for similar
purposes. The intended German patent was never granted, but
the company purchased a Swedish patent, and also established
works in Hamburg where they made and sold coffee from dates
without any patent.
A petition having been presented by two shareholders, it was
held that the main object for which the company was formed
had become impossible and, therefore, it was just and equitable
that the company should be wound up. Lindley, L. J. said: In
construing a memorandum in which there are general
words...they must be taken in connection with what are shown
by the context to be the dominant or main objects. It will not do
under general words to turn a company for manufacturing one
thing into a company for importing something else. Taking that
as the governing principle, it seems to be plain that the real
objects of this company which is called German Date Coffee
Co., was to manufacture a substitute for coffee in Germany under
a patent. It is what the company was formed for and all the rest
is subordinate to that".
This principle will, however, be of no help where a company is
formed for general purposes as opposed to a defined subject-
matter. Pointing this out in re Kitson & Co. Ltd [(1946) 1 All
ER 435 CCA)], Lord Greene MR said: The impossibility of
applying such a construction seems to be manifest when one
remembers that business is a thing which changes. It grows or
it contracts. It changes; it disposes of the whole of its plant; it
moves its factory; it entirely changes its range of products, and
so forth. It is more like an organic thing. It must be remembered
that in these substratum cases there is every difference between
company which on the true construction of its memorandum is
formed for the paramount purpose of dealing with some specific
subject-matter and a company which is formed with wider and
more comprehensive objects. With regard to a company which
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is formed to acquire and exploit a mine, when, you come to
construe its memorandum of association you must construe the
language used in reference to the subject-matter, namely, a mine
and, accordingly, if the mine cannot be acquired or if the mine
turns out to be no mine at all the object of the company is
frustrated, because the subject-matter which the company was
formed to exploit has ceased to exist...... But when you come to
the subject-matter of a totally different kind like the carrying on
of a type of business, then, so long as the company can carry on
that type of business, it seems that prima facie at any rate it is
impossible to say that its substratum has gone. The facts of the
case were: The company was incorporated with the object of
(a) acquiring an existing engineering concern and (b) carrying
on the business of general engineering. Subsequently the
company proposed to sell the original business and to embark
upon other general engineering activities. Some of the
shareholders petitioned for winding up on the ground that the
company's substratum had disappeared. The court rejected the
petition.
In Cotman v. Brougham the main object rule was excluded by
a declaration in the objects clause that every clause should be
construed as a substantive clause and not limited or restricted
by reference to any other sub-clause or by the name of the
company and none of them should be deemed as merely
subsidiary or auxiliary”. The House of Lords expressed strong
disapproval of the inclusion of such a clause, but their Lordship
held that it excluded the "main objects rule" of interpretation.
Thus the rule has failed to prevent the evasion of ultra vires.
And now the decision of the court of Appeal in Bell Houses
Ltd v. City Wall Properties [(1966) 2 All ER 674] has stamped
its approval upon another technique of evasion. In this case a
company's objects clause authorized it to carry on any other
trade or business which in the opinion of the board of directors
could be carried on advantageously in connection with the
company's general business. The court held the clause to be
valid and an act done in bonafide exercise of it to be intra vires.
But a clause of this kind does not state any objects at all. Rather,
it leaves the objects to be determined by the directors' bona
fides [Avtar Singh, pp.49 - 51].
4.7 CONCLUSION
It may be safely observed that, the doctrine of ultra vires, once
very useful to shareholders and creditors of the company, has
now practically become devoid of any value, though it may still
to some extent retains its potentiality for vice, name, that it can
allow persons to avoid with impunity an obligation which ought
to be fulfilled in good conscience and can thus be a trap for the
other innocent party. Though the entrapped party is not left
without a remedy, the remedies themselves are of limited
efficacy. All these factors underline the need for a major
legislative action in this area, aiming at both - simplification of
law and ensuring justice to the third party.
A company's liability to third parties no longer depends solely
on principles of agency or 'respondeat superior'. Though the
word 'organ' is not used, the Act recognizes that the board of
directors is not a mere agent of the company but an organic part
of it so that third parties can treat the acts of the board as acts of
the company itself. In case of tortious or criminal liability, the
courts have held that when 'managerial powers' have been
delegated by the board to other officers, those officers also may
be treated as organs, rather than agents or servants of the
company so that their acts can be regarded as those of the
company itself and not merely as acts of the officers for which
it is liable only vicariously. This state of affaris has resulted in
further eroding of the doctrine of ultra vires.
The 'English Company Law Revision Committee' (known as
the Cohen committee, 1945) recommended the abolition of this
doctrine, but this recommendation has not been implemented in
theory atleast, though in practice the doctorine at present is of
little utility value. In India, the 'Bhabha Committee' in 1952,
looked at the matter from the view point of the management of
the companies continuing to indulge in activities only very
remotely connected with their principal business, and remarked:
For present, we do not think that the evil is either so serious or
widespread as to call for immediate action. Strangely enough,
it did not look at the matter from the view point of innocent
third persons who are put to hardship and inconvenience for no
fault of theirs, but solely due to the doctrine of ultra vires, which
itself owes its origin to judicial creativity.
To overcome this injustice, it would be better if this doctrine
was abolished, and, registered companies, in their dealings with
outsiders, should have the same legal capacity to act as a natural
person, and so, as between the outsiders and the company, the
company should take full responsibility for its acts. Further, the
memorandum should lay down its objects clearly (instead of
phrasing it in broad terms capable of more than one
interpretation) form which the company's powers can be easily
inferred, and as between the company and its managerial
personnel, if the latter take the company beyond those powers,
they should be obliged to refund to the company, as they
presently do in cases of ultra vires expenditure [P S Sanghal,
p.98]. This course of action is possible because the principle of
ultra vires is not based on some dogmatic concept of limited
liability company. The 'object clause' indicates the permissible
range of corporate activities, every thing else beyond that is
implicitly prohibited so that the corporate capital may be
preserved for the protection of both shareholders and creditors.
But that protection does not in any way suffer if the memorandum
like the articles, is deemed to be a contract between the
shareholders and the company. Every contract made on behalf
of the company whether within or beyond its powers should be
valid. But if it involves a misapplication of corporate capital
the directors should be, and already are bound to replace it.
A step in the right direction, is the application of the European
Community Law in England, Sec. 9(1) of which provides that,"
in favour of a person dealing with a company in good faith, any
transaction decided on by the directors shall be deemed to be
one which it is within the capacity of the company". Thus as
against a third person acting in good faith, the company can no
longer plead that the act was ultra vires. It is to be presumed
that an application of this principleby the municipal courts will
sound the death knell of this doctrine of ultra vires.
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5 CONSTRUCTIVE NOTICE & INDOOR MANAGEMENT
SUB TOPICS
5.1 Introduction
5.2 Constructive Notice
5.3 Doctrine of Indoor Management
5.4 Exceptions to the doctrine
5.5 Conclusion
5.1 INTRODUCTION
In the last chapter we have seen how an act is devoid of all
effects if it is ultra vires the company, i.e., an act which goes
beyond the objectives stated in the object clause of the
memorandum is null & void. Sec 13 of the Indian Companies
Act, based on the recommendations of the Vivian Bose
Committee (1962), states that, in case of a company registered
after the 1965 amendment, the objects clause must be divided
into three sub-clauses, viz.,
(i) Main objects - This sub-clause has to state the main objects
to be pursued by the company on its incorporation and
objects incidental or ancillary to the attainment of the main
object.
(ii) Other objects - This sub-clasue must state other objects
which are not included in the above clause.
(iii) States to which objects extend - In the case of non-trading
companies, whose objects are not confined to one state,
this sub-clause has to mention the states to whose territories
the objects extend.
Now according to the principle of ultra vires if a particular act
of the company does not come under one of these clauses, it is
ultra vires the company and so null & void. Now, this raises
certain interesting questions - suppose, the third party claims
that it had not gone through the memorandum and hence was
not aware of its provisions; or that, they knew that the director
was authorized to do a particular act provided he followed the
given procedure and because he agreed to do the act they
presumed that he had followed the prerequisite procedure, etc.
To combat with these situations in a manner which would prove
to be just & equitable to all concerned, the judiciary came up
with two more doctrines: 'constructive notice' and 'indoor
management'. We would now deal with each of these in detail.
5.2 CONSTRUCTIVE NOTICE
The Memorandum and Articles of Association of every
company are registered with the Registrar of Companies. The
Registrar's office is a 'public office' and consequently the
memorandum and articles become 'public documents', easily
accessible to public and open for inspection on payment of a
small fees. Every person who deals with the company in any
manner , has a duty imposed on him to inspect these documents
and to make sure that his contract is in conformity with their
provisions. Whether the person has actually read these
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documents or not he is presumed to have done so and to be
aware of the contents of these documents. This kind of presumed
notice is called 'constructive notice'. In Mahony v. East
Holyford Mining Co. [(1874-80) All ER Rep.427], Lord
Hatherly said : Every joint stock company has its memorandum
and articles of association.....open to all who are minded to have
any dealings whatsoever with the company, and those who so
deal with them must be affected with notice of all that is
contained in those two documents." Kotta Venkatswamy v.
Rammurthy [AIR 1934, Mad. 579], shows the practical effects
of this rule. Here, the articles of association of a company
required that all deeds etc. should be signed by the Managing
Director, Secretary and a working Director on behalf of the
company. The plaintiff accepted a mortgage deed executed by
the Secretary and working Director only. It was held that, the
plaintiff could not claim under this deed. The Court observed,
"If the plaintiff had consulted the articles she would have
discovered that a deed such as she took required execution by
three specified officers of the company and she would have
refrained from accepting a deed inadequately signed.
Notwithstanding, therefore, she may have acted in good faith
and her money may have been applied to the purposes of the
company, the bond is nevertheless invalid."
Moreover, a person dealing with the company is taken not only
to have read those documents but to have understood them
according to their proper meaning [Palmer, p.242]. He is
presumed to have understood not merely the company's powers
but also those of its officers. Further there is constructive notice
not merely of the memorandum and articles, but also of all other
documents, such as special resolutions, particulars of charges
etc., which are required by the Act to be registered with the
Registrar. But there is no notice of documents which are filed
only for the sake of record, such as returns and accounts.
According to Palmer, the principle applies only to documents
which affect the powers of the company. One of the suggested
approaches is that all documents which are open to public
inspection should be regarded as public documents [R. Baxt,
(1973) 36 Mod LR, pp. 43-44]. This is in keeping with the
disclosure philosophy of company law and things which are
required to be disclosed in public office should have public
effects.
Effect of Constructive notice
According to Palmer the various effects of the doctrine of
constructive notice are as follows:
Acts ultra vires the company
The powers of a company are, as has already been pointed out
limited to those derived expressly or impliedly from its
memorandum of association. By the operation of the doctrine
of constructive notice every person dealing with the company is
treated as having actual or constructive knowledge of the
contents of the memorandum. Consequently, if an act is ultra
vires the company, the other party cannot claim relief on the
ground that he was unaware of this : the doctrine of constructive
notice invariably operates against him. The only way to avoid
this consequence is to examine the public documents beforehand
to ensure that the company has power to enter into the proposed
transaction - a counsel of perfection which cannot reasonably
be practiced in the conduct of normal business transactions.[
But the risks assumed by a person who does not take this
precaution are relatively small, due to the wide terms in which
companies' objects are commonly drafted.
Acts outside the authority of the directors
A company, being an artificial person, can only act through
agents. A person dealing with the company should therefore, in
addition to examining the powers of the company, ensure that
the necessary powers have been given by the company to its
agent. The agents will normally be the directors or executive
employees of the company, and their powers are conferred either
directly by the company's articles of association or by an
authority under the articles. An example of the former is found
in the normal provision of the articles whereby the directors are
empowered to borrow money upon the security of the company's
assets, subject, perhaps to certain limits. An example of the
latter occurs in the usual articles empowering the directors to
appoint a managing director and delegate certain powers to him.
Where an act is intra vires the company but outside the authority
of the director (or other agents) two possibilities exist. The
lack of authority may be evident from the public documents of
the company, in which case the doctrine of notice, actual or
constructive, applies without mitigation, subject to what is said
below on ratification. The person dealing with the directors is
fixed with notice of the directors' powers and of any limitations
and restrictions thereon imposed by the articles or other
regulations, and cannot hold the company bound by the directors'
act. This would be the case if, for example, the directors gave
security on a loan in excess of their specified borrowing powers,
or a single director signed a bill of exchange which, by the
articles, required the signature of two directors. So, too, if the
articles provide that the seal of the company is to be affixed in
the presence of two directors, who are to sign their names, a
person dealing with the company must see that this is done.
On the other hand there may be cases in which the lack of
authority of the directors is not evident from the public
documents, e.g., where the articles require the directors to obtain
the consent of the members by ordinary resolution before
exercising their specified borrowing powers or where the
powers of the board of directors may be delegated by a
resolution of the board to a managing director or a committee.
In these cases a person dealing with the company cannot gather
from the public documents that a director has exceeded his
authority. If such a person honestly and without reason for
suspicion thinks that the director with whom he negotiates is
authorized to act for the company, the company will normally
be bound by the director's act under the rule in Royal British
Bank v. Turquand, which is considered in detail later.
Ratification
While an act which is ultra vires the company is incapable of
ratification, an act which is intra vires the company but outside
the authority of the directors may be ratified by the company in
proper form. For example, if directors have without a quorum
purported to act in a manner which is authorized for the directors,
a proper meeting of the directors can ratify the act. Likewise, if
directors purport to act in a manner for which authority has not
been delegated to them (i.e., where the power is retained by the
company in general meeting) the company in general meeting
can ratify it. This does not amount to an alteration of the articles,
but an exercise by the general meeting of its powers, so that an
ordinary resolution suffices.
Inconsistent agreements
No agreement can be made by a company with a third party
which purports to override any rights created by the articles.
Thus, in a case dealing with the rights of a managing director,
Harman. J. said :
So, everybody who becomes a managing director of this
company which has adopted Table ‘A' knows that he has certain
rights, and that the board cannot alter them." [Palmer, PP 243-
245]
Concluding remarks
Constructive notice is more or less an unreal doctrine, a fiction
created through judicial imagination. It is a theory which fails
to take into consideration the practical realities of today's world.
Firstly, people know a company through its officers and not its
documents; and secondly, the businessmen of today rarely have
the time to go through these documents to make themselves
aware of their contents and to understand them. While entering
into a contract, they rely on their contacts and instincts and not
on these documents. In such circumstances it seems unfair to
saddle them with the knowledge of documents, the existence of
which they are barely aware of.
Sec. 9 of the European Communities Act, 1972 has abrogated
this doctrine. The courts in India also do not seem to have
taken it seriously. For example, in Dehra Dun Mussoorie
Electric Tramway Co v. Jagmandardas [AIR 1932 All 141],
the articles of the company expressly provided that the directors
could delegate all of their powers except the power to borrow.
Even so, an overdraft taken by the managing agents without
approval of the Board was held to be binding on the company,
the court saying that such temporary loans must be kept outside
the purview of the relevant provision.
5.3 DOCTRINE OF INDOOR MANAGEMENT
Rule of constructive notice is applied by the courts, in order to
protect the company against the outsider, so that an outsider
may not reap benefit from his act of negligence (in not going
through the company's documents). Though, the rule was
justified, it did result in undue hardship to those outsiders who
were aware of the contents of the documents but had no means
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of knowing whether certain technicalities/procedures (for ex:
sanction by the board of directors or general body of
shareholders, etc) mentioned in the documents had been followed
or not. To rectify this position, a new rule known as 'doctrine
of indoor management' was evolved in the case of Royal British
Bank v. Turquand [(1856) 119 ER 886]. The brief facts of
this case are as follows. The directors of a company borrowed a
sum of money from the plaintiff. The company's articles
provided that 'the directors might borrow on bonds such sums
as may from time to time be authorized by a resolution passed
at a general meeting of the company'. The shareholders claimed
that there had been no such resolution passed by them authorizing
the loan, and therefore, it was taken without their authority. The
company was, however, held bound by the loan. Once it was
found that the directors could borrow subject to a resolution,
the plaintiff had the right to infer that the necessary resolution
must have been passed. Lord Campbell, C J, delivering the
judgment observed:
"If no illegality is shown as against the party with whom
the directors contract under the seal of the company, excess
of authority is a matter only between the directors and the
shareholders — at all events, we think that the bond cannot
be rendered illegal and void from any irregularity in the
proceedings of the company, nor even by an excess of
authority, the plaintiff's having acted with good faith, and
the shareholders not being prejudiced . The plaintiffs have
bonafide advanced their money for the use of the company,
giving credit to the representations of the directors that they
had authority to execute the bond; and the money which
they advanced and which they now seek to recover, must
be taken to have been applied in the business of the company
and for the benefit of the shareholders. If the plaintiffs must
be presumed to have had notice of the contents of the
registered deed of settlement, there is nothing to show that
the directors might not have had authority to execute the
bond as they asserted".
On an appeal to the court of Exchequer Chamber, the judgement
in favour of Turquand was affirmed, Jerris, C. J., observing:
"We may now take for granted that the dealings with these
companies are not like dealings with other partnerships, and
that the parties dealing with them are bound to read the
statute and deed of settlement. But they are not bound to
do more. And the party here, on reading the deed of
settlement, would find, not a prohibition from borrowing,
but a permission to do so on certain conditions. Finding
that the authority might be made complete by a resolution,
he would have a right to infer the fact of resolution
authorizing that which on the face of the document appeared
to be legitimately done".
The rule laid down in this case was elaborated and applied by
the House of Lords in Mahony v. East Holyford Mining Co
[(1875) L R 7 H L 869], where Lord Hatherly gave it the name
of doctrine of indoor management” and stated it in the following
words:
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"....the company entering upon its business and dealing with
persons external to it, is supposed on its part to have all
those powers and authorities which, by its articles of
association and by its deed, it appears to possess; and all
that the directors do with reference to what I may call the
indoor management of their own concern, is a thing known
to them and known to them only; subject to this observation,
that no person dealing with them has a right to suppose that
anything has been or can be done that is not permitted by
the articles of association or by the deed ... But, after that,
when there are persons conducting the affairs of the
company in a manner which appears to be perfectly
consonant with the articles of association, then those so
dealing with them, externally, are not to be affected by any
irregularities which may take place in the internal
management of the company"
The rule may be summarized in the words of S.C. Sen ( Sen,
p.116] as follows-
"While persons dealing with a company are assumed to
have read the public documents (viz., memorandum and
articles of association) of a company and to have
ascertained that the proposed transaction is not
inconsistent therewith, they are not required to do more;
they need not enquire into the regularity of internal
proceedings (indoor management) and may assume that
all this being done regularly".
This rule has been widely applied by the Indian Courts. For
example, in Sri Kishan Rathi v. Mondal Bros & Co Ltd [AIR
1967 Cal 75], the plaintiff - petitioner claimed a loan of Rs.1,000/
- which had been granted by him to the defendant company on
a bill of exchange, being a Hundi, for Rs.1,000/-, made by N.C.
Mondal, the then manager and director of the limited company.
It was the plaintiff's contention that the Hundi was dishonoured.
Articles of association of the defendant company gave the
borrowing powers to the Manager and Director provided a
resolution had been passed at the meeting of the board as required
by Sec. 292 of the Companies Act, 1956, delegating authority
to the manager and director which was not done in this case.
Holding the company bound to pay the loan, Mukharji J.,
observed: From a review and analysis of all these relevant articles
it is indisputable in the facts of the present case that the director
and manager had prima facie authority to draw the Hundi on
behalf of the company. The lender who lends money to the
company in these circumstances on a promissory note or bill of
exchange executed by the manager and director after having
found on inquiry from the memorandum and the articles the
existence of such power to borrow, need not and cannot, and is
not obliged, in my view, to look further in the internal
management of the company and embark on an investigation
whether a particular manager and director who is given such
powers under the memorandum and articles have nevertheless
lost it or qualified or limited it by an internal resolution contained
in the internal minutes book or resolution of the company's
directors and if so what are the terms of such qualification or
limitation? This is exactly what is meant by internal
management".
This rule of 'indoor management' is based upon obvious reasons
of convenience and practicality in business relations. Firstly,
the memorandum and articles of association are public
documents, open to public inspection. But the details of internal
procedure are not thus open to public inspection. Hence an
outsider is presumed to know the constitution of a company;
but not what may or may not have taken place within the doors
that are closed to him". The wheels of commerce would not go
round smoothly if persons dealing with companies were
compelled to investigate thoroughly the internal machinery of a
company to see if something is not wrong". People in business
would be very shy in dealing with such companies.
Secondly, in the words of Prof. Gower, "the lot of creditors of a
limited company is not a particularly happy one; it would be
unhappier still if the company could escape liability by denying
the authority of the officials to act on its behalf" [Gower, p.153],
The rule is of great practical utility and has been applied to a
variety of cases, involving irregularities in internal management.
Thus, for example, the rule has been applied, to cover acts done
on behalf of a company by defacto directors who have never
been appointed [Mahony v. East Holyford Mining Co (1875)
33 TLR 338]; or who having been regularly appointed, have
exercised an authority which could have been delegated to them
under the company's articles, but was never delegated [Kishan
Rathi v. Mondal Bros (1961) 1 Comp LJ 19 (Cal)]; or who
have exercised an authority without proper quorum [County
of Gloucester Bank v. Rudry Merthyr Steam & House Coal
Colliery Co (1895) 1 Ch 629] etc. The ‘Thurquands rule' is an
illustration of judicial protest to and erosion of the ultra vires
doctrine. It is a rule based on justice, equity and good
conscience, and also on the general presumption of law and
practical presumption of regularity. But, this doctrine in many
of the earlier decisions had the misfortune to be clothed with
the title of ‘ultra vires', so that it started being treated as a species
of ‘ultra vires transactions'. The net result being, that no sooner
had the doctrine been born that pulls and counter-pulls started
in different directions leading to subsequent confusion.
The pulls were in entirely opposite directions. Those obsessed
with the idea of protection of shareholders property were in
favour of enforcement of an extension of the ultra vires doctrine
and therefore started to whittle down the efficacy of the rule. In
other decisions, the beneficial effects of the doctrine were
maintained and outsiders dealing with the company protected
by not requiring them to see that the 'indoor management' rules
were duly complied with. The result of this struggle was that
the basic object of this rule was lost sight of by the judges.
According to Gower during the last 30 years the tendency has
been to" whittle it away notwithstanding the vigorous opposition
by judges more familiar with commercial practice" [ Sen, p.125].
5.4 EXCEPTIONS TO THE DOCTRINE
It is nearly a 140 years since the doctrine of indoor management
was laid down in the Turquand's case, and since then, a sharp
division amongst the judiciary regarding the relative merits of
the doctrines of 'ultra vires' and 'indoor management', has
resulted over the years in laying down of several exceptions to
this rule of indoor management. These exceptions are as
follows:
1] Knowledge of irregularity
This is the most basic of all exceptions, that a party who deals
with the company and who has knowledge of an irregularity in
its internal management in connection with the subject-matter
of his dealing cannot claim the benefit of the Turquand's rule.
Such knowledge may arise from the fact that the person
contracting was himself a party to the internal procedure. Thus,
in Howard v. Patent Ivory Manufacturing Co [(1888) 38 Ch
D 156], the directors could not defend the issue of debentures
to themselves because they should have known that the extent
to which they were lending money to the company required the
assent of the general meeting which they had not obtained. But,
in Hely-Hutchinson v. Brayhead Ltd [(1967) 2 All ER 14] it
was held that, the mere fact that a person is a director does not
mean that he shall be deemed to have knowledge of the
irregularities practised by the other directors. Here, a newly
appointed director entered into contract of indemnity and
guarantee with the company through a director whom the
company had knowingly allowed to hold himself out as having
the authority to enter into such transactions, although in fact he
had no such authority. The new director had no knowledge of
the irregularity. The company was held liable. But the general
principle remains that a person who is himself a part of the
internal machinery cannot take advantage of irregularities within
the company. Any other rule would encourage ignorance and
condone dereliction from duty" [Per Lord Simonds in Morris
v. Kanssen [1946] AC 459].
2] Suspicion of irregularity
Protection of this rule is also not available, where though the
third party has no actual knowledge of any irregularity, the
circumstances surrounding the case are such that, they arouse
'suspicion of some irregularity' in the minds of the person. Thus,
in Anand Bihari Lal v. Dinshaw & Co [AIR 1942 Oudh 417],
the plaintiff accepted a transfer of the defendant company's
property, from the company accountant who had no authority
to transfer. Holding the transfer void, the court observed, we
are not here considering the claim of a transferee who was a
stranger to the Bank, but one who had probably been familiar
with its character from its very inception, and who knew at least
something about its constitution and was acquainted with the
fact that its MD had died only 16 days prior to the transfer ....
The plaintiff could not have supposed, in the absence of a power
of attorney, that the accountant had the authority to effect the
transfer of the company's property".
3] Forgery
The rule in the Turquand's case does not apply if a document is
forged so as to purport to be the company's document. In Ruben
v. Great Fingall Consolidated [(1906) AC 439] a share
certificate was forged by a secretary who then purported to issue
it on behalf of the company, in return for money advanced.
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The certificate was under the seal of the company with signature
of two directors. The company refused to register shares. The
plaintiff contended that whether the signatures were genuine or
forged was a part of the internal management and, therefore,
the company should be estopped from denying genuineness of
document. But it was held that the rule has never been extended
to cover such a complete forgery. Lord Loreburn observed, "It
is quite true that persons dealing with limited liability companies
are not bound to inquire into their indoor management and will
not be affected by irregularities of which they have no notice.
But this doctrine, which is well established, applies to
irregularities which otherwise might affect a genuine transaction.
It cannot apply to a forgery". An important point to note in this
regard is that, the bar against relief being granted against forged
instruments applies only when the company refuses to be bound
by the instrument. In the words of Andrew R. Thompson [(1955-
56) 11 Toronto Law Journal, p.238], A company may represent
that a forged instrument is genuine. In such case, it will be
estopped from denying that a forged instrument is genuine as
against an outsider who has relied to his detriment upon the
representation. Also, a company may represent that the forger
has authority to execute the forged instrument. In that event it
will be bound by the forged instrument against an outsider who
has relied on the apparent authority to execute the instrument".
Thus, in Official Liquidator v. Commr. of Police [(1969) 1
Comp LJ 5 (Mad)], a document on which a company borrowed
a sum of money was executed by the managing director who
was the chief functionary of the company, and, in order to comply
with the other requirements of the articles, the signatures of two
other directors were forged. The company was not allowed to
eschew liability on the document. The court observed, "we hold
the company liable as a matter of social and economic policy.
The basis of liability is the eminently practical view that if
authority is conditioned on facts peculiarly within the agent's
knowledge his representation express or implied should bind
the principal".
4] Representation through Articles
This exception deals with the most controversial and highly
confusing aspect of the Turquand's rule. In general, the articles
of a company have what is known as the 'delegation clause'.
Lakshmi Rattan Lal Cotton Mills v. J K Jute Mills Co [AIR
1957 All 311], explains the meaning and effect of a delegation
clause". In this case, one G was a director of a company. The
company had managing agents of which also G was a director.
Articles authorized directors to borrow money and also
empowered them to delegate this power to any or some of them.
The company refused to be bound by the loan on the ground
that there was no resolution of the board delegating the
borrowing power to G. Yet the company was held bound by
the loan, the court observing that "even if there was no actual
resolution authorizing G to enter into the transaction, the plaintiff
could assume that a power which could have been delegated
under the articles must have been actually conferred. the actual
delegation being a matter of internal management, the plaintiff
was not bound to enter into that".
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Thus, the effect of a delegation clause is that, a person who
contracts with an individual director of a company, knowing
that the board has power to delegate its authority to such an
individual, may assume that the power of delegation has been
exercised" [Houghton & Co v. Nothard, Lower & Wills Ltd
(1927) 1 KB 246].
Now suppose, that the plaintiff had not consulted the company's
articles, before contracting with an individual director and
therefore, had no knowledge of the existence of such a power of
delegation. Could he in such a situation, assume that the power,
the existence of which he did not know at the time had been
exercised; and, would the company still be estopped from
denying the director's authority in the face of the plaintiff's
ignorance of the articles? This question has been time & again
debated in the courts with varying results. Thus, in Rama
Corporation v. Proved Tin & General Investiment Co
[(1952) 1 All ER 554], one T was the active director of the
defendant company. He, purporting to act on behalf of his
company under which he took a cheque from the plaintiffs. The
company's articles contained a clause providing that the directors
may delegate any of their powers, other than the power to borrow
and make calls, to committees, consisting of such members of
their body as they think fit”. The board had not in fact delegated
any of their powers to T and the plaintiffs had not inspected the
defendant's articles and, therefore, did not know of the existence
of the power to delegate. It was held that, the defendant company
was not bound by the agreement. Slade, J., observed, A person
who at the time of entering into a contract with a company has
no knowledge of the company's articles of association, cannot
rely on those articles as conferring ostensible or apparent
authority on the agent of the company with whom he dealt .
Justifying his position, he further said, the rule of ‘indoor
management' is based upon the principle of estoppel. Articles
of association contain a representation that a particular officer
can be invested with certain of the powers of the company. An
outsider, with knowledge of the articles, finds that an officer is
openly exercising an authority of that kind. He therefore,
contract with the officer. The company is estopped from alleging
that the officer was not infact so authorized.
This judgement was subjected to a lot of criticism mostly on
two points:
(1) everybody is deemed to have a constructive notice of the
articles. Brushing this aside, slade J., said, doctrine of
constructive notice is a negative one. It operates against
the outsider who has not inquired. It cannot be used against
the interests of the company;
(2) the major criticism is that, even if the plaintiffs had read the
articles, all that they would see would be that the directors
had the power to delegate their authority, not whether such
a delegation had actually been made or not. Moreover, the
company may make a representation even apart from its
articles, for example, by holding out an officer as possessing
certain authority - in which case the company would
automatically be estopped from denying the officer's
authority. Thus, articles will be relevant only if they had
 contained a restriction on the apparent authority of the
officer concerned. A better rule of law in this regard appears
to be the one stated by Atkin L J, in Kreditbank Cassel v.
Schenkers Ltd [(1926) 1 KB 826], "If you are dealing with
a director in a matter in which normally a director would
have power to act for the company, you are not obliged to
inquire whether or not the formalities required by the articles
have been compiled with, before he exercises that power".
So the deciding test on this point now seems to be - was the
concerned act within the ostensible or apparent authority
of the officer of not? If it was, then the company is bound
by the act irrespective of whether the third part is aware of
the contents of the articles or not.
5] Acts outside apparent authority
Lastly, if the act of an officer is one which would ordinarily be
beyond the powers of such an officer, the plaintiff cannot claim
the protection of the Turquand's rule, simply because under the
articles, the power to do the act could have been delegated to
him. In such a case, the plaintiff cannot sue the company unless
the power had, in fact, been delegated to the person or officer
with whom he dealt. Thus, in Kreditbank Cassel v. Schenkers
Ltd [(1926) 1 KB 826 (CA)], the defendant company, by its
memorandum, had power to draw and accept bills of exchange,
and, under its articles, the directors were empowered to
determine 'who shall be entitled to sign, draw, accept, etc, bills
on company's behalf'. The defendant's business was that of
forwarding agents. They had a branch at Manchester under a
branch manager who, without having received any authority from
the company, and in fraud, drew seven bills purporting to do so
on company's behalf. The company was sued on these bills as
drawers. It was held that, having regard to his position, drawing
of bills was not within the ostensible authority or was otherwise
precluded from setting up the want of authority.
5.5 CONCLUSION
As is evident from Slade, J., observations in Rama Corporation
case, the general opinion of the judiciary in England seems to
be, that, the rule in Turquand's case is based on the 'principle of
estoppel'. The Indian judiciary on the other hand have evolved
their own basis for the rule, as evident from various
pronouncements for example, in T R Pratt Ltd v. E D Sassoon
& Co Ltd [(1936) 6 Comp Cas 122], it was held: The reason
for the rule, I take it, is that it would be disastrous in a business
community if contracts made with companies could be
impeached on account of matters known to the company but
not to the other contracting party:.. Similarly, in Iron Traders
(Private) Ltd v. Hiralal Mittal [AIR 1962 Punj 277], it was
observed: This principle sometimes expressed as the doctrine
of indoor management is designed to protect innocent persons
who are acting bonafide in the belief that the company is
transacting business in accordance with its articles".
Thus, in India, the rule is considered to have its origin not in
estoppel but on considerations of business convenience and
justice. In the words of Sen, to appreciate the correct nature of
the doctrines of 'constructive notice' and 'indoor management'
the following points have to be kept in mind:
1) In respect of acts not within the authority of the agent and
for which the company is not held liable, the expression
'ultra vires' is a complete misnomer. Unauthorized
transactions do not form any species of the true ultra vires
doctrine.
2) Unauthorized transactions should be dealt with in the light
of the ordinary law of agency including the law relating to
holding out.
3) The law of agency is not different in the case of companies.
Companies have not been given any special consideration
by any statute and are not entitled to any other special
consideration. Apart from 'limited liability' of shareholders,
no further protection is warranted or justified and the statute
has not purported to give any such protection.
4) The judicial obsession apparent in some cases, of
safeguarding the shareholders interest at any cost must be
treated as out dated and no longer applicable. Though none
dispute, that, the shareholders interests should be protected
within the bounds of the company law, a further extension
of such protection is unwarranted under the statute and is
contrary to the rules of justice, equity and good conscience.
5) The ‘doctrine of constructive notice’ in present times is
illogical. In any country, the everyday life would become
impossible if customers or persons dealing with a company
are called upon to check the articles and memorandum of
the company. Though they are public documents, it is
impossible and impractical for a person to check them up
before entering into a transaction with the company. To
impute the purchaser of a tooth-brush with knowledge of
the memorandum and articles of the manufacturing company
is not only bad law, but, it also reduces the law to the level
of ridiculous absurdity. Every society has been
industrialized to such an extent, that, practically every action
of man is touched by a company somewhere or other. It is
absurd to expect every person to go and read the articles
and memorandum before every such transaction, and to
impute the whole community with notice and knowledge of
the articles and memorandum is now completely illogical
and should be eliminated in arriving at a judicial conclusion.
6) The Turquand's rule is a wholesome application of the law
of agency and rule of justice, equity and good conscience.
The exceptions which have tried to whittle down this rule
should be considered to be bad law so far as they transgress
the norms of equity. Industrialization has brought about a
change in social values and behaviour, and 19th century
conceptions evolved when the company did not play an
important role in an individuals life no longer hold good.
Excessive loyalty to the ultra vires doctorine and an obsession
with protection of shareholders interests has led to an unfair
curbing of the protection accorded by the Turquand's rule,
resulting in a general detriment to the society. No statutory
modification is necessary, but the judiciary has to check the
unnecessary growths and apply correct principles in the light of
modern values and conditions.[Sen, pp 138-140].
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6. LEGAL INSTITUTIONS UNDER COMPANY LAW
SUB-TOPICS
6.1 Introduction
6.2. Registrar of Companies
6.3. Company Law Board
6.4. Company Court
6.1 INTRODUCTION
In the preceding chapters we have seen how the concept of
corporate personality, its nature and scope, has been defined,
elaborated upon and later limited by means of judicial
interpretation, i.e., the courts have played a very important role
in defining the area within which the company and its
management can play. This raises an important question : which
is the court having jurisdiction to decide questions relating to
company matters, and what are the other judicial or quasi-judicial
authorities which have the power of regulation over the
company? Primarily there are three such authorities so involved
- the Registrar, the Company Law Board and the Company Court.
Previously, sometime in the sixties a Company Law Tribunal
was also established, but it did not function for long and was
abolished by the Act of 1967. We will now deal briefly with the
remaining authorities.
6.2 REGISTRAR OF COMPANIES
Sec. 2(40) of the Companies Act, defines Registrar as - 'Registrar
means a Registrar, or an Additional, a Joint, a Deputy or an
Assistant Registrar, having the duty of registering companies
under this Act.' Admittedly, this definition leaves a lot to be
desired, as it hardly gives a clear view of a ‘Registrar' as an
official.
The 'Registrar' is one of the most important persons with regard
to a company. The Central Government appoints a person as a
Registrar of State on such terms and conditions it deems fit.
Generally, every state has one 'Registrar of Companies' whose
office is situated in the capital of the State. But depending on
the amount of work in that particular state, more than one
Registrar may be appointed, or the Registrar may be aided in
his work by Additional, Joint and Deputy Registrars. In the
definition of Registrar, officers of lower rank have been put in a
descending order - the common element being, that, so long as
each of these officers have the duty of registering companies
under the Act, each has to be considered as a Registrar. By
virtue of the provision contained in sec. 19 of the General Clauses
Act, 1897, read with sec. 2(40) of the Companies Act, it is
sufficient for the Act to specify the duties of the Registrar, for
such duties would also automatically become to be the duties
of Additional, Joint, Deputy or Assistant Registrars. sec. 609(2)
enables the Central Government to make regulations with respect
to the duty of the Registrars, pursuant to which the Companies
Regulations, 1956 were framed. Apart from this, throughout
the Act, there are various provisions laying down what the
Registrar should do in respect of a particular matter.
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To that extent, the Act itself specifies the duties of the Registrar,
which automatically apply to the Additional, Joint, Deputy &
Assistant Registrars.
Before the formation of the Company Law Board (CLB) in 1988,
the Registrar of Companies performed quasi-judicial functions
alongwith administrative functions. But at present, the quasi
judicial functions have been transferred to the CLB and the
Registrar mainly deals with administrative functions. The duties
and powers of a Registrar are extensive and it is beyond the
scope of this module to go exhaustively into them, but some of
the functions which the Registrar performs are - receive various
documents required for incorporation; give a certificate of
incorporation to the company, in case of public companies he is
also required to give a certificate for commencement of business;
maintain registers; in some cases apply for compulsory winding
up of a company, etc. He has the power to impose fine in case
of infringement of any given provision by the company or the
defaulting officer. He also has the power to strike off the name
of a 'defunct company' from the Register of Companies and such
other powers. All in all, one can say that the Registrar is one of
the most important functionary in the company arena.
6.3 COMPANY LAW BOARD
Section 10 E of the Act deals with the constitution of 'Board of
Company Law Administration', nowadays commonly known as
the Company Law Board or the CLB. This section was
introduced by the Amendment Act of 1963, for creation of a
new administrative authority which would exercise certain
statutory powers as well as powers delegated by the Central
Government. It was conceived as a matter of administrative
reform and the CLB was expected to bring greater efficiency,
cohesion and dispatch in the administration of the act. Initially
the CLB consisted of 5 members which was later increased to 9
by the 1974 amendment, in view of transfer of certain powers
exercised by the courts, to the Board, and simultaneously sub-
sections (4C) & (4D) were also introduced clothing the CLB
with powers of civil court in order to enable the Board to
discharge its quasi-judicial functions, for example, the powers
of confirming the alteration of memorandum u/sec. 17 and the
consequential powers and functions under Ss. 18 & 19, the power
to sanction and issue of shares at discount u/sec. 79, the power
to order rectification of the register of charges and the power to
extend the time for filing of charges u/sec. 141, and power to
call an extraordinary general meeting u/sec. 186. Since the CLB
was delegated with powers and functions of the Central
Government, necessary amendment was also made to section
637 of the Act.
Until the Amendment Act of 1988 came into force, the Board
had to function as two separate bodies, one as delegatee of the
Central Government and other as an independent body. The
1988 Act, substantially changed the character of the CLB, by
increasing the scope of powers and functions of the CLB as an
independent body by amending Sec. 10E on one hand, and, by
substituting Company Law Board” for the words "Central
Government" or "Court” as the case may be in several sections
of the Act. The CLB has also been clothed with certain new
powers which do not strictly fall within either of these two
categories, for example, Ss. 58A, 80A, 113(1), 235, 236, 237,
247, 248, 250, 251 (relating to investigation into affairs of the
company), 269, 408 etc.
The independent character of the CLB can also be gleaned from
several other provisions of this section. Thus, new sub-sec (2A)
now requires the Central Government to appoint members with
prescribed qualifications and experience. Sub-section (5) makes
it binding on CLB not only to follow principles of natural justice,
but to be also guided by the dictates of its own sense of discretion.
Sub-section (6) entitles the CLB to lay down its own procedure
for conduct of its business, i.e., the CLB is no longer subject to
the control of the Central Government in exercise of its powers
or discharging of its functions. Under the new sub-sec (1A),
the CLB may exercise and discharge powers and functions
conferred on it under 'any other law' as well. Sec 22A of the
Securities Contracts (Regulation)Act, 1956 contains one such
provision conferring certain powers and functions directly on
the CLB. Under the same sub-sec (1A), CLB may also be
authorised to discharge powers and functions conferred on it by
notification, provided there is an enabling provision in the statute
in this behalf. Sec. 2A of the MRTP Act is one such provision
under which a notification may be issued authorising the CLB
to exercise and discharge the powers and functions with regard
to determination of group, inter-connection and on the question
of same management which the Central Government discharges
but may decide instead to allow the CLB to discharge the same.
The CLB is a specialized body with responsibility to watch the
working of the corporate process. When it makes a finding of
facts, reaches a conclusion and passes an order, it is entitled to
prima facie respect unless there are glaring circumstances to
the contrary [Union of India v. Swedeshi Cotton Mills Co
Ltd. (1979)49 Comp.Cas 74 (SC)]. It is obligatory on the part
of CLB to act in accordance with principles of natural justice,
as is evident from the provisions of sec. 10E(5).
Now that the CLB is vested with powers previously exercised
by the High Court, the CLB is required to act as a judicial body
while dealing with any matter before it. When the statute
provides that the CLB shall act in its own discretion, it indicates
that the statute reposes confidence in the board because of the
peculiar skills of the members constituting it and the confidence
reposed in the Members [who are appointed in accordance with
the Company Law Board (Qualifications, experience and other
conditions of services of Members) Rules, 1993] or in the Board,
and from this it follows that there is a presumption that the Board
is required to do the act itself and cannot redelegate its authority
[Barium Chemicals Ltd. v. CLB, (1966)36 Comp. Cas. 639
(S.C.)].
Appeals against the CLB orders: The 1988 Amendment also
inserted a new section 10F, providing for an appeal to the High
Court against an order of the CLB, on questions of law. No
appeal lies on question of facts. So the High Court cannot go
into the question of fact in a second appeal, however gross the
error may seem to be [Sri Sinha Ramanuja Jeer v. Sri Ranga
Ramanuja Jeer, AIR 1961 SC 1720]. But a finding of fact is
open to attack as erroneous in law when there is no evidence to
support it or if it is perverse. The question may arise as to
which High Court has the jurisdiction to entertain an appeal
against a CLB order ? The recent Supreme Court decision in
Stridewell Leathers (P) Ltd., v. Bhankerpur Simbhaoli
Beverages (P) Ltd. [(1993)12 CLA 151], stated that it is the
High Court having jurisdiction in relation to the place at which
the registered office of the company is situated, which is
competent to hear an appeal under this section.
6.4 COMPANY COURT
The last of the legal institutions wielding authority over the
companies is the company court. Section 10 of the Act deals
with 'jurisdiction of the courts', and provides that -
(1) The court having jurisdiction under this Act shall be
(a) the High court having jurisdiction in relation to the
place at which the registered office of the company
concerned is situate, except to the extent to which
jurisdiction has been conferred on any District court
or District Courts subordinate to that High Court in
pursuance of Sub-Section (2); and
(b) where jurisdiction has been so conferred, the District
Court in regard to matters falling within the scope of
the jurisdiction conferred, in respect of companies
having their registered offices in the district.
(2) The Central Government may, by notification in the Official
Gazette and subject to such restrictions, limitations and
conditions as it thinks fit empower any District Court to
exercise all or any of the jurisdiction conferred by this Act
upon the Court, not being the jurisdiction conferred -
(a) in respect of companies generally, by sections 237,
391, 394, 395 and 397 to 407, both inclusive ;
(b) in respect of companies with a paid up share capital
of not less than one lakh of rupees by Part VII (sections
425 to 560) and the other provisions of this Act relating
to the winding up of companies.
(3) For the purposes of jurisdiction to wind up companies, the
expression "registered office" means the place which has
longest been the registered office of the company during
the six months immediately preceding the presentation of
the petition for winding up.
Throughout the Act, wherever the expression Court” occurs, it
has to be understood to be referring to the High Court except
where the Central Government has notified that in respect of
certain matters, the expression Court"will refer to any District
Court. In exercise of this power, the Central Government
empowered all the District courts in the Union of India, except
in Jammu and Kashmir, to exercise jurisdiction in the following
matters, viz;
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Sec. 89 - Termination of disproportionately excessive voting
rights in existing companies.
Sec.113 - Limitation of time for issue of certificates
Sec.118 - Right to obtain copies of and inspect trust deed
Sec.141 - Rectification of register of charges by court.
Sec.144 - Right to inspect copies of instruments creating
charges and company's register of charges.
Sec.163 - Place of keeping, and inspection of registers and
returns
Sec.196 - Inspection of minute books of general meetings.
Sec.219 - Right of member to copies of balance sheet and
auditor's report
Sec.234 - Power of Registrar to call for information or
explanation
Sec.304 - Inspection of the register of directors.
Sec.307 - Registrar of directors' shareholding, etc.
Sec.614 - Enforcement of duty of company to make returns,
etc. to Registrar.
Provisions of sec.10 are not derogatory to the ordinary civil and
criminal jurisdiction conferred on courts in India in their normal
hierarchy. The Company Court [i.e. the High Court or District
Court as the case may be] does not have jurisdiction in all
company matters. Except in cases where the Act confers
jurisdiction on the Company Court or some other authority like
the Central Government or the CLB, either expressly or by
implication, all other disputes pertaining to a company are to be
resolved through the forum of civil courts when the disputes are
capable of being so resovled. Under section 9 of the Civil
Procedure Code, the civil court has jurisdiction on all matters
unless there is a clear provision of law ousting the jurisdiction.
Thus, in the absence of any specific remedy against the
requisition for an extraordinary general meeting under sec. 169
called with an improper purpose sec. 9 CPC can be invoked [B.
Sivaraman v. Egmore Benefit Society Ltd., (1992)9 CLA 48
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(Mad.)]. The Company court has no jurisdiction to grant relief
in respect of grievances relating to individual rights of members,
as distinguished from their corporate rights. Relief can be
granted by a civil court for declaration of the proceedings of
annual general meeting of a company as void or for compelling
a company to hold the annual general meeting [Stat Title Works
Ltd. v. M. Govindan, AIR 1959, Ker 254 and R.
Prakasham v. Sree Narayan Dharma Paripalan Yogam
(1980)50 Comp. Cas. 6119Ker)]. But where the relief sought
is such as could be obtained by filing a petition before the High
Court, say under sec. 398 [this power is now exercised by CLB],
the civil court has no concurrent jurisdiction [Nava Samaj Ltd.
v. Civil Judge, AIR 1966 MO 286 (DB)]. So also, the
jurisdiction of High Court is confined only to those provisions
of this Act where a reference is made specifically to court and
does not extend to those matters where prosecution for criminal
offenses lies. No jurisdiction is conferred by s.10 as regards
matters which may be agitated by or against an company or by
or against any officials of the company. Jurisdiction u/s.10 is
confined to matters specifically brought before the court by virtue
of the provisions of the Act. Thus, for example, if a general
complaint is made alleging non compliance with the provisions
of sec. .253, the jurisdiction of High Court cannot be invoked,
there being no provision in Companies (Court) Rules, 1959 for
the High Courts to entertain such a complaint. A complaint
filed in such a case must be dismissed and the complainant must
be left to seek his relief by way of appropriate civil proceedings.
Neither s. 2(11) nor s. 12(1) exclude the jurisdiction of the civil
courts either expressly or by implication. In the absence of any
provision of law conferring on the High Court exclusive
jurisdiction the civil courts will have jurisdiction u/s 9 of CPC.
The Andhra Pradesh High Court accordingly, dismissed the
petition for a declaration, inter alia, that the removal of a director
under s. 253 was illegal, leaving it open to the petitioners to
seek appropriate remedy from a civil court having jurisdiction
[K.K.Maheswari v. Rockhoar Building Materials Ltd.,
(1993)12 CLA 140].
7. CASE LAW
Lee v. Lee's Air Farming Ltd [(1960)3 All ER 420]
Lee formed the respondent company to carry on his business of
spreading fertilizers from the air. He held 2999 of its 3000
shares, and was by its 'articles' the sole governing director, in
which capacity he appointed himself as a chief pilot of the
company drawing some salary. He was killed in an air crash
while flying for the company. His widow filed a suit for
compensation. If Lee qualified as a 'worker' (defined as any
person who has entered into or works under a contract of
service....with an employer....whether remunerated by wages,
salary or otherwise), then his widow was entitled to be paid
compensation by his employer i.e. 'the company under the
Worker's Compensation Act 1922 (M.Z) Mrs. Lee appealed
against the ruling of Court of Appeal of New Zealand, that Lee
could not be a 'worker' when he was also in effect the 'employer'.
The substantial question to be decided was, whether Lee was a
'worker' within the meaning of the 1922 Act ? Was he a person
who had entered into or worked under a contract of service with
an employer ? House of Lords held that, any contractual
obligations were not invalidated by the circumstances that the
deceased was sole governing director in whom was vested the
full government and control of company......the capacity of the
company to make a contract with the deceased could not be
impugned merely because the deceased himself acted as the agent
of the company in its negotiation....it is a logical consequence
of the decision in Salomon's case that a person may function in
dual capacity. Control would remain with the company whoever
might be the agent of the company to exercise it. The fact that
so long as the deceased continued to be governing director, with
attitude of powers, it would be for him to act as the agent of the
company to give the order and does not alter the fact that the
company and the deceased were two separate and distinct legal
persons. If the deceased had a contract of service with the
company, then the company had the right to control. Just as
company and deceased were separate legal entities so as to permit
contractual relations being established between them, so also
were they separate legal entities so as to enable the company to
give an order to the deceased.....
The appeal on the basis of this reasoning was allowed and Mrs.
Lee obtained a compensation.
Tunstall v. Steigmann [(1962)2Q 593 (CA)].
Mrs. Tunstall (the tenant) carried on a business as a wardrobe
dealer in shop premises leased from Mrs. Steigmann (the
landlord). Mrs. Steigmann also owned the next door shop,
where she carried on the business of a pork-butcher. In April,
1961, she gave the tenant six months notice to quit, relying on
S.30(1)(g) of the Landlord and Tenant Act, 1954 which reads
as "..... that on the termination of the current tenancy the landlord
intends to occupy the holding for the purposes, or partly for
purposes, of a business to be carried on by him therein'. Before
the matter came up for hearing, Mrs. Steigmann had formed a
company, in which she held all except two shares (which were
held on her behalf by her nominees), to take over her business.
The country court judge held that, she might still intend to carry
on the business notwithstanding that it was owned by the
company and he refused to grant the tenant a new lease. The
tenant filed an appeal against this judgement.
Allowing the appeal held, 'I have reached this conclusion with
some reluctance, for it seems to me that the construction of
S.30(1) (g), which I have been compelled to adopt, may well
lead to some very bizarre results. Thus, it will be possible for
an absentee landlord, living in idleness away from the holding,
to resist the grant of a new tenancy upon proof of an intention to
occupy, through his agent or manager, for the purpose of carrying
on his business through such agent or manager. On the other
hand, a hard-working landlord, who has transferred his business
to a company or which he retains complete control, and who
genuinely needs to obtain possession of the holding so that his
company's business may be carried on there with the aid of his
own labour, will nevertheless apparently be without any right to
oppose an application for a new tenancy by a tenant however
undeserving. It seems, however, impossible to escape the
conclusion that this is the effect of what Parliament has enacted,
If the results are though undesirable, only parliament can put
that right.... '
People's Pleasure Park Co. v. Rohleder [(1908) 109 Va 439]
Certain lands were transferred by one person to another
perpetually, with an enjoinment or restriction, that, the transferee
could not sell the property to coloured persons. The transferee
transferred these lands to a company composed exclusively of
Negroes. An action was commenced against the transferee by
the original transferor of lands, for annulment of the conveyance
of lands to the company on the ground that 'all the members of
the company being Negroes, the property had, in breach of the
restriction, passed to the hands of coloured persons.
The court rejected this argument and held that, 'members
individually or collectively are not the corporation, which has a
distinct existence - an existence separate from that of its
shareholders. It leads its own life....if stands apart as a separate
subject and, in contemplation of law, as a stranger to its own
members'.
Re F.G. (Films)Ltd. [(1953)1 WLR 483]
An American company produced a film called 'Monsoon' in
India technically in the name of a company incorporated in
England. The English company had a capital of £ 100 in £ 1
shares, 90 of which were held by an American director. The
production was financed by the American company. In these
circumstances the Board of Trade refused to register it as a
British film and their decision was upheld by the court, which
observed that : 'it would be a mere travesty of the facts to say or
to believe that this insignificant company undertook the
arrangements for the making of the film. They acted, in so far
as they acted at all in the matter, merely as the nominee of, and
agent for the American company'.
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Freewheel (India) Ltd. v. Dr. Veda Mitra [AIR 1969 Del.
258]
A 52% subsidiary company proposed to issue further capital
which, following Sec.81, was offered to the existing holders of
equity shares. The holding company requested the court that its
subsidiary should be restrained from going ahead with the issue
as it would deprive the parent company of their controlling
interest and would also depreciate the value of its shares.
Kapur, J, refused to issue the injunction prayed for and said:
Here the parent holds only a nominal majority in the share capital
of the subsidiary. With the meager majority alone I am not
prepared to hold, even if it were possible to do so for such a
purpose, that the subsidiary company had lost its identity as a
separate legal entity".
A.G. v. Great Eastern Railway [(1880)5 App.cas. 473]
The company was incorporated by statute to acquire the
undertaking to two existing railway companies and to construct
and run certain other railways. The question before the court
was whether it was within its powers, as defined by the
incorporating statute, to hire locomotives and rolling stock to
another railway company operating in the same area. Lord
Selborne, L.C. observed ......I assume that your Lordships will
not now recede from anything that was determined in the
Ashbury Railway Company v. Riche. It appears to me to be
important that the doctrine of ultra vires, as it was explained in
that case, should be maintained. But I agree with Lord Justice
James that this doctrine ought to be reasonably, and not
unreasonably, understood and applied, and that whatever may
fairly be regarded as incidental to, or consequential upon, those
things which the legislature has authorized, ought not (unless
expressly prohibited) to be held, by judicial construction, to be
ultra vires...." It was held that the concerned activities were
intra vires the company, being within its express powers.
Bell Houses Ltd v. City Wall Properties Ltd [(1966)2 All ER
674]
The plaintiff company's principle business was the acquisition
of vacant sites and the erection thereon of housing estates. In
the course of transacting business, the chairman acquired
knowledge of sources of finance for property development. The
company introduced the financier to the defendant company,
and claimed the agreed fees of £ 20000 for the same. The trial
judge held that the contract was ultra vires the plaintiff company
and , therefore void.
On appeal, the court of appeal reversed this decision, relying
on a clause in the memorandum which authorized the company,
to carry on any other trade or business whatsoever which can,
in the opinion of the board of directors, be advantageously
carried on by the company in connection with its general
business”, and held that,' since the directors honestly believed
that the transactions could be advantageously carried on as
ancillary to the company's main objects, it was not ultra vires'.
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Mahnoy v. East Holyford Minig Co. Co. [(1875) L. R. 7 H.
L. 869]
The liquidator of the respondent company sued Mahony as
public officer of the National Bank, Dublin, alleging that the
bank had paid money from the company's account without due
authorization. The bank had acted upon a letter signed by one
wall as secretary of the company, enclosing a copy of a
'resolution'of the board of directors. This resolution named
three directors, and instructed the bank to pay cheques signed
by any two of them and countersigned by the secretary.
Specimen signatures were attached. The instruction was entirely
in accordance with the company's memorandum and articles,
and would have been in order, except that there had never been
any proper appointment of the directors or secretary by the
company, the roles having been simply assumed by those who
had formed the company. The House of Lords held that, the
company was bound by cheques which the bank had honoured
in accordance with the instructions contained in the letter. It
was observed, "Those articles of association and that partnership
deed are open to all who are minded to have any dealings
whatsoever with the company, and those who so deal with them
must be affected with notice of all that is contained in those
two documents. After that, the company entering upon its
business and dealing with persons external to it, is supposed on
its part to have all those powers and authorities which, by its
articles and deed, it appears to possess; and all that the directors
do with reference to what I may call the indoor management of
their own concern, is a thing known to them and know to them
only; subject to this observation that, no person dealing with
them has a right to suppose that anything has been or can be
done that is not permitted by the articles or deed..... A banker
dealing with a company must be taken to be acquainted with
the manner in which, under the articles of association, the moneys
of the company may be drawn out of his bank for the
purposes of the company. And the bankers must also be taken
to have had knowledge, from the articles, of the duties of
directors, and the mode in which the directors were to be
appointed. But, after that, when there are persons conducting
the affairs of the company in a manner which appears to be
perfectly consonant with the articles, then those so dealing with
them, externally, are not to be affected by any irregularities
which may take place in the internal management of the
company. They are entitled to presume that of which only they
can have knowledge, namely, the external acts, are rightly done,
when those external acts purport to be performed in the mode in
which they ought to be performed..... If we are not now to hold
that the bankers are to be protected in honouring the drafts of
these three persons, who they were informed, were authorized
to draw the cheques, can be safe against being bound to inquire
into all the minute transactions which may have taken place
indoors....."
8. PROBLEMS
1. Some of the partners of a partnership firm carrying on the
business of plying buses, formed a private limited company,
which they could do under law even while the partnership
continued to be running concern. These partners, sold to
the company their own buses which were being used by the
firm before. The second set of partners who constituted
the minority, sued the first group forming the company, for
accounts and their share of profits on the ground that, in
reality the company was not a different entity from the firm,
and that the business carried on by it was the same as that
of the firm. Decide.
2. A business concern was converted into a company, and all
the shares of the company were held by the persons owning
the business concern. They sold certain premises to the
new company. The difference between the selling price
and cost of the property in their hands was assessed as their
income. They contended that this could not be done as
there was no commercial sale, but only a transfer from self
to self. Decide.
3. Darby and Gyde (both undischarged bankrupts, with a
number of convictions for fraud) registered a company 'A'.
It had only 7 shareholders and had issued a mere £ 11 15 s,
If its nominal capital of £ 100,000. Darby & Gyde being
the only two directors were entitled to all of its profits. This
company, then proposed to float in England a £ 30,000
company under the name BC Corporation Ltd. and to sell
to it a quarrying license and plant, brought for £ 3,500, at a
price of £ 18,000. The prospectus inviting the public to
take debentures in BC Corporation Ltd., disclosed the role
of the company 'A' as vendor and promoter, but did not
mention the names of Darby & Gyde or the fact that it was
they who were to receive the profit on sale. BC Corporation
failed and went into liquidation. The liquidator claimed in
the bankruptcy of Darby for the secret profit which it was
alleged that he, as a promoter, had made. Darby contended
that it was not he , but the corporation who had been the
promoter. Decide.
4. A company was established to carry on the trade of a 'product
merchant' in Western Australia. It entered into speculative
contracts with merchants in Calcutta for purchase of jute.
The memorandum contained no express power to deal in
jute, but clause j reads : 'To carry on any other business
whether manufacturing or otherwise' the purchase of jute
is intra vires or ultra vires the company. Decide.
5. The memorandum of a company gave power to the directors
to 'borrow or raise or secure any sum or sums of money on
the security of the property of the company by the issue of
[Note: Please specify your name, ID number and address while sending answer papers].
debentures, and so on, for the purpose of company's
business'. They borrowed £ 6,250 and used the money to
pay of certain outstanding debts. The person lending money
was unaware of the purpose for which money was being
borrowed. Decide whether the lender could enforce
repayment of loan even though the purpose of loan was
improper and ultra vires.
6. The copyright in News Chronicle and Star newspapers,
together with plant and premises used in their production
was sold to Associated Newspaper Ltd. by the defendants.
The two papers ceased production and most of the 2800
employees lost their jobs. The defendants, arranged with
Associated Newspapers Ltd. that, after payment of the
expenses, the whole of the purchase money received should
be paid as compensation and pension benefits to these
displaced employees. A meeting of the shareholders of the
defendant company was called to authorize the directors to
distribute the money in accordance with this scheme. One
of the minority shareholders brought an action claiming that
the proposed payment was ultra vires and illegal. Decide.
7. Directors of a company borrowed money from a bank on
the security of a mill situated in Rangoon. The directors
had already exceeded the limit (of an amount equal to half
the paid-up capital) imposed on their power to borrow by
the articles. There was a provision in the articles that, 'the
company in a general meeting might by a special vote
enlarge the directors power to borrow'. The bank sought to
enforce the security relying on this clause, holding that they
were entitled to assume that 'the directors power to borrow
had been so extended'. The company resists the banks claim.
Decide.
8. Richards was chairman of directors of the defendant
company and its chief executive or 'defacto managing
director', who often committed the company to contracts
on his own initiative and only disclosed the matter to the
board subsequently. The board acquiesiced in this practice.
The plaintiff was chairman and managing director of another
company 'Perdio', which it was planned should eventually
merge with or acquired by defendants. As part of an
agreement to put more money into Perdio, the plaintiff (who
had been made director of the defendant company) was
given 2 letters signed by Richards, by which the defendants
agreed to guarantee the repayment of money owed to the
plaintiff and to indemnify him against certain losses. When
sued on these undertakings the defendant alleged that
Richards had no authority to make the contract in question.
Decide.
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9. SUPPLEMENTARY READING

1. Avtar Singh, Company Law, 9th edn. 1986, Eastern Book Company, Lucknow.

2. Gower, L.B.C., Gower's Principles of Modern Company Law, 5th edn. 1992, Sweet & Maxwell Ltd., London.

3. Ivamy, E.R.H., Topham and Ivamy's Company Law, 1974, Eastern Law House Pvt. Ltd., Calcutta.

4. Ramaiya, A., Guide to the Companies Act, 8th edn. 1977, Wadhwa & Company, Nagpur.

5. Schimtthoff, C.M., & Thompson, J.H., Palmer's Company Law, 21st edn.1968, Stevens & Sons Ltd., London.

6. Sealy,L.S., Cases & Materials in Company Law, 1st edn.(rep): 1975, Cambridge University Press, Cambridge.

7. Sen, S.C., The New Frontiers of Company Law, 1971, Eastern Law House, Calcutta.

8. Sangal, P.S., National & Multinational Companies, some legal issues, 1st edn: 1981, N.M. Tripathi Pvt. Ltd., Bombay.

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 Master in Business Laws

Corporate Law

Course No: III

Module No: III & VI

Corporate Management

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in

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Materials Prepared by:
Prof. N.L. Mitra
Ms. Sudha Peri
Materials Checked by:
Ms. Archana Kaul
Materials Edited by:
Prof. T. Devidas

© National Law School of India University

Published By:
Distance Education Department
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.

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 INSTRUCTIONS
As has already been stated, the structural design of corporation is the most important legal invention to
create a legal vehicle of industrial movement. People's participation in the raising of capital made it possible
for huge industrial undertakings requiring huge investments. The old concept of joint ownership started
changing until a professional management group came into the scene as an independent option of corporate
management through the framework of contractual system. Initially it was the movement of corporate
democracy to operate inside in order to manage the concern through the elected representatives. During the
British Rule, Indian Companies used to experience the management by outside agencies through the instrument
of contracts. Taking advantage of the system these managing agency houses created all conditions of
managerial anarchy in the corporate system. As a result, in Karachi Congress in early 30s the Indian National
Congress declared that the system was to be abolished after independence. Finally, in 1970 the system was
completely abolished. But the corporate democracy cannot by itself produce a clear, efficient and competent
management system. The BOD can hardly take the responsibility of day-to-day administration of the policy
adopted by the Board. It is, therefore, essential for a corporate system to thrive, to design an appropriate
professional managerial system. Fortunately, in the last twenty years, thanks to the popularity of management
education, a good professional management system is being built up. But still at the top level, there is
inadequacy. We have experimented with some other alternate methods. But all experiments failed including
that of Secretary and Treasurer.
One has to understand clearly the role of BOD in a Corporate set-up. BOD is composed of shareholders,
representatives, institutional nominees and Government nominees, in certain cases. It cannot take the position
of a top executive. With the development of technology even this type of constitution of the Board is also
changing. Professional Managers are necessary in the Board to properly investigate, study and design the
appropriate course of action. As such, shareholders' representatives are ipso facto inadequate even to frame
up the policy, far less to implement them. Obviously, again the thinking of contractual arrangements in
corporate management surfaced. Shareholders want their return on investment. As such, if they want to
contract out the management to outside professional agency or person what can be the grounds of objection?
Indian investors invest on the name of the promoters many of whom are professional managers. With
technological issues becoming more and more important professionalism in management is being demanded
more and more. That will mean changes in the structuring of the corporate management system including
that of the BOD. In this module we have discussed these issues in details. You have to supplement the
literature with books of modern authors specially Prof. Gower, Pennington and Berly.
The corporate structure has also presently gone into change. Earlier, companies used horizontal growth for
operational economy. Presently vertical growth and management takeover and mitosis in corporate structure
are the order of the day. New technology is individual efficiency specific. So modern companies have structure
out the operational level though through a claim of 'profit-centre' management structure, the control centre
growing very big, so much so that often the ultimate control centre remains invisible. You have to understand
the nuances of the modern management system. In the light of the demand the legal position is required to be
studied and criticized.
You have to make detail side-line note while reading the module and at the end of each chapter prepare
check-lists so that you can compare properly the Indian System with any other modern management system
of a developed country. I hope you will find the module interesting.
N. L. MITRA
Course Coordinator

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 CORPORATE MANAGEMENT

TOPICS

1. Corporate Control ....................................................................................................... 125

2. Corporate Management ................................................................................................ 130

3. Board of Directors ....................................................................................................... 141

4. Oppression & Mismanagement....................................................................................... 156

5. Investigations ................................................................................................................ 160

6. Case Law ........................................................................................................................ 164

7. Problems .......................................................................................................................... 167

8. Supplementary Readings ............................................................................................. 168

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1 CORPORATE CONTROL
SUB TOPICS
1.1 Introduction
1.2 Legal devices of control
A) Through complete ownership
B) Majority control
C) Control without majority control
D) Conclusion
1.3 Extra-legal devices of control
A) Minority control
B) Management control
1.4 Conclusion
1.1 INTRODUCTION
Uptil the 19th century, the stockholders or shareholders were
substantially the owners and managers combined in one. The
only group of importance within the company was the
shareholders and then the directors as the nominees or agents of
the shareholders. This was the ‘golden age’ for the shareholders'
democracy, wherein, the management was deemed to be running
a business on behalf of their owners. While they did have wider
powers than most agents, they were strictly accountable to the
shareholders. Although the directors were left in charge of the
business, legally speaking they were under the direct control of
the shareholders and any one of their decisions could have been
vetoed by the shareholders.
With the expansion of industry, spread of the economy and
popularity of the stock exchanges, share purchasing became
more common. ‘Share investment’ became the most popular
method of saving/investment, resulting in a wider dispersal of
stocks. This process was further hastened by the growth of giant
companies with a capital investment so large that it was
impossible for any single individual or group to have 51%
holding. Continuation of this pattern of dispersion has resulted
in individual stockholding becoming smaller and smaller, with
the result that no shareholder is individually important.
This position has been further aggravated by the advent of
‘institutional shareholders’, i.e. companies, banks, financial
institutions, mutual funds etc. The real ownership of shares is
not with any individual, but in large groups. The personal
element went completely missing from such groups. This change
of pattern led to a new state of affairs where the basic concepts
got completely changed. These changes according to Berle &
Mean were as follows:
1) The position of ownership has changed from active to
passive. Instead of actual physical property over which
the owner could exercise direct control, the owner now
helds a piece of paper representing a set of rights &
expectations. But over the enterprise and physical property,
the instruments of production in which he has an interest,
the owner has little control.
2) The spiritual values that formerly went with ownership have
been separated from it.
3) The value of an individual’s wealth was coming to depend
on forces entirely outside himself and his own efforts.
4) The value of the individual’s wealth not only fluctuated
constantly but the same happened to most wealth.
5) Individual wealth had become extremely liquid through
organized markets.
6) Wealth was less and less in a form which could be employed
directly by its owner. The newer form of wealth (ex: shares)
was quite incapable of direct use. Only through sale in the
market could the owner obtain its direct use. He was thus
tied to the market as never before.
7) Finally, in the corporate system, the “owner” of industrial
wealth was left with a mere symbol of ownership while the
power, the responsibility and the substance which had been
an integral part of ownership in the past were being
transferred to a separate group in whose hand lay the control.
As property was gathered under the corporate system, and
control was increasingly concentrated, the power of this control
steadily widened. Briefly, the past century saw the corporate
mechanism evolve from an arrangement under which an
association of owners controlled their property on terms closely
supervised by the state to an arrangement by which many men
have delivered contributions of capital into the hands of a
centralized control. This was accompanied by grants of power
permitting an almost unarticulated permission to deprive the
grantors, at will, of the beneficial interest in the capital thus
contributed. Thus, in corporations dispersion of shareholdings
led to the evolution of control and finally the rise of management
as a power. Under the modern corporate system, control over
industry began being exercised with a minimum of ownership
interest. As the activities of the corporation were exercised
through a board of directors for all practical purposes, control
lay in the hands of the individual or group, having the actual
power to select the board of directors either by mobilizing the
legal right to choose them or controlling a majority of votes
directly or indirectly through some legal device or by exerting
pressures influencing their choice. Hence in addition to
shareholders and directors “control” was recognized by Berle
& Means, as one of the most important constituent parts of the
modern corporate structure. Let us discuss in detail the various
kinds of control which can exist in a corporation.
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FLOW CHART INDICATING VARIOUS FORMS OF CONTROL
Control within a Company
Legal device
By complete By legal
ownership device without
majority ownership
By Majority
control
By pyramiding By non-voting
stock
1.2 LEGAL DEVICES OF CONTROL
As seen in the above flow chart there are three forms of control
which rest on a legal base, and revolve about the right to vote a
majority of the voting stock. We will now take up each one of
these devices in detail.
A] Control through almost complete ownership
This type of control is found in what may properly be called the
‘private corporation’ or ‘one man companies’ where a small
group of persons or a single individual own all or practically all
the outstanding stock. They are in a position of control, not
only because they have the legal powers of ownership, but also
because they are in a position to make use of them and, in
particular being in a position to elect and dominate the
management. In such an enterprise ownership and management/
control is combined in the same hands.
Since the 19th century, such companies have been the centre of
large scale controversy, usually based on two aspects, viz., (1)
whether the one man company had an existence apart from the
individual controlling it, and (2) whether, in case of private
corporations unchecked power and control could be vested in
the hands of a few individuals.
In response to the first, way back in 1936, in T R Pratt
(Bombay) Ltd v. E D Sasson & Co Ltd [AIR 1936 Bom 62],
Kania, J., observed that “under the law, an incorporated company
is a distinct entity, and although all the shares may be practically
controlled by one person, in law a company is a distinct entity
and it is not permissible or relevant to enquire whether the
directors belonged to the same family or whether it is, as
compendiously described as a ‘one-man company’”. A similar
observation was made much erlier, by the House of Lords in
Salomon v. Salomon & Co Ltd [(1897) AC 22]. Thus such
companies exist with the encouragement of both the legislature
and the judiciary and “the great majority of them are as bonafide
and genuine as in a business sense they are convenient and
suitable media for provision and application of capital to
industry” [Avtar Singh, p.6].
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Extra legal device
Minority control Management control
By means of By weighted
voting trust voting shares
With regard to the second, the position may be clearly understood
in the light of Lord Greene M. R.’s observation in re Smith and
Fawcett Ltd [(1942) Ch 304]. Here, a clause in the Articles of
a private company provided: “The directors may at any time in
their absolute and uncontrolled direction refuse to register any
transfer of shares”. The issued capital of the company consisted
of 8,002 shares of which the two directors of the company S &
F held 4,001 shares each. F died and his son applied to have the
shares registered in his name. But S, in the exercise of the above
power, refused to consent to the registration. He however,
offered to accept the applicant upto 2,001 shares, provided the
remaining were sold to him at a fixed price. The plaintiff brought
an action contending that S’s refusal to register was on a wrong
principle since it was not made for the benefit of the company
but was rather to preserve his own dominating position. It was
held that `Private companies are (no doubt)in law separate entires
just as much as are public companies, but from the business and
personal point of view they are much more analogous to
partnerships than to public corporations ....... The directors must
exercise their discretion bonafide in what they consider - not
what court may consider - is in the interest of the company. An
if they have done that the court cannot substitute its judgment
for theirs”.
B] Majority control
The first step in the separation of ownership and control is that
of ‘majority control’, and it involves ownership of a majority of
the outstanding stock by a single/small group of individual(s),
gives virtually all the legal powers of control which would be
held by a sole owner of the enterprise and in particular the power
to select the board of directors. But, in medium - large
corporations where there is a larger dispersion of stock, the
control of the corporation vests in the hands of the person(s)
holding the majority stock. This concentration of control in the
hands of the majority, in effect means that the minority have
lost most of their powers of control of the enterprise of which
they are part owners. For them, at least, the separation of
ownership and control is complete, though for the majority it is
still combined in their hands.
The majority’s powers of control may be to a slight extent curbed
by the existence of a compact minority which is ready, alert and
present to question the majority on its policies and acts, either
directly at the meetings or indirectly in the courts. But, when
the minority stock is widely scattered, then (in the absence of a
legal device) majority ownership means “undiminished control”.
Control to the majority group has arisen due to various reasons.
It is not really possible for a large group of persons to contribute
capital for a common enterprise, without loss of control by some
members of the group. It would clearly be impracticable for
each member to exercise a major element of control over the
enterprise. The disadvantages of “liberum veto” are too great
to make unanimous action predictable. Thus, grant of control
to the majority stockholder(s) is a natural and generally accepted
progression. This control has been granted on the presumption
that, in most (if not all) cases, the minority interest and majority
interest run parallel to each other. The problem arises when
these interests start conflicting with each other, because it is
then that accusation of oppression and mismanagement are
levied against the majority. But this particular point will be
dealt in detail later at the appropriate place.
C] Control through a legal device
Among the larger corporations, however, the separation of
ownership and control has passed far beyond the separation
represented in majority control. In a truly large corporation,
the investment necessary for majority ownership is so
considerable as to make such control extremely expensive.
Among such corporations, majority control is conspicuous more
by its absence than by its presence. More often than not, control
in such corporations in maintained with a relatively small
proportion of ownership, through the use of a ‘legal device’.
Some of these legal devices are briefly discussed below.
(i) Pyramiding: This is the most important of all legal devices
used by larger corporations. This involves the owning of the
majority of the stock of one corporation which in turn holds the
majority stock of another corporation, which further holds the
majority stock in still another corporation and so on. There is
no limit to the extent to which this process can go on. By issuing
bonds and non-voting preferred stock of the intermediate
companies the process can be accelerated. By the introduction
of two or three intermediate companies each of which is legally
controlled through ownership of a majority of its stock by the
company higher up in the series, complete legal control of a
large operating company can be maintained by an ownership
interest equal to a fraction of one percent of the property
controlled. The owner of a majority of the stock of the company
at the apex of the pyramid can have almost as complete control
of the entire property as a sole owner even though his ownership
interest is less than one percent of the whole [Sen, p.33]. Given
below is a graphic representation of this concept of pyramiding.
A
B
C D
E F G H
Here A, B, C, D, E, F, G & H are all corporate entities, with
A being at the apex of the pyramid, controls a majority stock in
B which in turn controls the majority stock in both C & D, which
further control E - F & G - H respectively. So, in effect, though
A actually holds majority stock only in Corporation B, due to
this pyramiding, is able to control six other corporations apart
from B. This is the process used by the various business
corporates of today.
(ii) Non-voting Stock: This method consists in arranging the
right attached to different classes of shares in such a manner,
that, most of the stock is disfranchised i.e., without the right
to vote (at least so as voting for directors is concerned),
and only a small class, or a class representing a very small
investment is permitted to vote. Ownership of just over
half of this privileged class [having the right to vote] is
sufficient to give legal control and virtually all the powers
of majority ownership [Sen, p. 33]. At present, non-voting
preferred stock is a common phenomena in U K and U S A.
In India, this mode of controlling device is absent, since
the Indian Companies Act specifically lays down the kinds
of shares which can be issued by a public company under
S. 86, namely: equity or ordinary shares and preference
shares. An interesting question which arises is that as there
is no restriction on the kinds of shares a private company
may issue does it mean that a private company can issue
non-voting shares? In theory yet it may do so since the law
gives greater flexibility to the private companies in matters
of exercising control over their capital but in practice, since
this kind of shares is not very popular in India, it is not
generally issued. There is a proposal mooted for allowing
the issual of non voting shares by companies but the outcome
of the proposal is as yet undecided.
(iii) Weighted Votes: This may be considered to be a variant
of the above legal device. This involves the issue of a large
number of shares having excessive voting power [for
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 Ex. one vote may carry the weightage of four votes] i.e.,
voting power in excess of the capital invested. Such
weighted shares result in the person(s) acquiring total control
of the company. In India, weighted shares cannot be issued
by a company, under S. 88 which states that, shares with
disproportionate voting rights cannot be issued. The same
position exists in England, as far as quoted or listed
companies are concerned. But, this restriction does not
apply to private companies. Thus, in Bushell v. Faith
[(1969) 1 All ER 1002], a clause in the Articles of a private
company which gave three votes for each equity share to a
director when a resolution was proposed for his removal
has been held valid.
(iv) Voting Trust: Apart from these modes of securing control
through direct or indirect ownership of the voting majority
another device which is widely prevalent in U S A is that of
the ‘voting trust’. This involves the creation of a group of
trustees, often a part of the management, with the complete
power to vote for all stock placed in trust with it. When a
majority of the stock is held in trust, as is usually the case,
the trustees have almost complete control over the affairs
of the company with them personally having little or no
ownership in the company. The ‘stockholders in turn receive
‘trust certificates’ instead of regular ‘share certificates’,
entitling them to share in such disbursements as the directors
may choose.
Control through a voting trust differs from all other forms of
legal or extra legal forms of control, in that, it is fixed, defined
and inalienable, with certain definite and well recognized
responsibility attached to it. Presumably, it is this open
acceptance of responsibility which has reduced criticism of
‘voting trust’, and perhaps for the same reason, it is not a device
which is used extensively in the larger corporations, since those
individuals desiring to control a company may not wish to assume
the responsibilities and liabilities which a trust would impose
upon them. The courts in U S A recognize such trusts as valid
despite the lack of statutory backing, unless such trusts are
formed with an improper motive or object, for example, if it
exists merely for the benefit of the trustees with no obligations
to perform any useful service for the protection of shareholders
or creditors, or if it unduly restricts the powers of directors.
Position in India: Under S. 153 of the Act, which declares
that, “no notice of any trust, express, implied or constructive,
shall be entered on the register of members”, a company is not
bound to recognize the existence of a trust, though it may do so
for its own benefit, without entering the trust in the Register.
For example, in S. Parmeshwari v. K M R Mills Ltd [AIR
1971 Mad 293], a managing director’s wife, having quarreled
with her husband and to teach him a lesson, brought an action
for winding up. All the shares held by her were financed by her
husband. The court held that, the company could take notice of
this fact and present it to the court for the purpose of showing
that her petition was not bonafide, and was brought to exert
pressure upon the managing director for settlement of the family
dispute. Under S. 158-B(1), the Central Government is
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authorized to appoint a person as a `public trustee’. Any person
holding shares in or debentures of a company in trust for another
person has to make a declaration to the public trustee, and failure
to make such a declaration involves a penalty. But S.187-C of
the Amendment Act of 1974 provides that a person whose name
appears in a company’s register of members, but who does not
hold the beneficial interest in the shares, should make a
declaration to the company specifying the name and other
particulars of the person holding the beneficial interest on the
shares. The right to vote on shares held in trust has now been
vested in the public trustee [S. 187-B], who may exercise the
right either personally or through proxy. He may even abstain
from voting, if he feels that the objects of the trust or the interest
of the beneficiaries would not be adversely affected by the
abstention. This provision, more than all others, would ensure
the failure in India of `voting trust’ as a legal device for
controlling the company.
D] Conclusion
Control based on a legal device, whether by pyramiding or
otherwise, is almost as secure, as control through sole or majority
ownership, though it involves very little ownership interest.
Ofcourse, in case of failure, this control is lost, though it is only
under the most unusual conditions that an individual or group
in legal control of a prosperous business becomes so entangled
in a situation that they can extricate themselves only by
surrendering this control.
1.3 EXTRA LEGAL DEVICES OF CONTROL
Untill now the discussion involving methods of control, has
involved a legal status. In each case, factual control has rested
primarily, on the more or less permanent possession of the legal
power to vote a majority of the voting stock, though the control
itself has been held with different proportions of ownership. At
one end of the scale, ownership and control have been wholly
combined, while at the other they are totally dissociated. Any
degree of combination or separation might be arranged, with
the control based on a legal status.
In the typical large corporation, control however does not rest
upon legal status. Here, control is more often factual, depending
upon a strategic position secured through a measure of
ownership, a share in management, or external circumstances
important to the conduct of the enterprise. Such control is less
clearly defined than the legal forms, is more precarious, and
more subject to accident and change. It is, however, actual,
capable of being exercised over a long period of years, and as
the corporation becomes larger with widespread ownership, it
tends towards a position of impregnability comparable to that
of legal control, a position from which it can be dislodged only
by a virtual revolution.
As in case of legal control, factual control may also involve
varying degrees of ownership, though never more than 50% of
the voting stock. It may rest to a considerable extent on the
ownership of large minority stock interest, or, when stock
interest is widely distributed, it may lie in the hands of the
management. Though no sharp demarcating line can be drawn
between the two they may broadly be categorized as minority
control and management control, and each of these is briefly
discussed below.
A] Minority Control
This type of control may be said to exist when an individual or
small group holds sufficient stock interest within a corporation
to be in a position to dominate it through their interest. Such
groups are often said to have a “working control” of the company.
Generally speaking, the control of such a group rests on its ability
to gather sufficient number of proxies in their favour, which
when combined with their substantial minority interest, is
sufficient to control a majority of the votes at the annual elections.
This automatically means that no other stockholidng is
sufficiently large enough to act as a nucleus around which to
gather a majority of the votes. This type of control is relatively
difficult to maintain in a relatively smaller corporation with
smaller stock holding. This is because a rival group may be
able to purchase a majority of the stock or a minority large
enough to attract the additional votes necessary, to obtain control
in a proxy fight. But, larger the company and wider the
distribution of its stock, the more difficult it appears to be to
dislodge a controlling minority. The reason for this is very
simple. The cost of mobilizing the votes of tens or hundreds of
thousands of stockholders by circularizing them and perhaps
conducting a publicity campaign, is prohibitive, that only the
very wealthy can dream of seeking this method of seizing control
from an existing minority.
Despite its advantages, ‘minority control’ suffers from a series
of limitations - i.e., the possibility of an ‘antagonist
management’. As long as the corporation functions smoothly,
minority control may be quietly maintained over a period of
time. But during a crisis or when the interests of the management
and controlling group are in conflict, the issue may be drawn
and a proxy fight to determine control may demonstrate the
extent of dependence of the controlling group on the
management. When such a fight for control begins factual power
is once more dependent on legal power and the stock holders
by their votes or their choice of proxy committees decide the
issue.
B] Management Control.
The last type of control is that in which ownership is as widely
distributed that no individual or small group has even a minority
interest large enough to dominate the affairs of the company. In
such situations, no shareholder is able to exert pressure upon
the management by virtue of his holding, or to use his holding
as a considerable nucleus for the accumulation of the majority
votes essential for control.
A shareholder has three alternatives to pursue during election
of the board, namely, he can (i) refrain from voting, (ii) attend
the meeting and personally cast his vote or (iii) he can sign a
proxy transferring his voting power to certain individuals
selected by the management of the corporation, i.e., the ‘proxy
committee’. Generally speaking, since a personal vote of the
shareholder has little or no effect on the election unless he has a
large shareholding, he is reduced to opt either for abstaining or
going in for proxy voting, by giving his right to vote to
individuals over whom he has no control and in whose selection
he did not participate. In either case he cannot exercise any
control. Conversely, control is in the hands of those who select
the ‘proxy committee’ namely the existing management. Where
ownership is sufficiently sub-divided, the management can thus
become a self-perpetuating body even though its share in the
ownership is negligible. This form of control is called as
“management control” [Sen, 36].
Though resting on no legal foundation, this type of control seems
to be comparatively secure especially where the stock is widely
distributed. This does not mean that in such cases, no possibility
of revolt does exist. A group outside the management may seek
control, and if the company has been seriously mismanaged,
then, a protective committee of stockholders may combine a
number of individual owners into a group which can successfully
contend with the existing management and replace it by another,
which in turn can be ousted by a revolution.
1.4 CONCLUSION
Normally control is exercised quietly over the years without
any active contest, which may result in the shareholder to choose
between two rival factions. A shareholder mostly plays the role
of a rubber stamp, though on occasions he may be in a position
to support an effort to seize control, a position similar to the
general population supporting a revolution. But, in either case,
the ordinary shareholder has little power over the affairs of the
company, and his vote is rarely capable of being used as an
instrument of democratic control. The separation of ownership
and control is total. The bulk of owners have in fact no control
over the enterprise, whereas those in control hold only a
negligible proportion of the total ownership.
Sometimes factual control is not found in the hands of any single
group. A controlling minority may be totally dependent upon
the management, and similarly a controlling management may
have to accede in some measure to the demands of a strong
minority in order to maintain its measure of control. It is not
unusual for two or more strong minority interests to enter into a
working arrangement by which they jointly maintain control
[something in the nature of a coalition government of minority
political parties]; or a minority and management may combine
as ‘the control’, or ‘joint control’.
Corporate control thus appears in many forms relatively defined
and stable legal positions, loosely defined and somewhat more
precarious factual situations. Each form is not complete in itself,
nor is it exclusive of others. Several methods may reinforce
each other.
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2. CORPORATE MANAGEMENT
SUB TOPICS
2.1 Speciality of corporate management
2.2 Structure of corporate management
2.3 Evolution of corporate management
2.4 Position of Directors
2.5 Workers participation in corporate management
2.1 SPECIALITY OF CORPORATE MANAGEMENT
Meaning of the Term
In different parts of the globe, different words are used to
designate the managerial setup. British firms and some American
businessmen are accustomed to use the term administration,
referring to activities, carrying out the policies laid down. Almost
in the same meaning the word ‘management` is used. Some of
the multinational firms use the word ‘executive`, meaning almost
the same thing. A very clear distinction of these terms cannot
therefore be underscored. In public service, people are more
accustomed to the word ‘administration` which refers to the
persons responsible for the functions. Administration is “that
function of an enterprise which concerns itself with the
overall determination of policy and major objectives.
Administration sets forth the general purpose of the enterprise,
establishes its major policy, formulates the general plan of
procedures, inaugurates the broad program, and approves the
specific major projects that fall within the general program.
[Spriegel and Lansburgh, 1.9]. If one examines the corporate
management, one would find that this is exactly what the top
management of a corporation does. Theoretically speaking this
task is assigned to a collective forum of management in a
company set up, democratically designed and popularly and
statutorily known as, ‘board of directors`. One can also
understand that a top executive of a modern company also does
this. Management concerns itself with the direction and control
of various activities to attain the business objectives.
Management is essentially an executive function; deals
particularly with the active direction of human effort [Spiegel
and Lansburgh, 1.9]. Spiegel and Lansburg try to explain the
term administration and management in terms of policy planning
and execution. The following diagram explains the co-relation.
Top Management
Administration
Management
Lower Management
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In the above diagram, it is shown that higher the level of
management, greater is the administrative power and fewer is
the management power; whereas lower the level of management
higher is the management power and fewer is the administrative
power. A top level manager is entrusted with more of policy
design and planning and devolution of appropriate authority to
the lower scales of management who gets the various activities
done with his direction and control. Therefore, the word
corporate management here is used to signify the entire
administrative and management process of a company. The
American management schools have strengthened the idea of
this wider context of meaning to the word management, including
within it not merely executive functions but also the policy design
and planning with strict criteria of objectives. Therefore,
presently, the term management includes:
i) determination of objectives;
ii) designing the policy;
iii) determining the plan of action;
iv) stipulating the procedure;
v) devolving appropriate authority to the lower level of
management; and
vi) receiving the accomplishment account and fixing the
accountability.
Corporate management is a team work. It has various levels of
functions and co-ordinations. Accordingly, these levels are
named as, (a) top management level (affixing the highest planner
and executive for getting things done); (b) upper management
level [who receives authority from the top management, divided
into certain systematic alignment of functions like sales,
purchase, secretariat etc. They are accountable for the total
function under each alignment respectively to the top boss], (c)
middle level management [who gets appropriate authority from
upper management to make the details of plan of action, identify
the actual grassroot level functionaries, arrange for the training
of manpower, provide the adequate instruments and tools as
required under the technology and allocate the task to the junior
level management]; (d) lowest level management [they are the
grassroot level managers who get the things done under
supervisional control, and give the accomplishment report to
their higher officials.
Outcome of the 17th century, gradually redefined by
refinement through succeeding statutes. It has been earlier
stated in module 1, that by the requirement of huge capital and
high technological development in the production processes,
the company form of business organization came into being
with distinctive characters, the most intricate amongst the
being disassociation of ownership and management. In this
form of business organization huge capital is collected from
equally huge number of shareholders spread over a very wide
geographical area. Most of them do not have competence for
understanding the technology of production and technicality of
distribution. Nor can they associate in taking a decision.
Therefore, these vast number of shareholders do not possess
any direct power of management. Gower, a famous British
author, has explained the diminishing value of shareholders
democracy in a corporate set up [Gower, 72]. We will be
explaining this statement in more detail at the appropriate place.
It will presently suffice to know that the management functions
in its totality, as enunciated by Spiegel and Lansburgh, is reposed
on separate statutory body. In a company, including corporations
the statutory bodies are:
1. shareholders in the general meeting; and
2. board of directors.
Whereas, the general meeting, specially the annual general
meeting, shall have some identified or statutory powers
respectively, the entire management power is vested with the
board of directors by virtue of Sec. 291. It stipulates that the
Board “shall be entitled to exercise all such powers, and to do
all such things, as the company is authorised to exercise and
do”. The Companies Act stipulates specific provisions for the
following statutory management offices:
a) Managing Director; (b) whole time director; (c) manager;
According to Sec. 197A a company cannot appoint and employ
more than one categories of management from (a) managing
director and (b) manager. “This is to stop a company from
employing more than one type of managerial personnel
simultaneously which is needless and expensive” [Ramaiya,
1232]. Since Sec. 197A does not contain any other category, a
company can have wholetime Director or Executive director
with Managing Director or Manager. Besides, as the methods
of management by a `director-in-charge’ or committee of
directors or agent under a power of attorney have now come
into vogue’ [Ramaiya, 1232] requiring broadening the scope of
Sec. 197A. Presently the use of American terminology for
managerial personnel, like President, Vice President, etc., has
been adopted in many companies. The Company Law
Department did not see any reason to object against the use
these terms provide the company used these terms clearly in the
Articles as to what they mean in so far as in the context of
managing director and in the Companies Act. It is essential for
the concerned company to make it clear to the prospective
investors what such nomenclature means in terms of the
conventional nomenclature of managing director, co-executive
director etc., ordinarirly used by the Companies [Company News
& Notes; Dec 2, 1963]. The department has also instructed
Registrars to be watchful to ensure that all statutory provisions
relating to managing directors are complied with by companies
which designate the managerial personnel with American
equivalent terminology.
SPECIAL FEATURES OF CORPORATE
MANAGEMENT
a) Division between ownership and management - the most
important feature of corporate management is that the owners
are not required to be the managers and vice versa. Ownership,
known as shareholding, is looked at from the point of view of
investment and not from the point of view of enterprise. People
buy shares in a company expecting returns. With a higher
probability of income they are ready to pay a higher price. So
shareholders are not managers themselves. They elect persons
with commercial prudence to the board of directors, who run
the enterprise to give the owners of the shares higher returns.
To become the director of the board, the Articles of association
may prescribe certain qualification shares. But it is not an
essential qualification for professionals to become whole time
directors or employers to become whole time directors in the
board. This issue shall be further discussed when we discuss
about the qualification of directors.
b) Professionalisation of management - Corporate
management is now a high technical process which demands
professionalism. Management schools from the whole world
produce thousands of professional managers in order to run the
corporate management at various levels. Professional managers
themselves act as a profit centre and maximize the turnover and
profit at every level. As a result, at the aggregate level, the
productivity and services are increased. Had there been no
separation of management from ownership, this
professionalisation could not perhaps be so developed.
c) Adaptation of technology - Corporate management is based
upon the concept of specialization. It involves appropriate
planning, proper delegation, development and motivation of
human resources, optimal use of material resources followed
by profits accountability. At every level there requires to be
specialization. The whole process is ideal for micro-level
technology-design and technology adaptation at the macro level.
The present day technology has overtaken the conventional
technology of the industrial civilization. The present day
technology generally referred to as ‘high-tech` is more a
compatible management approach towards man and his
machines, more so, a computer operator and his computer. This
'high-tech' technology requires a rapid development and
absorption of information which is the bed-rock of modern
scientific corporate management.
d) Accountability - A corporate manager at present is fully
accountable for whatever he does. He does not take cover under
the shield of a principal in a principal-agent design of
management. The members of the board of directors no longer
function as the agents of the shareholder as they used to do in a
joint stock company. As Gower has rightly pointed out that
'they are not mere creations of corporate democracy'. As a matter
of fact the corporate management is a creation of an independent
contract. As such, they are accountable for the net result but not
reviewable on the basis of decisions they take.
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Kuntz, O’donnel and Weihrich has outlined a
system analysis to management in the following diagram.
REENERGIZING THE SYSTEM

MANAGERIAL TRANSFORMATION PROCESS

INPUTS PART 2 PART 3 PART 4 PART 5 PART 6 OUTPUTS

PLANNING ORGANIZING STAFFING LEADING CONTROLLING

1. Human Nature of Nature of Nature of The human System and 1. Products

objectives; departmentalisation selection of factor; process of
2. Capital 2. Services
premising line & staff ; managers; motivation controlling;
3. Management control 3. Profits
decision Decentralization appraisal of leadership;
techniques;
4. Technological making committees managers; Communication 4. Satisfaction
control of
stragegies; & groups Manager & overall 5. Goal
policies; decisions; organization
performance; integration
development
effective Effective Effective
inputs of 6. Others
organizing managing

COMMUNICATION SYSTEM

1. Employees 6. Community External Variables

2. Consumers 7. Others 1. Opportunities
3. Suppliers 2. Constraints
4. Stockholders 3. Others
5. Government

from the above figures one can understand the input and output
analysis of the management system which comprises a
transformation process through various stages. The concerned
inputs necessary for a determined output of product services,
profits and others are: 1. Human Resources, 2. Capital, 3.
Management, and 4. Technology. The transformation process
involves planning, organising, staffing, leading and controlling.
Each of these stages have multiple functions. Management, as
has been already indicated, is a total concept of organic
functioning by a team to achieve a determined goal.
2.2 STRUCTURE OF CORPORATE MANAGEMENT
Prof. Galbraith divided corporations into two groups for the
purpose of study of corporate structures, Firstly, ‘entrepreneurial
corporations` which maintained the same classical structure and
did not change over the years, and secondly, ‘mature
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corporations` which came to be known as giants of modern days.
According to him these giant corporations are composed of
‘series of concentric circles`. Galbraith’s description of these
giants in a series of concentric circles is a unique reading.
According to him:
“It is more useful to think of the mature corporation as a series
of concentric circles. The band within each pair of circles
represents a group of participants with a different motivational
system. In the more spacious bands at the outer reaches are the
most numerous groups. Such in general is their motivational
system that they are the most loosely attached. At the centre is
what is now called the top management. There is the finest
attachment. Between are the others. With this image in mind
the motivational system of the various participants in the
corporation can be much more intelligently considered.
In the outermost circle in the mature corporation are the ordinary

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shareholders. This for all practical purposes is a purely pecuniary
association. The typical stockholder does not identify himself
with the goals of the enterprise; he does not expect to influence
these goals. He has a share in the ownership; normally his only
concern is that it return him as much money as possible. If he
can get more income or capital gain with equal security
elsewhere, he sells and invests there. No group loyalty - no
identification with the goals of the enterprise - normally prevents
his doing so..... The relation to the corporation of the largest
stockholders of General Motors, United States Steel, Standard
Oil and like enterprises, with few exceptions, is equally
impersonal... In the relation of the ordinary stockholders to the
corporation is the present case of pecuniary motivation.
The next inward circle is occupied by the production worker...He
has no illusion that he can accept the goals of the organization
as his own.
Yet, in fact, motives are more complex. The worker, unlike the
stockholder, lives in immediate daily association with the
organization. This itself is inducement to identification; an
individual comes to think to himself as an 'I.B.M. man', a
'Corning Glass man' or a 'Sears man'. The element of compulsion
the association has needed, and therewith, this barrier to
identification. The entrepreneurial corporation sought to
maximize the return to the owners. The maximization of the
pecuniary return of distant and presumably well-to-do persons
was not a goal with which the ordinary worker, human nature
being what it is, would be likely to identify himself. The more
ambiguous or less visibly egoistical goals of the techno-structure
SHAREHOLDERS
BOARD OF DIRECTORS
MANAGING DIRECTOR
COMPANY EXECUTIVE
SECRETARY DIRECTOR -
WORKS
MIDDLE MIDDLE
MANAGEMENT MANAGEMENT
LOWER LOWER
MANAGEMENT MANAGEMENT
are less sharply in conflict with identification of the worker.
Comparative security of tenure and the physically untaxing and,
on occasion interesting, character of modern technological
process also lower the barriers to identification...
Next as one moves inwards, are foremen and supervisory
personnel and the clerical, sales and other routine white collar
personnel. There emerge at their inner perimeter the technicians,
engineers, sales executives, scientists, designers and other
specialists who comprise the techno-structure; beyond these at
the centre are the executives or management. As one moves
through these inner circles, identification and adaptation become
increasingly important"(Galbraith, 62).
Anyway, it has been rightly stated that “the trend relating to
dispersion of shareholdings has become an accepted part of
corporations and the trend was continuing and
intensifying...Sterility of the shareholder power was found to
be an accepted and established feature of the modern
corporation” (Sen, 25). Adolf Berle very rightly observed that
the activities of a modern corporation demonstrate the gradual
erosion of even directors’ power, leave alone the shareholders,
in the trend of the rise of the power of techno-structure. A Board
cannot take any decision now a days, unless there is a thorough
market study and a proper planning by the techno-structure.
Shareholders have gone in the background. Berle pointed out
how capitalism gallops though the capitalist himself is in the
vanishing point.
Let us see the general structure of management of an Indian
Company.
Executive Directors are whole time directors of the company
CHAIRMAN
EXECUTIVE EXECUTIVE
DIRECTOR DIRECTOR
PERSONNEL SALES
MIDDLE MIDDLE
MANAGEMENT MANAGEMENT
LOWER LOWER
MANAGEMENT MANAGEMENT
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who generally rise from the ranks and are professionals. They
generally take the assignment of top line executives of the
company. Many of the Indian companies have now adopted the
management structure of American companies. American
SHAREHOLDERS
AUDIT COMMITTEE BOARD OF DIRECTORS
OPERATION POLICY COMMITTEE
PRESIDENT
EXECUTIVE EXECUTIVE
VICE-PRESIDENT VICE-PRESIDENT
GENERAL STAFF ADMINISTRATIVE
DIVISION
SENIOR EXECUTIVE SENIOR EXECUTIVE
MIDDLE EXECUTIVES MIDDLE EXECUTIVES
line-charge as the top executive in each division. In a number
of companies Vice-President belongs to the Board as full
member from the professional management. But Vice-Presidents
may be invitees to the Board as well.
2.3 EVOLUTION OF CORPORATE MANAGEMENT
Corporate Management has undergone a sea change in so far as
structures, functions and responsibilities are concerned in the
last hundred years. Management has become an important area
of study and research. Managers started analysing issues related
to their management functions from a multi-disciplinary point
of view. Management systems started adapting several ways of
analysis, specially from various behavioural perspectives.
Emergence of industrial psychology, sociology and economics
led management as a leading behavioural science. Let us see
some of the noticeable changes in the corporate management in
the recent times.
i) It is now established that the “chief executive job in every
business (except perhaps the very smallest) cannot properly
be organized as the job of one man. It must be the job of a
team of several men acting together” (Drucker, p.168). As
a result most successful companies have chief executives
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companies provide a positive role to the professional members
of the Board who lead the whole team of managers to achieve a
result. The management structure of General Motors is given
below:
Vice-Presidents are like Executive Directors. They hold the
BONUS & SALARY
COMMITTEE
FINANCIAL POLICY COMMITTEE
EXECUTIVE EXEXUTIVE
VICE-PRESIDENT VICE-PRISIDENT
OTHER OP. FINANCE LEGAL
DIVISION DIVISION
SENIOR EXECUTIVE SENIOR EXECUTIVE
MIDDLE EXECUTIVES MIDDLE EXECUTIVES
consisting several people. As a result the Standard Oil
Company has the chief executive consisting of a fourteen-
men Board of Directors composed entirely of full-time
officials of the Company. General Electric has a Chief
Executive team composed of President, and a number of
Deputies and Vice-Presidents engaged in policy formulation
and execution. Many other U.S. Companies like Dupont,
New Haven Railroad, Union Carbide etc., have such type
of management structure. The chief feature of this pattern
of management is that full time members of the Board
dominate the policy making.
ii) Professionalization has gone down to the basics of
management. No Board can take a decision on anything,
far more in the complex area of marketing, finance and
policy execution unless there are thorough research reports
placed before them by some professionals. Professionalism
is both inside and outside. Professionals dominate in the
Board and Board takes decisions only on professional
reports.
iii) Committee functioning has become another structure
adjustment in the present day management. According to
Drucker “members of the chief executive team who are
charged with responsibility for company objectives must
 work directly with the Board. One way to achieve this in a
large company (applied in several of our large businesses
with good results) in the formation of Board Committees in
each major area of objectives, with the company office
SHAREHOLDERS
BOARD OF DIRECTORS
PRESIDENT
VICE VICE VICE
PRESIDENT PRESIDENT/ PRESIDENT/
GENERAL DIRECTOR:
MANAGER PERSONAL
FINANCE PLANT ADV. PERSONNEL ADV.
COMMITTEE COMMITTEE COMMITTEE
WORKS MANAGER
MANUFACTURING
ADV. COMMITTEE
Each Committee is under the charge of an executive Vice-
Chairman/Director. Though the modern tendency is for a
functional and professional Board, Drucker suggested that “The
Board must be detached from operations. It must view the
Company as a whole. This means that working executives of
the Company should not dominate in the Board” (Drucker,
p.180).
In several senses corporate democracy has been proved to be a
myth. In corporate management the proof has been beyond
doubt. Though directors were elected by the shareholders from
amongst themselves initially before five decades, at present a
director need not be a member of the Company. According to
Drucker “the Board will be stronger and more effective if it is
genuinely an ‘outside` Board...” (Drucker, 180). The
constitution of the Board has now become the task of the Chief
Executives. Drucker has rightly pointed out the responsibility
of constituting a really detached and independent Board to
evaluate the functions of the Chief Executive, as the task of the
function of the Chief Executive. He said “it is one of the most
important things the chief executive team can do, and one of the
major conditions for its own success is discharging its job.”
Unfortunately at present, the Chief Executive in any Company,
is indulging in appointing only psychophant directors (a critique
termed them as ‘Ji Hoojoor` directors).
Corporate democracy is impossible to function due to (a) wide
disposal of shareholders and sharedholdings; (b) shareholders’
disinterest to perform ownership functions, (c) blind faith on
some industrial management houses and satisfaction on ‘return`
charged with primary responsibility in that area acting as
the Committee Secretary or Chairman.” A common example
of such a structure is given below:
SECRETARY LEGAL
DIRECTOR COMMITTEE
SALES
SALES ADV. ADMINISTRATION
COMMITTEE ADV. COMMITTEE
on investment; (d) incapacity of the shareholders to manage
affairs; (e) difficulty in organising the dispersed shareholders;
(f) minimum alternative, and many other reasons. Corporate
democracy is not only impossible to achieve, it is not desirable
too as per the running philosophy of corporations. That is why,
merger and take-overs are put as an enemy of the company and
not simply of the existing management. No chief executive will
like an active brand of shareholders.
2.4 POSITION OF DIRECTORS
Gower has very rightly observed that a company “remains an
artificial person; its policy can be formulated and decided upon
only by individual human beings, and can be put into effect
and carried out only by human agencies.” Since the Board of
Directors formulates the policy and gives effect to the same
and since all the assets or properties are put in the hands of the
Board of Directors, there is often a confusion about the legal
status of the Board of Directors of a company. Directors are
described by judges as managing partners, agents or trustees.
As for example, Selborne L.C. held in G.E.RLy Co. v. Turner
[(1872) L.R. 8 Ch. app 149] that “The Directors are the mere
trustees or agents of the Company - trustees of the Company’s
money and property; agents in the transactions which they enter
into on behalf of the Company.” Master of the Rolls Jessel
observed in Re. Forest of Dean Coal Co. [(1878) 10 Ch.D.
450] that “...they are commercial men managing a trading
concern for the benefit of themselves and of all the shareholders
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in it. They stand in a fiduciary position towards the company in
respect of their powers and capital under their control.”
(a) Directors as Agents: The agency power of the Board of
Directors of the Company is a statutory one in India. According
to Section 291 of the Companies Act “the Board of Directors of
a Company shall be entitled to exercise all such powers, and to
do all such acts and things, as the company is authorised to
exercise and do,” subject to the provisions of the Act. Under
this section the Board has a general agency power. It can do
any act which the company can do, to bind the company unless
the Act itself prohibits it. The only difficulty of directors acting
as the agent of the company, is how can an artificial body like a
company appoint an agent ! Gower also raised the question and
tried to resolve the dilemma ‘by regarding the decisions of the
majority of the company in general meetings as the acts of the
company itself`. Directors therefore, act as the agents of the
company. But it is to be noted that authority of the company is
to be exercised not by individual director as the agent of the
company but must be exercised by the Board. The Board, of
course, may delegate its authority to a director in which case he
acts as the agent of the company. Powers of the company to be
exercised by the Board can be exercised by the Board:
i) in its meeting,
ii) with the consent of the company in general meeting, and
iii) either in its meeting or through delegating the same to the
Chief Executives.
So any power that the company has, its Board can exercise unless
the same is required to be done otherwise in view of a clear
provision in the Statute. But an act which the company cannot
do, cannot be done by the Board; it is ultra vires to the Company
and the Board. In general principles of agency the agent’s power
is not only to be within the competence of the principal but it
has to be within the authorised power as well. So, an act intra
vires to the company can be ultra vires to the Board. As for
example, declaration of dividend cannot be done by the Board
though the company can do it. In India, of course, these powers
are statutorily restricted to be done by the general meeting of
the company itself. As such, such powers are statutorily ultra
vires to the Board. But generally speaking, all general powers
including business and commercial powers of the company can
be done by the Board. Powers which are statutorily to be done
by the General Meeting cannot he delegated by the company
nor can be ratified after the act is done by the Board. So in
India excepting these statutory powers of the general meeting
all other powers can be done by the Board. Of course by
prescription in the Memorandum or Articles same powers can
be restricted to be done by the General Meeting itself. Such
powers could be delegated by the company to the Board by
amending its constitutional documents. But an act ultra vires to
the company cannot be authorised or ratified. The principles
of ultra vires has been discussed in details earlier.
It has been stated that some powers of the Board can be done by
the Board in its meeting only. These powers are:
i) to make calls [section 292(1)(a)];
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ii) to issue debentures or borrow money otherwise [Section
292(1)(b)&(c)];
iii) to invest company’s funds and make loans [Section
292(1)(d)&(e)];
iv) to delegate the power to borrow [Section 292(1),(2),(3) and
(4)];
v) to fill up a casual vacancy in the Board [Section 262];
vi) to appoint Managing Director or Manager a person who is
Managing Director or Manager of another company (Section
297]; and
vii) to invest in shares or debentures under the same management
(Section 372).
The Board can exercise the following powers only with the
consent of the company in general meeting:
i) to sell, lease or otherwise dispose of the whole or part of
the under- taking of the company [Section 293(1)(a)]’
ii) to remit the debt due by a director [Section 293(1)(b)];
iii) to borrow in excess of capital and reserves [Section
293(1)(d)];
iv) to contribute to charities [Section 293(1)(e)];
v) to invest compensation amounts received in compulsory
acquisition of any of its properties [Section 293(1)(c)]; and
vi) to appoint sole selling agent [Section 294(2)].
All other powers of the company can be performed by the Board
by delegating the same to Chief Executives.
Directors are not merely agents because their duties are more
serious than an ordinary agent. Gower applied general principles
of equity to company directors and derived four principles to
be observed. “These are (1) that directors must act in good
faith in what they believe to be the best interests of the company;
(2) that they must not exercise the powers conferred upon them
for purposes different from those for which they were conferred;
(3) that they must not fetter their discretion as to how they shall
act; and (4) that without the informed consent of the company,
they must not place themselves in a position in which their
personal interests or duties to other persons are liable to conflict
with their duties to the company” [Gower, p. 553].
(1) Acting in good faith: Directors are required to act in good
faith towards the company in their dealings with the
company and on behalf of the company. “They should not
use the company’s money or other property or information
or other matters in their possession in their capacity as
directors, in order to gain any advantage to themselves at
the expenses of the company, and if they make any profit
for themselves or cause any damage to the company, they
will be liable to make good the same to the company”
[Ramaiya, p. 668]. As for example, in Re W & M Roith
Ltd [(1967) 1 WLR 432] the controlling shareholder and
director entered into a service agreement with the company
so that his widow was entitled to a pension for life after his
death. No thought was given to the question whether the
 contract was for the benefit of the company. It was held
that the company was not bound by the agreement. The
test of `whether the act is for the benefit for the company’ is
specified in Charterbridge Corporation v. Lloyds Bank
[(1970) Ch 62] as the `honest man in the position of a
director of the company concerned could.... have reasonably
believed that the transactions were for the benefit of the
company’.
(2) Proper purpose: Gower distinguishes between an act done
in excess of authority and act done for improper purpose.
He rightfully observed that the former ‘hardly seems to be
a breach of the fiduciary duty of good faith; the latter is’
[Gower, p. 556]. If a director exercises his power for a
purpose different from what he was required to take care
of, the director may be liable personally.
(3) Unfettered discretion: No director can delegate his
discretion to others. Any agreement by directors to vote in
a determined manner in a Board meeting is invalid. This
guiding principle only means that directors have absolute
freedom to take any decision freely in order to subserve the
interest of the company. A director is not bound by any
previous condition like ‘I shall vote with the majority’ in
the Board. Such an agreement is invalid. But that does not
mean that a director cannot make a valid contract to take
any further action in the Board meeting if that is necessary
to make a bona fide decision in a prior contract for the
interest of the company. Gower quoted the judgment of the
Australian High Court decision in this respect. According
to the judgment in Thorby v. Goldberg [(1964) 112 CLR
597], “there are many kinds of transactions in which the
proper time for the exercise of the directors’ discretion is
the time of the negotiation of a contract and not the time at
which the contract is to be performed .... If at the former
time they are bona fide of opinion that it is in the best
interests of the company that the transaction should be
entered into and carried into effect, I can see no reason in
law why they should not bind themselves to do whatever
under the transaction is to be done by the board”. The
principle is o be applied to the best interest of the company
and to the freedom of decision making by a director to
subserve the interest of the company and not of a group of
persons.
(4) Resolution of conflicting duty and interest: The equitable
principle of the common law is that directors must not place
themselves in positions where there will be a conflict
between their duty to the company and their self interest or
duty to any other person. Such a situation can arise when
in transactions with the company a director has a personal
interest involved. Lord Chancellor Cranworth explained
the principle in the most appropriate manner, thus:
“A corporate body can only act by agents, and it is, of
course, the duty of those agents so to act as best to
promote the interests of the corporation whose affairs
they are conducting. Such agents have duties to
discharge of a fiduciary nature towards their principal.
And it is a rule of universal application that no one,
having such duties to discharge, shall be allowed to
enter into engagements in which he has, or can have,
a personal interest conflicting, or which possibly may
conflict, with the interests of those whom he is bound
to protect..... So strictly is this principle adhered to
that no question is allowed to be raised as to the
fairness or unfairness of a contract so entered into....”
[quoted in Gower, pp. 559 - 60].
The issue comes clear on the question as to whether a director
of a company can have any interest directly or indirectly, in the
business of another competing institution. Gower critiqued the
decision in Bell v. Lever Bros [(1932) AC 161] holding that ‘it
is impossible to support’ the view that ‘a director cannot be
restrained from acting as a director of a rival company’. Gower
observed: “It has been held that the duty of fidelity flowing from
the relationship of master and servant may preclude the servant
from engaging, even in his spare time, in work for a competitor,
notwithstanding that the servant’s duty of fidelity imposes lesser
obligations than the full duty of good faith owed by a director
or other fiduciary agent. How then, can it be that a director can
compete whereas a subordinate employee cannot” [Gower
pp.571]. Lord Denning in Scottish Co-op Wholesale Society
v. Meyor [(1959) AC 324] observed that ‘one who is a director
of two rival concerns is walking a tight-rope and at risk if he
fails to deal fairly with both’.
Excepting in the case of whole time Director or Executive
Director, a restriction against being appointed in two competing
concerns as a Director is not legally possible. It is only provided
in Sec. 299 of the Companies Act, 1956 that a director is under
a duty to declare his interest in a contract with the company.
The errant director is liable to be fined. In Guinew v. Saunders
[(1990) 2 AC 663] the House of Lords decided that if a director
fails to disclose his interest, ‘the transaction becomes voidable
at the option of the company and the benefits received by the
director are recoverable by the company’. Conversely, it is also
suggested that if the interest is disclosed earlier, the transaction
is not voidable and the personal benefit not recoverable. In the
above case, declaration of interest prior to the transaction
contracted for, was prescribed in the article. In the absence of
that prescription, the situation cannot be different on the ground
of fiduciary obligation of the director.
The provision of Sec. 297 of the Companies Act is clearer than
the provision of Sec. 317 of the English Act in so far as the
following:
i) that the English Act, 1985 contains nothing “prejudicing
the operation of any rule of law restricting directors from
having an interest” in transactions with the company but in
the Indian law, except with a resolution specifically made
by the Board in its meeting, no contract can be entered into
by any director of the company or his relative, a firm in
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 which such a director or his relative is a partner, or a private
company of which the director is a member or director for
(a) the sale, purchase, or supply of goods and services and
(b) undertaking the subscription of shares or debentures of
the company. But the restriction shall not be operative if it
is done in cash at the prevailing market rate and the trade is
regularly done, and the service cost does not exceed in a
year rupees five thousand;
ii) that in the English Act, a prior declaration of interest is
enough to make the contract binding, otherwise it is
voidable. In Indian law the consent of the Board is to be
obtained for the transaction, otherwise the contract shall be
voidable at the option of the Board. Sec. 299 of the Indian
Companies Act 1956, makes the disclosure of interest
mandatory. He has to disclose the nature of his concern or
interest at a meeting of the Board or personally by serving
a notice. If a director fails to comply with the provision, he
shall be punishable with fine upto rupees five thousand;
iii) that according to Indian law, this disclosure rule does not
apply to directors of a company who do not hold together
not more than two percent of the paid up capital of the
contracting company;
iv) that the interested director is restrained from participating
or voting in the proceedings of the Board [Sec. 300(1)];
v) that the company shall keep a register to record the contracts
in which directors are interested specifying all stipulated
information and the nature of concern or interest of the
directors and the particulars of interest [Sec. 301(1)]; and
vi) that where a company enters into contract for appointment
of a manager or managing director in which any director
has any concern or interest, the company has to disclose
the interest of the concerned director to the members of the
company within 21 days from the date of entering into the
contract by sending an abstract of the terms of contract’
[Sec 302(1)].
Directors’ duties of care and skill as an agent of the company:
The standard of care and skill that a director must exercise while
functioning as an agent has been aptly identified in Re City
Equitable Fire Insurance Co [(1925) Ch 407] thus:
1) A director is not required to exhibit in discharging his
function any greater degree of skill than may reasonably be
expected from a man of his knowledge and experience.
2) A director is not bound to give continuous attention to the
affairs of the company. His duties are intermittent in nature
while only attending the meeting of the Board or of any
Committee. Though he is expected to attend these meetings
whenever he is reasonably able to do, he is not bound to
attend all such meetings.
A director is justified in placing reliance on the officials of
the company in the absence of any grounds of suspicion.
He has to leave the execution of the policy in the hands of
the officials and in the absence of any doubt, he may rely
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on their action to be presumed to have been done within the
statutory limit or as prescribed by the Articles.
While examining the duties of directors as per the Indian law
we will make detailed observations, but it is sufficient here to
note that directors as the alter-ego of the company are required
to discharge their duties bona fide and without any willful default.
b) Directors as trustees: Directors are not ordinary trustees
of the company in the strict sense of the term. But courts have
often held them as trustees of the company by way of analogy in
order to underscore the fiduciary relation with the company. In
Re City Equitable Fire Insurance Co [(1925) Ch 407] it was
rightly observed that ‘to describe directors as trustees seems to
be neither strictly correct nor invariably helpful’. Directors are
agents of the company with fiduciary relationship. This fiduciary
capacity is the ground of confusion between the two institutions,
viz., directors and trustees. Gower [at p. 551] explains these
fiduciary relationship under two heads: (1) fiduciary duties of
loyalty and goodfaith analogous to the duties of trustees (strictu
sensu) and (2) duties of care and skill (differing fundamentally
from the duties of normal trustees). Since directors have a special
position vis-a-vis a corporate personality, they while acting as
an agent of the company, have some fiduciary duties, such as,
(i) duty to act bona fide (ii) duty to disclose self interest (iii)
duty of unfettered discretion and (iv) duty to confine within the
purposes of the company for which it was constituted. These
duties are similar to the fiduciary duties of a trustee. Hence the
issue.
Directors have fiduciary relation with the company but not with
the shareholders or creditors. The most appropriate decision is
given in Percival v. Wright [(1902) 2 Ch 42]. Here, a
shareholder approached a director offering his share to be sold
to the director for a price. The director knew that there was a
deal with another company for selling the entire concern at a
higher value. The director purchased those shares. While
holding that the director does not have any fiduciary relation
with a shareholder, the court held that “there is no question of
unfair dealing in this case. The directors did not approach the
shareholders with the view of obtaining their shares. The
shareholders approached the directors and named the price at
which they were desirous of selling”. Had the director
approached the shareholder urging upon him to sell those shares
at a price to facilitate amalgamation, they would be accountable
to give back the profit made on those shares from the
amalgamating shares. Here the directors would be acting as
agent of the shareholders as well [Allen v. Hyatt (1914) 30
TLR 444]. Directors while giving advice to the shareholders in
a take-over situation have a fiduciary duty to act in good faith
[Frudential Assurance Co Ltd v. Newman Industries Ltd
(No. 2) (1980) 2 All ER 841].
Is Company Director an officer of the company: According
to Sec. 2(30) ‘officer’ of a company includes directors. But the
director of a company cannot be called as an officer of the
company in the sense that director of a company is not an
employee. Justice Romar rightly described the position of the
director as the prudent businessman of trust elected by the
shareholders to function for and on behalf of the company. A
director elected in the Annual General Meeting (AGM) of a
company is said to be ‘appointed by the company’. In so far as
the liabilities are concerned under the Companies Act, a director
of the company shall be liable as if an officer of the company
though he is not an employee.
2.5 WORKERS PARTICIPATION IN MANAGEMENT
(COMPANY LAW PERSPECTIVE)
Companies Act 1956 does not include anything directly
regarding workers participation in management. According to
Article 43A [inserted by the Constitution (42nd) Amendment)
Act 1976 vide s.9] of the directive principles of State policies
contained in Chapter IV of the Constitution of India, the State
shall take steps, by suitable legislation or in any other way, to
secure the participation of workers in the management of
undertakings, establishments or other organization engaged in
any industry. The frame of this basic principle of ‘workers’
right to participate in the management is generic in nature which
includes all enterprises both in the public as well as in the private
sector. But ever since 1976 not much has been done in this
regard. Some of the Banking Companies have such type of
provision to allow employees’ participation in management. As
for example, according to sec.19 of the SBI Act, one director is
to be nominated by the Central Government from among the
employees (a provision inserted by Act 48 of 1973). In some
financial institutions like IDBI such a provision does exist. But
in so far as the companies Act is concerned, there is no general
or particular provision for this.
Indirectly, there are certain provision for the employees to enable
them to become shareholders of the company and then possess
right to participate in the management. Some of these provisions
are given below:
(1) According to sec. 77(2)(b) a company may give directly or
indirectly financial assistance in accordance with any
scheme for the purchase of fully paid up shares in the
company or its holding company to be held by or for the
benefit of the employees of the company. Such a provision
shall not be hit by the general provision to restrict power of
the company to buy its own shares or to assist in buying
own shares.
(2) While placing the Finance Act, the Finance Minister
announced the opening of ‘Stock Option Scheme’ (SOC)
that while proposing a further issue of capital, they should
make a reservation of 5 percent of the further issue to their
employees/workers on an equitable basis. In the case of
public issues, shares not taken up by the employees/workers
may be issued to the public. In case of right issues an
additional offer has to be made simultaneously with the
offer to the shareholders at a price fixed. Unsubscribed
portion by the workers won’t lapse if not taken up by the
employees. Sec. 81 of course require special resolution for
issue of a right share in any other manner other than to the
existing shareholders on equitable basis. Such a resolution
should be produced for reservation to employees while
submitting the proposal.
Where loans or advances have been given to the employees/
workers by the company to buy shares under ‘Stock Option
Scheme’, the shares issued may be hypothecated against such
loans, to the company. Prior approval is necessary for such
arrangement.
Guidelines were issued for the purpose of allowing the ‘Stock
Option Scheme’ under Employees Convertible Debenture
System. The guidelines are as under:
1) The scheme is extended to all public limited companies.
2) It is a voluntary scheme both for employer and employee.
As such employer can offer share to his employees and
employees can take the same.
3) It is applicable to all regular/permanent employees.
4) Employees would be given three options of saving at three
different rates (say Rs.500, Rs.1000/- and Rs.2000/- per
amount) under the savings cum SOS. It shall be for a period
of 5 years.
5) At the start of the operation of the scheme, a convertible
debenture is to be issued which shall earn maximum rate of
interest under the guideline by CCI.
6) On completion of the 5th year, the ECD (Employees
Convertible Debenture) shall be converted into equity shares
at a price to be determined in the year in which the scheme
is introduced. According to CCI share price can be 80
percent of the average market price of the share or the fair
value as determined by CCI, which ever is less but can not
be less than the face value.
7) The total number of shares which an employee can get
depends upon the total equity the company is willing to
offer under ECD scheme. If the employees’ option exceeds
the number allowed by the company, the company has to
issue shares on the basis of pro-rata and the balance of the
ECD is to be returned in cash.
8) The equity shares issued against the ECD scheme are not
transferable within 3 years from the date of issue.
9) No employee can obtain more than 50 shares of Rs.100/-
each or 500 shares of Rs.10/- each.
According to SEBI guideline dated 11-6-1992, it is voluntary
on the part of the company to encourage employees to have
higher participation in the equity of the company. Suitable
percentage of reservation can be made subject to maximum of
5%. Participation upto maximum of 200 shares is permitted
subject to theses being non-transferable for a period of three
years. It therefore means that SEBI has kept the old CCI
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guidelines in operation. Similarly SEBI guideline of 11-6-1992
sec. H(1)(a) provides that reservation to employees of the
company (including Indian directors) is permitted subject to a
ceiling of 5% in a public issue.
These are provisions to encourage the employees’
participation in the stockholding and an indirect way of
provoking employees to participate in the management. In a
wider context, professional management is possible only when
managers are employees. The present constitution of Board of
Directors allow employees to become members of the board
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and they are not required to have qualification shares. At top
management level only employees become members of the
Board. Democratization at the level of employees to elect some
members in the Board is not what is contemplated under the
present form of legal prescription. At the lower level of
management, there are provisions in labour laws (say, Factories
Act) for workers to participate. As for example, workers’
representatives are required to be in Works’ Committee. In all
provisions regulating collective bargaining there is provision
for workers’ participation. But there is no such concept of
management under the Corporate Law’.
3 BOARD OF DIRECTORS
SUB-TOPICS
3.1 Constitution
3.2 Appointment
3.3 Retirement
3.4 Removal
3.5 Remuneration
3.6 Compensation for loss of office
3.7 Powers
3.8 Duties
3.9 Disabilities
3.10 Liabilities of the directors
3.1 CONSTITUTION OF BOARD OF DIRECTORS
The Board of Directors of a company can be only a policy
making organ or a policy-cum-control function organ. Most of
the British companies have policy making Boards who keep it
as far as practicable, away from day to day executive functions
which are given to the top executive of the company, generally
known as a Managing Director or a Chairman. American
companies on the other hand, keep a Board which is both the
apex policy making and controlling body. Professional
executives play a very important role in the Board itself. They
place reports on various issues like marketing, material purchase,
human resource development and utilization etc., and help the
Board to formulate policies. The team of whole time directors
take responsibilities of control functions. Indian companies are
in the transition specially after the abolition of the Managing
Agency system with effect from 1960. Under the Managing
Agency system the company used to contract the management
out to an external agency who was given the responsibility of
the top executive as well as dominative authority in the
constitution of the Board. This is now a matter of the past.
At present a Board in India is constituted with Directors, both
whole time and part time; a Managing Director/Chairman,
institutional Directors, additional directors and nominated
directors.
(i) Managing Director: Sec 2(26) defines a managing director
as a director who is entrusted with 'substantial powers of
management' and includes a director occupying the position of
a managing director, by whatever name called. He exercises
such powers subject to the superintendence, control and
direction of the Board of Directors. Such an appointment and
entrustment of power can be done by virtue of (i) an agreement
or (ii) a resolution in the general meeting or by its Board of
directors or (iii) by virtue of memorandum or Articles of
Association. But specific powers entrusted to a Director to
affix the common seal, draw and endorse cheque or any
negotiable instrument or sign a certificate of share, do not mean
substantial powers of management by virtue of those specified
powers alone. A chairman of a company performing this
substantial powers of management is deemed as the managing
director.
(ii) Whole time Director: Whole time directors are employees.
They are professional directors who are also called executive
directors or Vice Chairman in charge of operations. In some
companies, these whole time directors are invitees to the Board
or are non-voting members. In other cases they have equal
responsibilities to participate freely in the board meetings.
Though whole time directors are now an established feature,
yet the Companies Act has neither defined the term and position
nor it has provided for any special position excepting including
an explanatory note to Sec. 269(1) explaining whole time
director as a director in the whole time employment in the
company. He is an employee of the company and he discharges
such functions as may be assigned to him by the Board or the
Managing Director. These whole time directors are not elected
members of the Board and are not liable to retire after three
years in the office. Whole time directors get salaries. Though
the rationality of it can be questioned, but the approval of the
Government is required for appointing a managing Director or
a whole time director of a public limited company or a private
limited company which is subsidiary of a public limited company.
The approval is granted only when such a appointment is to the
interest of the company and the person so appointed is a fit and
proper person and his appointment is not against public policy.
The terms and conditions are also required to be reasonable
[Sec. 269(3)]. Then directors are not required to hold the
qualification shares as may be prescribed in the Articles of the
company.
(iii) Elected Directors: Elected directors are those who are
elected by the members to the post in every annual general
meetings (AGM). They are part time directors who are to attend
the Board/Committee meetings and devote some time to do some
specific things in relation to the management of the company.
The definition given to director in Sec. 2(13) is inclusive of any
one occupying the position of director, by whatever name called.
These directors are entitled to sitting fees for attending the
meetings and such other remuneration as may be stipulated by
the Articles of the company.
(iv) Institutional Director: Institutional Directors are those
who are nominated by the institutional members such as LIC,
UTI, IDBI, IFCI or SFC. These institutional members are either
mutual funds or development and industrial banks supplying
equity capital to the company. These members are not required
to acquire qualification shares as may be prescribed by the
Articles, nor are they required to retire by rotation.
(v) Nominated Directors: Institutional directors are all
nominated directors and not elected. Sometimes, commercial
banks or government may nominate a director in the Board for
the supply of loan capital or infra structural facilities or for any
other reasons including public policy. These nominee directors
also do not retire.
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(vi) Worker Director: If Articles so provide, workers may
nominate/elect their representative on the Board. Though
ensuring workers' participation in management is a directive
policy of the State as stated in Art of the Constitution of India,
yet there is nothing in the corporate law to insure such
representation. The company may ensure such a representation
by its Articles.
(vii) Manager: In Indian law there is hardly any definitional
distinction between a managing director and a manager, both
being the chief executive of the company excepting that a
Managing Director is himself a director, to be precise, the leader
of the Board of directors, whereas a manager may or may not
be a director, Sec. 2(24) of the Act defines a manager as an
individual, who subject to the superintendence, control and
direction of the Board, has the management of the whole, or
substantially the whole, of the affairs of the company, and
includes a director or any other person occupying the position
of manager by whatever name called, and whether under a
contract of service or not. Thus the definition is very wide and
denotes the top executive position of the company. He has to
be an individual and not a firm or a body corporate. Here the
manager is different from the managing agent who used to be
running the management of a company before 1970.
(viii) Additional Director: An additional director is one who
is appointed by the Board to hold the position upto the date of
the next AGM of the company. In Krishna Prasad Pilani v.
Colaba Land & Mills Co [(1959) 29 Com. Cas. 273] the
court held that the meaning of the clause upto the date of the
next Annual General Meeting of the company' means upto the
date when the next annual general meeting ought to be held at
the latest as per Sec. 166 of the Act. As such, additional directors
hold office only for a maximum period of time between one
AGM to the next AGM. This power is given to the Board subject
to the fact that the total number of members of the Board
including the additional director so appointed does not exceed
the maximum strength fixed for the Board by the Articles of the
company.
(ix) Alternate Director: The Board may appoint an alternate
director if so authorized by its Articles or by a resolution in the
general meeting in place of the original director who remains
out of the State for a period longer than three months. The
alternate director cannot therefore hold office for a period longer
than that permissible to the original director [Sec. 313 of the
Act].
3.2 APPOINTMENT
(I) Managing Director/Whole time Director
(a) General principles: Companies (Amendment) Act, 1988
has rewritten the whole of Sec. 269 concerning the appointment
of these officials. According to Sec. 269(1), every public
company, or private company subsidiary to a public company,
having a paid-up share capital of such sum as may be prescribed,
shall have a managing director or a whole time director or a
manager. No such appointment shall be made so without the
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approval of the Central Government unless such appointments
are made in accordance with the conditions specified in Schedule
XIII. Schedule XIII, Part I relates to some additional
qualifications which shall be explained afterwards. Part II relates
to remuneration. Part III relates to provisions applicable to Part
I and Part II.
(b) Qualification: There is no positive qualification prescribed
in the Act. In Schedule XIII of course, the following positive
qualifications are included; (1) He has to be one resident-in-
India or one who is in India for not less than twelve months
immediately preceeding the date of appointment and who has
come to stay in India for taking up employment or carrying on
business or profession in India; (2) He must have completed
the age of twenty five but not attained the age of seventy or the
age of retirement a specified by the company; and (3) If a
managerial person in more than one company, he has to opt for
drawing remuneration from only one company.
Sec. 267 provided for three negative qualifications. A person
so appointed (1) cannot be an undischarged insolvent; or (2)
he must not have suspended payment to creditors or made any
time any composition with them; and (3) must not have been
convicted by a court of an offence involving moral turpitude.
Part I of Schedule XIII included two more negative
qualifications: (1) he must not have been imprisoned or fined
in a sum exceeding one thousand for an offence under any of
the fifteen economic legislations including the Stamp Act,
Foreign Trade Act, Essential Commodities Act, Income Tax Act,
and Wealth tax Act; and (2) must not have been detained under
COFEPOSA. Sec. 316 provides for another negative
qualification. Accordingly a person who is managing director
or manager of any other company cannot be appointed as such
in any public limited company or in a private limited company
subsidiary to a public limited company. If such a person is
required to be appointed, the Board must take a resolution with
the consent of all the directors present in the meeting and this
meeting requires a special notice to be convened. If a person is
appointed in more than two companies as managing director or
manager before the commencement of the Act, he has to opt for
only two. The Central Government may permit any person to
be so appointed in more than two companies provided it is
satisfied that it is necessary for the proper working and
functioning of the companies as a single unit. The basic
philosophy behind these provisions is that the top executive of
any company must be a professional though in letter such a
qualification is not stipulated. The emphasis is given on the
whole time need of the company for the managerial leadership.
It is also emphasized that the corporate managerial service has
to attach individual responsibility and accountability unlike the
managing agency system. The managing agents existed prior
to 1970 were not employees of the company, nor were they
personally accountable. Besides there were no restrictions on
the number of assignments, term of office as well. There were
no prescriptions on qualifications and terms for the managing
agent.
The general qualification prescribed for a director is also
applicable to the managing director because he is a director
first. According to Sec. 253 no body corporate, association or
a firm can be appointed as the director of a company. So, these
bodies cannot be appointed as managing director or manager as
well.
(c) Who can appoint: A managing director is firstly a director.
He is appointed as a director in the shareholders meeting. The
Companies Act does not include any particular method of
appointment of a managing director excepting as mentioned in
Sec. 316(2). It is statutorily provided that a managing director
is to be appointed by the Board. In a given situation if a person
who is already a managing director of another company, he can
be appointed by the Board with consent of all directors present.
The Act otherwise empowered the board to be entitled to exercise
all such powers, and to do all such acts and things as the company
is authorized to do. The board is therefore empowered to appoint
one of the directors as the managing director. If the board thinks
that a professional/technical man is to be appointed as the
managing director, he is first required to be appointed as an
additional director under Sec. 260 or as a director in the general
meeting under Sec. 255 and then appointed/employed by the
board as the managing director. Irrespective of the terms of
appointment as the managing director, as soon as the person
ceases to be director he also ceases to be the managing director.
According to letter No. 8/212(60) dated 17th March, 1977
written by the Department of Company Affairs [Ramaiya, 635]
to the Institute of Company Secretaries and Administrators of
India Association, Calcutta, if such a person while he was
additional director of a company has been appointed as the
managing director, the latter appointment also ceases
simultaneously with the cessor of the directorship at the
commencement of the AGM. However, if such a person is re-
elected as a full-fledged director at the AGM, he continues as a
director of the company, and he shall continue as a managing
director also for the period for which he is so elected by the
AGM and for the period for which his appointment has been
approved by the Central Government under Sec. 269".
Directors are representatives of the shareholders and as such,
are required to be elected in the AGM (excepting nominated,
and additional directors). But a managing director is an
appointed employee of the company and, therefore, he is required
to be appointed by the Board unless the Articles of Association
provide otherwise
(II) Directors
a] General principles: According to Sec. 252, a public
company should have a minimum of three directors and a private
company (which is not a subsidiary of a public company) should
have a minimum of two directors. The Articles of a company
may prescribe a different minimum but this cannot be less than
three the statutory minimum, i.e., the Articles of a public
company may prescribe that the minimum number of directors
should be five, but in no case can they prescribe that the
minimum, number of directors of a public company will be two.
Further, only natural persons can be appointed as directors, i.e.,
corporate bodies, associations, firms etc., cannot be appointed
as director of the company, though such bodies may be the
members of a company.
Generally, the subscribers to the memorandum become the first
or initial directors of a company, till the election of regular
directors under Sec. 255E [s. 254]. But, this provision can be
negated, by some specific provision in the Articles of a company,
i.e., the Articles may make some provision for the appointment
of the first directors by naming certain specific persons.
A public company usually has two kinds of directors - whole
time directors and directors who are liable to retire by rotation.
According to Sec. 255, a minimum of two-thirds of the total
number of directors are to retire annually by rotation. This
retirement and subsequent election to fill up the vacancies takes
place in the AGM of the company. The other directors of the
company are also appointed in the general meeting.
The basic objective of this section seems to be to give the owners
of the capital (i.e., the shareholders) a real and substantial say
in the appointment of the management of the company, since in
the appointment of the first directors they usually do not have
any say. The first directors do not automatically become eligible
for reappointment, though they have to retire en masse in the
first AGM of the company. Sec. 255 does not apply to companies
whose Articles provide for the retirement of all directors of more
than two-third of them retiring. It only provides for a statutory
minimum which can be increased by the Articles.
When 2/3rd of the directors are required to retire by rotation,
the remaining 1/3rd may be required to retire or may be
permanent. The identity of this 1/3rd of the directors may either
be specified by their names [ex. Mr. X and Mr. Y shall be whole-
time director......] or by designation [ex.The Chairman shall be
whole-time director.......]. Where no specific provision has been
made in the Articles regarding this 1/3rd of the directors, they
are presumed to be non-retiring or permanent.
Sec. 255 does not apply to a Government Company, i.e., a
company whose entire share capital is held by the Central or
some State Government(s) or both, and to private companies.
The directors who retire by rotation are the senior most in the
company, but if two directors join service on the same day then
a lot is drawn as between these two to decide on the name of the
person required to retire by rotation.
The vacancy created by such retirement is as far as possible
filled up in the same meeting, by electing new directors or re-
electing the retiring directors. Each director seeking
appointment shall be voted for individually i.e., there is no
collective voting for appointment of directors i.e., if X & Y are
to be appointed as directors then, each will have to be appointed
by voting on separate motions, ex. that X be appointed as a
director and that Y be appointed as a director. A common motion
in the form of that X & Y be appointed as directors will be
invalid. Voting is in the first instance by a show of hands, and
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a poll is taken only if requested by the some member or the
Chairman feels it necessary to take a poll.
If for some reason, a director is not appointed in the meeting,
the meeting is adjourned, to be reconvened on the same day and
time a week later. If even in the adjourned meeting an
appointment is not made, nor is a resolution passed that the
vacancy caused by the retiring director shall not be filled up,
then, according to Sec. 256(4)(b), it will be presumed that the
retiring director has been reappointed, unless -
(i) such retiring director had sought to be re-elected but lost
the election in the reconvened meeting or prior meeting; or
(ii) the retiring director has given in writing that he is unwilling
to act as a director; or
(iii) he is either not qualified or has been disqualified form acting
as a director; or
(iv) a resolution either ordinary or special is required for his
appointment or reappointment, by virtue of some provision
under the Act; or
(v) the proviso to Sec. 263(2), stating that no provision for the
automatic reappointment of the retiring director in default
of another appointment shall apply, applies to his case.
A person cannot be appointed as a director unless he expresses
his willingness to act as such in writing and submits it to the
Registrar. Further, if the Articles provide for a director to have
a prescribed number of qualification shares before being
appointed as a director, a person not possessing such shares
cannot be appointed. In other cases, a director can become
disqualified from acting as such if he fails to acquire the requisite
shares within the prescribed time limit.
Sec. 265 provides that, a company through its Articles may
provide for the appointment of 2/3rd of its total number of
directors according to the principle of proportional
representation either through means of single transferable vote,
cumulative voting or otherwise. The appointments in such cases
are made once in three years and, if any vacancy occurs in
between, it can be filled byfollowing the procedure u/Sec. 262.
The basic requirement of this section is that the shareholders
are given a proportional representation, whatever the method
of voting be. Hence, directors cannot be chosen for certain
qualifications, like regional, ethnic, biological, economic
background, by giving a wide interpretation to the phrase 'or
otherwise' in the section. This phrase has to be read ejusdem
generis with the phrases single transferable vote or cumulative
voting, and cannot be interpreted to suit the needs of the
situation.
Single transferable vote: Here, the names of all candidates
contesting the election are noted on the ballot paper, with each
person having one vote only. The member has to indicate his
choice in order of preference, with the person he prefers most
ranking first till he has covered all the candidates. The election
of a candidate is based on a certain number of votes known as
quota being received by the candidate. The quota is arrived at
by dividing the total number of votes polled by number of
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candidates to be elected plus one and then adding one to the
result so arrived at. Thus, any candidate who gets votes equal
to the quota is elected. Surplus votes received by him are then
transferred to the other candidates.
Cumulative voting: In this, the total number of votes cast would
equal the total number of shares multiplied by the total number
of directors to be elected. Thus if there are 500 shares and 10
directors to be elected, the total number of votes cast would be
500 X 10) 5000. A candidate getting 500 votes would be
declared elected. Suppose, the minority faction holds 10%
shares i.e. 50 shares, total votes cast by the minority would be
50 X 10 = 500, i.e., their representative gets elected if all of
them vote in his favour alone. This method of
proportional representation though highly democratic is capable
of being abused by the 1/3rd faction of directors who are not
subjected to this voting because they may see to it that atleast 1/
3 of the remaining 2/3rd chosen by proportional representation
are also their representatives, i.e., in effect they have the entire
board in their control with 2/3rd majority (1/3 + 1/3) and can
run the company according to their own whims and fancies.
(B) Qualifications of Directors
The Companies Act has provided three types of regulations of
the qualifications of directors, viz.,
(1) Share qualification
(2) Disqualification
(3) Restrictions on appointment of directors
(1) Share qualification: The qualification for a director is
prescribed in the Articles of Association. Article 66 of Table
A, Sch. I, for example, provides for a share qualification for a
director. According to Sec. 270 every director has to hold a
qualification share as mentioned in the Articles of the company
or, in case he does not already hold it, he must acquire it within
2 months of his appointment as a director. Sec. 270(4) stipulates
that holder of a share warrant shall not be deemed to be the
holder of the shares specified in the warrant. Qualification shares
as prescribed by the Articles of Association cannot exceed a
nominal value of Rs.5000/- taken together; where the nominal
value of a single share exceeds Rs.5000/- the Articles cannot
prescribe the holding of more than one qualification share as
the basic requirement to qualify as director. The Articles cannot
also stipulate that a director must possess the qualification share
before his appointment or within a shorter time than 2 months
of his appointment. Such a provision shall be treated as void u/
S270(2). If a person does not hold the prescribed qualification
share even after the expiry of the said 2 months period, he shall
be punishable with a fine to the extent of Rs.50/- per day from
the day of expiry of time [Sec. 272]. The resolution of the board
of directors shall not be vitiated merely by participation of a
director whose appointment has become invalid due to the
absence of his qualification shares [Sec. 290]. But a director
acting singularly under some power delegated to him and
continuing as such even after the defect/disqualification is
pointed out shall compensate the company in an action for
damages (if any). Only individuals can hold the office of
directors, i.e., a body corporate or firm can not be appointed as
a director.
(2) Disqualifications: No person can be appointed as a director
if (i) he is found to be of unsound mind by a court of competant
jurisdiction and continues to be of unsound mind; (ii) he is an
undischarged insolvent; (iii) he has applied to be adjudicated
as an insolvent and his application is pending; (iv) he has been
convicted by a court of an offence involving moral turpitude
and has been sentenced to imprisonment for a period not less
than 6 months and five years period has not elapsed from the
date of expiry of the sentence; (v) the court has passed an order
disqualifying a person from being appointed as a director under
Sec. 203; or (vi) he has not paid the call amount within 6 months
from the day fixed for payment of that amount. A hold office at the pleasure of the institutions nominating
private limited company which is not a subsidiary of a public
company may by its Articles prescribe any other disqualification
[Sec. 274].
(3) Restrictions on appointment of directors - According to
Sec. 275 no one can hold the office of director in more than 20
public companies simultaneously. If a person who is a director
in 20 companies already accepts appointment as director in
another company, the new appointment shall not take effect
unless he effectively vacates his office of director in some other
company with in 15 days, and on his failure to do so, at the
expiry of such 15 days the new appointment shall become void
[Sec. 277]. Of course such a director can hold the office of
director in private or unlimited companies or Sec. 25 companies
i.e., those not engaged in carrying on business for earning of
profites, without attracting this provision. He may also hold the
position of alternate director in excess of 20 companies.
No person can be appointed as a director or a proposed director
through Articles or Prospectus unless by himself or by his
authorized agent he gives his consent in writing, and the same is
filed with the Registrar and either - (i) signed the memorandum
for shares not being less in number to the qualification shares
prescrbed or paid their value; or (ii) taken the qualification shares
or has agreed to take; or (iii) signs and files with the Registrar
an undertaking to take the qualifcation shares and pay for them.
or (iv) filed with the Registrar an affidavit that the qualification
shares are registered in his name (Sec. 266). These restrictions
are not applicable in the case of a private company or a company
not having a share capital or where a prospectus has been issued
by the comapny after the expiry of 1 year from the date on which
the company was entitled to commence business.
(c) Who can appoint the directors
(i) The members of the first Board of directors are usually
appointed by Articles of Association or by the Prospectus.
In the absence of the same, the signatories of the
Memorandum become the members of the first Board of
Directors [see Sec. 255].
(ii) Unless the Articles provide that all directors shall retire in
every AGM, not less than two third must retire in every
AGM they are known as Directors by rotation. The
directors shall retire by rotation on the basis of seniority
i.e., on the basis of date of appointment. In case two
directors are appointed on the same day and one is required
to retire, the selection shall be made either on the basis of
agreement or by lot. These directors are elected in the AGM
by the shareholders. The retiring directors may be
reappinted. So in course of time at least two-third of the
members of the Board will be appointed by the shareholders.
(Sec 255-256).
(iii) Non-retiring members of the Board are nominated members
of the institutional investors or the central government. They
are also qualified to be appointed to the seats of the retiring
members to be elected by shareholders. Ofcourse, the non-
retiring members do not retire in the ordinary way. They
them.
(iv) Casual vacancies may be filled by the Board of Directors
subject to regulations in the Articles (Sec 262) such a
director appointed in normal vacancy shall hold office
during the unexpired part of the original director in whose
place he is appointed. Additional directors are also
appointed by the Board of Directors subject to the
regulations in the Articles, who shall remain in office until
the next AGM (S. 260).
(III) Appointment of Manager
Under Sec. 2(24), a manager is a person who has been entrusted
with the whole or substantially the whole of the affairs of
the company and who works under the supervision and
control of the Board of Directors. Under S.3 the Act, a
company may have only one manager, though it may have
more than one managing or whole time director. The reason
for this restriction is that, an MD is entrusted only with a
substantial powers of management, whereas a manager is
entrusted with the management of whole or substantially
the whole or the affairs of the company. It logically ensues
that, two or more persons cannot be entrusted with whole/
substantially the whole affairs of the company, because then
the affairs entrusted to each one of them would neither be
the whole nor substantially the whole of the company's
affairs.
Sections 384-386 relate to the appointment of a manager and
are mostly by way of being negative conditions, i.e., they
basically specify as to who cannot be a manager rather than
who can be appointed as a manager. A person may be appointed
as a manager if:
(1) he is an individual, and not a firm etc.;
(2) he is neither an undischarged insolvent nor has been within
the preceding 5 years ever been adjudicated an insolvent;
(3) he has not suspended payment to his creditors nor has he at
any time in the preceding 5 years suspended such payment
or arrived at a composition with his creditors;
(4) he has not been convicted of any offence involving moral
turpitude in the preceding 5 years period; and
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(5) he is not employed as a manager or the MD of any other
company unless a unanimous resolution of his appointment
is passed by all the directors present in the board meeting,
a notice of which along with the intended resolution has
been circulated amongst all the directors present in India.
A peculiar provision relating to appointment of a manager is
the special powers given to the Central Government, viz.:
Sec. 385(2) The Central Government may, by notification in
the official Gazette, remove the disqualifications incurred by a
person in items 2,3, and 4 above.
Similar to the power of the Central Government to appoint a
MD for more than 2 companies, is the power of the Central
Government to appoint managers for more than 2 companies u/
Sec. 386(4), provided that the Central Government is of the
opinion that such companies would work better as an integrated
unit under the managership of one person.
3.3 RETIREMENT
The Companies Act speaks about 2 types of retirement, as well
as vacation of the office on specific grounds. The two types of
retirement are : (1) retirement by rotation, with a right to re-
election and (2) permanent retirement. Sections 280-282 dealing
with retiring age of directors were omitted by the Companies
Amendment Act, 1965 on the logic that the age of retirement
should be left to the institution concerned. So age of retirement
may now be regulated by internal rules vide the Articles. In so
far as the general principles are concerned, the Amendment Act
dispensed with the regulatory stipulation. Presently atleast two-
thirds of the members of the board of directors are required to
be filled up by directors retiring by rotation. At every annual
general meeting of the company atleast one-third of the members
or nearest to one-third shall retire from office on the basis of
seniority i.e. the date of appointment. In case two directors
were appointed on the same day the retirement is to be
determined either by agreement or by lot. The retiring director
may be re-appointed. If the place of the retiring director is not
filled up and the meeting has resolved expressly not to fill up
the vacancy, the meeting shall stand adjourned till the same day
next week, at same time and place. If the adjourned day is a
public holiday, then to the next day. If in the reconvened meeting
also the position can not be filled up and there is no specific
resolution for not filling the vacancy the retiring director is
deemed to be re-elected, unless the reappointment has been put
to vote and lost or the retiring director expresses his
unwillingness to be re-appointed or he is disqualified or a specific
resolution required for the purpose under the Act could not be
passed.
The other type of retirement is by vacation of office in any one
of the following cases, viz:
i) not fulfilling the conditions u/Sec.270 (i.e. failure to acquire
qualification shares); or
ii) becoming disqualified u/Sec.274 (for example, due to
unsoundness of mind, insolvency, etc.); or
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iii) violating the provision of Sec.295 (i.e. extending loans to
directors in contravention); or
iv) acting in contravention of Sec.299 (i.e. the director not
disclosing his interest when asked for); or
v) becoming disqualified u/Sec.203 (i.e. on account of being
convicted of an offence as mentioned); and
vi) removal from office u/Sec.284
In all the above cases as laid down in Sec.283 the position
becomes vacant by compulsion and of law not retirement. One
should not therefore confuse between retirement and vacation.
3.4 REMOVAL
Removal of a Director
The general principle that the authority which appoints also has
the right to remove also holds good in the case of appointment
& removal of directors. Sec. 284 gives the general body of
shareholders the right to remove any director by passing an
ordinary resolution, unless the said director is one who has been
appointed by the Central Government u/Sec. 408. This section
also does not allow the removal of a director holding office fir
life in a private company, nor does it apply to a public company
which has adopted the mode of appointing 2/3rd of its director
by means of proportional representation.
The ordinary resolution to remove a director needs a special
notice, which has to be given to the concerned director also, so
that he gets an opportunity to prepare a reply to that resolution,
and speak to the shareholders at the meeting. In Escorts Ltd v.
Union of India [(1985) 57 Comp Cas 241 (Bom)], it was held
that, a director’s right of representation would be a mere
formality if the director does not know the grounds on which he
is sought to be removed, because he will not then know as to
what representation he should make. So, the notice of the
meeting must be accompanied with a copy of the resolution
alongwith an explanatory statement, so that, the remaining body
of shareholders also come to know of the reasons as to why a
director elected by them is being sought to be removed before
completion of his term. Further, the power of removal must be
exercised by the shareholders in good faith, in the bona fide
interest of the company and not for any other reason.
On appeal [LIC v. Escorts Ltd, (1986) 59 Comp Cas 548 (SC)],
the Supreme Court observed that there was no necessity for a
statement of reasons to support a resolution for removal of a
director. In this case, the major concern of the supreme Court
was to see that, a minority group of shareholders in power could
not thwart the decision of majority shareholders to remove the
directors from the Board, and whether a meeting of shareholders
convened for this purpose should be restrained merely on
grounds that sufficient reasons did not support the resolution
for removal. Hence this decision cannot be taken as conclusive
on the issue whether a statement of reasons should support a
resolution of removal or not.
Exceptions: Though in general directors can be removed by
the shareholders, there are certain directors who cannot be
removed by them. A director who is not appointed by the
shareholders cannot be removed by them. thus, a director who
has been appointed as a representative of the Central Government
or the financial institutions cannot be removed by the
shareholders, though such a director can be removed by his
appointing authority. Thus, the Central Government can make
a reference to the CLB for removal of a director appointed by
it, and, if the CLB disposed of the reference in its favour, can
remove the director under Sec. 388E. Similarly, the court can
remove a director under Sec. 402 even if he has been appointed
by the shareholders, in order to prevent oppression and
mismanagement. Section 284 itself contains three exceptions
to the general rule that shareholders can remove a director by
passing an ordinary resolution, viz.:
(i) directors appointed by the Central Government u/Sec. 408
(ii) directors holding office for life as on 1.4.1952 in a private
company; and
(iii) directors appointed by a system of proportional
representation under Sec. 265.
The mode of removal envisaged under Sec. 284 is in addition to
any other special method of removal specified in the Articles of
the company. thus, in Shindler v. North Raincoat Co Ltd
[(1960) 2 All ER 269], the Articles of the company provided
for the removal of a director by the chairman of the company.
A director on being so removed challenged the validity of this
provision in the Articles. It was held that, a director who accepts
appointment subject to such a provision in the Articles cannot
subsequently complain. But, a director is not bound by such a
provision if it is introduced subsequent to his appointment, by
an amendment of the existing Articles.
Private Company: Section 284 applies to both private as well
as public companies. A private company can have two kinds of
directors, directors for life and ordinary directors. Now under
Sec. 284, even director for life can be removed unless he was
holding office as such on or before 1.4.1952. But, a director for
life can successfully thwart any attempt at his removal, by
introducing a clause in the Articles giving ‘weighted votes’ to
that director who is being remove. Thus, in Bushell v. Faith
[(1970) 1 All ER 53], a small private company consisted of
three persons C, K and G each having 100 shares of 1 pound
each. C and G were directors. Clause 9 of the company’s
Articles provided that, ‘when it was proposed to remove a
director he would on a poll, have the right to three votes per
share. C and K, being dissatisfied with G as a director proposed
to remove him. G demanded a poll, where he was entitled to
cast 3 votes for every 1 vote of C and K. Thus G polled 300
votes on his hundred shares against the 200 votes against him,
on the 200 shares held by C and K. G thus defeated the motion
for his removal. C and K challenged the validity of such a poll.
The trial court held that, a clause which gave a shareholder
treble voting power was invalid as it would make a “mokery”
of Sec. 184. On appeal, a majority of the House of Lords
reversed this decision. Lord Donoval observed, the Parliament,
being fully aware of the phenomenon of Articles of association
carrying “weighted votes” had made no provision against it
and had left it to the companies and their shareholders liberty to
allocate voting rights as they pleased. Though this decision has
been widely criticized, it is not without its merits. A private
company is more in a nature of partnership firm and is needed
to be treated differently. In the words of R. C. Beuthin, “in this
particular field it may be highly desirable that ‘partners’ should
be safeguarded in directorships, whether by means of special
voting rights or by means of shareholder’s voting agreements”
[Beuthin, (1969) SALJ 489].
Removal of a Managing Director/Whole time Director
There is nothing in the Act specifically which relates to the
removal of a MD. But since a MD is also a director, the
provisions applicable to the removal of a director would also
apply to the removal of a MD, unless there is some specific
provisions made in the Articles in this regard. Sec. 318(3) also
makes an indirect reference to the grounds on which a MD can
be removed from his office without the company becoming liable
for compensation. These grounds are as follows:
(a) where he has been guilty of fraud or breach of trust;
(b) he has been guilty of gross negligence or gross
mismanagement some additional ground on which he may
be removed are provided in Sec. 274 providing for
disqualification of directors viz:
(i) he has been found to be of unsound mind by a Court of
Competent jurisdiction;
(ii) he is an undischarged insolvent; and
(ii) he has applied to be adjudicated as an insolvent and his
application is in force.
The mere fact of removal of MD from his office does not operate
as removal from the office of director also unless otherwise
specified, i.e., a person may cease to be MD but may still act as
a director, unless the grounds on which he has been removed
from his managing directorship also disqualify him from acting
as a director.
Removal of a Manager
Once again nothing is specifically mentioned in the Act relating
to the removal of managers. Since a manager works under the
supervision and control of the Board and as his appointment is
by the Board it is to be presumed that the power of his removal
is given to the Board, though the exact procedure may be
specified in the Articles of the company. An important point to
be noted is that the manager of a company need not be a director
of the company (unless so specified in the Articles). Hence, in
cases where a director acts as a manager also, the mere fact that
he has vacated office as a director will not prevent him from
acting as a manager, unless the grounds of his removal as a
director also disqualify him from acting as a manager.
3.5 REMUNERATION
The rigid rule on managerial remuneration is not going a out of
fashion. In normal situations the fixation of remuneration to
management personnel is left in the hands of the company. But
here too, the old philosophy of the governmental regulation is
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still continuing though the stringency is gradually in the way
out. Managerial remuneration is discussed under three sub-
headings, viz., (a) managerial remuneration (b) remuneration
to directors and (c) remuneration to managing director and
manager.
(a) Managerial remuneration
Sec. 198 which provides the basic rule on fixation and
payment of managerial remuneration stands as follows after the
Amendment in 1988.
(a) Total managerial remuneration payable by a public limited
company or a private limited company subsidiary to a public
limited company cannot exceed 11% of the net profit for
the respective financial year computed on the norms laid
down in ss. 349-351. Remuneration to Directors shall not
be deducted form the gross profit for this purpose [Sec.
198(1)].
(b) The above percentage shall not include fees payable to the
Directors [Sec. 198(2)].
(c) Subject to the above limitation of 11% of the net profit, a
company may pay a monthly remuneration to its managing
or whole time director as stipulated in Sec. 309 or its
manager on stipulated in Sec.387.
(d) If the company does not have net profit, or inadequate net
profit, it can not pay any managerial remuneration
(excepting fees to the directors) to its directors, managing
director, whole time director or manager except with prior
approval of the Central Government.
Let us first understand what is and what is not included in the
managerial remuneration. According to Sec. 198 if managerial
remuneration includes:-
(i) remuneration payable to directors including managing
director, and whole time (executive) directors;
(ii) remuneration payable to manager.
It also includes perquisites like rent free accommodation or any
other benefit or amenity free of charge or at concessional rate
and expenditure incurred by the company to effect any insurance
on life or for gratuity or pension or for any other service which,
but not for the company paying, would have to be paid by the
above listed officials.
While ceiling to managerial remuneration is related to the net
profit, the concept of net profit remained as only a common
accounting practice. Of course ss. 349-351 and Schedule VI
provided for methods for calculating the net profit. According
to Sec. 349, in computing the net profit, credit is to be given to
subsidies given by the government but not for capital profit due
to share premium, share forfeiture, or selling of assets. From
the gross profit thus ascertained, deduction has to be made for
(a) usual working charges (b) bonus and commission to workers,
(c) Central taxes (d) corporate tax, (e) interest on loans and
debentures (f) depreciation as stipulated in Sec. 350 and
Schedule XIV, (g) insurance premium and (h) compensation
and damages paid.
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Ceiling of managerial remuneration: According to the
Amendment Act, 1988 if appointments of managing director,
whole time director and manager are made as per the provision
laid down in Part I of the Schedule XIII and the remuneration is
paid to them as per Part II, there is no necessity for prior approval
to be taken from the Central Government. If, however,
(i) the company in a financial year has no profit, or its profits
are in- adequate, the company cannot pay any remuneration
to its management (exclusive of fees payable to directors)
without prior approval of the Central Government. This
relates to the minimum level of remuneration in the absence
of adequate net profit; [Sec. 198(4)];
(ii) The company intends to pay remuneration to the managing
director or whole time director exceeding five percent of
the net profit where there is one such director, or ten percent
where there are more than one such directors, prior
permission from the central Government must be obtained
[Sec. 309].
(iii) the company increases the managerial remuneration which
exceeds the provision in Schedule XIII prior approval is
necessary to be taken from the Central Government [Secs.
310-311].
Whereas Sec. 198 provides for maximum remuneration. Part
II of Schedule XIII provides for details in the maximum as well
as minimum managerial remuneration. Schedule XIII has to be
read in addition to Sec. 309. According to Sec. 309 and Schedule
XIII
(i) a director who is neither a whole time nor a managing
director may be paid remuneration either by way of
periodical such as monthly remuneration or by way of
commission on the basis of specified percentage of the net
profit provided that such remuneration to such director, or
where there are more than one such directors, all taken
together remuneration not exceeding (i) one percent of the
net profit if the company has managing director or whole
time director or manager or (ii) three percent if it does not
have a managing director, or a whole time director or a
manager [Sec. 310(4)];
(ii) A managing director or a whole time director may be paid
remuneration in monthly payments or at a specified
percentage of net profits or provided the ceiling for one is 5
percent, and for more than one 10 percent [Sec. 309(3) and
Section I of Part II of Schedule XIII];
(iii) If a company does not have net profit or adequate net profit,
it may pay remuneration to a managerial person by way of
salary and prerequisites not exceeding a ceiling limit of
Rs.10,50,000/ a year or Rs.87,500/ a month calculated thus:
Where the capital of the company Monthly ceiling
i) less than rupees one crore Rs. 40,000/-
ii) Rs. one crore to five crores Rs. 57,000/-
iii) Rs. five crores to fifteen crores Rs. 72,000/-
iv) Rs. more than fifteen crores Rs. 87,500/-
b) Remuneration to Directors
According to Sec. 309 remuneration to directors is determined
either by Articles of association or by a resolution or, if the
Articles so provides, by a special resolution. A director may
receive remuneration by way of a fee for each meeting of the
Board and the committee thereof. The previous practice of
paying fees on monthly basis was dispensed with by the
Amendment Act of 1960. But by the Amendment Act of 1965
the same was reintroduced subject to the approval of the Central
government. Directors remuneration includes:
(i) remuneration received in any other capacity excepting in
professional capacity; and
(ii) monthly, quarterly or annual payment with the approval of
the Central Government; and/or
(iii) Commission on the basis of percentage on net profit.
A director, or all of them taken together if there are more than
one, shall receive not exceeding one percent of the net profit, if
the company has a managing director or whole time director.
But if the company does not have a managing director or whole
time director the remuneration can go up to three percent. The
company in the general meeting may, with the approval of the
Central Government, authorize the payment of a higher rate. If
the directors receive remuneration higher than the prescribed
limits without the prior approval of the Central Government,
that excess amount shall have to be refunded or be held in trust
for the company. The company does not have the right of waiver
of the recovery of such sum. A private limited company which
is not a subsidiary to a public limited company is, however, free
to provide any remuneration to the members of the board.
c) Remuneration to Manager
Subject to the provision of Sec. 198 regarding the overall ceiling
on managerial remuneration, the manager of a company may
receive either by a monthly payment or by way of specified
percentage of the net profits or partly by one way and partly by
the other, one percent of the net profits unless the Central
Government proposes a higher percentage of remuneration.
According to Rule 20A the Secretary has to submit an application
to the Central Government with form 25A filled in [Sec. 387].
Conclusion
The managerial remuneration of a company is therefore
dependent upon the type of the management that the company
has, and the provisions can be summarized as follows:
1. Company managed by its board of directors: 3% of the
net profits is the ceiling unless on a resolution passed by a
general meeting, the Central government permits a higher
rate percent. In case of the company not making adequate
profits, or incurring loss, directors are entitled only to the
fees for attending meetings of the board and of the
committee thereof [Sec. 309(2)]. Any remuneration
exceeding that amount shall require approval of the Central
Government.
2. If the company is managed by the board of directors
including a managing director or a whole time director, the
directors remuneration is limited to 1% of the net profit or
to the fees for attending meetings in the event of absence of
adequate profits, and the managing director or the whole
time director is entitled up to 5% of the net profit, or in the
absence of adequate profit, the amount stipulated as per the
scale specified in Section II of Part II of Schedule 13.
3. If the company is managed by a board of directors including
more than one managing director and/or whole time
directors, the members of the board are entitled up to 1%
of the profit or, in the absence of adequate profit each of
them entitled up to the specified sum as mentioned in Section
II of Part II of Schedule 13.
4. If the company is managed by a board of directors in
addition to a manager the members of the board are entitled
up to 3% of the net profits and the manager up to 5% of the
net profits. In absence of net profits, of course, the directors
are entitled to fees and the manager is entitled to the scale
amount as is specified in Schedule 13.
5. If the management of the company is in the hands of a board
of directors with one or more managing directors and/or
whole time director and also the manger the directors are
entitled to 1%, the manager is entitled up to 5% and the
managing director and/or whole time director up to 5% of
the net profit . In case of the absence of adequate profit the
above principle of scale of remuneration is applicable to all
managing directors, whole time directors and the manager,
where as the directors are only entitled to sitting fees.
3.6 COMPENSATION FOR LOSS OF OFFICE
In some cases a managing director or a whole time director or a
director holding the office of a manager may be required to
surrender the office not on account of winding but for any other
reason, before the term of the office is completed. According
to Sec. 318 in such cases such a person is entitled to
compensation for loss of office, or consideration for retirement
from office. This payment shall not exceed the remuneration
which the concerned person could have earned for the unexpired
portion of his term, or for three years, which ever is shorter.
The calculation is to be made on the basis of average
remuneration actually earned during the previous three years or
for the period for which he was engaged to the office if the
period was less than three years [Sec. 318(4)]. Of course if the
company is in the winding up within twelve months after the
date on which he ceased to hold the office, he is not entitled to
any compensation unless the shareholders are completely paid
off.
In the following circumstances no such compensation is
payable:-
1. Where the director resigning on account of reconstruction
or amalgamation, and has become the managing director
the manager or other officer in the reconstructed company;
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2. Where the office has been vacated by the director on account
of a fraud perpetrated by him and he has been found guilty
u/s 203 of the Companies Act;
3. Where the company is being wound up provided the
winding up was due to the negligence or default of the
director;
4. Where the director was guilty of breach of trust or gross
negligence or gross mismanagement of the conduct of the
officers of the company or its subsidiary or holding
company; and
5. Where the director has instigated or has taken part directly
or indirectly in bringing about the termination of the office.
No director of a company shall receive any payment by way of
compensation for loss of office or as consideration for retirement
from office if it is done in connection with the transfer of the
whole or part of the undertaking or property of the company
[Sec. 319(1)].
Similarly no director of a company shall receive any payment
by way of compensation on account of transfer of all or any of
the shares in a company having on transfer resulting from: (i)
the offer is made to the general body of shareholders; (ii) the
offer is made by a body corporate with a view to making the
company a subsidiary; (iii) an offer is made by an individual
with a view to obtain the control over not less than one third of
the total voting power; or (iv) the offer is conditional on
exceptance given extent. In case he receives any payment it
shall be deemed to have been received by his intrust for any
persons who have sold their shares a result of the offer made
[Sec. 320].
3.7 POWERS
It has already had explained that the company being a sui juris
requires a person in fact to represent it in dishcarging all its
powers and functions. The persons composing the board of
directors are those who exercise various powers both general
and specific for and on behalf of the company. Therefore it is
necessary to understand general powers and specific powers of
the board and the limitations to such powers. All powers of the
company are devided into two groups. Some statutory powers
forming a group are reposed in AGM. All other functional
powers are vested in board of director. These powers are
generally known as general powers of the board. Some times
on account of specific statutory provision or due to certain
stipulations in the memorandum and Articles of association some
special power is required to be discharged by the board.
General Powers of the board
According to Sec. 291 all powers of a company which the
company is authorised and can do are vested in the board of
directors excepting :
(a) powers specifically provided by the Act for the AGM, (b)
power particularly conferred by memorandum and Articles
of association on the company in general meeting; (c)
powers specifically determined by regulation passed by the
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company to be exercised by the company in the general
meeting.
But in the last power and operation as mentioned above i.e.,
power conferred on the company in the general meeting in view
of any corporate regulation passed by the comapny in general
meeting, shall not invalidate any prior act of the board which
could have been valid if that regulation had not beeen made
[Sec. 231(2)].
All these functional powers of the board can be either directly
performed by the board or can be performed through delegation
of power to the chief executives who would discharge these
functions under the supervision and control of the board.
According to the recommendation of company law committee
some of these powers are non-delegative. According to Sec.
292 the baord of directors of the company shall exercise the
following powers by means of resolutions passed in the meetings
of the board. These functions are:
(a) power to make calls;
(b) power to issue debentures;
(c) power to borrow money;
(d) power to invest funds; and
(e) power to give loans.
But according to the Amendment Act, 1960 the company may
delegate by specific resolution in the board meeting power
mentioned in (c), (d) and (e) to the cheif executive, on such
term and conditions as may be determined by the board. The
resolution has to specify the total amount which may be borrowed
by the delegate official or the total amount to which the funds
may be invested by him. The powers are specific powers of the
board.
The powers of the board have been grouped under three heads
in Ramaiya as follows:
1) Powers exercisable at the meetings of the board
Besides the five powers mentioned above in (a) to (e) the
following are other such powers:
a) filing the casual vacancies in the board [Sec. 262];
b) appointing as Managing Director or the Manager a person
who is holding such position in another company [Sec. 316
& 386];
c) consenting to a contract of the company with any director
or his relative or parties [Sec. 297]; and
d) investing in shares or debentures of a company under the
same management.
2) Powers exercisable only with the consent of the company
in general meeting
a) power to sell, lease or otherwise dispose off the whole or
part of the undertaking of the company [Sec. 293(1)(a)];
b) power to remit debt due by a director [Sec. 293(1)(b)];
c) power to borrow in excess of capital and reserves [Sec.
293(1)(d);
d) power to contribute to charities;
e) power to invest compensation amounts received on
acquisition of properties [Sec. 293(1)(c)]; and
f) Power to appoint sole selling agent [Sec. 294(2)].
3) Powers can be exercised by the board of through
delegation:
All other powers are exercisable by the board through the
delegatory process.
Since the general power of functions of the company are vested
in the board courts are reluctant to grant a generic injunction
restraining the directors from exercising their functions. In
Rajapalayam Industrial and Commercial Syndicate Ltd. v.
K.A.Veeraprakasham [(1989) 2 Comp L.J. 236} the judicial
bench set aside the order of a temporary injunction because the
company’s business had thereby become paralysed to the
prejudice of the company and many others.
The general management power vested in the board cannot be
usurped by the shareholders. In Automatic Self-cleaning
Filters Syndicate Company v. Cunningham [(1906) 2 Ch.
34] it was held that the directors cannot be compelled to do a
job by a specific resolution in a general meeting. If the
shareholders are not pleased with the management they may
remove them from the office and appoint others in their place.
In a number of cases, however, it was decided that general
meeting of shareholders may make regulations for the guidance
of directors, but cannot invalidate their prior actions. The
principle has been very aptly stipulated in Scott v. Scott [(1943)
1 All ER 582], that the resolution of the members opposing the
commencing of the action by the directors could be a nullity,
for, the powers vested in the directors they and they alone can
exercise this power. The subject was fully discussed the
Morarka Paint and Warnish Works Pvt. Ltd. v. Morarkko
[(1961) 31 Com. Cas. 301] where the court held that the powers
of the management being vested in the board and in exercise of
these powers the board instituted a case, shareholders had no
right to question the directors decision in this respect.
Shareholders may, of course call a requisitioned meeting for
removing the directors as provided in Section 284 [Escorts Ltd.
v. Union of India (1985) 57 Com. Cas. 241].
If one examines carefully the provision of Section 291 one
understands that the board of directors cannot act beyond the
power as constitutionally provided for the company to discharge
- Such powers are ultra vires to the board as well to the
constitution of the company. The corporate capacity is created
by the state through the process of incorporation to distinctly
empower the body corporate for a specific objective. Therefore
the board of directors cannot exceed that limit. This application
of the principle of ultra vires has already been explained earlier.
Here it is suffice to note that an act ultra vires to the company
and necessarily ultra vites to the board cannot be permitted by
the shareholders even with a special resolution in a general
meeting. But an act which is ultra vires the company cannot be
invalidated only on the ground that the board does not have the
power unless such restriction is imposed upon the board by
virtue of the statutory provision or constitutional provisions in
the company’s basic documents.
Special Powers of the Board
Special powers of the board are those which cannot be discharged
by the board through delegatory process, that is to say, powers
which are exercisable by the board only by means of resolutions
passed in its meetings. Some of the powers are: (a) power to
make calls; (b) power to issue debentures; (c) allotment of shares
and debentures; (d) refusal to register share transfer; (e) issue
of bonus shares; (f) further issue of shares; (g) filling of casual
vacancies on the board; (h) appointing Managing Director or
the Manager; and (i) investing shares and debentures of company
under the same management.
Derivated actions
According to Section 291 the board of directors is empowered
to exercise all powers of the company. It includes the power of
suing for and on behalf of the company. No power is given to
any individual or group of shareholders to represent the company
in any corporate litigation unless the shareholder himself has
his direct interest involved, or in other words, he has a lis. But
sometimes in very special situations where the board of directors
fail to protect the interests of the company the courts have been
authorising a shareholder or some shareholders to sue on behalf
of the company for ascertaining the company’s rights. The relief
is given to the company on the application of the shareholders.
This is known as derivative action. Sometimes shareholders in
general may have grievance against the company which is taken
up by a few. This is known as representative action.
Interestingly you have to note that in derivative action an
individual share holder derives you authority of representing
the company when the actual authorised person i.e., the board
fails to take the action. In Estmenco (Killer House) Ltd. v.
Greater Indian Council [(1982) 1 WLR 2;] (1982) 1 All ER
45] it was held that a derivative action is called as such because
it enforces the rights derived from the company as the corporate
body. In Indian law Central Government is authorised to allow
such proceedings on the ground of oppression and
mismanagement or conduct prejudicial to public interest [See
Sections 399-401]. In Brich v. Sullivan [(1958)1 All ER 56]
the court observed that a person filing a derivative claim has to
show that the company in a given situation has the right to sue
but being indulgent in the matter is unlikely to sue and therefore
he gets a derivative authority to sue.
Derivative actions are counter to the rule Foss v. Harbottle
[(1843) 47 ER 189]. In this famous case two of the shareholders
of the company took legal proceedings against the directors to
compell him to make good the loss sustained by the company
by reason of other fraudulent acts. In this case the court held
that as the act was capable of conformation by the majority the
court would not interfere. Thus it was left to the majority to
complain or condone. The principle is known as the majority
rule in the corporate structure. Derivative action therefore does
not arise in a situation where majority may complain or condone
the act itself. In the following cases however derivative actions
are allowed:
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a) Ultra-Vires acts: Lord Justice Romer observed very aptly
that the shareholders are entitled to have the affairs of a company
conducted in the way laid down by the company’s Constitution
[See, Re H.R.Harmer Ltd. (1959) 1 WLR 62 CA]. So
whenever the company’s functionaries used to ......the functional
limit of the company as laid down in the objective clause of the
memorandum shareholders are given the derivative power to
go to the court to come heavily on the functionaries of the
company for restraining them to carry on ultra-vires activities.
This principles has been explained in detail in a separate module.
b) Acts required to be done by special resolution: The
Companies Act itself stipulates that some of the activities of the
company can be done only by special resolution requiring special
majority. The last do not permit the company to transact such
activities by the company in any other manner. In such a case
any shareholder is allowed to draw the attention of the court by
a derivative action.
c) Fraud-Majority cannot commit fraud on the minority:
The Court cannot allow any managerial powers to be exercised
for perpetuating fraud on minorities. Through a derivative action
any shareholder can take such matter to the Court.
d) Exclusion from management: Majority of directors cannot
arrange the meeting in such a manner that the minority dissenting
directors cannot attend the meeting. If some of the directors
plan to exclude the minority directors from attending the meeting,
any shareholder can take the matter to the Court on derivative
action.
e) Wrongdoers in control: Where illegalities are committed
in the conduct of the company’s business any shareholder shall
have the derivative power to go to the Court [See Prudential
Assurance Co. v. Newman Industries Ltd. (No.2), (1982)
Ch.204].
f) Transfer of control: Where a resolution has been passed in
the company for transfer of controlling shares in a company
which involves complete structural changes of the company, a
shareholder does have a derivate action.
g) Further issue of shares: When the shares are alloted for
improper purpose or not for the bona fide interest of the company,
a member may bring an action to prevent the proposed allotment
[See Needle Industries (India) Ltd. v. Needle Industries
Nowky (India) Holding Ltd. (1981)51 Comp. Cas. 743].
h) Discriminating against a class of shareholders: In Griffith
v. Paget [(1977)5 Ch.D. 894] it was held by the Court that a
shareholder shall have derivative right if a resolution is passed
in the course of winding up to divide the proceeds in such a way
so as to prejudice a class of shareholders with same interest.
i) Improper rejection of vote: Right to vote in any manner is
the inherent right of a shareholder. If the Chairman of a meeting
improperly rejects the vote of a shareholder, he has a right to
have his vote recorded.
In some other situations like, oppression and mismanagement;
appropriation of corporate property by the majority holders;
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breach of duty of good faith and where personal rights of
shareholders are affected, a shareholder shall have the derivative
right to bring an action. But where issues are related to manner
of presentation of accounts, or stipulating the place of the
meeting or application of funds by the directors application of
issue proceeds or making a call, the Court refused to allow
derivative action.
Powers of a Director: A director does not have any power
excepting those which he can enjoy as a shareholder and those
which he has as a member of the Board. As a member of the
board he has a right to attend the meeting; participate freely in
the deliberations; right to vote whenever a voting is made in the
meeting on any issue and right to receive remuneration. He has
also right to receive all reports, explanations and copies of
accounts relevant to take decision in the meeting. But a director
does not have any other managerial power. All powers are vested
in the Board of Directors by virtue of Section 291. That is the
real legal position and the board of directors generally speaking
cannot delegate the power based upon the principle delegatus
non potest delegare. Exception to this rule is permissible
wherever delegation is expressly provided for by the Articles of
association or by the statute. In Nibro Ltd. v. National
Insurance Co. Ltd. [AIR 1991 Del 25] it was held that the
director was only one of a body of directors and alone he has no
power except such as may be delegated to him under the
provisions of Articles of association. In this case a director
instituted a suit on behalf of the company which was held to be
not merely a technical matter. Unless the board has specifically
authorised a director by a resolution he would not be called as
an authorised person. In Ferruceio Sias v. J. Mangaram
Mukhi [(1994) 1 Com. L.J. 345 (Del)] one single director
brought an action against a company to prevent merger
questioning the validity of the decision of board of directors at
the direction of the holding company and ignoring the interests
of the subsidiary company. He was neither authorised by the
board nor under the Articles. The Court refused to interfere in
the business judgement of the directors.
The provision of Section 291 vesting power in the board which
may be exercised according to the view of the majority of the
members of the board reflects that the statutory demand is the
collective wisdom of the board and not individual’s decision.
So unless the Articles otherwise provide the powers of the board
cannot be delegated. Besides it has been already stated that
directors cannot fetter their direction so as to act for the benefit
of a section of the share holders. So they cannot place any
restriction on their power by a contract.
If Articles of association has the provision of delegation and a
director or committee of directors acts on behalf of the company
then outsider may presume that the delegation has been properly
made. In Royal British Bank v. Turquand [(1856) 6 ENB
327] it was held that a person dealing with a company through
the medium of some persons managing its affairs is not effected
by internal irregularities. This is generally known as doctrine
of ‘indoor management'. The principle is applicable where the
constitutional documents permit the delegation and speak about
a formality of delegation. An outsider is not effected by the
absence of the formality became he may presume that a right of
representation is vested in the person as per the regulations stated
in the Articles. But if the Articles do not provide for any
delegation of authority by the board no one can presume the
authority of the director.
3.8 DUTIES
“The fact that the directors are fiduciaries imposes on them: (1)
Subjective duties of honesty and good faith, and (2) Objective
duties not to place themselves in a position where their duties
might conflict with their private interests. Each of these can be
subdivided resulting in four general principles: First directors
must act bona fide i.e., in what they believe to be in the best
interest of the company. Secondly they must exercise their
powers for the particular purpose for which they were conferred
and not for some extraneous purpose even though they honestly
believe that to be in the best interests of the company. Thirdly,
they must not fetter their discretion to exercise their powers
from time to time in accordance with the foregoing rules; and
Fourthly, despite compliance with the foregoing rules, they must
not, without the consent of the company place themselves in a
position in which there is a conflict between their duties and
their personal interests” [Gower, pp. 576-77].
This is perhaps the most apt summary of the duties of the
directors. The duties of the director varies according to the
nature and size of the company and have to be ascertained as
per the facts of each case. Justice Romer in City Equitable
Fire Insurance Company [(1925) Ch 407] gave three limits to
duty to care: (1) he is not expected to exercise greater degree of
skill than what is needed from a person of his experience and
knowledge, (2) he is not bound to give continous attention to
the affairs of the company and is not also bound to attend all
meetings, and (3) in the absence of any ground of suspicion he
is bound to trust the company officials.
Directors must act honestly and ensure that the company’s funds
are properly invested. They are not to indulge in dangerous
speculation. They are not bound to examine individual book
entries though they are empowered to inspect book of accounts.
While acting as directors they are bound to faithfully implement
the policies framed by the board.
3.9 DISABILITIES
There are several limitations imposed upon directors, some of
which are as follows:
1. According to Section 312 a director cannot assign his office.
Supreme Court had made distinction between assignment
and appointment. According to the Court “an appointment
to the office can be made if the office is vacant.” As such
appointment by a director to the office which previously he
used to hold was not included within the purview of the
section [See Oriental Metal Pressing v. Bhaskhar
Kashinath Thakur (1961) 31 Com. Cas. 143]. An
agreement made by the directors of a private limited
company appointing one of them as Managing Director
through a resolution passed in the meeting was not held to
be assignment of the office.
2. Any provision in the Articles of association or in an
agreement with a company exempting any director or an
officer from any liability or indemnifying him from any
liability shall be void unless of course Judgment is in his
favour or he is acquitted or discharged or in connection
with any application u/s 633 in which relief is granted to
him. No company shall grant any loan to its director without
obtaining prior approval of the Central Government, nor
can it stand a guarantee or place a security in connection
with such a loan. This is of course not applicable in case of
a private limited company or a banking company or a
holding company to its subsidiary. The Central Government
has specified guide lines for sanctioning such loans. In
Totalal v. The State [AIR 1963 Raj 6] the court held that
for the purpose of this section there is no distinction of a
loan from a deposit since the relationship of a debtor and
creditor is created in both the cases.
3. According to Sec. 297 except with the consent of the board
of directors, a director of the company or his relative, a
firm in which a director or his relative is a partner or a
private company of which director is a member or director,
shall not enter with any contract with the company (a) for
the sale, purchase or supply of goods, materials or services
or (b) for underwriting the subscription of any shares or
debentures of the company. This limitation does not apply
to the following cases:
1) purchase or sale of goods and materials from or to, as
the case may be at the market price;
2) contract between the company and a director or his
relative or related persons for sale or purchase of
goods or services in which the company or the director
regularly trades provided the cost does not exceed
five thousand; and
3) transactions in the usual nature of the business of
banking and insurance companies
The object of the provision is that the Board should have
information of the extent of interest of the directors in any
contractual dealings with the company. In Fatch Chand Kad
v. Hidsons (Paliala) Ltd [(1957) 27 Comp Cas 340] it was
held that the consent contemplated in not general but must refer
to particular situation and it requires complete information to
be given and not a general informatin to be given through a
circular with abstract information. The Central Government
delegated this power of approval to the Regional Directors by
notification no. GSR 563(E) dated August 19, 1993.
4) Sec. 293A prohibits and restricts political contribution by
a company. No Government company and no company
having less than three years’ standing shall contribute any
amount to any political party or for any political purpose.
Other companies can do it provided the amount does not
exceed 5% of the net profit in any financial year.
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5) Sec. 294 relates to the appointment of sole selling agent.
No company shall, after the passing of theCompanies
(Amendment) Act 1960 shall appoint a sole selling agent
for any area for a term exceeding five years at a time. The
agent may, however, be reappointed at the end of the term.
Of course the Central Government may direct the company
to furnish such information about the appointment of sole
selling agent as may be necessary to consider whether or
not such terms and conditions are prejudicial to the interest
of the company. In the event of the company’s refusal or
neglect to furnish the information, the Central Government
may appoint an investigator to investigate and report on the
matter. In case a company has more than one selling agent
for an area, the Central Government may examine the terms
and conditions of appointment for the purpose of
ascertaining whether one of the agents can be declared as
sole agent. According to Sec. 294A the Central Government
may notify that in certain category of goods and services,
sole selling agent can not be appointed. According to Sec.
294A, a sole selling agent is not entitled to any compensation
for loss of office in the following circumstances:
(a) if the company in the general meeting disapproves
the appointment;
(b) if the agent resigns;
(c) if the agent is guilty of fraud or breach of trust; and
(d) if the agent instigates the termination of his office.
6) No director shall hold any office or place of profit except
with the consent of the company in the general meeting by
way of special resolution [Sec. 314(1)]. No person related
to him in family or trade can also hold any office or place
of profit without the consent of the Board. Of course, the
post of managing director, manager or whole time director
are excepted.
According to Sec. 299 a director has a duty to disclose his
interest in any contract made by the company or in any of its
transaction. This is a natural requirement because a director
has a fiduciary relation with the company. Interested director
is required not to take part in the meeting dealing with the
transaction nor can he vote in the affairs. If he is present in the
meeting, he cannot be considered for the purpose of calculating
quorum of the meeting for that purpose. The company has to
maintain a register of contracts in which directors are interested
which shall record the nature of their interest. The whole
purpose is to provide for transparency in the policy formulation
and functioning of the Board so that the directors’ position is
clearly vindicated and their interest is known to all directors
before the decision is taken. In Needle Industries (India) Ltd
v. Needle Industries Newly (India) Holding Ltd the Supreme
Court held that the ‘interest’ involved on any issue of the
company’s management is not merely a ‘sentimental’ interest.
The relation of frindliness of a director is not sufficient an interest
which may disqualify a director to participate in the meeting
and the voting under Sec. 300.
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If a director has acquired an interest in any transaction of a
company after the company enters into the contract he has to
disclose his interest in the meeting of the Board at the earliest
opportunity. Similarly if a director having an interest in any
transaction of the company becomes director afterwards, he has
the liability of disclosure the moment he accepts the directorship
[M. O. Verghese v. Thomas Steaphen & Co Ltd (AIR 1971
Ker 223)]. The proposition laid down in Imperial Mecantile
Credit Association v. Coleman [(1871) LR 6 Ch App 558]
that if all the general body of directors are aware of the interest
of the director in any contract of the company, no disclosure is
necessary,does not hold good because, as per the clear provision
of Sec. 299 the statement making disclosure is necessary in that
event as well.
‘Non disclosure’ makes the contract voidable at the option of
the company and makes the defaulting director liable to account
for the secret profit. ‘Non-disclosure’by itself is not penal, but
if the director contravened the provision of Sec. 300 by attending
the meeting and voting on the resolution, he is punishable with
a fine upto Rs.5,000/-. (i.e., a partner, or a relative, or a firm in
which the director or his relative is a partner or a private limted
company in which he is a director or a member) is appointed to
an office or to hold a place of profit before the person becomes
a director, this restriction is not applicable. If any contravention
is made, the person concerned shall vacate the office from the
date next following the holding of the general meeting in which
the special resolution was passed approving the appointment.
3.10 LIABILITIES OF THE DIRECTORS
Directors both as policy makers of the company as well as some
of them being officers of the company have both personal, civil
and criminal liabilites. They have liabilities to the contracting
parties as well as to the company. Some of the liabilities are
discussed here under.
Civil Liability to the company
Directors liability to the company may arise where (1) the
directors are guilty of negligence, (2) the directors committed
breach of trust, (3) there has been a misfesance and (4) the
director has acted ultra-vires and the funds of the company have
been applied for such an act.
1. A director is required to act honestly and diligently applying
his mind and discharging the duties as a man of prudence
of his ability and experience would do. It has been
explained in the duties of a director as to what is standard
or due care and diligence expected of him as explained by
Justice Romer in Re City Acquintable Fire Insurance
Company [(1925) Ch 4007]. But if the director acts with
negligence he is liable to compensate the company.
According to Sec. 201 this liability of the director cannot
be excused by any provision of the articles of association.
According to Sec. 633, if it appears to the court in any suit
filed against the director on the ground of negligence,
default, breach of duty, misfeasance or breach of trust that
he acted honestly and reasonably the court may wholly or
partly relieve him from his liability. But in a criminal
 proceedings the court shall have no power to grant relief
from any civil liability. In the case of negligence there is no
necessity of proving fraud. The burden of responsibility of
proof that a director has acted negligently lies on the plaintiff.
But when the negligence is apparent the burden of proof is
shifted. As for example when the directors have made calls
on other shares their failure to make call upon shares held
by themselves was held to be so negligent that the bureden
of proof was held to have shifted.
(2) Directors have fiduciary relation with the company and as
such they have to discharge their duties as a trustee. For
any breach of trust resulting in the loss or damage to the
company they have to make good the loss. So if the director
makes any secret profit out of any transaction of the
company, he has to return the whole amount to the company.
Similarly, a director must account to the company for any
form of gift or bribe received by him from a supplier of
goods or vendor of properties to the company.
(3) Directors are liable to compensate against any act of
misfeasance. Any wilful misconduct or culpable negligence
falls within the category of misfeasance. If the directors
use the company property for personal gains they are guilty
of breach of trust and malfeasance. If a company is in the
process of winding up, the remedy for misfeasance lies in a
summons under Sec. 543 of the Act, which can be issued
within five years. The summon is to be based on the
information of specific acts of commission and omission.
As such, in Off. Liquidator v. Raghava Deshikachar [AIR
1974 SC 2069] it was held that the report of the official
liquidator has to contain a detailed narration of the specific
acts of omissions and commission on the part of individual
directors to proceed against them individually. If the
directors delegate their functions to the management and
blindly accept whatever is reported, they would be acting
negligently.
4) If the directors act ultra vires to the authority of the company
itself, the same cannot even be ratified by all the shareholders
agreeing to it. A company is a separate legal entity and not
an aggregation of interests of all the shareholders. As such,
what a company cannot do, the Board of Director also cannot
do. In such a case if the directors used the corporate resource
for an ultra vires act, directors have to make good the loss
to the company.
Civil Liability to Outsiders
Directors’ position to a third party is to be examined on the
basis of the principle of agency. Director act for and on behalf
of the company and therefore, they are not personally liable or
accountable to any third party. Even in case of any act ultra
vires to the company, directors are not personally binding
because every one has a constructive notice about the powers
of the company in regard to any contract as stipulated in the
memorandum and Articles of association. In this case one has
to distinguish acts ultra vires to the company and act ultra-vires
to the Board of Directors or a director when powers have been
delegated to him. As for example, if a director has taken loan
from another exceeding the amount which is within his power,
he is doing something which is ultra vires to his power but not
of the company. In such a case the principle of indoor
management as laid down in the case of Royal British Bank v.
Turqnand [(1856) 6 E & B 327]. In such a case third party can
presume that the company’s internal management of delegation
and authorisation is adequately done as represented by a director.
As such, the person can hold the company liable and the company
in turn may hold the director liable for reimbursement. But
suppose, the money borrowed is beyond the power of the
company, the third party (contracting party) may treat the same
as a breach of warranty of authority and hold the director
personally liable to pay the same. In case of contracts by a
director entered personally keeping the name of the company
undisclosed, the director shall be personally liable for such
contract ascertaining to the general principle of law of agency.
Even if the director discloses that he is a director but does not
use words sufficient to bind the company, he may be held
personally liable to the contracting party.
Directors are personally liable under Section 62 of the Act for
false statement in the prospectus to a third party on an action of
damages. Directors are personally liable to pay compensation
to the allottee (i) for irregular allotment [Section 71(3); (ii) failure
to pay application money if minimum subscription is not received
[Section 69(5); (iii) failure to repay the application money if
the application for listing is not made or if made, is refused.
Besides, directors are liable to pay damages primarily if a fraud
is committed or there is a tort.
Criminal liability of the Directors: Companies Act 1956 fixed
criminal liability on the directors on several issues. There are
more than 150 sections dealing with criminal or penal liability
of the directors and offices of the company. As for example
section 63 fixes criminal liability for mis-statement in a
prospectus. Similarly Sections 68, 75, 95, 113, 144, 192, 303,
and many other sections fix such criminal or penal liability on
director and officials of the company.
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4. OPPRESSION AND MISMANAGEMENT
SUB-TOPICS
4.1 Rule in Foss v. Harbottle
4.2 Prevention of Oppression
4.3 Prevention of Mismanagement
4.4 Powers of the CLB
4.1 RULE IN FOSS V. HARBOTTLE
We have seen in the earlier chapters, the ways and means by
which a determined group of individuals could acquire control
over the company. Once they acquire control, they can for all
practical purposes do whatever they want with the company with
practically no supervision or control, because even if they are
questioned on their acts in the general meeting, they always come
out winners because of their greater voting strength.
Generally speaking the Courts are loathe to interfere in the
internal administrative matters of a company unless the matters
are those which fall under the general scope of ‘indoor
management`. This rule was laid down in 19th century in the
case of Foss v. Harbottle [(1843) 67 ER 189], where two of
the company’s shareholders filed an action against the directors
of the company charging them with collaborating and effecting
numerous illegal transactions by which the company property
was misapplied and wasted. They prayed that the concerned
directors should be asked to make good the losses which had
occured due to their action. The Court rejected the action in
respect of all those transactions for which the majority
shareholders had a right or power to confirm, holding that: “The
conduct with which the defendants are charged is an injury not
to the plaintiff, exclusively, it is an injury to the whole
corporation. In such cases the rule is that the corporation should
sue in its own name and in its corporate character. It is not a
matter of course for any individual member of a corporation
thus to assume to themselves the right of suing in the name of
the corporation. In law the corporation and the aggregate of
members of the corporation are not the same thing for purposes
like this.”
This rule known as the ‘rule in Foss v. Harbottle’ was restated
in simpler terms in Edwards v. Halliwell [(1950) 2 All ER
1064] as: “The rule in Foss v. Harbottle comes to no more than
this. First, the proper plaintiff in respect of a wrong alleged to
be done to a company is prima facie the company itself.
Secondly, where the alleged wrong is a transaction which might
be made binding on the company by a simple majority of
members, no individual member of the company is allowed to
maintain an action in respect of that matter for the simple reason
that, if a mere majority of the members of the company is in
favour of what has been done, then cadet quaestio.”
So the question arises, in such an unequal division of power
what happens to the interests of the minority group of
shareholders? How can their interest be protected? One thing
has to be clearly understood here is that when we talk about the
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protection of the minority group we do not talk about ‘numerical
minority’ but of minority voting strength’. The reason for this
distinction is that a small group of shareholders may hold the
majority shareholding whereas the majority of shareholders may
between them hold a very small percentage of the share capital.
As for example, suppose a company has 500 shareholders. 5 of
the shareholders belonging to the same family hold nearly 70%
of the shares, whereas the remaining 495 shareholders have the
rest of 30% shares distributed amongst them. In such a situation,
though 495 does form a large body of shareholders, in effect
they are totally helpless in the face of their meager shareholding.
It is their interest which has to be protected in the face of such a
strong opposition.
It is for this purpose that certain exceptions to the above rule
were recognized and applied. These exceptions are as follows:
a) Ultra vires acts
b) Fraud on the minority
c) Acts requiring special majority
d) Wrongdoers in control
e) Individual membership rights
f) Oppression and mismanagement
Most of these exceptions have been dealt with at some point or
other in the earlier modules. ‘Individual membership right’
means the right which accrues to a shareholder by virtue of his
being a member and can be availed against the company and
the rest of the shareholders. For example, the right to vote on a
motion is an individual membership right and a shareholder can
approach the Court if he has wrongfully been denied the right to
vote by the majority. But by far the most important exception
recognized is that of ‘oppression and mismanagement`, i.e., when
the majority action results in either oppression of minority or
mismanagement of company affairs any shareholder can
approach the Court to seek appropriate relief. We would now
deal with this last exception in detail.
4.2 PREVENTION OF OPPRESSION
The term ‘oppression’ has been explained by Lord Cooper in
Elder v. Elder & Watson Ltd [1952 SC 49 (Scotland)] as,
“The essence of the matter seems to be that the conduct
complained of should at the lowest involve a visible departure
from the standards of fair dealing, and a violation of the
conditions of fair play on which every shareholder who entrusts
his money to the company is entitled to rely”. Here, the
allegations were that the petitioners who were two shareholders
in a small family company, were removed by the majority
shareholders from their position as directors of the company
and were also removed from their employment as secretary and
factory manager of the company. A relief was denied to them,
because they had not suffered as shareholders but in different
capacities i.e., in their capacity as director and employees of
the company.
Under Sec. 397, shareholders are granted relief from oppression
if the affairs of the company are conducted in a manner which
is, (1) either prejudicial to public interest or oppressive to any
member(s), (2) which would entitle the court to order winding
up under the just and equitable clause, but (3) such order of
winding up would unfairly prejudice such member(s). Let us
now take each of these conditions separately.
1 Oppression
Though it is easy to define oppression as, a persistent unjust
conduct resulting in an unduly harsh burden to the complaining
shareholder, it becomes more difficult to categorize the kinds
of acts which would result in such oppression. In the English
case re H. R. Harmer Ltd [(1958) 3 All ER 689], it was held
“The result of applications under Sec. 210 in different cases
must depend on the particular facts of each case, the
circumstances in which oppression may arise being so infinitely
various that it is impossible to define them with precision”. Sec.
210 of the English companies Act corresponds with our Sec.
397. Merely because the majority has indulged in minor acts of
mismanagement will not be deemed to be oppression. Thus, in
Lalita Rajya Lakshmi v. Indian Motors Co [AIR 1962 Cal
127], the petitioners alleged that the board of directors were
guilty of certain acts detrimental to the minority of the
shareholders. The acts complained of were that, the income
was deliberately being shown less by inflating expenditure, not
maintaining a check either on petrol consumption or on ticketless
travel, disposal of second hand buses at very low prices,
declaring low dividends etc. The court held that, even if each
of these allegations was proved there would still be no
oppression. Further, “to attempt to get a majority by lawful
means is not a fact or circumstance which justifies winding up
of the company”. What would amount to oppression has been
well explained in Kalinga Tubes Ltd v. Shanti Prasad Jain
[(1964) 1 Comp LJ 117] as, “There must be an unfair abuse of
the powers and impairment of confidence in the probity with
which the company’s affairs are being conducted as distinguished
from mere resentment on the part of a minority at being outvoted
on some issue of domestic policy. It is not lack of confidence
between the shareholders per se that brings the section into play
.... oppression involves atleast an element of lack of probity or
fair dealing to member in the matter of his proprietary right as a
shareholder. Persons connected with management of the
company’s affairs must in connection therewith be guilty of fraud,
misfeasance or misconduct towards the members. It does not
include mere domestic disputes between directors and members
or lack of confidence between one section of members and
another section in the matter of policy or administration. Much
less it covers mere private animosity between members and
directors”.
Oppression of majority
Though this section is generally applicable to cases where there
is an oppression of minority, in special cases if the court feels it
just, the section may be brought to apply on application made
by the majority who have been rendered helpless by the acts of
the minority. Thus in re Sindri Iron Foundry P Ltd [(1963)
69 CWN 118] it was observed, “if the court finds that the
company’s interest is being seriously prejudiced by the activities
of one or the other group of shareholders, that two different
registered offices at two different addresses have been set up,
that two rival boards are holding meetings, that the company’s
business property and assets have passed to the hands of
unauthorized persons who have taken wrongful possession and
who claim to be the shareholders and directors, there is no reason
why the court should not make appropriate orders to put an end
to such matters”.
Oppression qua members
The section comes into force only when the aggrieved member
is able to show that he has suffered an injustice in his capacity
as a shareholder of the company and not in any other capacity.
Thus, in re Lundie Bros Ltd [(1965) 2 All ER 692], a minority
shareholder of a private company was removed from his position
as a working director. He would have gained nothing from the
company if he had been merely a shareholder, because the
company didn’t pay any dividends, so that the only return he
got on his investment in the company was the remuneration he
drew as a director. Despite this he was not granted a relief
under this section, because he had suffered as a director of the
company and not as a member. This decision has been criticized
severely as being unrealistic, because being elected as a director
is one of the privileges of being a member, and a deprivation of
this privilege should amount to oppression of a members right.
2 Facts must justify winding up
Unless and until the facts alleged as being oppressive, justify an
order of winding up under Sec. 433(f) as being ‘just and
equitable’, Sec. 397 will not apply. A linking of Sec. 397 with
433 may result in some deserving cases being denied relief,
because Sec. 433(f) is itself fraught with difficulties and it is
difficult to categorize the cases which would come under it.
But, in general this clause is used to provide an alternative
remedy to winding up i.e., when the CLB feels that an order of
winding up will unfairly prejudice the petitioner or that such an
order would be worse than the malady.
3 Oppression of continuing nature
Lastly, the section will come into play only when the oppression
is of a continuous nature, i.e., isolated incidents of oppression
will not suffice. The wording of the section itself makes this
clear because it says that, the affairs of the company must be
conducted in an oppressive ‘manner’ - manner implying
something carried on over a period of time. This requirement
also prevents the court from taking into account any oppressive
behaviour in the past.
Who can apply under Sec. 397?
Sec. 399 specifies the requisite number of persons required to
sign an application alleging oppression u/s. 397 as follows:
(a) where the company has a share capital, the application must
be signed by atleast 100 members of the company or by
members holding one-tenth of the issued share capital of
the company;
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(b) where the company is without sharecapital, the application
has to be signed by one-fifth of the total number of its
members;
(c) the Central Government may on application allow any
member or members to sue if it feels its just or equitable to
do so.
If the requisite number of persons consent, then the application
may be made by one or more members on behalf of all of them.
Consent here has the same meaning as in section 13 of Contract
Act, i.e., people agreeing to the same thing in the same sense.
Thus, in M. C. Doraiswami v. Sakthi Sugars Ltd [(1980) 50
Comp Cas 154 (Mad)], a petition under Sec. 397 was rejected
by the Court, because the consenting members had been merely
told their signatures were needed for requisitioning a meeting.
The court held that, the signatories must be told of the specific
facts which are alleged to be constituting oppression. “There
cannot be a blanket consent”. Under Sec. 401, even the Central
Government has the power to apply for relief under this section.
Once a petition is admitted by the court, then it can be withdrawn
or compromised only with the permission of the court. Such a
permission is granted only if the court is assured that such
compromise would be in the best interests of both the company
and its shareholders [In re Kelly and Henderson P Ltd, (1980)
50 Comp Cas 646 (Bom)].
4.3 PREVENTION OF MISMANAGEMENT
Power corrupts - and more power corrupts even more: Once
control is acquired over the company, it is easy to give in to
temptation and start managing the affairs of the company in
such a manner that the best interests of the management rather
than the company are served. In short, there is ample scope for
‘mismanagement’ if the management is lacking in either the will
or capacity or both to manage.
Sec. 398 of the Act provides statutory relief against
mismanagement. For this section to apply it has to be proved
that:
a) the affairs of the company are being conducted in a manner
prejudicial to the public interest or to the company’s interest;
or
b) by reason of change in management or control of the
company there is every likelihood of the company affairs
being conducted in the aforesaid manner.
On a petition being made to the CLB, if it is convinced of the
genuineness of the petition make a suitable order with a view to
either bringing an end to such mismanagement or according a
suitable relief.
It is beyond the scope of Sec. 398, to consider or look at the
legality or illegality of an action, because the alleged change
may be perfectly legal, but it may still be prejudicial to the
company [re Thakur Paper Mills, 1975 Tax LR 1955].
Whenever there is a mismanagement, any member of company
can file a petition with the CLB. A petition u/Sec. 398 cannot
be filed for past msidemeanours or acts of mismanagement -
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the act complained of must be in the present and continuing,
except when the acts in the past project themselves as a
continuing wrong pervading the present conduct of the company
[C. B. Pardhanani v. M. B. Pardhanani (1990) 69 Comp Cas
106]. Rajmundry Electric Corporation v. A. Nageshwara
Rao [AIR 1956 SC 213], is a good illustration of what constitutes
mismanagement. Here, some of the shareholders of a company
filed a petition alleging mismanagement by the directors. It
was found that, the vice-chairman had been grossly mismanaging
the company, he had drawn large amounts for his personal
purposes, a considerable sum was owed to the Government
against supply of electricity, the factory machinery was in urgent
need of repairs, that the directorate had become greatly
attenuated and “a powerful local junta was ruling the roost”,
and those shareholders who didn’t belong to the chairman’s
faction were helpless and unable to set things right. The court
held this to be sufficient evidence of mismanagement, and
accordingly appointed two persons for a period of 6 months to
act as administrators to take over the management of the
company and invested them with all the powers of the directorate.
4.4 POWERS OF THE CLB
Initially the jurisdiction to hear petitions against oppression or
mismanagement was vested in the company court, but now this
jurisdiction has been transferred to the company Law Board by
virtue of 1988 amendment. Sections 397 and 398 vest wide
powers in the CLB in this regard. As observed by the court in
Lord Krishna Sugar Mills Ltd v. Abnash Kaur [(1974) 44
Comp Cas 210 (Del)], “in fact the Board may make any order
for the regulation of the conduct of the company’s affairs upon
such terms and conditions as may, in the opinion of the Board,
be just and equitable in all the circumstances of the case”. While
making an order the Board has of course to keep in mind the
objectives of these sections, and so the order must be such as
would end the oppression or mismanagement. Sec. 402 makes
an attempt to define the powers of the Board while making an
order under ss. 397 and 398. These powers are as follows:
1) Regulating the future conduct of the company’s affairs, as
for example, in Bennet Coleman & Co v. Union of India
[(1977) 47 Comp Cas 92 (Bom)], the court ordered that the
Articles of the company be so amended as to ensure that all
the directors appointed by shareholders will retire annually
though such a provision was against the provision of Sec.
255.
2) Allowing purchase of shares or interest of members by other
members of the company, or by the company itself.
3) If the company is allowed to purchase its own shares, then
the power to allow the consequential reduction of capital.
4) The rescission or alteration of any agreement between the
company and its managerial personnel.
5) In case, any fraudulent preference had been made within a
period of 3 months prior to the petition, then the power to
set aside such transaction.
6) The rescission, setting aside or modification of any
agreement with any person, after giving reasonable notice
to him and obtaining his consent.
7) Any other order which in the opinion of the CLB would be
just and equitable.
Wherever the CLB orders an alteration of the memorandum or
the Articles, the company is not at a liberty to alter it in a manner
which would be in contravention of the order. Similarly,
whenever an agreement between the company and one of its
managerial personnel is terminated, the person would not be
entitled to any compensation or damages, & nor will he be
capable of joining employment in the company in any managerial
capacity for a period of 5 years unless the CLB expressly permits
him to do.
Under Sec. 406, CLB can also start misfeasance proceedings
against the guilty officers, even if the company is not being
wound up. The powers of the CLB under these sections are not
affected by the presence of an arbitration clause, though it may
by its own discretion refer the matter to arbitration, and exercise
its own powers only after such arbitration is concluded.
Under Sec. 408, the Central Government has the power to
appoint directors to the board, on recommendation from the
CLB. The CLB can take up the matter to give such direction
either on a reference by the central Government or on an
application by not less than 100 members or by members holding
10% of the voting power. On an application being made, the
CLB makes the requisite inquiry in order to ascertain whether
such an appointment is necessary for better management of the
company. If it decides that it would be just and equitable to
appoint such a director, it would also have to specify the time
period for which such an appointment is to be made. For the
purpose of such additional directors to be appointed, the CLB
may also order a suitable amendment to the company’s Articles
and memorandum, and such an alteration may be in
contravention to the provisions in Sec. 265 etc. After such
appointment, no changes can be made in the board of directors
without the consent of the CLB. Under Sec. 409, the Central
Government has an additional power to prevent any proposed
change in the Board if it feels that it would be in the best interest
of the company. This power can be exercised on a complaint
by the managing director or any other director.
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5. INVESTIGATION
SUB TOPICS
5.1 Introduction
5.2 Mandatory Provisions
5.3 Permissive provisions
5.4 Certain other investigations
5.1 INTRODUCTION
In any industrial society, incorporated enterprises form the very
backbone of economy, and are the best mode of channelising
and increasing limited capital. In the beginning, shareholders
or suppliers of capital were in a position to exercise effective
control over the managerial abuse or misuse of power, but slowly
with increasingly diffused stockholding and the gradual eroding
of the effect of ‘doctrine of ultra vires’, shareholders today have
reached a stage where they were either entirely disinterested in
the management or are in hopelessly inadequate situation to act
in any constructive manner. In the words of A.A.Berle, “further
the shareholders are ill-equipped to challenge the widsom and
expertise of officers” [(1960) 60 Col. LR4]. This basically
means that any mode or remedy provided in the Act for
prevention of corporate abuse, and requiring the shareholder to
act is neither very practical nor effective for the following
reasons, viz:
1) Highly diffused stockholding resulting in disjointed
shareholders having practically no contact with each other,
i.e., lack of cohesion amongst the shareholders.
2) Change in basic interests of shareholders - from initially
being interested in every aspect of the company, they are at
Investigations
Mandatory provisions
On special by a court
resolution order
Fraud, Oppression
or illegality information
We would now deal with these provisions in detail.
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present interested only in the amount of dividend they will
receive, i.e., the shareholders identification with the
company is purely economic, and as long as they get regular
dividends they are not interested in how the company is
being run.
3) Lack of adequate information about the actual running of
the company, and more importantly lack of necessary skills
to interpret the information given to them and pick out the
lacunae or loop-holes in that information.
4) The formalities and expense involved in going to the Courts
makes the shareholders reluctant to approach the Court for
relief, even when there is a just cause for them to do so.
Further, in most cases the shareholders are not even aware
of the reliefs available to them, for example relief against
oppression and mismanagement. This ignorance of law is
blatantly taken advantage of by the powers that be who can
act in any manner they want without being hindered or
hampered by Court actions.
To prevent this unhampered course of action which may result
in gross misuse of power the Act provides for a secondary check
on the managerial powers, i.e., where the shareholders fail to
act the Central Government or the CLB can order an investigation
into the affairs of the company either suomotto or on an
application by the requisite number of members. These
provisions are mainly given in Sections 235-251 and may be
split up into mandatory provisions and permissive provisions.
The following flow chart gives an idea of the circumstances in
which these provisions come into play.
Permissive provisions
On members On report Suo motto
application by Registrar by CLB
Fraud Misfesance Inadequate
or misconduct
5.2 MANDATORY PROVISIONS
Under Section 237 the Central Government is bound to appoint
inspectors to investigate into the affairs of a company in the
following two cases, viz:
i) When the company by a special resolution (i.e., one passed
by three-fourth majority) demands an investigation; or
ii) When the Court passes as Order declaring that the affairs
of a company ought to be investigated and directs the Central
Government to appoint an inspector for the purpose.
The section does not specify the person(s) who can approach
the Court for such an order. In re Alembic Glass Industries
Ltd. [(1972) 42 Comp. Cas. 63 (Guj)], the Court holding itself
as not being subject to the provisions of sections 235 or 237(b)
observed:
“The Legislature in its wisdom has not put any such condition
before the Court can make an order, though the Court may in its
wisdom expect prima facie proof of some of these conditions.
While conferring jurisdiction on the Court to direct the Central
Government to appoint an inspector, the Legislature have not
thought fit to circumscribe the discretion or jurisdiction in any
manner. It would, therefore, be utterly inappropriate to curtail
or circumscribe or fetter the jurisdiction of the Court by reading
into the section something which is not there’.
This obviously does not mean that the Court can arbitrarily order
the Central Government to investigate into the affairs of the
company. There would have to be some really concrete, viable
reasons for it to make such an order. In
. V. Purie v. E. M. C. Steel Ltd [(1980) 50 Comp Cas 127
(Del)], the court observed that, ‘the section should be so
interpreted as to enable relief to be obtained only by some person
whose rights have been affected by the manner in which the
affairs of the company have been conducted or accounts
mintained and has, therefore, a grievance in the eyes of the law’.
Accordingly the court rejected the application made by the
landlord of the company who wanted investigation into the
company affairs on the grounds that he had paid some amount
to the managing director with a view of inducing him to vacate
the premises and the managing director (or MD) had
misappropriated the money, or that the MD was using his political
contacts for promoting the company business or that he had
misappropriated the money which he had borrowed from the
bank.
5.3 PERMISSIVE PROVISIONS
Under Ss. 234, 235 and 237(b), the Central Government or the
Company Law Board may appoint inspectors to investigate into
the affairs of the company. These provisions are discretionary
or permissive in nature i.e., there is no compulsion on them to
conduct such investigation. Another point to be remembered is
that the purpose of an investigation be it mandatory or
discretionary is merely the ‘gathering of information’ and such
an investigation is in no sense a judicial proceeding for purposes
of trial of any offence. A permissive investigation can be ordered
in any one of the following situations:
1. On member’s application: Under Sec. 235, the Central
Government or the CLB may appoint an inspector to
investigate the affairs of the company on the application of:
a) two hundred members or members holding one-tenth of the
total voting power; or
b) if the company has no share capital then, one-fifth of the
total members.
Under the 1988 amendment, the requisite number of
members have to file their application with the CLB, along
with evidence showing that they have a good reason to seek
such investigation. If the CLB feels it necessary they may
even be required to furnish a security (not exceeding
Rs.1000/-) to cover the costs of investigation. After giving
the parties to the application an opportunity to be heard, if
the CLB feels that the affairs of the company need to be
investigated, it gives a declaration to that effect. On such a
declaration being made the Central Government appoints
one or more inspectors who are required to submit a report
on the completion of the investigation.
2. On report by the Registrar: Sec. 234 confers on the
Registrar the power to call either information or explanation
in respect of documents submitted to him, and on the failure
of supplying of such information he can make a report to
the Central government for necessary action. Further, if a
creditor or member or such other interested person places
before him material showing that (a) the business of the
company is being carrited in fraud of its creditors etc., or
(b) otherwise for a fraudulent or unlawful purpose, the
Registrar can ask the company to furnish relevant
information after giving it an opportunity to present its case.
On the Registrar making a report that the company’s affairs
need to be investigated the Central Government appoints
competant persons as inspectors for the purpose. In Barium
Chemincals Ltd v. CLB [AIR 1967 SC 295], Hidayatullah
J., observed, “A further power is conferred on the Registrar,
who may, after being authorised by a Presidency Magistrate
or a First Class Magistrate, enter any place, search or seize
any document relating to the company, or its managerial
personnel, if he has reason to believe that it may be destroyed
or tampered with”.
3. By the Company Law Board: Under Sec. 237(b) the CLB
may suo motto appoint inspectors to investigate into the
affairs of the company or ask the Government to act in the
following three situations:
i) Fraud, Oppression or Illegality That is either when the
company is formed for any unlawful or fraudulent purpose
or when the affairs of the company are being conducted in
such a manner as to constitute fraud on the creditors or
oppression of some members.
ii) Fraud, Misfeasance or Misconduct: That is the promoter
while discharging, their duty, or the managerial personnel
of the company have been guilty of fraud, misfesance or
misconduct towards the company or the members. In
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 relation to these words a jurist observed, “These seem to be
words of very wide import: in Selangor United Rubber
Estates Ltd v. Cradock [(1967 1 WLR 1168], Goff, J.,
held, withdrawing some of his dicta in an earlier case [S. B.
A. Properties Ltd v. Cradock (1967) All ER 610], that
“other misconduct” is not to be construed ejusdem generis
with “fraud” and `misfeasance’ and that the statutory
workding quoted above does not include “moral turpitude”.
In veiw of this, it seems that [the] section ...... [would] extend
to wht was called in Re B. Johnson (Builder) Ltd [(1955)
Ch 634] as “common law negligence”. The Board of Trade,
however, are of opinion that this head does not include mere
mangerial inefficiency” [Avtar Singh, pp.398, 399].
iii) Inadequate Information: That the members hav ebeen
deprived of relevant information which they could
reasonabley expect from the company, for example,
information relating to the remuneration payable to the
managing director or director etc., or the contracts entered
into with them.
Manner of exercising discretion
Specifying the grounds on which the CLB can order investigation
effectively limits the CLB’s powers to order such investigation,
i.e., it cannot go on a fishing expedition in the hope that it might
be able to find some irregularity in the way the company's affairs
are being managed. CLB can order an investigation only if it
has some justifiable belief in the irregularity of the company's
affairs. In the Barium Chemical Ltd case it was observed,
“No doubt the formation of opinion is subjective ... [but] the
existence of “circumstance” is a condition fundamental to the
making of an opinion, the existence of circumstances, if
questioned, has to be proved atleast prima facie. It is not
sufficient to assert that the circumstances exist and give no clue
to what they are because the circumstances must be such as to
lead to conclusion of certain definiteness. The conclusion must
relate to an intent to defraud, a fraudulent or unlawful purpose,
fraud or misconduct or the withholding of information of a
particular kind. We have to see whether the chairman (of the
CLB) in his affidavit has shown the existence of circumstances
leading to such tentative conclusions. If he has, his action cannot
be questioned because the inference is to be drawn subjectively
and even if this Court would not have drawn a similar inference
that fact would be irrelevant. But if the circumstances pointed
out are such that no inference of the kind stated in Section 237(b)
can at all be drawn the action would be ultra vires the Act and
void.”
5.4 SOME OTHER INVESTIGATIONS
Apart from the above types of investigations, there are two other
situations discussed below, where an investigation may be
ordered, viz:
i) Investigation of ownership of a company
Sometimes the Central Government may feel that it would in
the interest of the general public to ascertain the actual persons
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in control of the company either financially or by materially
influencing the policy making of the company. In such cases,
the Government may appoint one or more inspectors under
Section 247 to investigate and report on the membership of the
company and other matters relating to it. The 1988 Amendment
empowers the CLB while dealing with any matter before it to
declare that the affairs of the company need to be investigated
and on such a declaration being made the Government appoints
inspector(s) to carry out the investigation. Where the company
is being managed by managing agent, secretaries etc., the
inspector will have the power to investigate into the ownership
and control of shares. He also has the power to find out as to
who else had shared the remuneration of such managing agents
or secretaries etc. The cost of investigation is borne by the
Government out of the money provided by the Parliament, but
it may order the recovery of such expenses from persons on
whose application the investigation was ordered.
ii) Investigation of ownership of shares
If it appears to the Government or the CLB that there is a good
reason to investigate the ownership of shares in or debentures
of a company etc., it may undertake an investigation under
Section 248, but it is not necessary that they appoint an inspector
for that purpose. The Government or the CLB itself may require
the following persons to give information, viz;
a) a person who is or was interested in those shares;
b) a person who acts or has acted, in relation to those shares
or debentures as the legal adviser or agent of the person
interested in such shares or debentures. Such a person would
be required to give all relevant information regarding those
shares including the names and addresses of those persons
who had acted in his behalf in relation to such shares or
debentures. Section 248(4) makes a person guilty of giving
false information liable to punishment, even if the false
information was given out not deliberately but merely
recklessly.
If as a result of any of the above investigations the CLB comes
to a conclusion that there is a justifiable reason for ascertaining
the complete facts about any share(s) of the company, it may if
necessary, impose certain restrictions, on these shares under
Section 250, viz:
a) Any transfer of such shares would be void.
b) If the shares are yet to be issued, they shall not be issued,
and if they are issued in contravention of the order the issual
would be void.
c) No voting rights can be exercised in respect of those shares.
d) No ‘rights shares` can be issued in respect of those shares.
e) Except in case of liquidation, no money will be paid by the
company in respect of those shares either in the form of
dividend or capital or otherwise.
The maximum period for which these restrictions may operate
is 3 years. Further, if the CLB fears that as a result of transfer of
some shares there might be a change in the constitution of the
board of directors and such a change may not be in the best
interests of the public, it may restrain such a change from taking
place without the CLB’s prior approval, and may also direct
that voting rights on those shares cannot be exercised for a period
of 3 years.
Section 250-A provides that an investigation may be initiated
even when an application for prevention of oppression or
mismanagement is pending or the company has passed a special
resolution for voluntary winding up. Similarly, an investigation
which is in progess will not be stopped or suspended by reason
of the fact that an application for prevention of oppression or
mismanagement has been made or a special resolution for
winding up has been passed [Avtar Singh, p.407].
5.5 POWERS AND DUTIES OF THE INSPECTORS
An inspector has the following powers intended to facilitate his
smooth discharge of duty, viz:
a) He may wherever necessary investigate the affairs of other
companies in the same management or group. But in certain
situations under Section 239(2) he is required to take the
permission of Central Government before doing so.
b) He may require the managerial personnel or any other person
to produce before him all the relevant books, papers and
documents of the company.
c) He may require the personal attendance before him of any
concerned person and examine such a person on oath.
d) Failure of a person to produce the said books etc., or to
appear in person is a punishable offence.
e) If he wants to examine a person on oath but lacks the
jurisdiction to do so, he may apply to the Central
Government for necessary orders.
f) If he has reasonable grounds to suspect that some relevant
material may be destroyed or falsified, he may apply to the
Magistrate under Section 240-A for seizure of such material.
Functions
i) When he examines a person on oath he has to take down
notes in writing.
ii) He has to act in a fair, reasonable, impartial and just manner
through out the proceedings.
iii) On completion of the proceedings, he has to make a report
under Section 241 to the Government in the required manner.
The Government is required to forward a copy of the report
to the interested parties.
Status of the Report
In Maxwell v. Department of Trade [(1974)2 All ER 122
(CA)], the inspectors report was highly critical of the conduct
of the Chairman and the chief executive of the company. The
latter challenged the report, alleging that it was unfair on the
ground that he was not accorded an opportunity to be heard and
so it was a violation of the principles of natural justice. Rejecting
the petition the Court observed that, ‘the report of the inspector
is not an evidence in the real sense of the word and, therefore
the persons hit by the report have every chance to disprove its
contents. But without doing so they cannot ask the Court not to
act on it.”
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6. CASE LAW
Barium Chemicals Ltd v. The Company Law Board [(1966)
36 Comp Cas 639].
The CLB issued an order appointing four persons as inspectors
under Sec. 237(b) to investigate into the affairs of the appellate
company. The company challenged the order on grounds that,
(a) it was malafide and (b) the board had taken into consideration
materials extraneous to the scope of Sec. 237(b), and had based
its order on such material. The CLB chairman in his affidavit
order alleged that as a result of delay, faulty planning and
bungling of the project, there had been double expenditure, and
continuous losses over a period of time wiping out one-third of
the share capital. Further, the shares of the company were being
quoted at half their face value and severance of their connection
by some eminent persons. Rejecting the CLB’s contention the
Supreme Court held that these circumstances “cannot by
themselves suggest an intent to defraud or fraudulent
management ....... Mere bungling or faulty planning cannot
constitute either misfeasance or misconduct”.
Shanti Prasad Jain v. Kalinga Tubes Ltd [AIR 1965 SC 1535].
A private company was controlled by three groups of share
holders (i.e., the petitioners and the two respondents) holding
equal proportion of shares and having equal representation on
the board. They had also entered into a written agreement to
maintain this equilibrium, but the said agreement was not
incorporated in the Articles of the company. Later, so as to
avail of loan facilities, the company was converted into a public
company, and there was a proposal to issue 39,000 additional
shares. As per Sec. 81, these shares should have been primarily
issued to the existing shareholders on ‘rights basis’, but the
respondents forming the majority group, passed a resolution
and offered the new shares to outsiders. The petitioner
challenged the issue of shares to outsiders on the ground that
the allottees were friends of the majority group and the allotment
had been deliberately made to them with a malafide intention of
increasing their voting strength and squeezing out the petitioner.
This they contended was “oppression” within the meaning of
Sec. 397. The issue to be decided was, ‘whether the resolution
offering shares to the outsiders was passed in good faith for the
benefit of the company or merely to capture a absolute majority
and to squeeze out the petitioner?
Barman, J., held this conduct to be oppression of minority.
Reversing this judgment on appeal the Orissa High Court
observed, “private agreement between the parties to maintain a
equilibrium was not binding on the company. ..... The fact that
the affairs of the company were managed with holding of shares
in equal proportion amongst the three groups for a period of
four years by itself cannot create a right in favour of the
petitioner that it must continue in the same manner even when
the company becomes public. To compel the majority
shareholders, in these circumstances, to offer the new shares
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only to the existing shareholders would, far from being an
oppression of the majority, be to deprive the majority of a right
conferred upon them by Sec. 81 entitling them to direct free
issue of shares. It would also not be compatible with dynamic
concept of industrial expansion. For instance, the expansion
scheme would require large capital in crores and any one of the
groups may not be in a position to subscribe its proportionate
shares as any one or both or residual groups can do. The balance
is bound to be disturbed and equilibrium lost even if the affairs
of the company be conducted bonafide”. The Supreme Court
supporting this decision observed, “.... it is not enough to show
that there is just & equitable cause for winding up on the
company ..... It must further be shown that the conduct of the
majority shareholders was oppressive to the minority as members
and this requires that events have to be considered not in isolation
but as a part of a consecutive story. There must be continuous
acts on the part of the majority shareholders....... showing that
the affairs of the company were being conducted in a manner
oppressive to some part of the members ..... and such oppression
must involve at least an element of lack of probity or fair dealing
to a member in the matter of his proprietary rights as a
shareholder”.
Re Five Minute Car Wash Service Ltd [(1966) 1 All ER 242].
The company was incorporated on 13th May, 1958 with a share
capital of 2,351 shares of one pound each of which Mr. E held
1240 shares and was the chairman and MD of the company. In
December 1964, a further allotment of 750 shares was made of
which Mr. E did not acquire any. The petitioners alleged that
before Dec, ’64 Mr. E had been conducting the affairs of the
company in a manner oppressive to the minority completely
disregarding their interests, and that since Dec ’64 two of
shareholder companies [holding 748 & 801 shares respectively]
had failed to use their voting powers to curtail the actions of
Mr. E and had permitted and condoned his oppressive conduct.
The alleged acts of oppression were stated to be differences of
opinion on matters of policy, inefficient conduct of company’s
affairs.
Dismissing the petition, Buckley, J., held: “To succeed in
obtaining relief under Sec. 210 (i.e., Sec. 397 of the Indian Act):
First the matters complained of must affect the person or persons
alleged to have been oppressed in his or their character
as a member or members of the company. Harsh or unfair
treatment of the petitioner in some other capacity, as, for
instance, a director or a creditor of the company, or as a person
doing business or having dealings with the company or in relation
to his personal affairs apart from the company cannot entitle
him to any relief under Sec. 210. Secondly, the matters
complained of must relate to the conduct of the affairs of the
company. Thirdly, they must be such as not only to make the
winding up of the company first and equitable, but also lead to
the conclusion that the affairs of the company are being
conducted in a manner which can properly be described as
`oppressive’ of the petitioner, and, it may be, other members.
The mere fact that a member of a company has lost confidence
in the manner in which the company’s affairs are conducted
does not lead to the conclusion that he is oppressed; nor can
resentment at being outvoted; nor mere dissatisfaction with or
disapproval of the conduct of the company’s affairs, whether on
grounds relating to policy or to efficiency, however well funded.
Those who are alleged to have acted oppressively must be shown
to have acted at least unfairly towards those who claim to have
been oppressed”.
Dr. V. Sebastian v. City Hospital P. Ltd [57 Comp Cas 453].
A petition of mismanagement u/s 398 was filed against the
respondent company. One of the grounds for the petition was
the removal of a person from office of secretary by the board of
directors. Dismissing the petition the court observed: “It is not
correct to say that this provision comes into play only when
there is actual mismanagement and that `mismanagement’ in
the context must mean maladministration of the day to day affairs
of the company......The business of a company may be running
smoothly in a commercial sense and there may be nothing wrong
with the day-to-day business management...... Relief cannot be
moulded in advance on the basis of mere apprehensions, till a
change of management actually takes place, and the aggrieved
parties move the court under Sec. 398(1)(b). There is no
presumption that every majority in every company would
oppress and mismanage, and a mere attempt to get a majority or
to assert majority rights in accordance with law will not attract
ss. 397 and 398. The normal rule in proceedings under chapter
VI is that the state of affairs complained of should exist at the
time the petition is presented, and the apprehension based on a
possible change of management yet to take shape cannot justify
remedial action at this stage”.
R S Vishwamitra v. Amar Nath Mehrotra [59 Comp Cas
854].
The requisitonist passed resolutions removing the three sitting
director and electing new ones in their place, nut this resolution
could not be given effect because of an interim order of the
court. Later on the sitting directors moved for quashing the
resolutions on the ground that ‘the management and control will
go to the hands of the opposite parties’. Rejecting the application
it was held, “The new directors have not yet taken over the charge
of the affairs of the company. Unless the new directors take
over charge and they conduct the affairs of the company, in any
manner, has affected the company or the conduct of the directors
is prejudicial to the public interest or prejudicial to the interest
of the company, it can be judged as to whether an application
under Sec. 398 should be entertained and a relief granted to the
petitioners. In my opinion, so far as Sec. 398 is concerned, the
petition is not maintainable at this stage. It is wholly premature”.
Viswanathan v. Tiffins B. A. & P. Ltd [AIR 1953 Mad 520]
A clause in the Articles of the company authorized the directors
to fill casual vacancies and also to increase the number of
directors subject to the maximum number prescribed in the
Articles. Some casual vacancies occurred and were promptly
filled up in the general meeting by the shareholders. These
appointment were challenged on the ground that once the power
to appoint had been delegated to the board it could not have
been exercised at a general meeting. Upholding the
appointments the court held, “A company has inherent power
to take all steps to ensure its proper working and that, of course,
include the power to appoint directors. It can delegate this power
to the board and such delegation will binding upon it, but if
there is no legally constituted board which could function or if
there is a board that is unable or unwilling to function then the
authority delegated to the board lapses and the members can
exercise the right inherent in them of appointing directors”. The
court found that at the time of the general meeting there was no
director validly in office and, therefore, the members had the
right to elect.
Alok Prakash Jain v. Union of India [(1973) 43 Comp Cas
68 (Cal)].
The Central Government under the powers granted to it under
sections 388-B to 388-E, made a reference to the CLB for the
removal of the directors of a company. This reference was
challenged on the grounds that the government had no real basis
to arrive at that conclusion and also challenging the constitutional
validity of the section itself. The court observed, “It seems to
us that in the facts of this case, it cannot be said that there was
no material to justify the opinion, which the Central Government
formed. The charges are sufficiently grave and serious,
namely,fraud, misappropriation, manipulation of accounts,
diversion of the company’s funds, illegal declaration of dividends
and unlawful payment of traveling expenses. Full particulars
with dates and amounts involved have been furnished....... The
power of the Central Government is not of discriminatory nature,
for the word “may” couples power with duty and, therefore,
when the circumstances justify a reference; that the delegation
of the power to the CLB is not invalid as the Board functions
subject to the control of the Central Government and that the
resignation by the director either before or after the reference
does not make it infructuous. The power is not merely to remove
from an existing office but is also to restrain from future
conduct”.
Marshall’s valve Gear Co Ltd v. Manning Wardle & Co
Ltd [(1909) 1 Ch 267].
‘A’ and 3 other persons were the directors of M. Co. and they
held substantially the whole of the subscribed capital of the
company. A was the majority shareholder, but held less than
three-fourth of the share capital. N. Co. was committing an
infringement of M. Co.’s trade mark and the other three directors
had personal interest in N. Co. As a result, in a board meeting
they passed a resolution declaring to start any proceedings
against N. Co. Hence, A at a general meeting of shareholders
resolved and commenced an action against N. Co. to restrain
the alleged infringement. The other 3 directors applied for
striking down the name of the company on the ground that as
the Articles had left the power of management with the board,
the shareholders could not interfere by a simple resolution.
Holding that the majority of the shareholders had the right to
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control the action of the directors in the matter the court observed,
“Now it is obvious that in the position in which they (directors)
have placed themselves on this question their duty and their
interest are in direct conflict. On the once hand, it is their duty
as directors to protect the interest of the original patent which is
the property of the company; on the other hand, their personal
interests are clearly to maintain the validity of the patent which
belongs to them. And, therefore, the majority shareholders are
entitled to decide whether or not an action in the name of the
company shall proceed”.
Barron v. Potter [(1914) 1 Ch 895].
There were only two directors in a company and both of them
refused to act with each other. There was no provision in the
Articles enabling the shareholders to increase or reduce the
number of directors in a general meeting, and so they
approached the court. It was observed that, as there was a
deadlock in the administration resulting from the fact that the
directors were unwilling to act and exercise their powers, the
company had inherent power to take necessary steps to ensure
the working of the company and to appoint additional directors
for the purpose.
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Raymond Engineering Works v. Union of India [AIR 1970
Del 5].
The prospectus of a company disclosed that it had purchased its
managing agent’s property for six and half lakhs, but refrained
from mentioning that the managing agent himself had paid only
rupees three and half lakhs for it, i.e., a profit of Rupees three
lakhs was concealed from the shareholders. The company
brought no action, but applied to the Government for approval
of the appointment of the same managing agent as managing
director. The Government granted approval subject to the
condition that he refunded Rs.2,75,000/- to the company, the
balance allowed to him as reasonable expenditure. This
condition was challenged on the grounds that it was unjustified
and that the government did not have any power to impose such
restrictions under Sec. 637-A. Upholding the condition the court
observed, “the profit may not be illegal. But the Government
was entitled to think that it was an unconscionable profit”.
7. PROBLEMS
1. The merchant shipping Act of 1874 provide that a ship
owner would not be liable to make good a loss or damage
to the goods unless he was ‘actually at fault’. A merchant
suffered heavy losses when he sent his goods by a ship
owned by a company. The loss occurred due to the
negligence of the managing director of the company. The
merchant filed a claim against the company for the loss
suffered by him. The company contends that it being an
artificial person was incapable of ‘actual fault’ and hence
could not be made to pay. Decide. [See, (1914-15) All ER
280].
2. The Articles of a company delegated the power to appoint
directors to the board of directors and further added ‘under
no circumstances shall the general body of shareholders
have the power of appointment of directors’. There were
some casual vacancies in the board which were promptly
filled up by the shareholders in the general meeting. These
appointments were challenged by the board as being
unauthorized and unlawful. The shareholders relying on
the decision in Viswanathan v. Tiffins B. A. & P. Ltd
uphold the appointment. Decide. [See, AIR 1950 PC 81].
3. Of the two directors of a company, one died and the other
submitted his resignation. There was no provision in the
Articles relating to resignation by a director. The company
refused to accept the resignation. The director seeks your
advise. [See, (1977) 47 Comp Cas 652 (Mad)].
4. Mr. A. was appointed as Managing director of a company
for a period of 5 years; at a monthly salary of Rs.5,000/-;
annual increment of Rs.500/-; commission on profits @1%
subject to the ceiling of half the annual salary; gratuity,
medical allowance, house rent allowance etc. The Central
Government approved the appointment by reduced the term
to 2 years and also slashed the salary and other emoluments,
but failed to give any reasons for these changes. Discuss
the validity of this order. [See, (1980) 50 Comp Cas 437
(Guj)].
5. At a company meeting a resolution was passed to elect some
directors by a separate election. Mr. X was a candidate in
the election by he lost the election. He was again proposed
as a candidate to fill up a second vacancy, but the chairman
keeping in mind his first defeat, rejected his candidature.
[Note: Please specify your name, address and ID No. while sending in your answers]
Mr. X files a suit questioning the chairman’s right to refuse.
Decide. [See, (1964) 1 Comp LJ 105; AIR 1932 Mad
100].
6. A public company doing forward contract business amended
its Articles under a statutory direction so as to deprive its
nontrading members of their right to vote, to call meetings,
to elect directors and to receive dividends. The deprived
members challenge the action as being ‘oppressive’. Decide.
[See, AIR 1961 Punj 485].
7. A society created a subsidiary company to enable it to enter
the rayon industry. Subsequently, when the need for the
subsidiary ceased to exist, the society adopted a policy of
running down its business which depressed the value of the
shares of the subsidiary. The managing director and another
shareholder challenge this action of the society as being
‘oppressive’. Decide. [(1958) 3 All ER 66].
8. There was continuous infighting among the directors of a
company who were also the shareholder. The interest of
the company were being totally ignored, as a result of which
the company started incurring losses from year to year. The
directors started their own separate business, and even
proper records of the company were not available. Decide
whether this would amount to mismanagement u/s 398.
[See, 55 Comp Cas 702].
9. Mr. A being the majority shareholder and director of a
company wants to sell the sole undertaking of the company
at a price well below the real value of the undertaking. The
undertaking is presently running at a loss but is capable of
earning huge profits under proper management. Discuss
whether the minority shareholders can approach the court
under ss. 397 or 398. [See, AIR 1964 Ker 114].
10. There has been a successive fall in the profits of a company
over the years. The director’s relatives have been appointed
to high positions and paid high salaries. The company has
formed 2 other subsidiaries which are being managed by
the director’s relatives. The parent company has given huge
loans to these subsidiaries, but no interest has been realized
on these loans. Discuss whether these facts warrant an
investigation into the affairs of the company under Sec. 237.
[See (1975) 45 Comp Cas 33 (Del)].
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8. SUPPLEMENTARY READINGS
1. Avtar Singh: Company Law, 1986, Eastern Book Co., Lucknow.
2. Chakraborti, A M: Taxman’s Company Law, 1994, Taxman Allied Services (P) Ltd., New Delhi.
3. Drucker,P., The Practice of Management, 1900, Allied Services (P) Ltd., New Delhi.
4. Gower, Modern Company Law, 1992, Sweet & Maxwell. London.
5. Galbraith, New Industrial Estate, 1967, Prentice Hall, New York.
6. Goyle, L C: Statutory Remedies for Oppression & Mismanagement in Companies, 1990, Eastern Law House, New Delhi.
7. Koontz, et. al., Management, 1983, McGraw Hill International, New Delhi.
8. Landsbrough, Industrial Management, 1955, Asia Publishing House, Bombay.
9. Ramaiya, A: Guide to the Companies Act, 1995, Wadhwa & Co., Nagpur.
10. Sen, S C: The New Frontiers of Company Law, 1971, Eastern Law House, Calcutta.
11. Schmitthoff (ed), Palmer's Company Law, 1982, Stevens, London.
12. Wright, D, Touche Ross, Rights & Duties of Directors, 1986, Butterworths, London.

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 Master in Business Laws

Corporate Law

Course No: III

Module No: IV

Company Law and Secretarial Functions

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in

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Materials Prepared by :
Ms. Sudha Peri
Dr. N. L. Mitra

Materials Checked by :
Dr. P. C. Bedwa
Ms. Archana Kaul

Materials Edited by :
Mr. V. S. Mallar
Mr. T. Devidas

© National Law School of India University

Published by :
Distance Education Department
National Law School of India University
Post Bag No. 7201
Nagarbhavi, Bangalore - 560 072

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 INSTRUCTIONS
In our second module on corporate law we have seen that one of the basic attributes of a company
is that it is a ‘legal person’ with an existence which is separate and distinct from those who were
instrumental in forming the company. A ‘legal person’ is one who is recognized by law as having
certain rights and imposed with certain liabilities. In most major matters the law does not treat a
legal person any differently from a natural person. Though, a legal person has a status which is
more or less on par with that of a natural person, there is one area where it differs from a natural
person. A natural person can conduct all his business on his own - he does not have to depend
much on other persons to do something for him. But a ‘legal person; being a creation of judicial
imagination is unable to act or think on its own. Although the consequences of the acts [be they
advantageous or disadvantageous] are attributed to the company - the act itself has to be done by
the natural person. So a legal person acts vide the agency of human beings.
The natural person acting on behalf of a company come under various categories, namely
shareholders (who act as financiers), workers, employers, technicians, administrative staff and the
management. The smooth and efficient running of a company is dependent upon the amount of
cohesion and cooperation amongst these various categories of human beings. The more all of
them are involved in the working of the company, better would be the results. To achieve this
cooperation and cohesion - the Companies Act has made provisions to see that every person in the
‘company family’ is kept informed of the various developments within the company by holding
meetings at regular intervals and whenever needed. So we have, meetings of the shareholders, of
the creditors, of the board of directors, of their committees etc., where relevant information is
given, necessary proposals put forward, debated upon, voted and passed in the form of resolution,
and further action taken on those resolutions through allocation of powers and responsibilities and
appropriating accountability. In short, one may say that majority of the policies of company business
are conducted through these meetings.
In this module we are discussing the responsibility of the company official, known as Secretary,
who co-ordinates all such corporate decision making bodies; helps in supplying all necessary
information; passes on the relevant policy formulated to appropriate management authority to
functionalize those decisions and builds up linkages of various stages of management bodies and
finally prepares reports and returns and submits the same to appropriate authorities. Secretary is
the person who heads the accounting and legal decision in a company. In fact an author makes an
analogy between the ‘heart’ of a human body and the function of the office secretary. Several
routine functions of the Secretary are included in this module with appropriate annexures. You
will benefit if you read some basic book on ‘Company Secretary’ along with this module in order
to properly appreciate the key functions of this officer.

N. L. MITRA
Course Co-ordinator

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 COMPANY LAW AND SECRETARIAL FUNCTIONS

TOPICS

1. Introduction ........................................................................................................................ 173

2. Company Secretary ........................................................................................................... 174

3. Meetings .............................................................................................................................. 180

4. Reports, Applications, Approvals ...................................................................................... 201

5. Checklist of important functions ....................................................................................... 211

6. Case Laws ............................................................................................................................ 215

7. Problems ............................................................................................................................. 218

8. Supplimentary Readings ................................................................................................... 219

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1 INTRODUCTION
Overs the years in company law the procedural matters have
become extensively important. This is because of domination
of positive structure of law in company matters. Regulations,
rules, orders, guidelines dominate the whole working
environment of the corporate sector. The procedural matters
have become so complicated that a professional secretary for
the company became inevitable. The Companies Act therefore
had to be amended to incorporate the compulsory appointment
of a professional secretary in order to oversee the administrative
set up and take care of the regulatory mechanism. A company
secretary plays a key role in the corporate administration. He is
placed in a staff authority relationship with the board of directors
of the company. In many of the companies he is the chief of the
finance division as well. He is responsible for the detailed
functioning of the secretariat. A company generates the systems
of reporting and accountability. Some are for in-house
consumption and some are required to be disclosed to the public.
The corporate functioning is mostly composed of H planning G
a plural policy making board and execution of a singular top
executive with his team of professional managers. The
Secretariat of the company functions as heart of the company
pumping its resources to various limbs with adequate
communication of instructions and guidance. The following
diagram presents the importance of the secretariat and secretarial
functioning:

General
Meeting

BOARD Governmental
Capital Market
Regulation
Regulation

Top Executive Company

HRD HRD
Managing Secretary
Committee Director
Director
Secretariat

Marketing Company
Management Auditor

Middle
Management

Lower Level Finance

Management Committee

Therefore it is quite evident that policies are laid down in
meetings in the form of resolutions. The chief executive prepares
instructions for the execution of the policies and the secretariat
ensures that the company adheres to the governmental rules,
regulations, guidelines and orders. Therefore the secretariat
has two types of functioning, namely, co-ordinates the internal
information system between various functionaries of the
company and see only between the company and outsider
including the governmental agencies. This module therefore
incorporates various types of meetings of different organism of
the company, different types of resolutions and the business
transacted in various systems of resolutions and various types
of reports that are considered in the meetings of various organis
and submitted to various authorities.

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2. COMPANY SECRETARY
SUB TOPICS
2.1. Introduction
2.2. Definition
2.3. Qualifications, Appointments and Removal
2.4. Rights of a Secretary
2.5. Duties and Liabilities
2.6. Legal Status
2.1 INTRODUCTION
In the present age of mega industries with extensive business
operations the majority of a company's work is done through
meetings. A meeting cannot be arranged at the drop of a hat. A
lot of spade work has to be done before a company meeting can
be conducted or held. The question thus arises, who is the person
who is responsible for getting this work done? Who sees to the
paper drafting, circulation of notices? Who checks the quorum?
Who takes down the minutes? Who files the copies of the
minutes, etc., with the Registrar? All these seemingly
unimportant functions alongwith a myriad other functions are
all performed by one of the most important officers in the
company, known as the 'company secretary'.
2.2 DEFINITION
The term 'secretary' owes its origin to the Latin word
"secretarius" meaning a "confidential officer". Thus the use of
secretaries has been prevalent since the ancient past. In fact,
even in those days any organization worth its name had a
secretary. For example, in ancient Rome a secretary had an
important say in the affairs of the State, and besides writing for
his masters or maintaining their accounts, a secretary also acted
as a historian. It has been said that the profession of secretary is
one of the oldest in the world, and that wherever there was a
man of action, there too was a man of the pen to record his
deeds. Much of our knowledge of ancient times is derived from
the Scribes, who were the secretaries of their day." [Kapoor,
p.42]. The Oxford Dictionary defines the word secretary as a
person" whose office it is to write for another; especially one
who is employed to conduct correspondence, to keep records
and to transact various other business for another person or for
a society, corporation or public body."
The question now arises, who is a company secretary? Section
2(45) of the Act states that, "secretary means a company
secretary within the meaning of clause (c) of sub-section (1) of
section 2 of the Company Secretary Act, 1980, and includes
any other individual possessing the prescribed qualifications
and appointed to perform the duties which may be performed
by a secretary under this Act and any other ministerial or
administrative duties." Further, section 2(45-A) provides,
"secretary in whole-time practice" means a secretary who shall
be deemed to be in practice within the meaning of sub-section
(2) of section 2 of the Company Secretaries Act, 1980 and who
is not in full-time employment.
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The original definition of the secretary stated that, "secretary
means any person, if any, who is appointed to perform the duties
which may be performed by a secretary under this Act". This
definition (i) excluded the firms and body corporates from the
office of the secretary, and (ii) the duties of the secretary were
not specified.
The present definition under the Amendment Act, 1988 drops
the word "purely" before the words ministerial or administrative
duties" so as to enlarge the scope of the functions of the secretary.
The present definition specifies three thing namely:
1. An individual alone can be appointed as a secretary of a
company and a firm or a body corporate cannot be appointed
as a secretary.
2. The company secretary should now possess prescribed
qualifications. Under the previous Act no specific
qualifications were laid down under the law. The Central
Government now, under the Company (Secretary
Qualification) Rules 1975 has laid down that a person to be
qualified as a Secretary should possess the membership of
the Institute of Company Secretaries of India.
3. The duties of the secretary are purely ministerial or
administrative duties. They are not executive or managerial
though limited managerial powers may be delegated by the
board.
The duties of the secretary are sometimes laid down by the board
of directors and sometimes defined by the articles of association.
But the board cannot alter the duties of the secretary as
determined by the law. Besides, the general duties imposed by
the board or the articles, the secretary has to perform a number
of statutory duties.
It should be noted that the present definition has been further
amended by the Amendment Act, 1988 so as to bring the
definition under Section 2(45) of the Act in line with the
definition of the "Company Secretary" contained in the
Company Secretaries Act, 1980. According to Section 2(1)(c)
of the Company Secretaries Act, 1980, "Company Secretary"
means a person who is a member of the Institute of Company
Secretaries of India constituted under the Act.
The Companies (Amendment) Act, 1974, under Section 383A
laid down that, every company having a paid-up share capital
of not less than Rs.25 lakhs shall have a whole time secretary
and where the Board of Directors of any such company
comprises of only two directors, neither of them shall be the
secretary of the company." Under the Amendment Act of 1988,
the limit of paid-up share capital of rupees twenty five lakhs has
been deleted and is provided that the said amount shall be such
as may be prescribed by the Central Government. Other
companies whether public or private whose paid-up share capital
is less than the amount so prescribed need not appoint a whole
time secretary.
It should be noted that the Companies (Amendment) Act, 1988
provides that only an individual can be appointed as the company
secretary as was provided under old Amendment Act, 1974.
Secondly, a company secretary must possess qualifications as
prescribed by the Central Government.
The Act further provides that a company can appoint a secretary
with 'limited executive powers of management' delegated by
the Board of Directors in addition to his routine duties. If the
secretary is entrusted with routine duties he is called "Routine
Secretary" while he will be termed as "Executive Secretary" if
he is entrusted with limited executive managerial powers. It
should be remembered that in practice, the secretary will be the
manager of the company when he is delegated with general
managerial powers. In case, he acts as a director he may be the
Managing Director in the eyes of the Company Act, [Acharya,
pp.2-3].
2.3 QUALIFICATIONS, APPOINTMENT AND
REMOVAL
A] Qualifications
A company secretary must possess the following qualifications
as per the Companies (Appointment & Qualification of
Secretary) Rules, 1988:
i) If the paid-up share capital of the company is Rs.50 lakhs
or more the company has to appoint a whole-time secretary,
the person to be appointed as a secretary must be a member
of the Institute of Company Secretaries of India [S. 383A].
Accoriding to S. 383A any idnvidual holding office of
Secretary in more than one company having a sharecapital
of Rs.25 lakhs or more must vacate the office of Secretary
in all other companies excepting one to which he selects to
act as the secretary. Therefore if one reads Sec. 383A with
Rule 2(3) of the above Rules, it may be concluded tht a
company having share-capital worth Rs.25 lakhs and more
upto 50 lakhs shall appoint only whole time secretary with
the qualification as prescribed under Rule 2(4) stated below.
And a company having less than Rs.25 lakhs worth of
sharecapital can have a part time secretary but with
qualification as stipulated in Rule 2(4).
If the paid-up share capital of the company is less than Rs.50
lakhs, the company may appoint any individual as a whole time
secretary provided he has atleast one of the following
qualifications, viz:
i) membership of the institute of Company Secretaries of India
constituted under the Company Secretaries Act, 1980, or
ii) passed the Intermediate examination conducted either by
the earlier or present Institute of Company Secretaries of
India, or
iii) M. Com. or post-graduate in company secretaryship from a
recognized university; or
iv) LL.B. from any university; or
v) membership of the Institute of Chartered Accountants of
India, or
vi) membership of the Institute of Cost and Work Accountants
of India; or
vii) post-graduate diploma or degree in management from either
a university or one of the IIM's in Ahmedabad, Bangalore,
Calcutta or Lucknow, or
viii)post-graduate diploma in company law and secretarial
practice from Udaipur University, or
ix) post-graduate diploma in company secretaryship from
Institute of Commercial Practice, Delhi Administration or
diploma in corporate laws and management from Indian
Law Institute, New Delhi, or
x) membership of the Association of Secretaries and Managers,
Calcutta.
The proviso to this section states that, the moment the paid up
share capital of the company increases to Rs.25 lakhs or more,
the company should comply with provisions of Rule 2(1) and
(2), within a year of such increase. These rules do not apply to
those persons who have been in service as a whole time secretary
immediately before 30.10.1980.
Apart from these prescribed qualifications, it is desirable for a
company secretary to possess certain other general
qualifications, namely:
a) A general education of moderately high standard, with a
proficiency in English and the vernacular in use.
b) A thorough knowledge of Taxation Laws, Accountancy and
Company Law and sufficient knowledge of the basic
principles of management, manpower planning etc.
c) He must have a good knowledge of office management and
administration.
d) He should possess a pleasing personality, since he forms a
link between the management and employees and
management and third parties etc. He should be able to
communicate and cooperate with all kinds of people.
e) He should have atleast a working knowledge of the technical
side of his employer's business.
To put it briefly, "Attention, application, accuracy, method,
punctuality and despatch are the principal qualities required for
the efficient conduct of business of any sort." (Chakraborti, et.al.,
p.17].
B] Appointment
The first secretary of the company is appointed by the promoters
at the pre-incorporation stage, in the same manner as the first
directors are appointed. Such a secretary is generally called as
the pro-tem secretary, and he holds office till the incorporation
of the company or appointment of a regular secretary. The
regular company secretary is appointed by the board of directors
in their first meeting. Even if the person to be appointed as
secretary is mentioned in the articles, he cannot take charge till
his appointment is confirmed by the board, and a contract of
service finalized between the company and the secretary.
The Companies (Amendment) Act, 1974 prohibited
appointment of firm or body corporate to be the secretary of a
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company. According to Sec. 383A(2a) firm or body corporate
holding the office of a secretary had to vacate the office within
six months from the commencement of the Amended Act.
Therefore, only individuals can be appointed as secretary of a
company, i.e., unlike membership in a company which can be
acquired by an association, firm or incorporated body, the post
of a secretary is reserved only for natural persons and legal
persons can neither aspire nor be appointed as a secretary.
A director of a Company can be appointed as a secretary,
provided he discloses his interests and does not participate in
the discussion or subsequent voting on the motion 'appointing
him as secretary' (Sections 297-299). In cases, where the director
or his relative is to be appointed as a secretary, the appointment
can only be through a special resolution passed in a General
Meeting. The terms and conditions of service of a secretary are
also fixed up in the board meeting. Where however, only two
directors are there, then, neither can be appointed as a secretary
[383A(1)].
The procedure for appointment is broadly as follows:
a] Passing of a resolution by the board of directors [in case
the person proposed to be appointed is not a director of the
company or a relative of such director].
b] Contract of service to be executed between the company
and the secretary.
c] The appointment to be recorded in the relevant register.
d] A return in duplicate in Form No.32 to be filed with the
Register within 30 days of appointment.
C] Removal
Since the Secretary is an employee of the company, he can be
removed from service or dismissed from office under the general
law governing the employer-employee relationship. In general,
the power of removal is given to the authority having the power
of appointment i.e., in this case the board of directors has the
authority/power to remove a secretary from service. A secretary
may be removed from service on any of the following grounds,
viz:
a) when the time period for his service elapses; or
b) when he has been given a proper notice for dismissal as
required under the contract due to
i) making a secret profit; or
ii) being convicted of an offence involving moral
turpitude on his part, for ex., fraud, negligence, etc.
Before being removed from service, the principles of natural
justice should be followed, i.e., ( i) he should be given a notice
and (ii) he should be given an opportunity to be heard, if the
contract requires that a notice of specified period (say 3 months)
should be given before he can be removed, then such a notice
should be given before removing from service. A notice can be
dispensed with, where the secretary has acted in a manner
justifying his instant dismissal, for example, when he is guilty
of misconduct, wilful disobedience, fraud, negligence or other
acts of misfeasance of substantial magnitude. Even when the
secretary is struck by permanent disability either mental or
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physical leaving him incapacitated, he can be instantly dismissed.
Where the power of dismissal is given to the board, removal by
the managing director on his own initiative is bad [Haryana
Seeds Devp. Corp. Ltd. v. J.K.Aggarwal, (1989) 65 Com.
Cas. 95 (P & H)].
2.4 RIGHTS
A company secretary enjoys rights both under the statute and
under his contract. Some of these rights are as follows:
a) He has the right to supervise and control the secretarial
department of a company.
b) He has the right to sign all documents which require an
authentication by the company.
c) He has a right to claim remuneration for his services, and in
case of wrongful dismissal he can also claim damages for
the same.
d) The board of directors have the authority to delegate some
of their powers to the secretary. In case of such delegation,
the secretary has the right to exercise the powers of the
board to the extent of delegation.
e) Being the principal officer of the company, he has the right
to keep the common seal of the company in his possession
and to use the seal whenever needed.
But these rights of a secretary are restricted. A secretary thus
does not have the following rights, viz:
i) He cannot represent the company or enter into any
contract on behalf of the company unless authorized
to do so.
ii) He has no right to either allot shares or register a
transfer of shares unless so authorized by the directors.
iii) He has neither the right to borrow money nor lend
money on behalf of the company.
2.5 DUTIES AND LIABILITIES
a] Duties
A secretary has duties both under the statute and those arising
from a contract, apart from certain general duties of ministerial
or administrative nature which attach to him because of his
position as a secretary.
Statutory Duties
a) Companies Act: He is responsible for proper maintenance
of books and registers; issue of notice, preparation and
authentication of agendas, resolutions and minutes of the
meeting; filing of relevant documents with the Registrar,
supervising the issue, allotment, transfer and registration
of shares, custody and use of common seal, etc.
b) Income Tax Act: He is responsible for the deduction of
the requisite income tax from dividends and salaries, timely
filing of returns, issual of income-tax paid certificate to every
employee/shareholder.
c) Indian Stamp Act: He is responsible to see that all legal
documents bear adequate stamp as required under this Act,
or under any other relevant statute.
d) Sales Tax Act: He is responsible in ensuring the timely
submission of tax-returns to the authority.
e) Other Acts: He is responsible to ensure the compliance
with all regulations under any other Act (for ex: FERA,
MRTP, etc) and which may apply to his company. He should
also see to the compliance of various labour legislation
regulations for example, Minimum Wages Act, Workman's
Compensation Act, Factories Act, etc.
General Duties
Agent to Director: Under law, a company secretary being under
total control of the board is an agent of the directors, and as
such must carry on their instructions to the full (since his acts
would impute to the directors). He can exercise only such powers
as have been specifically delegated to him by the board. He
may sometimes act in an advisory capacity to the board especially
on administrative or ministerial matters.
Duties towards Shareholders: Despite being for all practical
purposes an agent to the directors, a secretary is expected to act
in the best interests of the shareholders and to safeguard their
interests amongst themselves as well as vis-a-vis the company.
This duty is imposed on him because of two possible reasons:
(i) he is an officer of the company and as such is obliged to act
in the best interests of the company and shareholders; and (ii)
the directors being in a fiduciary duty vis-a-vis the shareholders
and he being an agent of the directors the fiduciary duty is also
passed on to him. Being the primary link between the board
and the shareholders, he keeps them informed of the board
decisions, and also passes on their complaints, grievances etc.,
to the board. He is also responsible for circulating notices,
convening and conducting meetings, maintaining records, issuing
'call' letters, registering allotment/transfer of shares, supplying
information and document copies if so required, payment of
dividends etc.
Liaison Officer: He is the person who acts as a liasion or link
between the board, employees, all the shareholders and the
outsiders and is the main source of information for each of these
groups i.e., he is the person who keeps each category informed
about the activities or problems etc., of the remaining. This
liasioning may be done by him either orally or by means of
circulating letters, notices etc., or by use of mass media i.e.,
through advertisements etc.
Office Executive: Being the chief administrative head of the
company, he is responsible for organizing, supervising and
controlling/co-ordinating the office work for which he is directly
responsible to the M.D. and the board. His duties include,
correspondence, filing, accounting, taxation, registration etc.,
and in case there are different departments/personnel dealing
with each one of these, he is required to coordinate with each
one of these for a smooth and efficient functioning.
Duties vis-a-vis Stock Exchange: It is essential for a public
company to have its shares listed in at least one stock exchange.
This listing essentially requires that the stock exchange should
be fed with some relevant and upto date information and it is
the duty of the secretary to supply them with this information.
Even before that, being the person who deals with important
correspondence, it is he who would have to apply to the stock
exchanges to seek their permission for listing the shares of his
company at their exchange.
In general, a secretary's duties are largely of ministerial or
administrative in nature and he does not have the power to
negotiate contracts, borrow money or make policy decisions, or
acknowledge a debt/liability on behalf of the company [Lakshmi
Rattan Cotton Mills Co. Ltd. v. Aluminium Corporation of
India Ltd., [(1967)37 Comp Cas 586 (All)].
The functions of the secretary of a company have considerably
expanded during the past eighty and more years. He is no more
a mere clerk or servant as was stated in several decisions of the
English Courts such as Barnett Hoares and Co. v. South
London Tramways Company, [(1887) 18 QBD 815 (CA)];
George Whitechurch Ltd. v. Cavanagh, [1902 AC 117];
K.A.Krishnan v. Indo Union Assurance Co. Ltd., [(1944) 14
Com Cases 10 (Mad)]. Short of managerial functions his powers
and duties extend to the whole field of administration of the
affairs of the company, so that an outsider dealing with him may
assume that functions and duties other than managerial, are
normally within the ambit of the secretary's powers unless there
are circumstances to show that they are limited in respect of
particular matters." HALSBURY'S LAWS OF ENGLAND,
paras 540-548 (4th Edn., Vol.7).
In England the duties of secretary are thus described: The duties
of the secretary will depend on the size and nature of the company
and of the arrangement made with him. But in any case he will
be present at all meetings of the company and of the directors
and will take proper minutes of proceedings, he will issue under
the direction of the Board all notices to members and others
that may be requisite; he will conduct all correspondence with
shareholders in regard to calls, transfers, forfeiture and otherwise,
and will keep the books of the company or such of them as
relate to the internal business thereof, e.g., the register of
members, the share-ledger, the transfer book, the register of
mortgages, etc. He will also make all necessary returns to the
Registrar of Companies” (PALMER'S COMPANY GUIDE,
122-123 (36th Edn.).
The company secretary performs many of the administrative
duties imposed upon companies, such as delivering documents
to the Registrar of Companies and engaging office staff. In
Maidstone Buildings Provisions Ltd. Re, (1971)1 WLR 1085:
(1971)3 All ER 363, PENNYCUICK V C said: 'So far as the
position of a secretary as such is concerned, it is established
beyond all question that a secretary, while merely performing
the duties appropriate to the office of secretary, is not concerned
in the management of the company. Equally I think he is not
concerned in carrying on the business of the company. On the
other hand, it is equally well established, indeed it is obvious,
that a person who holds the office of secretary may in some
other capacity be concerned in the management of the company's
business.[Ramaiya, p.50]
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B. Liabilities
Once again the liabilities of a secretary can be studied under
two headings, namely, statutory and contractual.
Statutory Liabilities
Being the Chief administrative head of a company, a secretary
of the company has certain liabilities imposed on him under the
various sections of the Act. Briefly he made be liable for the
following acts or omissions, viz:
a) Default in filing and circulating of Statutory Report or in
holding the Statutory Meeting.
b) Default in holding Annual General Meeting.
c) Default in circulating member's resolution's, due notice of
which has been given.
d) Failure to submit to the Registrar relevant documents [like
copy of balance sheet; annual returns etc] as per the
requirements of the Act.
e) Failure to duly notify a board meeting.
f) Failure to file certain resolutions and agreements with the
Registrar.
g) Failure to take down or file the minutes of meetings, or in
allowing inspection of the minutes book when requested.
h) Failure to have the name and address of the registered office
of the company painted or affixed outside every office/place
of business, or failure to have the company name engraved
on the common seal or printed on the letterheads etc.
Contractual Liabilities
This as the name itself indicates arise by virtue of his contract
of service with the company. But these liabilities can be broadly
categorized as under:
i) Being the agent of the directors' he is responsible for the
proper discharge of his duties and exercise of power-in case
of failure to do so he becomes liable to them.
ii) He is liable if he leaks out confidential information however
inadvertantly, except where such a leak is warranted in the
proper exercise of his duties.
iii) In case the company suffers any loss or damage due to his
acting beyond his authority, then he becomes personally
liable for such loss or damage.
iv) In performance of his duties he is expected to exercise
reasonable care and skill, and failure to do so or the negligent
performance of duty would render him personally liable
for any loss occasioned by such conduct.
v) He is liable to account for any secret profits made by him in
course of duty.
vi) In case of misfeasance, like fraud, then he becomes
personally liable alongwith the company vis-a-vis the
aggrieved party who can sue him instead of the company.
But if he has acted innocently and within the scope of his
authority he also has the right to be indemnified by the
company, whenever such third party sues him. Further, the
secretary cannot be made personally liable for a fraud
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committed by his assistant etc., unless he was also a party
to such a fraud.
2.6 LEGAL STATUS OF A SECRETARY
The secretary is only a subordinate officer and he has no
managerial functions. He performs such functions and exercises
such powers as the Board may delegate to him, and these powers
may be extensive or limited according to the terms of
appointment in each case, and there is nothing to prevent their
being extended to the sphere of managerial functions also. But
no one entering into contractual relations with the company can
assume without further enquiry that the secretary as such, has
authority to make representations or do anything binding on the
company. Barnett Hoares and Co. v, South London
Tramways Co., [(1887) 18 QBD 815].
This view, however, has been modified in Panorama
Developments (Guildford) Ltd. v. Fidelis Furnishing Fabrics
Ltd., [(1971) 3 All ER 16 (CA)], by the Court of Appeal where
LORD DENNING M.R.,t Petiti thus describes the present
position of the company secretary: Times have changed, a
company secretary is a much more important person nowadays
than he was in 1887. He is an officer of the company with
extensive duties and responsibilities. This appears not only in
modern Companies Act, but also by the role which he plays in
the day-to-day business of the companies. He is no longer a
mere clerk. He regularly makes representations on behalf of
the company and enters into contracts on its behalf which come
within the day-to-day running of the company's business. So
much so he may be regarded as having been held out as having
authority to do such things on behalf of the company. He is
certainly entitled to sign contracts in the administrative side of
the company's affairs, such as employing staff and ordering cars
and so forth. All such matters now come within the ostensible
authority of a company secretary.” SALMON,J. has concurred
in this judgement and emphasized that the secretary is the chief
administrative officer of the company and in respect of matters
concerned with administration he has ostensible authority to sign
contracts and do all things within the ambit of administration.
Even in the light of this decision it cannot be assumed, in the
absence of facts or special circumstances in any case, that the
powers of a secretary have expanded to any extent over the area
of managerial functions. Functionally, a secretary as such can
only being secretarial duties and exercising secretarial powers.
He cannot be equated with a manager whose powers and
functions are distinct from those of secretary as understood by
the business world. It may be noted that his remunerations not
taken into account for purposes of calculating overall managerial
remuneration under section 198.
Though a secretary as such has limited powers, there is nothing
in the Act to prevent a company entrusting him with wider powers
and responsibilities. If managerial powers are given to him and
they extend to the management of the whole affairs of the
company,the secretary though called by that name, will really
be the manager or if he is also a director, the managing director
or whole-time director for purposes of this Act.
Under the scheme of the Act, it would be seen that where a
company appoints a secretary, it is his duty and responsibility
to see that the affairs of the company are conducted in accordance
with law and the requirements of the Company Act and other
laws (tax laws, factory laws, etc.), are duly complied with.
Accordingly in all cases where for contravention of any law by
the company, an officer of the company is punishable as an
officer in default, the secretary will be liable. See Section 5(d).
His true legal position is that he is an agent in the same position
as any other agent of the company. If his dealings are such that
the company is not bound by them, he may himself be liable as
in the case of a director (as regards this see Notes under sections
291 and 293) on the ground of breach of warranty of authority.
If he does any unauthorized acts or makes unauthorized
representations the company is not bound by them).
Although the secretary of a company is treated for civil purposes
as a mere administrative assistant of the Board with a very limited
authority to engage in transactions on the company's behalf,
statutes creating new criminal offences often make him
responsible for the company's crimes to the same extent as the
directors. In this respect criminal law is more in accordance
with reality, because the secretary is often a full-time director as
well, and he may be as influential in managing the company's
affairs as his fellow directors.
Illustrative cases of a Secretary's role: Certain English cases
have considered different aspects of a secretary's role; these cases
are being set out below:
i) The knowledge of directors is in the ordinary circumstances
the knowledge of the company, but the knowledge of a mere
official such as the secretary, would only, be the knowledge
of the company if the thing of which the knowledge is
secured is a thing within the ordinary domain of the
secretary's duties. Houghton and Co. v. Nothard, Lowe
and Wills Ltd. [(1927) All ER Rep 97 (HL)].
ii) The secretary is not liable or accountable, as the directors
are, for loss which may be incurred by the company by
reason of any mis-application of funds of the company even
with his knowledge unless the said mis-application was due
to his own fraud or negligence. (Joint Stock Discount
Company v. Brown, [(1866) LR e Eq 139].
iii) The offices of a director and secretary are so incompatible
that one and the same person cannot hold both. (Boschoek
Proprietary Ltd. v. Fuke, [(1906) 1 Ch 148)].
iv) Where the same person is the secretary of two companies,
knowledge acquired by him for one company is not notice
to the other. Fenwick, Stobart and Company [1902 1 Ch
507].
v) If the acts of the secretary are done within the scope of his
authority, it has been laid down that the principal (i.e., the
company) is liable for the fraud of the secretary acting within
the scope of his authority whether the fraud is committed
for the benefit of the principal or for the benefit of the agent.
[Lloyd v. Grace Smith and Co., (1912) AC 716 (HL)]
[Ramaiya, pp. 52-53].
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3. MEETINGS
SUB-TOPICS
3.1. Introduction
3.2. Nature of Meetings
3.3. Kinds of Meetings
3.4. Notice for Convening Meetings
3.5. Chairman
3.6. Quorum
3.7. Agenda, Resolutions, and Minutes
3.8. Motions and Amendments
3.9. Voting
3.10. Adjournment and Dispersal
3.11. Conclusion
3.1 INTRODUCTION
Meetings are the best example of 'democratic functioning' within
a society. We have come to a stage where very rarely in an
institution is a decision reached without a meeting of all the
concerned persons being called, wherein the relevant matter is
discussed. A stage is now reached where even within families,
decisions are reached only after a meeting is held between the
concerned persons. To put it succinctly, 'meetings have come
to stay'.
There are various kinds of meetings presently in vogue - from
legislative assemblies, municipal councils etc. i.e., meetings of
the elected representatives of the people to meetings of group
(for example meetings of NGOs working in the field of 'child
labour', to meetings between two or more individuals. To
differentiate between various kinds of meetings we have come
up with a varied nomenclature and we now call them as,
conferences, seminars, summits, convocations, congregations,
get-togethers, congress, assembly, gathering etc., each implying
'a coming together of various people for a specific purpose'.
Just as we have various kinds of meetings, we have various kinds
of people participating in these meetings from school going
children to the Chairman and Managing Director of a company
to the members of Parliament/Legislative Assemblies -
depending on the venue and purpose of the meeting; which also
decides the issues to be dealt within that particular meeting.
The history of 'meetings' in their present form can be traced
back to the reign of King Henry VIII, when Thomas Cromwell
transferred the government machinery into an administrative
set up, where departments functioned in conjunction with the
royal power. Each morning a meeting used to be held at the
'Board of the Green Cloth' to exercise budget supervision and
control over expenses of the various government departments.
Then, in Queen Elizabeth I's reign the parliamentary debate
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format of meeting was evolved, which forms the basis of modern
day meetings. The parliamentary mode of meetings has been
adapted to suit the general needs and conveniences of everyday
meetings.
Broadly speaking, a meeting can fall in any one of the following
categories:
a) Formal Meeting:- Which is convened either under a statute
or by a person in authority, usually presiding over an
institution (ex: a parent-teacher meeting in a school). Such
meetings are governed by the rules and regulations given
under the statute or under the bye-laws of the institution.
b) Informal Meeting:- Which is either convened by a person
for some specific purpose (ex: a public meeting) or may
take place without any formal planning (ex: meeting between
friends). There are no set guide lines governing these
meetings.
It is possible to fit any meeting within one of these categories.
As may be guessed - meetings under Company Law are usually
formal meetings, with specific norms laid down in the Act itself.
We would now see the nature and scope of meetings under
Companies Act in detail.
3.2 NATURE OF MEETINGS
In Sharp v. Dawes [(1876)2 QBD 29] it was held, the word
'meeting' prima facie means a coming together of more than
one person. It is of course possible to show that the word
'meeting' has a meaning different from the ordinary meaning
but there is nothing here to show this is be the case..." This case
established a fundamental rule relating to meetings i.e., it
required the coming together of atleast two persons. But like
every rule, even this has an exception. Thus, in East v. Bennet
Bros. Ltd. [(1911)1 Ch. 163], all the preference shares of a
company were held by one single person. A meeting of
preference shareholders was attended by him alone. It was held
that the meeting was proper. For the purposes of this module, a
proper definition would be, ordinarily an assembly of two or
more persons, properly convened and constituted, coming
together for discussion of defined topics, the transaction of
business of a common interest or some other lawful purpose,
and presided over by a properly appointed Chairman [Taggart,
p.111]. The act itself does not define the term ‘meeting' as such.
3.3 KINDS OF MEETINGS
There are various kinds of meetings dealt with under the Act.
These meetings of various interest groups are shown in the
following diagram grouped around the Company Secretary
because he is the person who has to see that the meeting is held
properly and also has to keep the records.
 Annual General
Meeting Extraordinary
S. 166 General Meeting

Statutory
Meeting
Convened Requisition
S. 165
by CLB Meeting
S. 186 S. 169

Share
holders'
Other Meeting
Preference
Class
Shareholders'
Meetings
Meeting

Debenture
Creditors'
Holders'
Company Meeting
Meeting
Secretary

Employer- Committee
Workers' Meetings
Meeting Board of
Director's
Meetings

NOTE: An important point to be remembered is that though all these various kinds of meetings are called under the statute [i.e.,
Companies Act] it is only one meeting which is called as 'statutory meeting' as such. The remaining kinds of meetings are called
by different names. We will now discuss each of these meetings in detail.

Shareholders Meetings
1) Statutory Meeting
Section 165(1) states that, every company limited by shares,
and every company limited by guarantee and having a share
capital, shall, within a period of not less than one month and not
more than six months from the date at which the company is
entitled to commence business, hold a general meeting of the
meeting of the members of the company, which shall be called
"the statutory meeting".
For this meeting to be fruitful, the shareholders or members
should have all the relevant information relating to the company
on hand. For this purpose, section 165(2) provides that, the
directors should send to every member a detailed report known
as statutory report” atleast 21 days before the day of the meeting.
This report must be certified by atleast two directors one of
them being the managing director and the auditors, for purpose
of verifying that the contents of the report are true to their best
knowledge.
A copy of this report is also to be sent to the Registrar, and a
default in filing of the report or holding of the meeting makes
the company and the responsible person(s) liable to a fine which
may extend to Rs.500/- (sections 165(9)]. A delay in sending
the report to the shareholders can however be condoned by the
unanimous vote of all members present and voting.
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The importance of 'statutory meeting' cannot be better stated
than in the words of Palmer, The obvious purpose of a statutory
meeting with its preliminary report is to put the shareholders of
the company in possession of all the important facts relating to
the new company, what shares have been taken up, what money
received, what contracts entered into, what sums spent on
preliminary expenses, etc. Furnished with these particulars the
shareholders are to have an opportunity of meeting and
discussing the whole situation, the management, methods and
prospects of the company. [Palmer, Pp.455-456]. Holding of a
statutory meeting is in fact held to be of such paramount
importance that failure to hold the meeting may be a ground for
the court to order compulsory winding up under section 433(b).
Since the basic purpose of this meeting is to keep shareholders
informed - the provisions of section 165 do not apply to private
companies [section 165(10)].
2) Annual General Meeting
Section 166(1) states that, every company shall in each year
hold in addition to any other meetings a general meeting as its
annual general meeting and shall specify the meeting as such in
the notices calling it; and not more than fifteen months shall
elapse between the date of one annual general meeting of a
company and that of the next.”
There are two provisions to this sub-section, the first saying
that, if the first annual general meeting (or AGM) is held within
18 months of incorporation it shall not be necessary for the
company to hold any other AGM in the year of incorporation or
the next year. Thus, for example, a company is incorporated in
May 1994. If its first AGM is held within 18 months i.e., say in
September 1995 then no other general meeting will be necessary
either for 1994 or 1995. The second proviso, says that in special
circumstances the Registrar may extend the time for an AGM
to be held by 3 months provided it is not the first AGM.
Two consequences follow the failure of not holding an AGM.
Firstly, the CLB can order the holding of an AGM on an
application made to it by any member under Section 167 of the
Act. While making such an order the CLB can pass any other
consequential or ancillary order or directions, in relation to the
calling/conduct of the meeting. A meeting called in accordance
with the CLB directives will be deemed to be an AGM [section
167(2)]. This power to call an AGM vests exclusively in the
CLB and the Court cannot exercise it even under its inherent
powers.
Secondly, failure to call this meeting either in the regular course
or in pursuance to the CBL directives, would make the company
and every officer responsible for the default liable to a penalty
under section 168, which may extend to Rs.5000/- and in case
the default continues then Rs.250/- per day for every day of
default. The facts of Sree Meenakshi Mills Co. Ltd. v. Asst.
Registrar of Joint Stock Companies [AIR 1938 Mad 640]
provide a good illustration on this point. Here, the company
called one general meeting in December 1934, which was
adjourned to March 1935 and then held. The next AGM was
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held in February 1936. The company was prosecuted for failure
to hold a meeting in the year 1935. On behalf of the company it
was contended that an AGM was held in March 1935 and so the
prosecution was invalid. The Court held that, the meeting held
in March 1935 was the adjourned meeting of 1934. There should
be one meeting per year and as many meetings as there are years.”
The company was accordingly fined. But in Kastoor Mal
Banthiya v. State [AIR 1951 Ajm 39], a private company had
only two members the accused and his brother, both being the
directors also. The brother was critically ill during the period
when an AGM was to be called, and hence the accused did not
call an AGM. In these circumstances, failure to hold the meeting
was not held to be a wilful default and consequently the accused
was held to be not liable for a fine.
Under section 166(2), an AGM should be held during business
hours, on a working day and at the registered office of the
company or at any place within the town where the registered
office is situated. The Central Government may exempt a
company from the application of these provisions. The time for
an AGM may be fixed through the articles of the company or by
a resolution passed in the AGM, i.e., in the first AGM a
resolution may be passed fixing the time for the second AGM
and so on.
Need for an Annual General Meeting
An AGM is an important institution provided by the Act for the
protection of the shareholders rights. The present day companies
as seen in an earlier module, represent a sharp division between
ownership and control. The shareholders being the capital
investors have an interest in knowing that the persons in whom
they have vested the management and control of the company
are not misusing their authority or mismanaging the funds. An
AGM gives the shareholders a place and opportunity to review
the working of the 'management' and the 'company'. It is also
the place where some directors retire and others are elected in
their place. Theoretically atleast this is one means by which a
shareholder can exercise effective control i.e., by refusing to
re-elect a unsatisfactory director. So also the company auditors
retire at this meeting and the question of their reappointment or
replacement decided upon. The company declares its dividends
in the AGM. The Chairman of the company delivers a speech
on the occassion listing the achievements made and setbacks
suffered by the company in that year. The accounts of the
company are put before the shareholders for their information
and scrutiny and the shareholders can ask any question in relation
to such accounts. All in all, an annual general meeting is an
occassion where the investors of capital (i.e., the shareholders,
and the managers of the capital (i.e., the directors and other
officers) meet on neutral ground to review the working of the
company during the year and to form broad plans for the working
of the company in the next year. Since it provides a means by
which the arbitrary working of the management can be effectively
kept in check, the compulsion to hold the AGM once a year
cannot be done away with.
Let us now examine the situation from a practical view point. forms with names given in the form itself and forget about the
The shareholding of a modern industry is extremely widespread meeting feeling that they have done their duty. Their only interest
both in terms of the geographic area and populationwise. For a in the meeting is in the amount of dividend being declared in
major company you will find people in various parts of the the meeting and this information they can obtain sitting in their
company holding shares - the number of shares varying from homes. So they fail to see the necessity of stirring themselves
the minimum number of shares allotted [or in some cases just up to go and attend some dull meeting. In reality an AGM has
one single share] to a really sizeable chunk of the total become a routine matter with just 50-100 persons attending out
shareholding. Now let us consider an example of TELCO having of a total shareholder strength of say 3-5 thousand. The entire
its registered office in Bombay. Now consider a person A in proceeding is conducted by means of proxies - and in this manner
Hyderabad, one B in Calcutta, one C in Gauhati, one D in the faction of directors having a majority back-up are able to
Nagpur, each having 10 shares, each of face value of Rs.10. get away with all their whims and fancies in the AGM. Today,
The following figure gives a fictitious representation of some an AGM instead of being a tool in the hands of the shareholders
of the shareholders in TELCO, and let us assume that each person to be wielded for exercising control over the management, has
has not less than 5 shares and not more than 50 shares, each become a mere formality to be complied with in pursuance of
share of face value of Rs.10/-. statutory requirements and in some cases a tool in the hands of
the majority backed management to exercise their control over
Madras Jorhat the remaining management.
418 3
3) Extraordinary General Meeting
Shareholders Shareholders
According to Table A, Reg. 47, any general meeting other than
an annual general meeting will be deemed an extraordinary
Amethi Guahati general meeting. As seen earlier in the flow chart - an
18 10
extraordinary general meeting can be of three types - called by
Shareholders Shareholders
the board; on requisition, or called by the CLB. We will now
take up each one of these in detail.
Trichur Delhi a) Meeting called by the Board
15 128
TELCO Regulations 47 and 48 of Table A of the Act, give the power to
Shareholders Shareholders
AGM on
the Board to call an extraordinary general meeting whenever
1.6.1995 at
10 am in they think it is needed. It is further provided that any director or
Bombay Meerut any two members of the company can convene the meeting, if
Bombay
250 26
sufficient number of directors are not there in India to form the
Shareholders Shareholders
quorum. Though the directors have the right to convene such a
meeting they don't have the right to postpone it once it is called.
Notice specifying the time, date and place of meeting should be
Hyderabad Burdwan
given to all members required to be present and voting of the
60 11
Shareholders Shareholders meeting. When some special business is to be conducted, then a
text of the proposed business etc., should also be attached to the
notice. Once convened, the proceedings of the meeting will be
Jamshedpur Calcutta in the same manner as in an AGM.
440 100
b) Meeting convened on requisition
Shareholders Shareholders
Section 169 of the Act deals with the provisions related to the
calling of an extraordinary general meeting on requisition by
Now the question is - how many of these persons would have the members. The procedure to be followed is given below.
an interest or be in a position to go for the AGM ? A person a] A minimum number of persons holding 1/10th of the total
holding 1 share or even 10 shares will be having a weightage of voting power of the company (where there is no share
say .0001% of the total votes cast. In such a case - how can capital) are entitled to requisition a meeting, in writing and
he influence any decision taken by the Board. Further he will signed by them and addressed to the Board and deposited
incur an expense of over Rs.1000/- in merely going to the at the registered office of the company.
meeting and coming back and to naturally he would wonder b] Where shares are held jointly, the requisition should be
whether attending the meeting is worth the amount of expenses signed by all the joint owners of the shares.
and inconvenience involved ? Logically - the answer to this
c] Each requisition should deal with one matter only, if 2 or
question is 'no' and so most of the shareholders especially the
more matters are to be mentioned then they should be each
ones with minor shareholding do not attend the meeting. Now
requisitioned separately.
with every notice of a meeting a proxy form is also sent and
90% of the shareholders of the company simply fill in these
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d] The requisition itself may consist of several documents, each
signed by atleast one requisitionist.
e] The Board of Directors is required to call a meeting within
21 days of deposit of a valid requisition. In case they fail to
do so, then, the requisitionists may call for a meeting within
45 days from the date of deposit of the requisition.
f] The requisitionists can make a call for meeting in the same
manner as the Board would do, and the meeting should not
be held later than 3 months from the date of deposit of
requisition.
g] The Board is liable to recompense the requirements for any
reasonable expenses incurred by them in the calling of the
meeting as a result of the Board defaulting to do so.
h] The company can recover the above mentioned sum from
the defaulting directors.
4) Meeting convened by the CLB
When it becomes impracticable” for a company to hold a general
meeting, not being an AGM, it can approach the CLB under
Section 186. In such cases, the Board can either on its own or
on application of the directors or members order a meeting to
be called and held in accordance with its directions.
'Impracticable' means 'not practical' from a reasonable point of
view. This power to call a meeting was previously exercised by
the company court, but later transferred to the CLB vide
amendment of 1974. The manner in which the court should
proceed in such matters has been well explained In re Ruttonjee
and Company Ltd. [(1968)2 Comp. L.J. 155]. Here, the board
of directors of a company were divided into two groups, and,
each group claimed that the others were not the lawful directors.
Neither group made an attempt to requisition a meeting. An
application was made to the Court by one of the groups to order
a meeting. The Court refused, and advised them to requisition
a meeting themselves and ascertain the reaction of the other
group. Giving reasons for its refusal the court observed that
this power should be used sparingly with caution so that the
court does not become either the shareholder or a director of
the company trying to participate in the internecine squabbles
of the company. The court should interfere only when it is
convinced that the application to it has been made bonafide in
the larger interest of the company, and for the purpose of
removing a deadlock which otherwise prima facie appears to be
irremovable, and there exists proof which on the face of it atleast
shows that a meeting called in an ordinary manner would be
invalid or unfruitful.
Since the Company Law Board is now required to exercise this
function, it is logical that the CLB should also act in the above
stated manner and interfere only when genuinely required to do
so. An important point to be remembered is that in such meetings
even one member present in person or by proxy will constitute
the quorum for the meeting.
Class Meetings
These are meetings of one particular class of shareholders, as
for example, meeting of the preferential shareholders etc. The
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main objective of such meetings is to discuss and vary any rights
or obligations related to those shares. The articles of association
usually provide not only for the various classes of shares but
also the rights and liabilities attached to each class. They also
make provision of such specified shareholders of a class to hold
meetings and the quorum for such meetings as also that manner
in which these meetings can be called and conducted.
If not less than 10% of the issued shareholders of that class
object to the variations made, they may apply to the court to
have the variation cancelled [section 107], and, in cases where
such an application is made the variation shall not have effect
till the Court confirms it. Such applications have to be made
within 21 days of the resolution confirming the variation has
been passed, and may be made by such members who are
authorized in writing. The courts order is final. After a court
order is made a copy of the decision has to be forwarded to the
Registrar for his records within 15 days of receipt of order.
Board of Directors Meeting
Under section 285 of the Act, the Board of Directors should
meet atleast once in 3 months and a minimum of 4 times in a
year. This provision was introduced to ensure that the directors
met at reasonably frequent intervals and remain in constant touch
with the affairs of the company. Though a director is not obliged
to attend all the meetings of the Board, he is required to whenever
he can reasonably do so. Section 283(9) ensures the attendance
of the directors by stating that, the office of the director stands
vacated if he wilfully absents himself from three consecutive
board meetings or all meetings held within 3 months whichever
is longer, without obtaining prior leave of absence from the
Board. Further, frequent absence from the meetings may be
indicative of negligence on the director's part and may make
him liable for a penalty. The reason for this was given by the
Courts in a very early case Charitable Corporation v. Sutton
[(1742)26 ER 642] as, [I]f some persons are guilty of gross
non-attendance, and leave the management entirely to others,
they may be guilty by this means if breaches of trust are
committed by others.” The general practice however is not to
hold a director liable for things happening in his absence at the
board meeting.
Notice of board meeting has to be in writing and given to every
director who is in India. There is no prescribed format for the
notice, nor is there a specified mode of service of the notice. If
notice is not given to even one director, the meeting will be
invalid, and the business transacted in such an invalid meeting
would naturally be void. The business can be validated by
ratification in a subsequently convened regular meeting. The
notice may not specify the agenda of the meeting and even if is
specified it need not be adhered to. Unlike an AGM a board of
directors meeting is relatively informal, for example, no specified
notice period is given i.e., it is not necessary to give a 21 days
clear notice for holding a board meeting. Even a few minutes
notice is sufficient - what is required is that each director should
be informed - how long ago the information was given is
immaterial. Thus in Smith v. Paringh Mines Ltd. [(1902)2
Ch 193], there was a vacancy in the board of directors and a
meeting of the board was called to fill the vacancy. The board
consisted of only two directors T and B who was also the
Chairman. T did not attend the meeting. B went towards T's
personal office and chanced to see T in the passage outside his
office. After a few minutes talk standing there in the passage
itself, B proposed F's name for the vacancy, and T objected. B
being the Chairman gave his casting vote in favour of F and
declared F elected. T went to court claiming the election of F
was invalid. Upholding the election as valid the court observed
There is no reason why a meeting should not be held in a
passage."
But, in Barron v. Potter [(1914)1 Ch 895], with similar fact
situation the Court gave a totally opposite decision. Here, there
were only two directors P & C in a company and they were not
on speaking terms with each other. It became impertinent that
certain other persons were appointed to the Board as additional
directors to remove the impasse. P waited at the railway station
for C, and, on his alighting from the carriage proposed 3 names.
C kept silent, whereupon P gave his casting vote in favour of
the 3 persons named by him and declared them elected. C went
to court. Holding the appointment of these directors as invalid
the court observed, A director cannot have a board thrust upon
him without his consent and against his will." Leaving aside
the seeming contrariness of these decisions, what is to be noted
is that in neither case was the meeting itself held to be invalid
despite the extremely informal circumstances in which they were
held. Thus, the Act only requires that the Board should meet
regularly at specified intervals, but how it meets and where it
meets is left to the discretion of the Board members themselves.
Meeting of the Creditors
There are not company meetings in the real sense of the word,
but involve meetings in which the company calls its creditors in
order to arrive at some desired to arrangements or compromise.
Sections 391-393 deal with these kinds of meetings, where not
only is the power to compromise with creditors is given but
also the method in which such compromise can be reached is
given. Whenever Court may issue relevant directions and orders
for a meeting between the company and the creditors. If at this
meeting the proposed compromise is agreed to by a majority of
3/4th creditors present and voting, the court may sanction the
scheme and it then becomes binding on all the concerned parties.
The court order takes effect only after a certified copy of the
order is filed with the Registrar. Such copy should also be
attached to every copy of Memorandum issued after such an
order has been passed.
Meetings of Debenture Holders
Whenever a company issues debentures and appoints trustees
for them, it also provides for the holding of meetings by such
debenture holders, giving them the power to vary the terms and
conditions of the security or to vary their rights in respect of
such debentures, in certain cases; for example, in order to enable
the company to raise funds by issuing fresh debentures; to vary
rate of interest payable etc. The decision of requisite majority
is binding upon the minority.
Rules and regulations regarding the holding of meetings of such
debenture holders are mentioned either in the Trust Deed or
endorsed on the Debenture Bond, and they are binding both on
the company as well as the debenture holder. Some of the rules
relate to format of notice, length of notice, place of meeting,
Chairman, quorum, passing of resolution etc. Thus, all rules
which may be needed for conducting a valid meeting are
provided for in these rules.
Meeting in Winding-up
Whenever a company decides to go in for winding-up it may
call a meeting of its contributories (in case of members' voluntary
winding up) or its creditors (in case of creditors' voluntary
winding up). These meetings are generally held to ascertain
broadly the total value of assets of the company and the total
debts/liabilities of the company, and then to pass a special
resolution for winding up of the company. A liquidator(s) may
also be appointed at such a meeting, who on appointment takes
charge of the assets and affairs of the company and manages
them in a manner which would prove beneficial to the interests
of the company, the shareholders and the creditors. He is
required to have regard to any resolution passed by the creditors
or contributories and for this purpose he may call a general
meeting. He is also bound to call a general meeting whenever
the creditors/contributories by resolution direct or when 1/10th
in value of the creditors or contributories request him to do so
[section 460(3) and (3)(6)].
3.4 NOTICE
'Notice' as such has not been defined in the Act, but may be
loosely defined 'as a document providing information about a
specified event.' Most of the work in a company is done through
'meetings' and every meeting is preceded by a 'notice'. A meeting
held without giving a valid notice is invalid and any business
transacted at such a meeting is void. Further, if a notice is not
properly drafted or served it is invalid which in turn makes the
meeting invalid. A valid notice consists of the following essential
elements.
a) Form of notice
In general a notice convening a meeting is in writing and may
sometimes be advertised in the paper. The Act however does
not prohibit 'oral notice' from being given. In general, the bye-
laws or bye-laws of the company themselves specify the format
of a notice since the Act itself is silent. The word 'Notice' must
be written at the top proclaiming the nature of the document.
b) Contents
A notice to be valid must contain the following:
i) Nature of meeting, (ii) date, time and place of the meeting;
(iii) agenda of the meeting, (iv) any other relevant detail, (v) if
it is a notice of a 'statutory meeting' then the relevant documents
mentioned in the Act must also be annexed to the notice.
c) Notice to be signed by proper authority
In general it is the company secretary who has the common seal
in his possession and is authorized to send notices under its
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signature. In cases where there is no secretary to perform these
functions, the principal officer of the company is deemed to be
the proper/competent person to perform this job, provided he
has been so authorized by the management. A notice issued by
an incompetent person has no validity.
d) Length of notice
This is one of the most important ingredients of a notice. The
Act itself provides that a notice of 21 days should be given in
case of statutory meetings or AGM. In other cases, reasonable
time should be given. Time period is provided so that persons
receiving the notice may have the time to attend the meeting.
Where a time period is mentioned, say 21 days, then these 21
days are to be computed from the date of receipt of the notice
by the members and the notice shall be deemed to have received
by the person at the expiry of 48 hours from the time of posting.
So also the notice should be of 21 clear days i.e., the day and
date of posting should be excluded from computation. Thus, in
N.V.R. Nagappa Chettiar v. Madras Race Club [(1949)1 MLJ
662], a meeting was proposed to be held on November 7th for
which the notices were posted on 16th October. It was held
that, the notice period fell short by a day as in computing the 21
day interval the date and day of posting was to be excluded.
The notice period can be shortened by the consent of the
members. Thus under Section 171 in case of an AGM all the
members can voluntarily consent to a shorter notice period either
before or after the meeting. In case of other meetings, consent
of 95% of the paid up share capital, or consent of 95% of the
total strength of members would be necessary to validate a
reduced notice period.
e) Service of notice
Service of notice incorporates two aspects - the mode of service
and the persons to whom it should be concerned. If the articles
provide for a specific form of serving the notice, then such a
mode has to be strictly adhered to. Notice must be sent to the
registered address of the concerned person.
Notice should be sent to each and every member or person
entitled to be present at the meeting. Deliberate or willful failure
to send the notice to even one single will invalidate the notice
and the meeting. But accidental omission of service does not
invalidate the notice. This is based on the logic that the acts of
a corporation are those of the majority of the 'corporately
assembled', i.e., the meeting should be held after giving a notice
which would enable every corporator an opportunity to be
present.
f) Clear and unambiguous
The notice should be clear in its language, so that the reader is
left in no doubts as to its meaning. The language should be
simple, to the point, and unambiguous leading to a clear
understanding.
g) Agenda
A notice which does not give the purpose of the meeting is not
very valid. Every meeting is held for a definite agenda and a
notice convening the meeting should also give the receiver a
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clear and frank understanding of the matters to be discussed in
the meeting and on which he would be required to vote. Section
173 specifies two kinds of businesses conducted at a meeting,
viz:
a) General Business - that is the routine business which is
conducted at regular meetings, for example, in an AGM
the general business is placement and discussion of accounts,
declaration of dividends, the retiring and election of
directors, auditors etc.
b) Special Business - that is any business which does not come
under the above category.
A notice must specify any special business which is intended to
be transacted at the meeting, and should include all the material
facts concerning each item of the special business, including
the interests of the directors or managing agents in the subject
matter. Thus, in Narayanlal Bansilal v. Maneckji Petit Mfg.
Co. Ltd. [(1931)33 Bom LR 556], a company had managing
agents, whose terms and conditions of appointments were sought
to be changed by means of adopting new articles. The notice
which was sent out, gave the particulars of the proposed special
resolutions but not the details of the important changes sought
to be effected. Hence, the resolutions passed on the basis of the
above notice were held to be invalid. So also in Kaye v.
Croydon Tramways Co. [(1898)1 Ch 358], a notice calling a
meeting stated that the purpose of the meeting was to adopt an
agreement for the sale of one company's undertakings to another,
but failed to specify that the directors would be making a
substantial profit out of the transaction. The court held that the
notice did not make a fair disclosure of the purpose for which
the meeting was convened. But, where a shareholder by his
conduct shows or proves that he was aware of the true nature of
the business to be transacted at the meeting, he cannot complain
of the insufficiency of particulars provided in the notice
[Parsuram v. Tata Industrial Bank Ltd. [AIR 1928 PC 180].
Given below is a specimen notice of the annual general meeting.
THE MYSORE PAPER MILLS PVT. LTD., BANGALORE
NOTICE
Notice is hereby given that the Forty-second Annual General Meeting of the
company will be held on Tuesday, the 8th of May 1994, at Mysore Chamber of
Commerce Buildings, Kempegowda Road, Bangalore City, at 10.00a.m. to
transact the following business:
1. To receive and adopt the Audited Accounts and Balance Sheets for the
year ended on 31st March 1994, and the reports of the Directors and
Auditors.
2. To declare dividends.
3. To elect as Director:
(i) Mr.A.R.Rao, one of the Directors, who retires by rotation under Article
44 of the Articles of Association of the Company and is eligible for re-
election, will be 68 years at his next birthday on October 1994, and a
resolution that the age limit prescribed in Article 69 of the Company
shall not apply to him is necessary.
Special notice of the following resolution for exempting him from the
age-limit is hereby given:
"RESOLVED that Mr.A.R.Rao who has completed 67 years of age be
and is hereby re-elected a Director and that the age-limit prescribed under
 Article 69 of the Company shall not apply to him."
Explanatory statement is annexed to the Notice posted to the shareholders
separately.
NOTE: Special Notice signifying intention to move the above resolution
has been received from a shareholder.
4. To appoint Auditors for the current year and for their remuneration.
The Share Transfer Books of the company will be closed from 25th April
1994 to 8th May 1994 (both days inclusive).
NOTE: A member entitled to attend and vote at the meeting is entitled to
appoint a proxy to attend and vote instead of himself and a proxy need
not be a member of the company.
By Order of the Board
Sudha Peri
Secretary
Asiatic Buildings
Kempegowda Road
P.B. 570, Gandhi Nagar P.O.,
Bangalore-560 009.
Dated 7th March 1994.
N.B.- The Board of Directors have recommended payment of dividend at 7%
plus Bonus 4% on every share of Rs.10 for the year. The dividend when
declared will be made payable at the Bank of Mysore Ltd., Bangalore, or its
Branches on and after the 24th May 1994. The dividend warrants will be
posted to those shareholders whose names stand on the register on 8th May
1994.
3.5 CHAIRMAN
A meeting cannot be conducted unless there is a person to preside
over it, someone who would channelize the meeting into the
specified area and maintain a control over the proceedings. The
person who presides over the meeting is known as the 'Chairman'
of the meeting. He may be either elected before convening the
meeting or at the time of the meeting itself. Section 175 of the
Act states that, if the articles of a company do not specify the
person who is to act as the Chairman, than, the members present
and voting at the meeting shall elect someone from amongst
themselves to act as the Chairman, than, the members present
and voting at the meeting shall elect someone from amongst
themselves to act as a Chairman. The election shall be either by
a show of hands or by poll. But in general, the promoters or
directors of the company decide before hand that one of them
would act as a Chairman and the normal practice is that the
Chairman of the Board of Directors would act as the Chairman
of the meetings. Regulation 51 of Table A provides that, if
there is no such Chairman or the Chairman does not come within
15 minutes of the starting of a meeting or he proclaims his
unwillingness to act as a Chairman, the directors present at the
meeting should elect some other director to act as a Chairman
for that meeting. If no director is present within 15 minutes of
the start of meeting then any member of the company may be
chosen by the other members to act as a Chairman for that
meeting.
QUALIFICATIONS: The Act itself is silent as to the requisite
qualifications for a Chairman, though it does give some
qualifications for a person to act as a director. Though no
academic qualifications can be prescribed, there are a few
general characteristics or traits which a person should possess
for him to be able to act as a good Chairman. It is to be noted
tht lack of these traits will not disqualify a person from acting as
a Chairman since no basic qualifications are prescribed as such.
These traits which a Chairman should possess are as follows:
i) He should be well educated and be well versed in the rules
and regulations governing the conduct of a public meeting.
ii) He must have a command over the language in which the
meeting is proposed to be conducted.
iii) He must not have a fear of public speaking and should be
able to address the meeting clearly and with confidence.
iv) He must be a man with a clear vision and integrity.
v) He should be rational in his approach and be impartial.
vi) He should be good nurtured but firm so that he can bring
the meeting to order without being rude or offensive.
vii) He should be tolerant and patient and should interfere in an
ongoing debate only when genuinely necessary.
viii)He should be capable of hearing both sides of a debate with
an open mind and not let his personal biases or prejudices
influence his decision or vote. As a Chairman he may
sometimes be acting in a quasi judicial manner and will be
expected to act in an appropriate manner.
Chairman's qualifications are better described in the words of
Crew, the ideal Chairman should be a man of infinite tact and
practice, possess judicial mind, be able to command respect of
the meeting, be absolutely impartial in rulings, never allowing
to be questioned - and always ready and resourceful when
difficulties arise. He should be firm yet courteous, able to govern
men, not allow himself to be carried away by party or other
feelings, able to endure bores cheerfully. A Chairman should
possess a calm, placid temparament, have a proper sense of the
dignity of his position, not be garrulous (talkative) and be
accustomed to rule without fusiness, hauteur, or bullying."
[Chakraborti, A.P., 169].
APPOINTMENT: As stated earlier, in general the articles make
a provision for the appointment of a Chairman. If no such
provision is made, then he is elected by the members present at
the meeting (Sec. 175). Where there are more than one persons
interested in the post then a Chairman pro term is selected by a
show of hands, who would then conduct a poll to elect the
Chairman for that meeting. If the meeting has been convened
either by the Government under Section 167 or by the CLB
under Sectiokn 186, then the Chairman may be appointed by
the Government or the CLB as the case may be.
STATUS: Being the presiding officer he holds an important
position in any meeting. He is the person in authority who has
absolute control over the proceedings of meeting and who is
responsible for the orderly conduct of the meeting. The question
arises, where does the Chairman derive his authority from,
because in many cases a person's selection to Chairmanship
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may be just by way of an accident i.e., he does not plan on
assuming the authority - but he still exercises it. The answer to
the question is simple - he derives his authority from the meeting.
In the words of Jervis, LCJ in Taylor v. Nesfield, Public meetings
must be regulated somehow, and where a number of persons
assemble and put a man in the chair they devolve upon him by
agreement the conduct of that body. They attorn to him as it
were, and give him the whole power of regulating themselves
individually. This is within reasonable bounds. The Chairman
collects as it were, his authority from the meeting.” [Bhal, p.244]
POWERS: A Chairman has the following powers accruing to
him by virtue of his position as the presiding officer of the
meeting. These powers are mainly those which would prove
helpful to him in conducting the meeting in a smooth orderly
manner. These powers are as follows:
1. To decide points of order: It may happen sometimes that
when one member is speaking on some issue, another may
get up and enquire whether the statement being made are in
order. This is known as stating a point in order. When such
a point in order is raised, the Chairman has the power to
give his ruling on it, and his ruling is final regardless of
whether it be right or wrong.
2. To decide on priority of Speakers: If several speakers get
up at the same time and also want to speak at the same time,
the Chairman has the power to decide on who would speak
first, who would be second and so on.
3. To stop discussion on a matter: Whenever the Chairman
feels that a discussion on some issue is being prolonged
needlessly and is leading nowhere, he has the power to make
a ruling that all discussions on that matter would lease
forthwith, and to put the motion/issue to vote, so to eliminate
further discussion.
4. To have disorderly persons ejected: In case certain
members in the meeting start behaving in a disorderly
manner and refuse to pay heed to the Chairman's requests
or warnings, he has the power to save them physically
removed (using minimum force) from the meeting.
5. To exercise a casting vote: Sometimes the articles of a
company may provide that in case the meeting is equally
divided on some issue i.e., there is a tie then the Chairman
will have casting vote. Exercise by the Chairman of his
casting vote would decide the issue one way or other. This
power cannot be exercised if the power is not specifically
granted under the articles.
6. To declare a resolution passed: After the voting is over
he has the power to declare that a particular motion has
been carried. His declaration is a conclusive proof of the
fact.
7. To adjourn the meeting: He has the final right to adjourn
the meeting either at the end after all the business for the
day has been concluded or in exceptional circumstances in
the middle of the meeting itself. Adjournment is usually
given with consent of the members present at the meeting.
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DUTIES: Being in such a responsible position also entails
certain liabilities or duties. The duties of a Chairman are as
follows:
i) To see that meeting is duly convened and conducted:
To see that it is being convened only after giving a valid
notice to the concerned persons, and that the necessary
quorum is present for the meeting.
ii) Confirming the minutes: He has to read the minutes of
the preceding meeting and sign them after they have been
approved as correct by the members.
iii) Business conducted as per agenda: In general, he is
required to take up the issues for consideration in the order
set up in the agenda for the meeting. He may with the
consent of the members, change this order if the
circumstances so require.
iv) To maintain order in meeting: This may be set to be one
of his primary duties, as without order no serious business
can be conducted in the meeting. For maintenance of order
he is authorised to issue strict warnings to the concerned
persons and if the warnings are not heeded he can have the
disorderly person physically removed from the meeting.
v) To decide whether motions/amendments are in order:
Sometimes a member may make a motion or propose an
amendment which is not in strictu sensu within the scope of
that particular meeting. It is the duty of the Chairman to
refuse/reject such motions/amendments as otherwise the
meeting may become highly unchannelised.
vi) To disallow discussion except on specific motions: There
may be a tendency on the part of some members to start a
discussion even without a definite motion put before the
meeting. The Chairman is duty bound to put a stop to such
premature discussions as they may result in waste of precious
time.
vii) To see that minority are not oppressed or suppressed:
In every meeting there are bound to be person(s) whose
views do not coincide with the views of the majority. It is
the duty of the Chairman to see that these persons in the
minority have sufficient opportunity to state their views and
as far as possible give them as much time to speak as has
been accorded to the majority.
viii)To ascertain the sense of the meeting: Ascertainment of
the sense of meeting is another important duty, and means
that the Chairman is required to properly ascertain whether
the majority of persons present and voting in the meeting
are in favour of a motion or are against it. For this purpose,
he is required to put every motion or amendment to vote by
show of hands, and if required or demanded, by a poll later.
In either case, he is required both to record the votes and to
declare the results of the voting.
ix) Not to adjourn the meeting: The Chairman is duty bound
not to adjourn the meeting, till such a move is demanded by
the members.
x) General duty to regulate: He is duty bound in general to
see that the meeting is conducted in a smooth and orderly
manner, and to act as an impartial arbitrator while solving
 disputes or squabbles which may have arisen, to give a
patient hearing to all persons, and be scrupulously honest
in the discharge of his specific duties and eminently
reasonable and impartial in the exercise of his powers.
3.6 QUORUM
No meeting can start without the requisite 'quorum' being present,
i.e., a meeting can start only if the prescribed minimum number
of persons are present. Thus quorum is the minimum number
of persons required to be present in person or by proxy for
conducting a meeting. In general, the quorum for a meeting is
fixed by the articles itself. Where the articles do not make a
provision then sec 174(1) of the Act becomes applicable, which
provides that: Unless the articles of a company provide for a
larger number, five members personally present in case of public
company (other than a public company which has become such
by virtue of section 43-A) and two members personally present
in the case of any other company, shall be the quorum for a
meeting of the company. Thus the articles can provide for a
larger quorum but cannot reduce the quorum below the statutory
minimum. If within half an hour of the start of meeting the
quorum is not present the meeting stands adjourned to
reassemble a week later on the same day and time [sec 174(3)
and (4)]. If at the reassembled meeting also the requisite quorum
is not present the persons actually present shall constitute the
quorum [section 174(5)]. An interesting situation may arise
where at the reassembled meeting only one person is present -
will it mean that a single person shall constitute the quorum and
that he shall convene the meeting himself and have a meeting
with himself ? A situation of this kind arose in Sharp v. Dawes
[(1876)2 QBD 26], where a meeting was called by the company
to make a call on the shares. Only one person attended the
meeting but he had proxies of the other shareholders. He
presided over the meeting, passed a resolution for making calls,
proposed and gave a vote of thanks and then adjourned the
meeting. The validity of the call was questioned in the Courts.
Holding the call invalid the court observed, The word meeting”
prima facie means a coming together of more than one
person...This was not a meeting within the meaning of the Act."
There are two situations where the business transacted at a
meeting attended by a single person would be held valid, viz:
a) When the single person belongs to a 'class' all by himself,
i.e., he may be the only equity shareholder or only
preferential shareholder etc. In such cases, a meeting for
that 'class' would be valid though he is the only person
present [See, East v. Bennet Bros. Ltd., (1911)1 Ch 163].
b) When the CLB calls a meeting either under sec 167 or under
sec. 186 it may be directed that even a single person
attending the meeting in person or by proxy shall constitute
the quorum.
The next question which arises is - whether the quorum should
be present at the beginning of the meeting or should it be present
throughout the meeting ? The English courts have given
contradictory decisions on this issue. Thus, in Henderson v.
Lontit and Co. Ltd. [31 Scottish Law Reports 555], it was
held that, it must be a quorum of effective members i.e., members
qualified to take part in and decide upon questions brought before
the meeting" and such a quorum should be present when the
business is actually being transacted, and not quorum being
present merely at the beginning of the meeting. Then in re Hartly
Baird Ltd. [(1954)3 All ER 695], it was held that it was sufficient
if the quorum was present at the beginning of the meeting, and
it was not necessary for a quorum to be present throughout. But
later still, in re London Flats Ltd. [(1969)2 All ER 744 (Ch
D)], it was held that, if at the time when the business was being
transacted if the requisite quorum was not present then the
business which was transacted became invalid. A very confusing
state of affairs to be sure.
Regulation 49 in Table A of the Companies Act, 1956, requires
the quorum to be present at the time when the meeting proceeds
to do business, i.e., under the Indian law, mere presence of a
quorum at the beginning of the meeting is not sufficient.
In the American Encyclopedia Dictionary of business it is stated
that, A quorum must be present not only to begin a meeting, but
to transact business. Thus, if, during the meeting a number of
stockholders depart, leaving less than a quorum present the
meeting must be discontinued by adjournment. However, if a
meeting is once organized and all the parties have participated,
no person or faction, by withdrawing capriciously and of the
sole purpose of breaking the quorum, can render the subsequent
proceedings invalid. This view point also effectively answers
the criticism levied against the judgement in re London Flats
Ltd. by Avtar Singh, Should it be the law that minority
shareholders, realizing that they cannot defeat a resolution by
constitutional process of voting against, it, should be able to
frustrate the wishes of the majority by walking out of the
meeting”? Thus, whenever the members walk out of a meeting,
leaving it short of quorum the business transacted becomes
invalid, but if the members walk out deliberately and with mala
fide intentions, then lack of quorum does not effect the validity
of transactions. So also in County of Gloucester Bank v.
Rudry Merthyr Steam and House Coal Colliery Co. [(1895)1
Ch. 629] it was held that, third parties not having notice of the
fact that quorum was not present when business affecting them
was transacted at the meeting, will not be affected by such lack
of quorum.
Unless specifically questioned or the lack becomes apparent on
the face of record, a quorum is always presumed to have been
present at a meeting. A representative of a corporate body
appointed under sec. 187 or representative of the President or
Governor of a State under sec. 187-A is deemed to be a member
personally 'present' for the purposes of quorum. Similarly, if
two or more corporate bodies who themselves are members of
a company are represented by one single individual, then for
purposes of quorum each of these body corporates will be treated
as being personally present through the individual representing
them. This raises interesting possibilities suppose A, B, C, D,
and E are corporate bodies who are members of 'L & T Co.
Ltd.' Suppose each one of A, B, C, D, and E is represented by
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the same person 'X'. In a meeting called by 'L & T Co. Ltd.' X
attends as representative of A, B, C, D & E and each of these
body corporates is deemed to be personally present. Even if no
other person attends the meeting, the quorum will be still satisfied
as X' is representing 5 persons so legally there are 5 members
present, though factually only a single person is attending. So,
though it has been held that a meeting of one person is not valid
etc., in cases like this the meeting will be valid though attended
by only one person.
On the other hand, in case of several joint owners of a share,
they will be collectively regarded as one person for the purposes
of quorum and only one of them will be entitled to vote on the
shares held jointly by them. Ramaiya has however given a
illustration of a Punjab High Court case Jarnail Singh v. Bakshi
Singh [AIR 1960 Punj. 455] where an Australian case was cited.
The court observed, Our attention has also been drawn to an
Australian case Transcontinental Hotel Ltd., In re,ld be a
machinery to strike d own su 1947 SASR 49, referred to in
volume I of Palmer's Company Precedants, p.488 (17th edn.) in
the footnote. In that case the articles of association of a limited
company required that a quorum of two members should be
personally present of a meeting of the company to pass a special
resolution. It was held that the presence of two persons who
were registered as joint holders was a sufficient compliance with
the articles of association. In other words, for purposes of
quorum, two joint holders were treated as two members of the
company [Ramaiya, p.1124]. Even in re Saunders (T.H.) and
Co. [(1908)1 Ch. 415] it was held that, the joint holders can
insist on having their names registered in an order they prefer,
and can also insist on their holding being split into several joint
holdings with their names in different orders i.e., on priority
basis [ex: No.1 - Mr. X; No.2 - Mr.Y...], so that each one of
them may get a right to vote as first named holder in one or
other of the joint holdings. The same position should be tenable
in India under sec. 41 of the Act.
3.7 AGENDA, RESOLUTIONS, AND MINUTES
A] Agenda
Agenda means 'things to be done' or 'matters to be discussed'.
A meeting called without fixing the objective of the meeting
would be totally infructous. Thus for a meeting to gain validity
the subject matter should be decided before convening the
meeting. Fixing of agenda is also essential for the smooth
conduct of the meeting, in an orderly manner and to be assured
of the fact that no important matter has been left out of discussion.
For this reason, it is deemed essential that, for any meeting be it
of shareholders or creditors or of board of directors to put down
the business intended to be transacted on a piece of paper called
as "Agenda Paper" or simply "Agenda".
In general, it is usual practice to put the routine matters at the
top of the agenda and the special matters at the bottom so that
more time for discussion on special matters is available after a
quick disposal of the routine matters. It is also considered
desirable that similar matters should be grouped together for a
more fruitful discussion.
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There are two ways of preparing an agenda, viz:
1] By giving only a brief reference to the business intended
to be discussed, as for example:
i) Reading of minutes
ii) Approve the transfers
iii) Election
2] By giving slightly more details about each item of business,
as for example:
1. To read and sign the minutes of the last meeting held
on 1.5.1994.
2. To discuss and approve the transfer of shares bearing
Nos.164-198.
3. To elect the directors to fill up the vacancy left by
retirement of 2 directors in the last meeting.
This second mode of agenda preparation is more helpful to the
secretary in drafting the minutes.
Generally speaking, for any meeting there are two kinds of
agendas prepared - one meant for the use of the Chairman and
secretary, which has the complete wordings of the resolutions
to be passed alongwith the names of the proposer and seconders
(if fixed before hand) and some space in the margin for them to
make notes, and, the second meant for circulation amongst the
members of the meeting.
Though not necessary, it is desired to affix a copy of the agenda
to the notice calling the meeting, so that members come totally
prepared to the meeting. In case a meeting has been adjourned,
it is neither necessary nor desirable to prepare and send a fresh
agenda for the adjourned meeting, which in general is nothing
more than the old meeting continued after an interval. In case a
new agenda is prepared, then care should be taken to see that it
is properly headed, and as far as practicable it is limited to the
unfinished business of the previous meeting.
Though, 'agendas' have no legal significance as such, it is better
to preserve the copies of the agenda as they provide ancillary
evidence of the business conducted at the meeting, and in
analyzing the background circumstances resulting in a particular
decision being taken, if such decision becomes a matter of
controversy sometime in the future.
B] Resolutions
A resolution in broad terms is a proposal which has been put to
vote in the meeting and passed. A major part of the company's
work is done vide resolutions. Under the Act, there are three
kinds of resolutions which are recognized, viz:
i) Ordinary Resolution (sec. 189): This is a resolution which
has been passed by the numerical majority of the members
present and voting, either personally or by proxy. Generally,
most of the company business is transacted through ordinary
resolutions, except where the Act specifically lays down
that a special resolution' would be needed. Some of the
business which may be transacted through an ordinary
resolution is:
 a) Adoption of a statutory report (sec. 165).
b) Adoption of the Balance Sheet and Profit and Loss
Account at the AGM (sec. 210).
c) Election of directors.
d) Appointment of auditors and fixing of their
remuneration (sec. 224).
e) Declaration of dividends and sanctioning of the
amount which is to be carried over to Reserve.
f) Issual of shares at discount (sec. 79).
g) Authorizing the Board of a public company or a
private company which is a subsidiary of a public
company to sell or dispose of the undertakings of the
company (sec. 293).
Wherever it is provided that, the company in general meeting
may” do some act, it is presumed that the act is to be done by
means of an ordinary resolution. On the effect of an ordinary
resolution, it was observed in North-West Transportation Co.
Ltd. v. Beatty [(1887)12 AC 589 (PC)], unless some provision
to the contrary is to be found in the charter or to other instrument
by which the company is incorporated, the resolution of a
majority of shareholders, duly convened, upon any question with
which the comp.any is legally competent to deal, is binding upon
the minority, and consequently upon the company, and every
shareholder has a perfect right to vote upon any such question,
although he may have a personal interest in the subject-matter
opposed to, or different from, the general or particular interests
of the company."
Given below is a specimen ordinary resolution relating to the
appointment of a director.
"That Mr. M. N. Nair who is an additional director appointed
under article 128 of the Articles of Association and who
holds office till the date of next Annual General Meeting,
but being eligible offers himself for election, and for whom
a notice proposing him as a director has been received from
a member, be and he is hereby appointed a director of the
Company".
ii) Special Resolution (sec. 189): A special resolution is one
which has been passed by a majority of not less than 3/4th of
the members present and voting at that meeting of which an
advance notice that a resolution is intended to be proposed as a
special resolution has already been given to the members. A
special resolution has the following characteristics, viz:
a) atleast 75% of the voting members must be in favour of it,
b) the resolution in the exact form in which it is passed should
have been set out in the notice convening the meeting.
c) the notice should also specify that that particular resolution
is to be passed as a special resolution;
d) a notice period of 21 clear days has been given for the
meeting; and
e) an explanatory statement under sec. 173(2) was duly
attached to the notice for conducting special business.
A special resolution is an important tool in the company
mechanism, by the use of which many important things within
the scope of company's powers are done. The reason why so
many conditions are attached to the passing of a special
resolution seems to be, that, the members and the company
should be given sufficient time to think over and apply their
minds to the important changes/activities proposed to be taken
up, and further that such major actions should have the approval
of a majority of persons being affected by the change. Some of
the business which are transacted by means of special resolution
are:
i) Alteration of Memorandum of Association for purpose of
changing its registered office from one State to another (sec.
17).
ii) Alteration of the name of the company after obtaining prior
approval of the Central Government (sec. 21).
iii) Alteration of articles of association (sec. 31).
iv) Creation of a Reserve share capital (sec. 99).
v) Reduction of share capital if so authorized under the articles
(sec. 100). Such reduction is of course subject to approval
of the Court.
vi) Appointment of inspectors to inspect the affairs of the
company (sec. 237).
vii) Remuneration payable to a director, if so required under
the articles (sec. 309).
viii)To render the liability of directors, managing agents,
secretaries and treasurers or managers unlimited (sec. 323).
ix) Appointment of managing agents or his associates as buying
or selling agents for places outside India (sec.s 356 and
358).
x) Voluntary winding up of company (sec. 484).
Given below is a specimen of 'special resolution making
additions to the objects clause of the Memorandum of
Association (Sections 16, 17 & 18).
"Resolved that the following objects be added in the
Memorandum of Association and the Memorandum be
altered to that extent:-
(1) To acquire or establish and operate and carry on
business of Textile Mills, Woolen Mills, Rayon Mills
and Silk Mills.
(2) To acquire or establish and carry on the manufacture
of buttons, hooks, needles, zippers, sewing machines
and machine parts for Industrial and Domestic
purposes.
(3) To acquire, establish and carry on the business of
manufacturing cardboard cartons and packing boxes
of all types and varieties for Industrial and Domestic
purposes.
(4) To acquire, establish and carry on any other business
which in the opinion of the Directors can be profitably
undertaken alongwith manufacture, sale and export
of textiles.
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(iii) Resolutions requiring special notice: Under sec. 190
of the Act, a new provisions has been introduced, that transacting
of some special kinds of business can be only through resolutions
for which special notice has to be given. The notice period is
now 14 clear days. On receipt of such a notice, the company
should give a notice to its other members of this resolution
alongwith a notice of the meeting, or atleast 7 days before the
meeting, by way of an advertisement or in any other manner
permitted by the articles. The matters in which a resolution
with special notice must be given are:
a) A resolution at AGM proposing to appoint a new auditor
instead of the reappointment of retiring auditor(s) (sec. 225).
b) A resolution at the AGM expressly forbidding the
reappointment of a retiring auditor (sec. 225).
c) A resolution that a particular person shall not be eligible
for reappointment as a director who is liable to retire due to
rotation of directors (sec. 261).
d) A resolution to remove a director before his term expires
(sec. 284).
e) A resolution to appoint a director to fill in the vacancy caused
due to (d) above (sec. 284).
The articles of a company may add other matters for which a
special notice would be required. The basic objective of giving
a special notice of a resolution is to invite specific attention of
the company and the members to the matter in hand, so that
they realize it is something more important and that they have
to apply their minds to it. Even where it is the company itself
i.e., the Board of Directors themselves want to move a resolution
on any of the matters mentioned above, they may be required to
give a special notice under this sec.. In such cases, the company
may either give the required special notice by including it in the
'meeting notice' itself or may give a separate 14 days notice to
the shareholders as the sec. provides.
Apart from these three kinds of resolutions which have been
specifically provided for in the Act, two other kinds of
resolutions are also used by the kinds of resolutions are also
used by the companies, viz:
Unanimous resolution - This phrase in strictu sensu means that
it has been passed by every member present in the meeting,i.e.,
every person present and entitled to vote, has voted in favour of
the resolution. The word 'unanimous' meaning 'of one mind' is
sometimes improperly used to indicate resolutions carried
without dissent i.e., say if 100 persons are present at the meeting,
80 vote in favour of the resolution and 20 abstain from voting,
the resolution is termed as being carried 'unanimously'. This is
an improper usage of the term. Such resolutions should properly
be recorded as having been passed 'without dissent'. "Nem Con"
(short of nemine contradicente i.e., no one saying otherwise) or
"nem dis" (short of nemine dissentiente i.e., no one dissenting)
are two other ways commonly used to indicate resolutions passed
without dissent.
Though a 'unanimous resolution‘ indicates that the entire body
of voters is in favour of the resolution, a company cannot take
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the help of a unanimous resolution to validate an ultra vires act.
As Lord Cairns, L.C., observed in Ashbury Railway carriage
and Iron Co. Ltd. v. Riche [1875)44 LJ Exch 185], 'If every
shareholder of the company had been in the room and had said:
that is a contract which we desire to make, which we authorize
the directors to make" the case would not have stood in any
different position from that in which it stands now. The
shareholders would thereby, by unanimous consent, have been
attempting to do the very thing which, by Act of Parliament
they were prohibited from doing.
Written resolution: In general, the motions are proposed orally
and then voted upon either by show of hands or by poll. A
resolution in writing is possible only if a provision to that effect
is made in the company's articles. Such resolutions are valid,
though no meeting is held to pass them, and usually applies to
board of director's proceedings or to a company having very
few shareholders. A written resolution is usually required to be
signed by every person entitled to vote on it. The rules may
provide for a written resolution to be passed only 'unanimously'
or may provide that the persons signing should specify whether
they are 'in favour' or 'against it, and if a majority are in favour
the resolution is passed. This kind of resolution is not much in
vogue, and is generally used, when it is known that there is no/
not much difference of opinion on the proposed resolution and
where holding of a meeting would result in an inconvenient/
impractical delay.
Passing of a resolution should always be by a clear majority
[either simple or three-fourth as the situation demands]. If the
voters are equally divided, then the motion is not carried. In
such situations, the articles sometimes provide the Chairman
with a right to exercise his 'casting vote' which is helpful in
breaking the tie. But in cases, where no such casting vote is
provided for, a motion ending in a tie has to be abandoned atleast
for that time. It may again be proposed in a later meeting with
or without amendments and again put to vote.
As soon as a resolution has been passed or a motion is lost, the
result should always be declared firmly by the Chairman, so
that the people present are clearly aware of the results. If it is
required to be passed by a special majority, then the Chairman
is also required to announce the votes for and against the motion
and these have to be specifically recorded. The Act requires
that some kinds of resolutions (ex: special resolutions) should
be registered with the Registrar within a specified time limit - in
such cases a copy of the resolution has to be filed with the
Registrar within that time and failure to do so entails a penalty.
C) Minutes
We have seen earlier that one of the duties of the Chairman is
reading and signing of the 'minutes' of the previous meeting.
The word 'minutes' is derived from the Latin 'minutes' meaning
made small”. The shorter Oxford English Dictionary defines
minutes as a brief summary of events or transactions, especially
(usual plural) the record of the proceedings of an assembly,
committee etc." In Osborn's A concise Law Dictionary, minutes
has been explained as, (1) Notes or records of business transacted
at the meeting. (2) Copies of a draft order or decree before
being embodied in a formal judgement of the court." Thus,
'minutes' can be defined as a brief or short summary of a business
transaction.
Under Common Law there is no requirement of maintaining the
minutes of a meeting, but sec. 193(1) of our Companies Act
provides that: Every company shall cause minutes of all
proceedings of every general meeting and of all proceedings of
its Board of Directors or of every Committee of the Board, to
be kept by making within 30 days of the conclusion of every
such meeting concerned, entries thereof in books kept for that
purpose with their page consecutively numbered."
The provisions of this sec. embody the suggestions of the
Company Law Committee in para 79 of their Report: Our
attention was drawn to the failure on the part of the management
of some companies to record in the minutes a fair summary of
the proceedings of general meetings, inclusive of material
questions asked and replies given and comments made. This,
in our view, is not a healthy practice and should be discouraged
by positive provisions inserted in the sec.. In view of the fact
that general meetings are usually very sparsely attended, a
practice has grown up of circulating the minutes of such meetings
to all shareholders. It is, therefore, essential that these minutes
should contain a brief but authentic record of all that happens at
general meetings, so that the absentee shareholders may be in a
position to form some reliable idea of what transpired at these
meetings. We, therefore, recommended that the provisions of
this sec. should be so amended as to provide explicitly that the
minutes of the general meetings should contain a fair summary
of the proceedings of such meetings and, in particular, of all
material questions asked or comments made. We further
recommended that such minutes should not be circulated or
advertised at the expense of a company, unless they contain the
matters mentioned above. It will be necessary for the chairman
of the meeting to decide what is fair summary of its proceedings
or what questions asked or comments made would be deemed
to be material for the purposes of the meeting, but a statutory
obligation to cast the minutes in a particular manner will, we
trust, be a useful safeguard against the manipulation by dishonest
and unscrupulous persons.
"As regards the minutes of directors' meeting, the only
recommendation that we make is that they should record the
names of those directors, if any, who dissent from any decisions
arrived at these meetings. Some witnesses questioned the
desirability of such a provision. They argued that the decisions
taken by a Board of directions partook of the nature of a
collective decision, and if it was made obligatory to record the
views of dissentient directors, differences on a board might be
encouraged. We have given due consideration to this point of
view, but are unable to accept it. The concept of the collective
responsibility of directors, however, attractive in theory is
warranted neither by the facts about company management in
this or other countries nor by the fundamental postulates of
company law. On the contrary, we feel that our suggestion will
promote rather than hinder the sense of responsibility among
directors and will provide a useful check on the errant elements
among them, who now find it easy to hide the undue influence
which they exercise over the affairs of companies under the cloak
of unanimity." [Ramaiya, p.1217].
The 1960 amendments to sec. 193 were made in order to ensure
the authencity of the minutes of proceedings of general meeting
or meetings of the Board of Directors. For this purpose, sec.
193(1-A) and (1-B) provides as follows:
1. that all minutes should be entered in consecutively numbered
pages (to be kept in the form of a book - that is the pages
should follow each other serially but need not be bound
within 30 days of each meeting, and
2. that apart from initialing every single page, the last page of
the recorded proceedings should also be added and signed
by the Chairman of the meeting.
The 'minutes' for a period of say 6 months or so may be bound
and kept as record. The Department of Company affairs gave a
clarification in this regard vide their File No.8/16/(1)/61-PR)
by saying - 'In view of the provisions of sub-sec. (1B) of sec.
193, which prohibits attaching of the minutes of a meeting in
the minutes book by pasting it or otherwise every company has,
apparently to maintain the minutes in a bound book only.
However, this provision is not incapable of a different
interpretation. Maintenance of minute books in loose-leaf form,
whereby loose leaves which were serially numbered could be
taken out and re-inserted after the proceedings had been typed
on them would not, strictly speaking, amount to 'attachment'
within the meaning of the sub-sec.. In view of this and also in
view of the fact that the use of loose-leaf forms for minutes
books is a convenient modern technique for neat and expeditious
recording of the minute, specially for big companies where the
minutes may run into many pages. Field Officers are advised
not to insist on minutes being kept in a bound book. No general
advice in this regard need, however, be issued by them to the
business community, on the contrary companies which may
approach the Field Officers in the matter may be given the
suggestion that it would be preferable for them to keep bound
minute books. No action, however, need be taken if a company
is found to be keeping loose-leaf books, unless there is any
interpolation in the minutes'.
Contents of Minutes: Minutes should contain a record of the
names of all members present, and, if needed even the names of
the persons who were absent. Further, minutes should provide
a fair and accurate summary of the proceedings of the meeting.
In case of Board meetings it should also contain the names of
the directors voting in favour of a resolution and those against
it. It should also contain a record of the names, etc., of the
persons who may have been employed. If in a Board meeting,
some director either arrives or leaves during the proceedings
then a mention should also be made of that particular fact.
Need for Minutes: A question may arise - why should one
maintains a record of the proceedings of any meeting ? What is
the use of such a record ? The answer to these questions is
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provided under sec. 194 of the Act which provides, Minutes of
a meeting kept in accordance with the provisions of sec. 193
shall be evidence of the proceedings recorded therein." In
Escorts Ltd. v. Sai Auto [(1991)72 Comp. Cas. 483 (Del)] it
was held that, district who was bound to acknowledgethe only
way to prove the passing of some particular resolution at a
meeting was to produce the minutes book in which the concerned
resolution was recorded as passed. The mere fact that the
proceedings are recorded in a minutes book is not conclusive
evidence of the proceedings being regular, and the court can
inquire into the validity of the notice convening the meeting
[Betts and Co. v. Macnaghten, (1910)1 Ch 430]. The minutes
of a meeting are merely prima facie evidence of the proceedings,
not conclusive evidence and the minutes may be rebutted or
supplemented by other evidence. For minutes to act as prima
facie evidence they have to be signed by the Chairman (or in his
absence by any other director authorized in this regard). For
the application of sec. 194 it is essential that the minutes book
be kept in proper form and shape and in accordance with the
requirements under sec. 193.
Further, according to sec. 195, where minutes of' the proceedings
of any general meeting of the company or of any meeting of its
Board of directors or of a committee of the board have been
kept in accordance with the provisions of sec. 193 then, until
the contrary is proved, the meeting shall be deemed to have
been duly called and held, and all proceedings there at to have
duly taken place, and in particular, all appointments of directors
or liquidators made at the meeting shall be deemed valid." Thus,
the minutes book not only results in being a permanent record
of the proceedings of the meeting, but also gives rise to a
presumption that the proceedings at the meeting were regular
and valid and that the meeting itself had been called in the
prescribed manner. A properly kept minutes book gives rise to
a presumption of validity and regularity. Presumption means
that - it will be accepted by the Courts as proved unless evidence
is brought to show that the presumption is false or invalid. Thus,
a party may bring in additional/outside evidence to show that
the meeting was not convened in the regular manner, or that the
proceedings in the meeting were irregular, or that the
appointment of some director is invalid etc., but till such evidence
is brought to prove conclusively the irregularity of the meeting
or some proceeding in the meeting, the presumption under sec.
195 will act in favour of the regularity of meeting/proceedings.
3.8. MOTIONS AND AMENDMENTS
I] Motions
The term 'motion' can be best described in the words of Erskine
May as:
The term "motion" which in its wide sense means any proposal
made for eliciting a decision of the House covers several distinct
forms of proceedings.
Motions may be divided into:
1. Independent or Substantive Motions; and
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2. Dependent or Subsidiary Motions.
The former term explains itself.
The latter kind of motions cover:
1. Ancillary motions dependents on an order of the day, such
as a motion that a bill be now read a second time, or that the
House agrees with a report of the Committee;
2. Motions made for the purpose of superseding questions,
such as motions for the adjournment of a debate;
3. A motion dependent on another motion, such as an
amendment.
Stated generally, substantive motions require notice, whereas
dependent or subsidiary motions do not [Taggart, p.37].
Curzon's dictionary of law defines 'motion' as, (1) Formal
proposal made at a meeting, (2) Oral application to a judge or
court requesting an order directing performance of an action in
the applicant's favour. To put it briefly, a motion is a proposal
put before a meeting for either a discussion or a debate. A
motion indicates the discussion on some term in the agenda.
Thre are basically two kinds of motions, viz:
(i) Formal Motion: This includes all motions moved by the
members with the object of: (i) adjourning the meeting, (ii)
dropping an item on the agenda, from discussion, (iii)
adjourning the debate on a motion, (iv) applying closure to
the motion. Thus for example, when a motion is moved to
adjourn the meeting it takes the form: "that this meeting be
now adjourned."
A motion should always be in writing and necessary notice
should be given before a motion is proposed: Though a motion
is generally seconded it is not necessary. A motion should always
relate to a matter within the scope of the meeting and should be
phrased in a clear and unambiguous manner. A motion should
always be in the affirmative and commence with the word 'That',
so that when it is passed and is converted into a resolution it
may read as...'Resolved that - A formal motion may be moved
in any of the following forms:
(a) The Closure: Suppose, a member feels that enough time
has been spent on discussing a particular motion, he may
move that the 'question be now put'. This motion is known
as closure. If this motion is allowed by the Chairman, the
discussion on the motion stops and the motion is put to
vote. But if the motion is disallowed, the discussion on the
main motion keeps continuing.
(b) Previous Question: The object of this motion is to prevent
further discussion on the main motion under discussion if
he feels that to take a decision on that point at that moment
would be unwise or inconvenient; but cannot be put when
an amendment to the motion is under discussion. If the
motion is carried, the main motion is dropped otherwise it
is continued with.
(c) Proceed to next business: Having a similar objective to
the 'previous question', this motion is put in the form, that
the meeting do proceed to the next business." This motion
is resorted to whenever a member feels that the motion
 under discussion is of lesser importance, than some other
matter pending discussion. If the motion is carried, the
discussion shifts to the next topic on the agenda otherwise
it continues with the original motion.
(d) Adjournment: This motion is resorted to when a member
wants the entire proceedings of the meeting to be suspended
either indefinitely or for a particular period. A motion of
adjournment takes precedence over every other motion of
the house. Such motions have to be seconded, before being
put to vote. If the motion is carried, the proceedings of the
meeting cease from that moment.
(ii) Substantive motion: Whenever a member feels that some
motion is unacceptable/unsuitable in the form it is presented,
may propose an amendment to it. Such amendments
immediately become embodied in the original motion, and,
this altered motion is known as a 'substantive motion'. A
substantive motion cannot be further amended in a manner,
where it would be recovered into its original form.
Apart from these basic forms of motions which may also be
termed as the 'valid motions' you have certain other kinds of
motions, namely:
Lapsed Motion: If by the rules of the company, some particular
motion is required to be seconded, then such a motion lapses if
it is not so seconded. Such a lapsed motion is also known as a
dropped motion in parliamentary language.
Unacceptable Motion: This is a motion which the Chairman
of a meeting declines to accept on grounds of it lacking certain
essential elements. Following are certain basic elements which
a motion should contain, failing which the validity of a motion
is in jeopardy. These elements are:
i) A motion should be within the scope and ambit of the
Constitution, rules and articles of association of a company.
A motion which is ultra vires these documents is invalid as
being contrary to law.
ii) A motion should comply with any statutory requirements
made as to regulate the form/content etc., of the motion.
iii) A motion must be within the scope and ambit of the meeting
in which it is being prompted.
iv) A motion should be relevant to the subject matter or business
to which it relates or to the business for the conduct of which
the meeting has been convened.
v) A motion must neither directly nor indirectly try to negate
the results of a prior motion which has already been put to
vote, ie., a motion cannot try to be a negative of a motion
already passed or be a reverse of a motion which has been
lost (i.e., not passed).
vi) It should not be a redundant motion i.e., a mere repetition
of a prior motion or decision or policy.
If a motion contradicts any one of the first two conditions, the
motion is ab initio invalid, but in the remaining cases if not
totally invalid, its validity would certainly be in jeopardy as the
Chairman may refuse to accept the motion.
Invalid Motion: Sometimes an unacceptable motion may be
carried through in a meeting and thus become a resolution. For
example, a motion which is ultra vires the Companies Act may
be passed by the meeting and so become a resolution. But merely
because it has been approved by a majority - it does not become
binding on the company. Such motions are deemed to be ab
initio invalid and cannot be ratified especially if it contravenes
the Act, the provisions of the memorandum or articles of
association [Ashbury's Case]. But if a resolution has been
passed in a meeting convened without a proper notice or in a
meeting without the requisite quorum, or being outside the scope
of the meeting where it was passed, then it may be possible to
ratify such a resolution in a subsequently convened meeting.
The possibility of ratifying an invalid motion would depend on
the nature of the invalidity - i.e., if it is inherently invalid then it
cannot be ratified, if it is invalid due to a mere technical
irregularity then it is possible to ratify it.
Motion vis-a-vis Resolution
Generally speaking, the terms 'motion' and 'resolutions' are used
interchangeably, giving the impression that these terms are
synonymous. But such an impression is not correct. A motion
is a proposal on the subject matter under discussion, which is
put to vote. If after the voting, a motion receives a favourable
response from the majority of the members present and voting
(either personally or by proxy) i.e., if it is passed by a majority,
then such a motion becomes a 'resolution'. Thus, 'resolution' is
a passed motion - a motion which lapses or is deemed invalid
cannot become a resolution, even if in the latter case it has been
voted in favour by a majority of the members present at the
meeting. Unless a resolution is passed, the meeting fails to attain
its objective, or we may say that a meeting where no resolution
is passed achieves or accomplishes nothing - because, though a
debate or discussion might have taken place, nothing of legal
value ensues unless and until a resolution is passed, because it
is only a resolution which is legally binding and not a motion or
a debate.
Characteristics of a Motion
A motion being the basis of legally binding decisions, should
incorporate within it certain essential characteristics. Apart from
the substance or subject matter of a motion, even its form may
be important because a motion may be rejected by the Chairman
atleast in the form it has been presented. Some of the points to
be kept in mind while framing a motion are as follows:
i) Form: It should always be in a positive and affirmative
form, unless and until a negative form would achieve a
special benefit or advantage, e.g., to ensure that a
disallowance of a request or rejection of a proposal is
specifically recorded in the minutes. Generally speaking,
care should be taken to see that a 'yes' vote does not support
a 'no' proposal.
ii) Content: It should be complete and plain so that the
resulting resolution can be plainly identified with the
objective and substance of the motion. As far as possible,
a motion should be short, concise and to the point, but
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 comprehension and clarity should not be compromised with
in favour of brevity. If needed, two or more motions can be
proposed on the same subject, instead of one single, lengthy
or complex motion.
iii) Wording: Every motion should commence with the word
that, and it should be precise and definite both in its language
and import. A motion should be devoid of any traces of
vagueness, ambiguity or uncertainty [Harrey v. Adelaide
and Hindmarsh Tramway Co. Ltd., (1884)15 SALR 136,
cited in Taggarts at p.410].
iv) Drafting: A motion should be so framed that it enables the
voter to conveniently vote a 'yes' or a 'no' on it, i.e., the
motion should be so drafted as to facilitate the decision
making of a member.
Once a motion is moved, it is put to 'debate', i.e., before putting
it to vote the members are given an opportunity to discuss or
put forward their views on the motion. Generally speaking,
every person except the moves of the motion is given only one
opportunity to speak. The mover may be given a second chance
so that he may be able to reply to some of the querries on the
motion. But, the Chairman has a discretion to allow a member
to speak a second time if he deems it necessary. Further, the
seconder of a motion may reserve his right to speak to the end -
where he may be able to reply to all the doubts or questions
raised in the debate. But a seconder's right to speak is on par
with the right to speak of any other member i.e., to say, if the
motion has been 'put to vote' before the seconder has had his
say then he looses his opportunity to speak.
A motion which has been moved and accepted by the Chairman
becomes the property of the meeting, in the sense that, the mover
has no further control over it, and, such a motion has to be put
to vote, unless, (a) the members consent to the withdrawal of
the motion, or (b) one of the formal motions of 'previous
question' etc., is passed in order to prevent voting on it, or (c)
certain amendments to the motion are moved in which case, if
the amendments are passed they become embodied in the
original motion and what is then voted is the new and changed
motion i.e., the motion in its original and unamended form is
lost.
II] Amendments
When a motion is put to debate, it may be debated in the form it
has been moved, or some member may propose an alteration or
change either in the form or content of the motion. Such an
alteration though termed an amendment is strictly speaking only
a 'proposed amendment' to the main motion, and is moved not
to defeat the main motion but merely to modify it in some respect.
Characteristics of an Amendment: As far as possible an
amendment to a motion should possess the following
characteristics, viz:
i) It should be in writing and submitted to the Chairman. A
written amendment facilitates greater understanding, and
avoids waste of precious time which may result if the
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amendment is oral or not clear. Unfortunately, though
desirable and highly conducive to the efficient functioning
of a meeting is rarely followed or insisted upon - unless a
'written amendment' is required under the standing orders
or statute etc.
ii) The format of an amendment should not be a 'direct negative'
of the main motion.
ii) It should not raise a point which has already been debated/
disposed of in an earlier vote.
iv) It must be moved before the main motion is put to vote by
the Chairman.
Unacceptable Amendments
Just as a motion may be declared unacceptable or invalid, an
amendment to a motion may also be declared invalid/
unacceptable by the Chairman under the following
circumstances, viz:
a) It does not incorporate the essential characteristics of an
amendment i.e., it either negates the motion or raises a point
already discussed or i.e., moved after the motion is put to
vote.
b) It is inconsistent with a prior approved amendment to the
same motion.
c) It is inconsistent with a prior resolution passed at the
meeting.
d) It is beyond the scope, purpose or notice of the meeting.
e) It is beyond the scope of the question or matter under
consideration, i.e., it does not relate to the motion.
f) It is immaterial, irrelevant or offered in a spirit of mockery.
g) It is proposed with a specific intention of preventing the
meeting from reaching a decision.
h) It is proposed only with an intention to delay or defer the
progress of the meeting.
i) All amendments have to comply with the requirements of
the statute, bye-laws, standing orders etc., which apply to
the meeting in question.
A Chairman should accept an amendment if he is in doubts about
the acceptability or otherwise of the amendment, since a rejection
by him of a valid and material amendment may result in a legal
action and a consequential invalidation of the resolution on the
motion [Henderson v. Bank of Australasia, (1890)45 Ch D
330].
Though an amendment cannot be so worded as would result in
a complete alteration of the original motion so as to turn it into
a totally new motion, it can be so worded as to change the entire
wording of the original motion - so long as it is relevant to the
text and terms of the original motion and such redrafting does
not result in negating the original motion.
Once an amendment is moved, it is debated on in the same
manner as a debate on the motion is carried on. While discussion
on an amendment is going on any discussion on the main motion
is suspended, and, this discussion takes a priority over all others
- and must be strictly material/ relevant to the proposed
amendment. After the debate is brought to an end, it is put to
vote, and, if carried by a majority, the said amendment is
incorporated in the main motion in such a manner that it becomes
part and parcel of the motion i.e., the original motion changes
into the new amended version. if the proposed amendment is
'lost' in the voting, then the original motion revives and is open
to further debate or amendments before being put to vote.
3.9 VOTING
We have been repeatedly using the phrases 'put to vote' or
'members present and voting' or in person or in proxy etc., we
will now deal with the meaning of these phrases and terms.
One of the primary duties of a Chairman is to ascertain the
'sense of the meeting', which he does by putting a motion to
vote. 'Voting' may euphemistically be described as 'the
registering of one's decision in favour of or against a proposal'.
After a motion is put to vote, the Chairman counts the votes in
favour of the motion and those against it, and if the majority
are in favour of the motion, he declares the motion as passed
and a resolution is framed. Thus 'sense of the meeting' is to
check whether the majority of the voters favour the proposal or
not.
There are five modes of voting which are generally recognized,
namely:
i) By Voice or Acclamation: Here, all those who are present
indicate their approval or disapproval by saying 'yes' or 'no'
or by cheering/ applause when the motion is put to vote.
This mode is usually used when the Chairman is of the
opinion that there would be unanimous voting either in
favour or against a particular motion. He hears both the
voices and then declares whether the 'Ayes' have it or the
'Noes' have it.
ii) By Division: Here, the Chairman asks the meeting to divide
themselves into two blocks - one block consisting of
members in favour of the proposal and the other block
consisting of members against the proposal. The number
of members in each block are then counted and the result
declared accordingly. Voting through proxies is disallowed
under this mode.
iii) By Ballot: Here members are required to record their
decision on a ballot/voting paper given to them, and after
marking on it they deposit the paper in the ballot box. A
counting is done later and results declared accordingly.
iv) By Show of Hands: Here, when the motion is put to vote,
the Chairman first asks those in favour of the motion to
raise their hands (only one hand to be raised by one person),
and the number of hands in favour are counted. Next, the
same procedure is repeated to ascertain the number of hands
against the proposal, and the results declared by the
Chairman. His decision on the voting is final and conclusive.
v) By Poll: Here, the members votes are counted by referring
to their voting rights under the articles of the company.
This method differs from the above methods, because when
a poll has been properly demanded and granted, every
person has a right to vote in proportion to the number of
votes he has - generally 'one vote per share' is the accepted
norm. Voting by proxy is allowed under this mode.
Under the Act, a poll may be demanded by:
a) the Chairman of the meeting suo motto, (b) in case of a
public company by atleast 5 persons having voting rights and
present in person or by proxy; (c) in case of private companies
by one member having the right to vote and present in person or
proxy when the strength of the meeting is 7 or less than 7
members; but if the strength is more than 7 than poll can be
demanded by atleast 2 persons present in person by proxy; (d)
by member(s) present in person or by proxy and holding not
less than one-tenth of the total voting power on that resolution
or on which not less than Rs.50,000 has been paid or (e) by
member(s) holding shares equivalent to one-tenth of the paid
up capital on the shares conferring the right to vote.
Under the Companies Act, only the last two modes of voting
i.e., by show of hands and by poll are recognized. sec. 177 in
fact provides as follows: At any general meeting, a resolution
put to vote of the meeting shall, unless a poll is demanded under
sec. 179, be decided on a show of hands." Thus, priority is given
to voting by show of hands, though a poll may be demanded
without going through the formal procedure of a show of hands
[Holmes v. Keyes (lord), (1958)2 All ER 129 (X)]. In case
two or more resolutions are to be put to vote, the Chairman may
put them to vote en bloc, unless a separate voting is demanded
by some shareholder.
Voting by show of hands is basically a crude if convenient
method of voting and hence the Act makes provision for voting
by poll under sec. 179. When a poll is demanded and ordered,
any prior results obtained by show of hands come to nought.
Whenever a poll is duly demanded it has to be taken, unless the
person demanding the poll withdraws his demand. The meeting
continues till the poll is conducted. A Chairman may fix the
time of taking the poll, but cannot declare the poll closed as
soon as the time is over, if the votes are still coming. He can
close the poll only after waiting a reasonable time in order to
ascertain that no more votes are forthcoming. If he improperly
excludes a voter or prevents him from voting, the poll will be
invalidated [Shaw v. Tati Concessions Ltd., (1911-13) All ER
Rep 694] unless he can prove that the excluded members votes
would not have made any difference to the results [Ex Parte
Hawby, (1854)3 E & B 718].
Time for taking poll: Sec. 180 provides as under:
i) A poll demanded for adjournment shall be taken
immediately; and
ii) A poll on any other question, should be taken within 48
hours of the demand being made. But if there is a
breakdown of the poll arrangements and it could not be
taken at the time fixed by the Chairman, he is duty bound
to take the poll at a later time though the 48 hours time
limit specified under sec. 180 has lapsed. He is required
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 under these circumstances to fix and notify a new date and
time for the poll and give the voters an opportunity to poll
on that day. He cannot refuse to grant the poll.
[M.K.Srinivasan v. W.S.Subramaniya Iyer, AIR 1932
Mad 100].
Who can vote ?
A company is allowed to issue two kinds of shares: Equity or
ordinary shares and preference shares. Every holder of equity
shares is entitled to vote in a meeting [sec. 7(1)]. A preference
shareholder can exercise his right to vote only on those
resolutions which affect his rights attached to the preference
share [sec. 87(2)] i.e., he does not have a general right to vote.
Under sec. 181, a shareholder can be prevented from exercising
his right to vote if he has not paid the call-money on his shares
or there are other sums due from him to the company. A
shareholder cannot be prohibited from voting on any other
ground, for example, that he had not held his shares for a
specified period etc [sec. 182].
Voting as such is not the only mode of company action, though
it is the most prevalent one. An agreement unanimously agreed
to by the members is sufficient to express corporate will, though
a formal vote may not have been taken. Thus, in re Beiley Hay
and Co. Ltd., [(1961)3 All ER 693], a meeting was attended
by all the five members of a company. Two members held half
the voting power and the remaining half was held by the other
three members. On a resolution for voluntary winding up of the
company, the two members with half the voting right voted in
favour and the other three abstained from voting. It was held
that the resolution was passed unanimously by the members.
Brightman,J., held, It is established law that a company is bound
in a matter, intra vires the company, by the unanimous agreement
of all its corporators.” Quoting Astbury,J., he further said, Where
a transaction is intra vires the company and honest the sanction
of all the members of the company, however expressed, is
sufficient to validate it." Explaining his reasons for holding the
resolution unanimous, he said, Admittedly three of the five
corporators did not vote in favour of the resolution, but they
undoubtedly suffered it to be passed with knowledge off their
power to stop it... If corporators attend a meeting without protest,
standby without protest while their fellows purport to pass a
resolution, permit all persons concerned to act for years on the
basis that the resolution was duly passed and rule their conduct
on the basis that the resolution is an established fact, it is idle
for them to contend that they did not assent to the purported
resolution".
Just as a voter is entitled to abstain from voting, under sec. 183,
a voter may split his votes in favour and against the proposal,
when a poll is taken. He has the right to distribute his vote in
any manner be wants or desire.
3.10 VOTING BY PROXY
When a meeting is convened, a person has two options either to
be present personally or to ask someone else to do it on his
behalf. When he is present personally, he can exercise his right
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to vote in person, but when he abstains from attending the
meeting, he can vote on a resolution through the hand of another.
A person who votes on someone else's behalf is known as a
'proxy'. Generally speaking, a voting by proxy is allowed only
in case of a 'poll', though the articles may provide for proxy
voting even in case of voting by show of hands. This mode of
voting has become very popular and common in the present
context of large companies with extremely dispersed
shareholding. Voting by proxy is provided for under sec. 176
of the Act, and the section also provides for various rules
governing such a voting, namely:
i) A proxy has to vote in accordance with the directions issued
to him.
ii) He does not have the right to speak on the motion.
iii) The instrument appointing a proxy must be in writing and
signed, and should be deposited with the company atleast
48 hours before the meeting.
iv) Proxy forms in blank should be supplied to the members
alongwith the notice of the meeting.
v) A proxy being in effect a contract of agency is always
revocable, even if its terms provide otherwise, but such
revocation is always subject to the provisions of the articles.
Thus, in Narayan Chettiar v. Kaleeswar Mills [AIR 1952
Mad 515] a proxy had exercised his votes in the first poll of
a meeting. Before the final poll was held, the proxy was
revoked and the member cast his vote personally. There
was no provision in the articles prohibiting such a
revocation. The Chairman rejected the revocation. The
court held, that in the absence of a specific provision in the
articles, the revocation was valid and rejection of it by the
Chairman was therefore untenable.
Under sec. 187-B, right to vote on shares held in trust is now
vested in the public trustees who may exercise the right
personally, or appoint someone to vote on his behalf or he may
abstain from voting altogether if he feels that the interests of the
trust would not be adversely affected by such abstinence.
Similarly, where a company is a member of another company it
may appoint a representative to look after its interests. So also,
in case of any government being a member, it has the power to
appoint representatives to attend the company meetings on its
behalf. Such nominees hold the position of a proxy.
The question arises - who can be appointed as a proxy ? The
Act itself remains silent on this issue the only mention made in
the Act is that any person entitled to attend and vote at a meeting
can appoint another person to vote on his behalf. Thus, only a
member of the company can appoint a proxy, but any person
can act as a proxy regardless of whether he is a member of the
company or not. Unless the articles of the company prescribe
some qualifications for a proxy, there is no restriction under
the Act for anyone to act as a proxy - only requirement being
that 'a proxy should be an individual', whether the individual is
a minor, lunatic or physically disabled makes no difference to
his right to act as a proxy. But in practice, since a proxy is
required to vote on someone's behalf and may sometimes have
to exercise this right using his own discretion, it would be more
logical and practical to appoint an adult as a proxy - one who is
able to understand the proceedings and the consequences of his
vote.
Appointment of a Proxy
Generally, alongwith the notice convening a meeting a blank
proxy form is also issued to the members. If a member intends
to appoint a proxy, he should do so in writing (in the prescribed
format), sign the form either personally or his duly authorised
attorney should sign it for him, and deposit the form with the
company atleast 48 hours before the meeting. If the member
appointing a proxy is a body corporate, then the proxy from
should be under its seal and signed by a person authorised by
the company in this regard (such authorisation is usually given
to the company secretary).
If the articles of a public company or of a private company being
the subsidiary of a public company, prescribe a longer period
than 48 hours for the deposit of the proxy, then such longer
period will be treated as invalid, and it will be deemed that only
48 hours requirement has been specified [section 176(3)].
If the signature on the proxy form does not coincide with the
signature in the members'register, the proxy can be rejected by
the company, unless the person is authorised to write his name
differently. The articles of a company may provide that the
member's signature on a proxy form should be attested by two
witnesses. If such a clause is there, then a proxy form can be
rejected if such an attestation is not there.
If the proxy is executed outside India it must be properly stamped
within 3 months after being received in India, else such a proxy
is treated as invalid.
If shares are held jointly by persons, then the proxy should be
signed by all such joint holders. Execution of proxy by any one
or only some of the joint holders of shares will make the proxy
invalid, unless and untill such person had an authority from all
the other joint holders to execute the proxy on his own.
Given below is a specimen of blank proxy form.
Form of Proxy
Name of the Company
I/we..........................of.....................in the district
of........................being a member/members of the above named
company hereby appoint....................of.....................in the
district of....................or failing him................of....................
proxy to vote for me/us on my/our behalf at the meeting of the
class members of the company to which I/we belong to be held
on the .....................day of...............,19.....and at any adjourned
meeting thereof.
Signed this...........day of...............,19............
Appointment of more than one Proxy
As mentioned earlier, a proxy can be revoked any time by the
member/shareholder concerned. His revocation may be in
anyone of the following ways,viz:
i) Express revocation - By annulling the proxy issued and
informing the company, that, Mr.A....would no longer be
acting as proxy on behalf of......
ii) Implied revocation - This may be done in two ways, namely:
a) by the member himself attending the meeting and
exercising his right to vote personally; or
b) by the member depositing a fresh proxy with the
company appointing someone else as a proxy.
In case of more than one valid proxies being appointed by the
same person, the later in time will prevail over the former i.e.,
the former proxy is automatically revoked. Thus, if X appoints
'A' as a proxy by a form dated 12.7.1994 and appoints 'Y' as
proxy through a form dated 13.7.1994 and both have been
deposited with the company 48 hours before the meeting, the
appointment of 'Y' will prevail over that of 'A'.
If two proxies are appointed on the same date but different times,
then, the one later in time will prevail.
If more than one proxies are appointed on the same date and
time then all of the proxies will be invalid.
Position of proxy in case of the member's death
In case of the death of a member/shareholder appointing a proxy,
the authority of the proxy is revoked if the company has notice
of such death prior to the meeting. Regulation 63, Table 'A'
makes a provision in this regard as follows:
"A vote given in accordance with the terms of an instrument of
proxy shall be valid, notwithstanding the previous death or
insanity of the principal or the revocation of the proxy or of the
authority under which the proxy was executed, or the transfer
of the shares in respect of which the proxy is given.
Provided that no intimation in writing of such death, insanity,
revocationor transfer shall have been received by the company
at its office before the commencement of the meeting or
adjourned meeting at which the proxy is used."
Blank Proxy
Proxys have started being used as an important tool in the
passing of a resolution in which a director is interested, and
more often than not such a director or other person collect blank
proxy forms. A blank proxy form, even if duly signed and dated
by the member is not of much use, unless the proxy form
complete in all respects is deposited with the company before
the specified time. A proxy not being a contract deed, is valid,
though a blank form is handed over to the agent for filling up
the particulars and submitting it. Such an instrument is not
complete till it is filled up and affixed with proper stamp (present
stamp duty is about 30np. stamp). An unstamped proxy is
invalid. Thus, there is nothing irregular in a member handking
over a blank-signed proxy to a director to be filled up by the
later; but if the company circulates a proxy complete in all
respects but needing only the member's signature on it, then
such a practice is illegal and the officer etc., instrumental in
circulating such a filled proxy form is liable to be fined - the
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amount extending to Rs.1000/-. The reason for this seemingly
contradictory provisions is simple - when proxy forms are
circulated in the blank by the company a member is given an
option to fill the form with the name of his choice or to simply
sign it and give it to his agent to fill up the details, but when the
name is filled in by the company - the option is no longer
available to the member and he would be forced to accept the
person mentioned in the form as his proxy whether he likes it or
not, and this would amount to an interference with his right to
vote and appointment of proxy. It should be noted that, though
a company can not circulate a filled in proxy form it can circulate
a blank proxy form alongwith a list of names forming the 'panel
of proxies', from which the member can choose the proxy of his
liking.
The company is required to maintain a register for recording
the lodgement of proxies along with relevant details.
3.11 ADJOURNMENTS AND DISPERSAL
Sec. 165(8) of the Act provides that every meeting may be
adjourned from time to time, on a motion for adjournment being
passed by the meeting. The Chairman cannot suo motto adjourn
a meeting unless the power to do so has been granted to him
under the Articles. As far as possible, whenever an adjourned
meeting is reconvened either on the same day or at some later
date no fresh business should be dealt with at such a meeting,
i.e., at the reconvened meeting only the unfinished business of
the adjourned meeting should be taken up. If a meeting has
been adjourned for 30 days or more a fresh notice has to be
given to the members as if it is a regular meeting.
If a meeting has not been adjourned, and the specified business
for which the meeting was called with has been satisfactorily
dealt with and the requisite resolutions have been passed, then
the meeting is dispersed after a vote of thanks has been proposed
and given. A meeting cannot disperse, in cases where a poll has
been demanded on some issues, till the poll has been taken and
the results declared. In such cases, the meeting is only adjourned
and is dispersed only after conclusion of the poll.
3.12 CONCLUSION
Let us now try to summarize the procedure involved in convening
and holding of company meetings. The various steps involved,
is given below in the form of a check list:
1. Notice is to be circulated amongst all the members having
a right to be present at that meeting. The notice should
contain - (a) date, time and place of meeting; (b) nature and
objective of meeting; (c) any other necessary information
needed for the meeting; (d_ proxy forms in blank wherever
needed.
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2. Preparation of Agenda.
3. On the day of meeting, if a Chairman is not already
appointed, then a Chairman is to be chosen to preside over
the meeting.
4. Checking if quorum is present. If quorum is absent even
after half an hour of the start of meeting, the meeting stands
adjourned, to be reconvened a week later on the same day
and time.
5. The Chairman to take up each business on the agenda as far
as possible in a serial order.
6. Each item to be put in the form of motion by a member in
the form, for example, 'that Mr.A be elected a director'.
7. Each motion to be then put to debate where every member
is to be given one opportunity to speak in favour of or against
the motion.
8. In case, any amendments are proposed to the motion, then
the amendments are to be debated on - while suspending
the debate on main motion.
9. The amendments (if any) are then put to vote. If passed the
amendment becomes embodied in the main motion.
10. The main motion in its original/altered form is put to vote.
If passed by requisite majority [either simple or three-fourth
majority as the case may be] the motion becomes a
'resolution' passed by the meeting.
11. Voting in the first instance to be by show of hands, and if
demanded by a member then a poll to be conducted on the
motion. Poll may be taken at any time fixed by the Chairman
but within 48 hours of the demand being made. Further a
person may vote either in person or through a proxy.
12. On conclusion of the entire business, a vote of thanks to be
proposed and given and the meeting dispersed.
13. Before final dispersal any member can seek an adjournment
of the meeting and if the motion is passed, then the meeting
is adjourned to a specified later time and date.
14. On dispersal or adjournment, the secretary is required to
prepare the minutes of the meeting within 30 days of the
meeting and to file it in the 'minutes book'. Minutes form a
prima facie evidence of the proceedings of the meeting and
the resolutions passed therein.
15. A copy of the minutes is to be filed with the Registrar of
Companies within specified time limit alongwith copies of
resolutions passed etc. Failure to file them involves a
penalty.
4 REPORTS, APPLICATIONS, AND APPROVALS
I] REPORTS
Under the Act, the officers of the company are required to present
various reports to the shareholders on different occasions, giving
a concise summary of either the activities undertaken by the
company, or the decisions of the board of directors or the stating
of the company accounts etc. These reports are presented not
merely for 'information purposes' but also to accord the
shareholders etc., to question the concerned persons on that
report. Reports thus form an effective check on arbitrary action
and impose 'accountability' on the persons preparing and
presenting them. Some of the important reports are briefly
discussed below.
a) Statutory Report
As mentioned earlier, at every statutory meeting a statutory report
has to be presented, to provide the shareholders with up to date
information from the time of incorporation to the time of meeting.
A statutory report has to include the following informations:
i. The total number of shares allotted, categorizing them as
fully paid or partly paid, and the total amount of cash
received by the company against them.
ii. An abstract of receipts stating the sources and the payments
made, the balance cash in hand, estimated preliminary
expenses, commission/brokerage etc., to be paid on the
shares.
iii. An up-to-date information about the names, addresses and
occupations of the directors, managers, secretary of the
company.
iv. The particulars of any contract to be submitted to the
members for their approval alongwith proposed
amendments.
v. The details of any underwriting contract entered into by the
company and the extent to which such contract has been
fulfilled.
vi. Details of any arrears which may be due from the directors
etc., on call on their shares.
vii. If any commission or brokerage has been paid to the
directors, managers etc., for issue/sale of shares, the details
of such payments made.
A specimen statutory report is given below to have a clearer
understanding.

STATUTORY REPORT
(Pursuant to Section 165)

The name of the company: Synthetics and Chemicals (India) Ltd.

Date of Notice for holding Statutory Meeting:15th December 1990.
Date and Place of the Statutory Meeting:15th January 1991, at Resham Bhavan
Hall, 78, Veer Nariman Road, Bombay-1, at 3.00p.m.
Presented by: Ms.Padma Bhushan, Director of Synthetics and Chemicals
(India) Ltd.
The Board of Directors submit this Statutory Report to the members in
pursuance of Section 165 (i.e., within 7 days of the Report)
Cash received upto
Nominal value

Called up per
of each share

Particulars
of Shares

19-12-60
Number

share

Rs. Rs. Rs.

a) Allotted subject to payment thereof
in cash:
i) Equity 4,50,000 100 75 2,58,26,500
ii) Redeemable Preference Shares Nil Nil Nil Nil
iii) Preference Shares other than
Redeemable Preference Shares Nil Nil Nil Nil

b) Allotted as fully paid up otherwise

than in cash and the consideration
which they been have allotted:

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 i) Equity Nil Nil Nil Nil
ii) Redeemable Preference Shares Nil Nil Nil Nil
iii) Preference Shares other than
Redeemable Preference Shares Nil Nil Nil Nil

c) Allotted as partly paid up to the

extent of Rs. Nil per share and the
consideration of which they
been allotted:
i) Equity Nil Nil Nil Nil
ii) Redeemable Preference Shares Nil Nil Nil Nil
iii) Preference Shares other than
Redeemable Preference Shares Nil Nil Nil

d) Allotted at a discount of Rs. Nil per

share:
i) Equity Nil Nil Nil Nil
ii) Redeemable Preference Shares Nil Nil Nil Nil
iii) Preference Shares other than
Redeemable Preference Shares Nil Nil Nil

2. Expenses as estimated in the Prospectus:-

Rs. Rs.

Preliminary Expenses 1,59,500.00

Brokerage 1,65,500.00
Other Expenses 1,75,000.00
3,40,500.00
Rs. 5,00,000.00

Preliminary ex- Preliminary ex-

penses actually penses esti-
incurred upto mated to be in-
aforesaid date curred after the
(i.e. 19-12-60) aforesaid date
(i.e. 19-12-60)
Rs. Rs.

Law charges 25,250.00 Nil

Other charges in connection with
the preparation of the Memoran-
dum and Articles of Association
of the Company Nil Nil
Printing expenses 78,873.49 30,000.00
Registration charges 38,717.50 Nil
Advertisement charges 77,382.50 Nil
Commission on issue or sale of shares Nil 1,65,500.00
Discount on issue or sale of share Nil Nil
Miscellaneous expenses 1,85,480.22 2,00,000.00

Rs. 4,05,703.71 3,95,500.00

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 Receipts Rs. Rs.

Shares:
4,50,000 Equity Shares of Rs. 100 each of
which Rs. 75 per share called up 3,37,50,000
Less: Allotment monies in arrears Rs. 93,000
Unpaid Call (1st Call of
Rs. 25 per share is
made and is payable
on or before 31-12-60) Rs.78,30,500 79,23,500 2,58,26,500.00
Application Money Refundable 24,15,59,725.00
Other Receipts:
Interest on Short Term Deposits 12,99,501.96
Miscellaneous receipts 1,638.48 13,01,140.44
Amount Received and payable to Messrs.
Kilachand Devchand and Company
Private Ltd. 73,481.28

Total Rs. 26,87,60,846.72

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 Payments Rs. Rs.

Preliminary and Issue Expenses:

Registration Charges 38,717.50
Other Issue Expenses 3,66,986.21
4,05,703.71
Application Money Refunded
24,15,59,725.00
Capital Expenditure
Land
Building 4,14,529.71
Office Furniture and Equipment 76,025.04
Motor Vehicles 97,680.01
5,88,234.76
Advances and Deposits:
Land 3,24,767.91
Building ..
Plant and Machinery 69,77,834.85
Railway Siding 8,52,000.00
Other Accounts 1,04,850.00
Sundry Deposits 16,698.00
82,76,150.76
Other Items:
Salary and Wages 95,946.95
Printing and Stationery 9,743.65
Postage and Telegrams 64,719.33
Rent Rates and Taxes 4,053.00
Motor Car Expenses 4,622.74
Directors’ Fees 16,000.00
Travelling Expenses 96,000.06
Commitment Fees 83,256.25
Disclosure Fees 14,26,500.00
Professional Fees 1,72,638.67
Payment to Promoters as per agreement 15,00,000.00
Miscellaneous Expenses 62,328.77
35,35,809.42
Balances:
In Hand 501.48
At Banks in Current Account 50,14,346.59
At Banks in Short Term Deposits 93,80,375.00
1,43,95,223.07

Total Rs. 26,87,60,846.72

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4. Names, addresses and occupations of the Company’s Directors, Auditors, Managing Agents, Secretaries and Treasures,
Manager and Secretary.
A. DIRECTORS

Particulars of
changes, if any, in
entries in columns

Sr. Names Address Occupation (1), (2) & (3) since Date of the
No. the date of change
in corporation

1 2 3 4 5

1. Mr. Tulsidas Kilachand 95, Napean Sea Merchant Nil Nil

Road, Bombay 6
2. Ms. Padma Bhushan 95, Napean Sea Merchant Nil Nil
Road, Bombay 6
3. Mr. Elton H. Schulenberg 1200, Firestone Director, Vice- Nil Nil
Parkway, Akron, President and
17, Ohio, U.S.A. Treasurer The
Firestone Tyre &
Rubber Co.

B. AUDITORS
Sl. Name Address Description Particulars of Date of the
No. changes, if any change

1. Dala And Shah 49, Apollo Street, Chartered Nil Nil

Bombay 1. Accounts
2. Nanubhai And Co. 51, M. G. Road, Chartered Nil Nil
Bombay 1. Accountants

C. MANAGING AGENT, SECRETARIES & TREASURES

Nil Nil Nil Nil Nil

D. MANAGER
Nil Nil Nil Nil Nil

E. SECRETARY

1. Mr. K. B. Dabke Warden Court, .. Nil Nil

Cumballa Hill,
Bombay 26

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5. The Particulars of contract which is to be submitted to the Statutory Meeting Nil

6. Underwriting Contracts Nil

7. The arrears if any due on calls from Directors, Managing Agents, Secretaries &
Treasurers and Manager Nil

8. Particulars of any commission or brokerage paid or to be paid in connection with the

issue on sale of shares to any Directors, Managing Agents or Manager or if Managing
Agents is a firm, to any partner thereof, or if the Managing Agents is a Private
Company to any Director thereof Nil

We hereby certify that the above Report is true.

TULSIDAS KILACHAND Chairman

}
RAMDAS KILACHAND
B. K. DAPHTARY Directors
K. M. PREMCHAND
Bombay, Dated this 23rd day of December 1960.

We hereby certify as correct so much of the Report as relates to the Shares allotted by the Company and to the cash received in respect of such
shares and to the receipts and payments.
DALAL & SHAH
NANUBAI & CO.
Chartered Accountants
Auditors

Bombay, Dated this 23rd December 1960.

b) Annual Report
This is the report which is presented at every annual general
meeting held in pursuance of section 166 of the Act, wherein,
the board lay before the company, a balance sheet, and profit
and loss account for a period beginning the day following the
previous AGM and ending not more than 6 months prior to the
present meeting; boards' report; auditors' report; Chairman's
speech etc. Given below is a specimen of the Agenda of an
AGM of a company.
AGENDA
1) Secretary to read the notice convening the meeting.
2) Secretary to read auditor's report.
3) Ask the meeting whether the director's report, and accounts
as printed and submitted shall be taken as read.
4) Chairman's speech, after which he will -
i) move that the report and accounts as audited and
certified by the company's auditors, and placed before
the meeting, showing the position of the affairs of the
company as on 30th March, 1994 be approved,
adopted, and
ii) Call on Ms.Padma Bhushan to second the motion.
iii) Invite discussions.
v) Reply to questions, put the motion to vote and declare
the results.
5) Shareholder to move, and second -
That Mr.Y.L.Reddy, having expressed his willingness to
continue as director for another term, be reelected as director
for a period of 3 years, on the same terms and conditions of
service as before".
6) Shareholders to move, and second -
"That Kichha and Co. Ltd. having expressed their
willingness to continue as auditors, be reappointed as
auditors for the company for the year 1994-95, on the same
terms and conditions as before."
7) Vote of thanks -
To have a better understanding of the proceedings let us
have a look at how the 'minutes' of this particular meeting
would appear.
Minutes of the Above Agenda
The Annual General Meeting of the Synthetics and Chemicals
(India) Ltd., was held on 30th May, 1994 at 3.00p.m. at Resham
Bhavan Hall, 78, Veer Nariman Road, Bombay-400 001
(Registered Office).
Present
Shri. A.S.Menon in the Chair
Ms.Padma Bhushan
Mr.Y.L.Reddy Directors

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Mr.S.S.Ghosh
Mrs.Radha Menon
Shri.K.Lal, Solicitor
Shri.T.Devidas, Secretary
and 58 shareholders.
1) The notice of the meeting was read by the secretary.
2. The auditor's report on the company account as at 30th March,
1994, was read.
3) The reports of directors and accounts duly certified by the
company's auditors were also taken as read.
4) RESOLVED that the reports and accounts as audited and
certified by the company's auditors, now placed before the
meeting showing the position of the company's affairs as
on the 30th March 1994, be approved and that the dividends
recommended to be paid by the director's in their annual
report, @ 7% on preference shares and 9.5% on equity
shares for the year, be approved."
5) RESOLVED that Mr.Y.L.Reddy be re-elected as director
for a period of 3 years, on the same terms and conditions as
before."
6) RESOLVED that Kichha and Co. Ltd., be reappointed as
auditors for the year 1994-95, on the same terms and
conditions as before.
7) The meeting was dispersed with a hearty vote of thanks to
the board.
(Signed)
A.S.MENON
Chairman.
c) Director's and Auditor's Reports
Two of the major components of an Annual General Meeting
are the reports presented by the board of directors and the
auditors of the company relating to the affairs of the company,
financial or otherwise, during that financial year. Specimen's of
these meetings are reproduced below:
SYNTHETICS AND CHEMICALS (INDIA) LTD.
BOMBAY
DIRECTOR'S REPORT
For the third Annual General Meeting of the Shareholders to be
held on 8th May 1994.
To
THE SHAREHOLDERS,
SYNTHETICS AND CHEMICALS (INDIA) LTD.
Gentlemen,
Your Directors have pleasure to present for your consideration
the report on the working of the Company during the year ended
31st March 1994, the Profit and Loss Account for the year and
the Audited Balance Sheet as at 31st March 1994.
Production during the year was further increased over the previous
year's level by 14% sales of your company's products amount to
Rs.108,57,895 as compared with Rs.98,69,545 for the previous
year. Satisfactory progress was achieved in your company's
business during the year 1993-94, and operations for the year
show a net profit of Rs.6,27,541.73 as compared with
Rs.4,61,739.98 for the previous year. A sum of Rs.1,85,972.70
was paid as interest on the loans obtained from the Industrial
Finance Corporation of India and the State Bank of India, and
Rs.12,50,515 is set aside for Depreciation on Fixed Assets
calculated in accordance with the rates allowed for normal
depreciation and extra shift allowance as per Income-Tax Act.
Your Directors have made a provision of Rs.3,00,000 in addition
to the sum of Rs.80,000 made last year, to meet the liability of
payment of retirement gratuity to the employees. Further, your
Directors have set apart Rs.2,50,000 towards cost of repairs
and replacement.
No provision has been made for Income-Tax this year also as
the company has no assessable Income.
The balance left after making the above provisions, including
the carry over, is Rs.9,66,819.10.7 and your Directors have
decided to transfer Rs.2,50,000 to the I.F.C.I. loan Redemption
Fund and to recommend appropriation of the balance of
Rs.7,16,819.10.7 as follows:
1. To declare a dividend of 9.5% or at the rate of 95np. per
share of Rs.10 absorbing Rs. 5,38,610
2. To carry forward Rs. 1,78,209.10.7
With the installation of the auxillary equipments, namely Vacuum
Filters and additional Chippers, the current programme of
expansion is completed. Your Directors are taking action to
further the production of sulphuric acid and nitric acid to a tune
of about 10,000 tonnes a year.
Sri. K.Nagaraj, IAS, Director of Industries and Commerce, a
Director on our Board, resigned in April 1994 and Sri.P.Bhaskar,
IAS,M.P., has been appointed a Director on our Board in his
place as representative of Industrial Finance Corporation of
India.
Under Article 109 of our Articles of Association, Sri.A.M.Rao,
Sri.G.Sivareddy reitre by rotation and being eligible offer
themselves for re-election.
Under Article 151 (1)&(2) of the Articles of Association, the
Auditors of the company Kichha and Co. Ltd. retire and are
eligible for re-election.
Yours faithfully,
for and on behalf of the Board of Directors,
Chairman
Secretary
Dated: 31st April 1994.
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 REPORT OF THE AUDITORS TO THE SYNTHETICS
AND CHEMICALS (INDIA) LTD.
We have audited the annexed Balance Sheet of the Synthetics
and Chemicals (India) Ltd., as at 31st March 1994, and also the
annexed Profit and Loss Account of the Company for the year
ended on that date in which are incorporated the audited returns
from Sri Lanka and report that:-
1. We have obtained all the information and explanations
which to the best of our knowledge and belief was essential
for the purposes of our audit;
2. In our opinion proper books of account as required by law
have been kept by the company, so far as it appears from
our examination of the books, and proper returns adequate
for the purposes of our audit have been received from works
and other offices in India;
3. The Balance Sheet and Profit and Loss Account dealt with
in the report are totally in agreement with the books of
accounts and the returns;
4. In our opinion and to the best of our information and
according to the explanations given to us, the Accounts read
with the notes thereon give the entire information required
by the Companies Act, 1956, in the requisite manner and
provide a true and fair view -
a) in the case of the Balance Sheets of the state of affairs
of the company as on 31st March, 1994.
b) in the case of Profit and Loss Account, of the profits
for the year ending on that date.
Kichha and Company
Chartered Accountants
Bombay, 30th April 1994.
II) APPLICATIONS
Just as a number of reports have to be submitted, the secretary
of a company has to submit to the Registrar various applications
for differing purposes. In fact, the submission of applications
begins even before the company is incorporated i.e., from
submitting the application for incorporation. From then it is a
long stream of applications be it for equity participation or for
listing of shares or for NRI investment etc. In general, all these
applications have to be made in a fixed format, under the
company seal and signed by the secretary or any other person
authorised in this regard. It is not necessary that all such
applications have to be only from company to Registrar - in fact
depending on the purpose of the application the second party to
whom it is addressed keeps differing, for example:
Company to Registrar - for incorporation etc.
Company to general public - public issue of shares or private
placement of shares.
Company to stock exchange - for listing of its shares.
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Company to financial institutions - for underwriting commissions,
for getting loans etc.
Some of these applications may be in the form of advertisement
in mass media or otherwise and are more in the nature of
invitation to offers' for example - those inviting public to offer
for shares in the company. Given below are two specimen
applications, one for registration of Financial Institutional
Investors (FIIs) with SEBI and another for offering shares on a
private placement basis in a new company.
Application for registration of FIIs with SEBI and the
permission of RBI under FERA, 1973
Form FII-R-1
1. Name, address, telephone no. telex no. and fax no. of the
Registrant. In case of Registrant already has an office in
India, the particulars may also be given for that office.
2. Please indicate whether the Registrant belongs to any one
or more or the following categories.
Pensions Fund, Mutual Fund, Investment Trust, Asset
Management Company, Nominee Company and
Incorporated/Institutional Portfolio Manager or their power
of attorney holder (providing discretionary and non-
discretionary portfolio management services).
3. (a) The date and place of incorporation of the Registrant.
(b) Brief description of the principal activities of the
Registrant and the year of commencement of such activities.
(c) Brief description of the Group to which the registrant
belongs.
4. Name, address, telephone, telex and fax numbers of the
Securities Commission/Self-Regulatory Organisation/the
relevant statutory authority for the securities market with
whom the Registrant is registered in the country where the
Registrant is incorporated or in the countries of its
operations, and the registration number and period of
registration.
Please also state whether there has been any instance of
violation or non-adherence to the securities laws, code of
ethics/conduct, code of business rules, for which the
registrant, or its parent/holding company or affiliate may
have been subject to economic, or criminal liability, or
suspended from carrying out its operations, or the
registration revoked temporarily.
5. (a) Please indicate the names of the clients on whose behalf
you propose to invest in India.
(b) Please provide the following details regarding the clients:
i) Date and place of incorporation and Constitution (i.e.,
Partnership Firm, Private Company, Public Company,
Holding Company, Subsidiary, Pension Fund, Mutual
Fund, Investment Trust etc);
ii) Whether the client is registered with any regulatory
agency; if so, the name and address of the regulatory
agency, registration number and date of registration.
 iii) Objectives and principal activities of the clients
(investment/fund management, finance company,
investment company, mutual fund, pension fund, etc).
iv) Number of types of shareholders (i.e. individuals,
institutions, etc.) % distribution of assets between
groups of shareholders may also be provided.
v) Volume of assets.
(In case of Registrant is itself a Fund the information in
regard to 5(b) may be provided for itself).
6. Please indicate the manner in which you propose to conduct
your investments in India i.e., whether through an
establishment in India or through any other office outside
India. Please give details, and also the name of the contact
person/compliance officer.
7. Name and address of the designated bank branch in India
through whom investment is proposed to be made.
8. (a) Name, address, telephone no., telex no., and fax no. of
the domestic custodian. Please also present the background
information on the custodial including volume of business
handled, organisational infrastructure and the number of
investment companies for which it is acting, or has acted,
as custodian.
(b) Please state whether the Registrant has entered into an
agreement with the domestic custodian.
Documents to be enclosed with the application
a) Copies of Memorandum and Articles of Association and
Investment Management Agreements or any other
agreements authorising the Registrant to invest on behalf
of its clients.
b) Audited financial statements and annual reports for the last
5 years.
c) Documents to support registration with a securities
Commission and/or Self-Regulatory Organisation.
d) Copy of the custodian agreement with the domestic
custodian.
e) Declaration Statement (to be given as below).
We hereby agree and declare that the information supplied in
the application, including the attachment sheets, is complete and
true.
And we further agree that we will notify Securities and Exchange
Board of India and Reserve Bank of India immediately any
change in the information provided in the application.
We further agree that we shall comply with, and be bound by
the Guidelines relating to Foreign Institutional Investors, as
announced by the Government of India, and such other
guidelines/instructions which may be announced by the
Government/Securities and Exchange Board of India/Reserve
Bank of India from time to time.
We further agree that as a condition of registration, we shall
abide by such operational instructions/directives as may be
issued by Securities and Exchange Board of India/Reserve Bank
of India from time to time.
For and on behalf of.........................................................
(Name of the registrant)
Authorised Signatory......................................... ..........................
(Name) (Signature)
Date:
Place:
Notes-
1. Securities and Exchange Board of India (SEBI) and Reserve
Bank of India (RBI) reserve the right to call for any further
information from the Registrant regarding its applications.
2. Applications, superscribed Application for Registration of
Foreign Institutional Investor”, shall be submitted in
duplicate in sealed enveloped, at SEBI's office.
1. Letter offering shares on a private placement basis in a
new company
Regd. Office......................
PRIVATE AND CONFIDENTIAL
Dear Sir/Madam,
Sub: Private preferential offer of ........equity shares of Rs.10
each for cash at a premium of Rs.......per share to
Directors, their friends, relatives and associates.
and will be financed partly by a loan from and............consortium
and partly by issue of equity shares to the Directors, their friends,
relatives, associates and to Indian resident public. On completion
of the project the production of about........MTS per annum. The
project is in advanced stage of implementation.
We now have the pleasure to offer the shares of this Company
to you out of the preferential offer by private placement on the
terms set out in the enclosed application form. If you are
interested in availing of this offer, please return the enclosed
application from duly filled and signed alongwith the remittance
in the manner indicated in the form to the registered office of
the Company. Allotment of shares however, will be at the
discretion of the Board of Directors of the Company.
Unsubscribed portion out of this private preferential offer, if
any, will be subscribed by..........kindly note that the shares so
allotted shall be subject to the guidelines and clarifications
issued thereof from time to time by the Securities and Exchange
Board of India (SEBI), including, in particular, as to the lock-
in period. Please also note that this offer is meant for your
acceptance only and it cannot be renounced by you in favour of
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any other person. You may however accept the offer jointly with
any other person in which case you must be the first named
applicant.
By Order of the Board
.............
Chairman
III) APPROVALS
The purpose of some of the applications mentioned above is to
get an approval of the concerned institution or the government,
for the particular act. Thus, for example, if a company had to
change its name or its registered office from one state to another,
or to reduce its share capital it has to take the prior approval of
the Central Government. Similarly, if it wanted some FIIs to
participate in its equity issue, or wants some NRI investment or
wants to go in for a Euro Issue etc., then it has to seek the
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approval of SEBI and the Reserve Bank of India under FERA.
As a direct consequence of the liberal policies under the new
economic policies, most of the approvals in the latter case are
automatically given by the RBI. The basic objective of making
it mandatory on the company to seek approval of the concerned
authority whenever it contemplates a major change, is merely to
provide an impartial and trained authority an opportunity to
ascertain tht the best interests of the company, the shareholders,
creditors, and in some cases the country, would really be served
by such a change. The need to seek an approval also ensures that
a company does not take momentons decisions at the drop of the
hat, but takes the time to really think of all the consequences
which would ensue from such a change. The time required for
the granting of an approval also has an added advantage that if
the company has second thoughts about the whole matter then it
can withdraw the application (wherever allowed by the statute)
and no harm would be done to anyone.
5 CHECK LIST FOR A COMPANY SECRETARY
1. Pre and Post Incorporation issues
(a) For obtaining certificate of Incorporation
- Memorandum prepared in the appropriate format given in
table B, C, D and E of Schedule I of the Companies Act.
- 'Memo' and 'Articles' printed.
- These documents to be stamped properly according to the
Stamp Act of the State before signature.
- Subscribers to the documents signed in their own hand and
added their description.
- Lodged with the Registrar following documents :
- Memorandum and Articles
- Declaration of compliance
- Statement of authorized capital with appropriate fees
- List of persons who have consented to be the Directors
- If qualification share is to be subscribed, did Directors
subscribe or agreed to subscribe to it.
- A copy of ROC's letter approving the name
- Collect certificate of incorporation from ROC
- Obtain seal, registers and form of share certificate
- Steps taken to appoint full time directors if not appointed
by articles
- Prepare agenda paper for the BoD meeting
(b) For obtaining certificate of Commencing Business
(i) Company having share capital and going for public issue
- Appoint lead manager, co-manager, Registrar to the issue,
brokers, underwriters, bankers to the issue and for receiving
application money.
- Prepare draft prospectus in consultation with the lead
manager, and send the draft to all concerned.
- File initial listing application with the stock exchange.
- Hold board meeting to finalize the prospectus, authorize
opening of account, appoint an auditor.
- Send the prospectus to SEBI and the stock exchange for
vetting.
- Apply to RBI if shares are to be issued to NRI's, FII's under
Section 19(1)(d) of FERA, and to open bank accounts
abroad for collection of application money.
- Advertise the prospectus and print the share application
forms.
- Register to the issue to arrange for collection of application
forms and bank schedules.
- Fulfill the criteria of stock exchange listing, where the issue
is for Rs.3 crores or more and listing is proposed and confirm
salient features of prospectus, viz:
a) Every prospectus must be accompanied by a
application form.
b) An expert whose opinion is indicated in the prospectus,
should not be interested in the promotion, formation
or management of the company.
c) A copy of the prospectus duly signed to be delivered
to the ROC.
- After closing of the share application hold the board meeting
for share allotment.
- Ensure that minimum subscription is raised.
- Ensure application and allotment money is paid by the
directors.
- Obtain permission from stock exchange for listing.
- Pay the requisite stamp duty on shares.
- File declaration in Form 19 duly verified with ROC holding
all conditions are fulfilled.
- Obtain certificate to commence business.
ii) Company having share capital but not going for public
issue
- Prepare statement in lieu of prospectus and get it approved
in the board meeting.
- Submit statement in lieu of prospectus with ROC in
accordance with Schedule 111 of the Act.
- Arrange for payment of application and allotment money
in cash by the directors.
- Ensure total shares not allotted within 3 days of filing the
statement in lieu of prospectus.
- File a declaration in Form 20 stating all conditions fulfilled
with the ROC.
- Pay requisite stamp duty.
- Obtain certificate for commencement of business.
(c) Alteration to Memorandum of Association
(i) Objects and Registered Office
- Call a board meeting to decide the proposal, determine
date and time of GM and the notice therefor.
- Serve the notice to shareholders for the GM and to auditors
and stock exchange where the company is listed (3 copies);
- Pass a special resolution in the GM
- File a certified copy of the special resolution with
explanatory notes and Form No.23 with the Registrar within
30 days of passing of the resolution.
- Forward six copies of the amendments in the object clause
to the stock exchange.
- File petition with the Regional branch of the CLB in Form
No.1 of Annexure II of the CLB Regulation, 1991.
- Publish notice at least a month before the filing of petition
to CLB, once in an English daily and once on a regional
language newspaper.
- Receive copies of objections within 21 days of publication
of notice.
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- File petition as per Regulation 14 of CLB, 1991.
- Serve copy of petition with the ROC.
- File certified copies of the CLB orders with the ROC in
Form 21 within 90 days of the passing of order.
- Obtain certified copy of the order from ROC.
- Apply to CLB for extension of time for filing of documents
whenever necessary.
- Serve a copy of the notice along with the petition on the
Chief Secretary of the Government where the registered
office is situated (if change of registered office is needed).
- File certified copy of the CLB order with the printed copy
of the memorandum with ROC's of both the states (in case
of change of registered office.
- Register the order with the ROC of both the states within a
month of filing.
- Make necessary changes in all records, letterheads, etc.
- Arrange for the adoption of a new common seal.
(ii) Name Clause
- Call a board meeting to decide on change of name.
- Get the clearance of the new proposed name from the ROC
in Form No.1A.
- Send notice of the general meeting to the shareholders,
auditors and the stock exchange.
- Hold a general meeting and pass a special resolution.
- File a special resolution in Form No.23 with the ROC within
30 days of passing the resolution.
- File six copies of the amended memorandum with the stock
exchange.
- Apply for approval of ROC with the following documents:
a) reason for change of name;
b) certified copy of the amended memorandum and
articles;
c) certified copy of the annual report of the last year;
d) certified copy of the clearance of name by the ROC;
e) certified copy of the special resolution; and
f) treasury challan of payment of fees.
- Seek fresh certificate of incorporation from the ROC.
- Make changes in all documents.
- Arrange for the new common seal
(d) Alteration of Articles
- Hold board meeting to decide on alteration, and check that
proposed alteration is not inconsistent with the provisions
of memorandum or the Companies Act.
- Issue notices for a general meeting to all members, auditors
and stock exchange. Hold the general meeting and pass the
resolution.
- File 6 copies of amendment with the stock exchange where
the company is listed.
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- File with the ROC a certified copy of the special resolution
and explanatory statements in Form 23 within 30 days.
- Effect the necessary changes in all documents.
2. Checklist on Rights Issue
(a) Pre-Issue
- Decide on scheme of issue
- Check if memorandum permits the rights issue, else alter it
suitably.
- Ensure board has sufficient borrowing powers under section
293(1)(d) else pass suitable resolution.
- Ensure arrears on calls on existing shares are collected
before rights issue. In case of failure of payment forfeit
shares.
- Notify stock exchange of the decision of board and its date
to issue rights share.
- Convene a general meeting for consideration of matters
relevant to rights issue.
- Appoint lead manager to the issue.
- Obtain approval from RBI if securities are to be issued to
NRI's.
- Ensure standby arrangements for subscription to issue.
- Draft letter of offer and composite application form.
- Lead manager to forward letter of offer and application form
to SEBI for vetting alongwith diligence certificate and inter
se work allocation (if there are more than one lead
managers).
- Fix record date/book closure for the issue after vetting,
SEBI.
- Incorporate unaudited financial results upto last but one
month prior to date of letter of offer.
- Incorporate SEBI observations and finalize letter of offer.
- Send letter of offer to stock exchange for approval.
- Convene board meeting to approve of letter and its issual
to shareholders, and opening of bank account.
- Print letter of offer and application forms.
- Send 6 copies to the stock exchange.
- Appoint bankers to the issue, and arrange for acceptance of
application money at centres having recognised stock
exchanges.
- Ensure issual of instructions from controlling bank branch
to collecting branches.
- Apply to relevant stock exchange.
- Finalize advertising campaign.
(b) Post Issue
- Get certificate from lead manager confirming receipt of
minimum 90% subscription.
- Submit certificate to regional stock exchange for permission
to utilise proceeds.
- Issue letters to controlling branches for withdrawl of issue
proceeds.
- Ensure collection of application forms, schedules and final
certificates by the registrar from collecting branches.
- When needed, obtain inward remittance certificate/bank
certificate for NRI collections.
- If oversubscribed, prepare scheme of allotment with the
registrar.
- If undersubscribed, obtain development amount from
underwriters if any.
- Convene board meeting to approve.
a) scheme of allotment
b) fixing last date for payment of allotment money
c) printing and issue of letter of allotment/share
certificate etc.
d) opening of bank account for acceptance of allotment
money
e) opening of account for refund of excess application
money.
- Seek RBI approval in Form ISD(R) for share allotment and
issue of share certificates etc., to NRIs.
- Seek approval from regional stock exchange for specimens
and printing of -
i) letter of allotment/share certificate/debenture
certificate.
ii) allotment advice-cum-refund order
iii) allotment advice-cum-allotment money due notice.
- Arrange for autographic signature on share certificate and
refund of excess amount.
- If needed, issue cheques for underwriting commission.
- Despatch allotment-cum-refund orders, share certificates,
money due notice etc., within 6 weeks of closing of issue or
within 10 weeks of issue closing if permitted by stock
exchange.
- Pay service charges to lead managers, registrars and
advertising agents.
- Ensure issual of instructions from registrar to controlling
banks for acceptance of allotment money; and from refund
bankers to paying branches for payment of refund orders.
- File with stock exchange; listing application; distribution
schedule; Analysis Form for new issue (Table 1A) and
confirm that register of members/debenture holders is open
for registering transfers.
- Advertise in two national newspapers about date of despatch
of refund orders, letters of allotment, share certificates and
date of filing of listing application.
- File return of allotment of shares alloted in Form 2 with
ROC.
- Obtain pay orders from collecting banks against amount
collected by them.
- Obtain final proceeds certificate from bankers to the issue.
- Update register of members.
- Submit to SEBI a report alongwith compliance certificate
from a CA etc., within 45 days of closure of issue.
- Submit final report to SEBI within 90 days of issue closing.
- If debentures issued, complete formalities and create security.
3. Checklist on Registration of Charges
- Ensure that the relevant charge is covered within section
125(4).
- File particulars of charge with ROC in Form 8 within 30
days, alongwith certified copy of instrument creating the
charge and required fees.
- File with ROC Form 13 giving particulars of existing charges
(with modifications) and particulars of new charges and fee
of Rs.10/-.
- If unable to file the charge within 30 days then file it within
60 days giving reasons for delay, and pay extra fees.
- If charge not filed within 60 days, apply to CLB for extension
of time.
4. Checklists for Appointments
(a) Of Directors of public company
- Under the articles all directors are to retire at the AGM; or
- 2/3rd of the total board strength was to retire by rotation at
each AGM;
- such 2/3rd directors had been appointed at AGM ?
(b) Of Director of private company
- Check provisions of articles.
(c) Whole-time Secretary
a) Check whether paid-up capital of the company is such as
prescribed (Rs.50 lakhs) by Central Government ? If so,
whether the company has appointed a whole-time secretary
who is a member of the Institute of Company Secretaries of
India?
b) In other cases if secretary was appointed by the Company,
check whether he possesses qualifications prescribed in the
Companies (Appointment and Qualifications of Secretary)
Rules, 1988 ?
c) Check whether Form 32 has been filed with the Registrar ?
(d) Manager
1. In the case of the public company or subsidiary of a public
company with a paid-up capital of Rs. 5 crores or more,
ensure that a managing director, whole-time director or a
manager is appointed.
2. Convene a Board meeting to decide on the appointment of
manager and approve the draft agreement to be entered into
with him.
3. Ensure that the person proposed to be appointed as manager
does not suffer from any of the disqualifications or
disabilities mentioned in Sections 385, 386 and 388.
4. In the case of a public company and its subsidiary, where
the proposed manager is already a manager or managing
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 director on another company, ensure that notice of the Board
meeting and resolution to be moved thereat are given to all
the directors and the resolutions should be unanimously
approved by all the directors.
5. In the Board meeting, fix up the date, time, place and agenda
of the general meeting and approve the notice of the general
meeting to approve appointment of manager.
6. Send the notice of general meeting to the members, the legal
representatives of deceased and insolvent members and the
auditors.
7. Send 3 copies of the notice of the meeting to all the stock
exchanges where the shares of the company are listed.
8. Hold the general meeting and pass the resolution for
appointment of manager.
9. In the case of a public company, or its subsidiary, the
appointment shall be effective only on approval of the
Central Government if it is not in accordance with the
conditions specified in Schedule XIII to the Companies Act.
10. Where the approval of the Central Government is not
required, file the particulars of appointment in Form 25C
with the Registrar of Companies within 90 days from the
date of appointment in general meeting, duly certified by
the auditors of the company, the company secretary or a
secretary in whole-time practice.
11. Where a director of the company is interested in the contract
for appointment as manager, send a copy of the contract to
all the members within 21 days of the date of the contract
along with a memorandum specifying the nature of interest.
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12. File Form 32 in duplicate with the concerned Registrar of
Companies within 30 days of appointment.
13. Ensure that the manager notifies about his appointment to
other companies in which he is a director, managing director,
manager or secretary within twenty days.
14. Make necessary entries in the Register of Directors and
Managers.
15. Execute the agreement with the manager and get it notarised.
16. Make application to the Central Government in Form 25A
within 90 days from the date of appointment, with the
enclosures mentioned in the Rules.
17. Forward a copy of the memorandum to the stock exchanges
where the shares of the company are listed.
(e) Manager for number of Companies
Check whether the company employed a manager, who was
either the manager or managing director of any other company?
If so, check that:
i) the resolution for the appointment was duly passed at a
meeting of the Board with the consent of the directors
present at the meeting;
ii) the total number of companies in which he was manager/
managing director did not exceed two;
iii) Central Government’s permission obtained, if the person
concerned was the manager of more than two companies.
Note: GM - General Meeting
ROC - Registrar of Companies
CLB - Company Law Board
6. CASE LAW
Gopal Vyas v. Sinclair Hotels and Transportation Ltd.
[(1990)68 Comp Cas 516 (Cac)].
The petitioner proposed the name of one N as director of the
respondent company at its 14th AGM, and gave notice of the
fact under sec. 257 of the Act. The company refused to inform
the other members of the said proposal on grounds of non-
compliance with provisions of sec. 188 of the Act. The petitioner
contended that the company was under an obligation to inform
its members of such proposal. It was held that, sec.s 188 and
257 covered different fields. Section 257 was a specific
provision giving a right to an individual member to give notice
thereunder. The specific right that has been given under 257
does not provide that the implementation of such a right will
have to be in accordance with the procedure laid down in Section
188 of the Act. So an order was given to the company to consider
the notice given by the petitioner at its AGM.
P.C.Bohra and others v. National Sports Club of India:
[(1991)71 Comp Cas 333 (Delhi)].
The plaintiffs were members of a registered society. By two
separate undated notices, the Secretary-General of the society
convened an ordinary general meeting (AGM) and an
extraordinary general meeting (EGM) respectively, both to be
held on the same date, the former for adopting the audited
statement of accounts and the annual reports, and the latter for
certain amendments to the society rules. The plaintiff filed a
suit for a declaration that the notices and proposed amendments
were invalid and sought an interim injunction on the grounds
that: (1) the executive committee had not authorized the
Secretary-General to call the general meeting on that date; (2)
the executive committee having authorized the Secretary-
General to call an EGM on a different date, the change of date
at the instance of the Central Council, was prejudicial to the
personal rights of the members; (3) the corrections in the minutes
of a previous meeting were carried out by the Central Committee
not unanimously but only by a majority; (4) the resolution
approving the proposed amendments was not passed by all
members of Central Council, and (5) hence, the notice proposing
amendments without approval of the Central Council was
invalid. Held that, (i) the Central Council had much wider
powers than the Executive Committee, and looking to all the
circumstances, prima facie the decision of Central Council in
authorizing the Secretary-General to convene the AGM and
EGM on the same date was not against general human conduct.
(ii) Though the notice convening the meeting had to be issued
by the Secretary-General, the decision to hold the meeting had
to be taken by the Executive Committee or the Central Council.
What was important was the decision and fixing of the date was
a mere formality, and the only requirement was that a 15 days
clear notice had to be given. (iii) Despite the fact that notice
was undated, the fact that plaintiff received the notice on
31.12.1989 for a meeting to be held on 18.2.1989 (i.e., more
than 15 days later) satisfied the requirements and notice was
within rules and plaintiff's personal rights were not infringed.
(iv) If an error was committed by the Secretary on the 'draft
minutes', it could be corrected by the members at the next
meeting, as happened in this case. Thus there was nothing to
invalidate the procedure. (v) It was not open to the plaintiff's to
challenge the meetings of the Central Council on the ground that
the existing council did not have its full strength.
B.Sivaraman and others v. Egmore Benefit Society Ltd.
[(1992) 75 Comp. Cas. 198 (Mad)].
The applicants-plaintiffs were shareholders of the respondent
company, and had been elected as its directors at the AGM, and
had since been functioning as such directors. Defendants no.2
to 5 were directors of the company earlier to this meeting and
were to retire by rotation and accordingly defendants 2 to 4
stood for being re-elected as directors of the company as well
as fill up the vacancy caused by the retirement of one of the
directors. Defendants 4 to 13 were the requisitionists who had
requisitioned an EGM of the company and notice had
accordingly been given. As per the memorandum and articles
of the company, the board of directors was to consist of 12
members of whom 1/3rd were to retire at every AGM by rotation,
and they were eligible for re-election. Thus, in this meeting 4
directors were to retire by rotation and a fifth vacancy was caused
due to retirement of one director.
Accordingly all the applicants were nominated for the 5 posts
of directors. Voting was held at the AGM by show of hands and
the plaintiffs were declared elected. The Chairman suo motto
ordered a poll to be conducted on the same date, and the results
were announced on 29.12.1991, where all the applicants were
declared to be duly elected. Resolutions to that effect were
passed and entered in the minutes book. The applicants were
intimated of their being elected and after giving their written
consent, they started acting as directors. Defendants 4 and 5
having lost the election, started writing to the company, falsely
alleging some support to call an EGM on April 2, 1991, and for
which a notice dated 7.3.1991 was given. The applicants averred
that the EGM was illegal and in fact void, and fearing that their
rights might be prejudiced by the proposed EGM, they sought
an interim injunction order restraining the EGM from being held.
It was held that, by virtue of the record of proceedings in the
minutes book duly made and filed with the Registrar the
applicants were validly elected directors, since the defendants
had produced no evidence to dislodge the presumption under
sec. 195 of the Act, and that the scrutineers' report contained no
evidence of manipulation of the poll. Since the applicants were
duly elected as directors, the respondents were not entitled to
convene an EGM for purpose of removing the applicants and
declaring themselves as directors of company.
Balwant Singh Sethi v. Sardar Zorawarsingh Hushnak Singh
Anand [(1988)63 Comp. Cas. 310 (Bom)].
A requisition calling for an EGM was challenged by the first
respondent, as being invalid and unlawful and hence not capable
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of being acted upon. Further he also sought a permanent
injunction restraining the appellant defendant 2 and other
requisitionsts from convening the EGM. The trial court granted
the injunction and feeling aggrieved defendant 2 preferred an
appeal alongwith a civil application for stay of order passed by
the trial court pending hearing of the appeal. The objection to
convening the meeting was based on the following grounds: (a)
One of the signatories to the requisition was not a member of
the company; (b) no explanatory note required under sec. 173
and so requisition was invalid, (c) the venue was deliberately
fixed at a far of place so that most members could not attend it,
(d) subject no.3 in the requisition regarding constitution of an
adhoc committee was not as per the Act or bye-laws; (e) the
notice for requisition was signed by only one of the
requisitionists; (f) it was not made clear in the notice as to
whether the voting could be by proxy; (g) the notices were posted
on 2 consecutive days and so some of the members could not
have a clear notice of 21 days.
Held, under sec. 53(2)(b)(i) of the Act, notice of a meeting is
deemed to be served at the expiration of 48 hours after the letter
containing it is posted. When notices for a meeting to be held
on September 21, 1987 were posted on August 31 and September
1, 1987, they could be deemed to have been received on
September 2 and 3rd respectively. The members could not
therefore be held to have had 21 days clear notice of the meeting.
The appellants had thus been unable to make out a prima facie
case so as to interfere with the impugned order of the trial judge
- the appeal was dismissed.
In re, Swadeshi Polytex Limited, [(1988)63 Comp. Cas. 709
(Delhi)].
The AGM of the defendant company was held on 15.3.1986,
and the board of directors elected with many shareholders voting
in proxy. The plaintiff filed a suit against the Chairman of the
meeting and the company, alleging that the proxies in favour of
R were all dated 13.3.1986, and that the dating had been done,
not at the time of execution of instruments by the shareholders,
but by the proxy holder at the time of submission of instruments
to the company, with the object of making those the last proxies
of the shareholders. Some shareholders had also issued proxies
in favour of M. The petitioner sought a declaration that the
proxy executed last by the members of the company should
prevail over those executed earlier, regardless of the date
mentioned on the instruments of proxy, and an injunction
restraining defendants from permitting any person declared
elected as member of its board to act as director. The plaintiff
also filed an application seeking interim relief during pendency
of suit.
Dismissing the application it was held, (1) that there was nothing
wrong with the practice prevalent among interested parties of
obtaining blank proxy forms from shareholders unable to attend
the annual general meeting and then depositing the forms duly
filled up, with the company before the meeting, (2) if there
were two or more proxy instruments given by a shareholder iro
the same shares, the proxy bearing the later date would
supercede the earlier ones. The later date had to be taken as
date of signing of proxy forms by the shareholders, (3) such a
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grievance could be made only by a person who had executed a
blank proxy form, and since none of the shareholders had
complained that their proxies had been misused, the plaintiff had
no basis to raise objection on behalf of them. (4) the plaintiff
would suffer no irreparable injury if an injunction was refused
as all decisions were to be taken by the board in regular procedure
- but if it were granted the affairs of the company would be brought
to a stop, resulting in a loss to the company and the shareholders.
The balance of convenience was in favour of the defendants, (5)
no prima facie case had been made out for grant of ad interim
injunction restraining the newly elected board from exercising
their rights and obligations.
T.L.Arora v. Gangaram Agarwal [(1988)63 Comp. Cas. 736
(Delhi)].
The plaintiff filed a suit for declaration that plaintiff no.1 was
director of the company, validly re-elected at the AGM, alleging
that, plaintiff 1 was the sole representative of the NRI group of
shareholders and had the support of other local shareholders in
the form of proxies, but that defendant 1 in conspiracy with
other directors and support of bogus shareholders had forged
the proceedings on the minutes book to show that plaintiff 1
had not been reelected. The defendants filed an application
contending that the plaintiffs other than plaintiff no.1 had no
grievance, and they therefore had no cause of action and were
not necessary or proper parties to the action.
Dismissing the appeal it was held that, the plaintiffs as
shareholders had a right to have a board of directors of their
choice, and a right to vote by proxies under sec. 176. Where
these rights were adversely affected, the shareholders certainly
had a right to challenge the proceedings of the rman with a right
tomeeting where these rights had been denied. This right was
joint and several, and all such aggrieved shareholders could join
together as plaintiffs in the same suit. The fact that all such
shareholders were out present at the AGM held for electing the
board of directors was of no consequence, so long as they were
present through proxies. The suit was therefore properly
maintainable by the plaintiffs.
Subal Dutta and Sons Pvt. Ltd. v. Asst. Registrar of
Companies [(1986) 59 Comp. Cas. 823 (Cal)].
The AGM of the petitioner company for the year ending on
14.4.1983, was called for 12.10.1983. Since the auditor's report
and audited accounts had not been received till then, the meeting
was adjourned and held on 7.1.1984 i.e., within 15 months of
the AGM of earlier year. In the adjourned AGM, the balance
sheet and profit and loss account of the company were laid and
adopted and copies thereof filed with the Registrar on 13.1.1984.
The Registrar filed a complaint alleging that an offence under
sec. 220(3) of the Act had been committed by the company in
relation to the year ending on 14.4.1984. The company applied
to the High Court to have the criminal proceedings quashed.
Held, the AGM was held initially within the stipulated time
and the adjourned meeting was held within 15 months as
envisaged under sec. 166(1). Thus, the AGM for the year ending
on 14.4.1983, was held by the latest date on or before which
that meeting should have been held in accordance with the
provisions of the Act. Since in that meeting the balance sheet
and profit and loss account were laid and copies thereof sent to
the Registrar within 7 days, there was no violation of sec. 220(1),
and the prosecution was not maintainable and had to be quashed.
Joseph Michael v. Travancore Rubber and Tea Co. Ltd.
[(1986) 59 Comp. Cas. 898 (Ker)].
In 1979, the appellants had purchased through brokers some
shares in the respondent company and had lodged the transfer
deeds and share certificates with the company for transfer
registration. The board declined to register the transfer in
exercise of their powers under Article 24 of the company as
amended in 1965 and duly registered with the Registrar. The
appellants thereupon filed a petition in the High Court under
sec. 155 for rectification of the register of members, challenging
the validity of article 24 on the ground that it gave the board the
right to refuse to a register a transfer of even fully paid up shares,
whereas prior to the 1965 amendment, Original registration 20
permitted the board to exercise such a right only in respect to
partly paid up shares, on the ground that the explanatory
statement to the notice for the meeting held in 1965 for adoption
of new articles fell short of statutory requirement. A single
judge of the High Court dismissed the petition holding that the
appellants were not competent to challenge the validity of Article
24 in the proceedings before the company court. On appeal it
was held that, sec. 173 of the Act was mandatory and not
directory. But whether the statement annexed to the notice of
the meeting contained full and frank disclosure of the material
facts concerning each item of business must essentially depend
on the facts of each case. A minor defect arising out of absence
of strict conformity with provisions under sec. 173(2) might not
render an amendment of the articles of association null and void.
Appeal dismissed.
In re Moorgate Mercantile Holdings Ltd. [(1980)1 All ER
40].
A notice was circulated amongst the members, specifying the
intention of holding an extraordinary general meeting for the
purpose of passing a special resolution to cancel the company's
share premium account on the ground that the amount credited
to the account had been lost. Later it was realized, that the
amount in question also included a small amount arising from a
recent issue, and this small amount was not lost. At the meeting,
the special resolution had to be suitably amended in order to
provide that the entire account had not been canceled, but had
been reduced to a certain amount. The resolution in its changed
form was challenged in the court as being invalid.
Upholding the challenge, the court confirmed that the resolution
had not been passed validly. Laying stress on sec. 189(2)(a) the
court held, intention to propose the resolution as a special
resolution” means that the resolution passed at the meeting must
be the same as that specified in the notice. In principle however
the Court agreed that a genuine need for an amendment may
arise and it should be allowed within reasonable limits. It is to
be noted that here the persons concerning the meeting were aware
that an amendment would be necessary and should have taken
proper steps prior to the meeting itself.
Panorama Development (Guildford) v. Fidelis Furnishing
Fabrics [(1971)3 All ER 16].
The plaintiff ran a business of 'hiring cars'. The Secretary of the
defendant company hired cars from the plaintiff ostensibly on
behalf of the company by telling him that these cars were needed
for being used as conveyance by important clients of the company.
The negotiation was done through letters etc., written on Company
stationery and he signed as Company Secretary”. The cars in
fact were for the personal use of the secretary and not the company.
The plaintiffs sued the company for the 'hire charges'. The
company refused to pay saying the secretary had no authority to
hire the cars. The plaintiff filed a suit.
Holding the company liable for the hire charges as the act was
one within the ostensible authority of the secretary. Lord
Denning M.R. observed:
"But times have changed. A company secretary is a much
more important person nowadays than he was in 1887. He
is an officer of the company with extensive duties and
responsibilities. This appears not only in the modern
Companies Act, but also by the role which he plays in the
day-to-day business of companies. He is no longer a mere
clerk. He regularly makes representations on behalf of the
company and enters into contracts on its behalf which come
within the day to day running of the company's business.
So much so that he may be regarded as held out as having
authority to do many things on behalf of the company. He
is certainly entitled to sign contracts connected with the
administrative side of a company's affairs, such as employing
staff, and ordering cars, and so forth. All such matters now
come within the ostensible authority of a company's
secretary."
Concurring with this opinion Salmon,L.J. held,
"Whatever the position of company's secretary may have
been in 1887, I am quite satisfied that it has altered a great
deal from what it was then. At the end of the last century a
company secretary still occupied a very humble position
very little higher, if any, than that of a minor clerk. Today,
not only has the status of a company secretary been much
enhanced, but the state of affairs has been recognized by
the statutes...I think there can be no doubt that the secretary
is the Chief Administrative Officer of the company. As
regards matters concerned with administration, the secretary
was ostensible authority to sign contracts on behalf of the
company. If a company is ordering cars so that its servants
may go and meet foreign customers at airports, nothing is
more natural than that the company should hire those cars
through its secretary. The hiring is part of his administrative
function. Whether the secretary would have any authority
to sign a contract relating to the commercial management
of the company, for example, a contract for the sale or
purchase of goods in which the company deals, does not
arise for decision in the present case, but contracts such as
the present fall within the ambit of administration."
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7. PROBLEMS
1. Some member of a company executed two instruments of
proxy to vote at its AGM. A shareholder challenged the
validity of dating on one set of proxies, and applied for
certified copy of the proxy instruments forming part of the
record of civil court in some other proceeding. The Registrar
ordered issue of the certified copies of the proxies. The
company contended that such an order adversely affected
its rights and so should be declared void. Decide [See,
(1988)63 Comp. Cas. 689 (Delhi)].
2. The executive committee of the company limited by
guarantee passed certain election Rules 6(c) provided that
a proxy appointed through an instrument. Other than the
printed instrument duly despatched by the company, shall
not be valid. Rules 7 and 8 dealt with lost proxies and
revocation of proxies respectively and provided for issuance
of fresh proxy forms by the company. Some of the members
sought an injunction against the company restraining it from
enforcing or implementing these Rules on the ground that
they went beyond the stature. Discuss the validity of this
contention [See (1990)69 Comp. Cas. 158 (Delhi)].
3. The duly elected directors of a managing committee of a
cooperative society sent a requisition to the joint Registrar
of Cooperative Societies to summon a special meeting of
the committee to consider the proposed no confidence
motion against the Chairman. The Joint Registrar called a
special meeting and sent a notice to all the elected members
of the managing committee. This notice was challenged by
a writ petition on the ground that co-opted technical
members and nominees of financial institutions, who were
members of the board and entitled to it and vote at the special
meeting under sec. 73-ID of Maharashtra Cooperative
Societies Act, 1960 or the Act had not been served with the
notice. The High Court upheld the petition and directed
that fresh notice should be sent to these members also. This
order was further appealed against in the Supreme Court
on grounds that:
1. Section 27(9) of the Act debars government or other
nominees to vote at any election of the Committee of
the Society;
2. Under sec. 73-ID (i) only those members who are,
entitled to sit and vote at any meeting" may participate
and vote at a special meeting;
3. Under bye-law 29 of the society, the nominees of
financial institutions etc., not being entitled to function
as Chairman or vote at election meetings, they were
also not entitled to sit and vote at the special meeting.
Discuss the validity of these contentions [See,
(1990)69 Comp. Cas. 1 (SC)].
4. X and Y were members of 2 rival groups of shareholders.
Y was appointed as a director of the company in an
[Note: Please specify your name, ID number and address while sending answer papers].
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extraordinary general meeting. There was no indication to
show who requisitioned the convening of the EGM, how
the company issued a notice, and the minutes of the meeting
were recorded in a book which was not minutes book.
Though the notice convening the meeting was purported to
be issued by the company, there was no board meeting held
for considering the requisition, and no board-decision to hold
an EGM was taken. X and a few others challenged the
appointment of Y on the ground that, the EGM where the
articles were amended so as to provide for 3 directors on
the board instead of 2 consequent to which Y was elected
to the board, was illegal and hence Y's election was invalid.
Keeping in mind that the book in which the minutes were
noted was not available to be produced before the Court
discuss the validity of this plea [See, (1993)77 Comp. Cas.
324 (Mad)].
5. Under the articles of a company the quorum for a directors'
meeting was two. In a particular meeting, two directors
were present, and in the course of the meeting, one of them
was appointed as managing director and co-editor of the
paper run by the company. This appointment was challenged
on two grounds, namely, (1) lack of quorum, and (2) invalid
voting, as an interested person cannot vote in his own case.
Discuss the validity of these contentions. [See, AIR 1915
Mad. 1179].
6. Despite a valid requisition being made the directors of a
company refuse to call a meeting. The requisitionists
themselves circulated a notice for the meeting to be held on
1.1.1994 at the registered office of the company. When the
people convened for the meeting they found that the
directors had locked the premises and prevent the meeting
taking place. The requisitionists then shifted the venue of
the meeting to another place, and passed some resolutions
removing 2 directors. These resolutions were challenged
as being invalid on the grounds that the meeting was invalid
as it was not held in the specified place. Discuss [See AIR
1951 Mad 542].
7. In a general meeting, voting by show of hands was held on
a motion relating to sale of company undertakings. Despite
there being a clear indication of the majority not being in
favour of the motion, the Chairman of the meeting declared
the resolution 'passed'. The shareholders challenged the
chairman's ruling. The chairman relying on sec. 178 says
that his ruling is 'conclusive' and cannot be challenged.
Decide [See AIR 1937 Cal 645].
8. A poll was demanded by a member after voting results were
announced. The chairman ordered the poll to be conducted
and subsequently announced the results of the poll. The
results are challenged on the ground that the chairman had
improperly rejected certain proxies which if accepted might
have given a different result. The chairman claims his
decision is final. Decide [See, AIR 1955 Cal 132].
8. SUPPLEMENTARY READINGS
1. Avtar Singh, Company Law, 9th edn., 1989, Eastern Book Company, Lucknow.
2. Acharya, B.K. and Govekar, P.B., Company Law and Secretarial Practice, 3rd edn. (rev.): 1990, Himalaya Publishing House,
New Delhi.
3. Bhandari,M.C.,Guide to Company Notices, Meetings, Resolution and Minutes, 11th edn., 1990, Wadhawa and Co., Nagpur.
4. Chakraborti,A., et.al., Secretarial Practice and Company Law, 1st edn., 1988, Kalyani Publishers, New Delhi.
5. Chandratre,K.R., et.al., Bharat's Compendium on SEBI, Capital Issues and Listing, 2nd edn: 1994, Bharat Publishing
House, New Delhi.
6. Kapoor,N.D., Company Law and Secretarial Practice, 2nd edn. (rev.), 1980, Sultan Chand and Sons, New Delhi.
7. Ramaiya,A., Guide to the Companies Act (Part 1) 13th edn, 1995, Wadhwa and Co., Nagpur.
8. Taggart,W.J., Horsley's Meetings, Procedure, Law and Practice, 2nd edn., 1983, Butterworths, Sydney.

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 Master in Business Laws

Corporate Law

Course No: III

Module No: V

Corporate Investment
&
Investors' Protection

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in

220

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Materials Prepared By :
1. Dr. N.L. Mitra
2. Mr. Sunder Rajan, FCA
Materials Checked by:
1. Ms. Sudha Peri
Materials Edited by :
1. Mr. Mohandas Pai, FCA
2. Dr. P.C. Bedwa

© National Law School of India University

Published By:
Distance Education Department
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.

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 INSTRUCTIONS
In Corporate Law Module - 1 you must have learned the following.
a) What are the features of a company form of organisation? What makes it distinctly different and advantageous from other
forms of business organisations?
b) How are a private limited company and a public limited company to be formed?
c) What are the documents necessary for the formation of companies?
d) When can the company commence business?
c) What are the various forms of the company?
f) What are the contents of the Memorandum of a company?
g) What is the procedure for alteration of the Memorandum? and
h) What are the significant differences between the Memorandum and Articles?
If you have carefully noticed the Companies Act, 1956, you must have seen that we have: covered the area between Section 1 and
Section 54 of the Companies Act as well as some other sections necessary for discussing the areas covered by Part I and Part ll,
of the Act.
This module primarily concerns the raising of funds from various sources for the company. Therefore in this module we have to
learn-
a) Different types of share capital and loan capital
b) Different types of company securities.
c) Documents necessary for raising capital.
d) Various ways of raising capital.
c) Different regulatory measures for protecting Investors’ interests.
f) Various types of agencies and institutions involved in transactions of stock, shares and debentures.
g) Role of stock exchange and the importance of listing securities with the stock exchange.
h) Various regulatory procedures relating to share transactions.
i) Structuring and restructuring the share capital of a company.
j) Transfer and transmission of shares and stocks.

If you open your Companies Act, you will find that Chapter III and Chapter IV of the Act provide the substantive and procedural
laws relating to the subject under study. You have to appropriately take note of various Company Rules and other related regula-
tions in order to understand the subject in its entire operation. The Capital Issue Controller used to oversee the whole operation
before 1992. Presently the Security Exchange Board of India is incharge of regulating the whole capital market. You know that
a company has to raise its share and loan capital from the primary market i.e. the public at large. But public limited companies
require avenue for facilitating quick and easy transfer of shares and other securities. For this purpose the secondary share markets
known as Stock Exchanges came into operation. You have to understand how this share market operates. In order to appreciate
the regulatory system of the country you have to understand organisation and functions of the Security Exchange Board of India
(SEBI) which oversees the functioning of the Stock Exchanges.
Once you have the above goals of learning the subject you may ask yourself the questions raised there at the end of each sub-
topics and can make a self evaluation.
Since this is a vast area, the reading material exceeds 100 pages. I hope. you will find the study material very informative. You
have to supplement with the recent developments in the corporate sector which you will find in journals and new papers every
day.
N.L. Mitra
Course Co-ordinator

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 CORPORATE INVESTMENT AND INVESTORS' PROTEC-
TION

TOPICS

1. Nature and Types of Corporate Securities .................................................................... 224

2. Modes of Raising Capital .............................................................................................. 228

3. Investors' Protection ...................................................................................................... 240

4. Raising of Share Capital .............................................................................................. 252

5. Share, Shareholder and Member .................................................................................. 260

6. Transfer and Transmission ........................................................................................... 267

7. Re-structure of Share Capital ....................................................................................... 270

(a) Increase of Share Capital

(b) Conversion of Shares into Stock and vice-versa

(c) Alteration of Members’ right

(d) Reduction of Share Capital

8. Case Law ........................................................................................................................ 275

9. Problems ........................................................................................................................ 278

10. Supplementary Readings .............................................................................................. 279

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1. NATURE AND TYPES OF CORPORATE SECURITIES
SUB TOPICS
1.1 Introduction
1.2 Kinds of Securities
1.3 Ownership instruments — Nature and Type
1.4 Debt Instruments Security — Nature and Type
1.5 New Financial Instruments and Regulatory Environment
1.1 INTRODUCTION
What is a Corporate Security?
A security is a document evidencing ownership of an asset.
Black’s Law Dictionary defines the word “Securities” to mean
“stocks, bonds, notes, convertible bonds, warrants or other
documents that represent a share in a company or a debt owed
by a company or Government entity”. Section 2 (h) of the
Securities Contracts (Regulation) Act, 1956 lends an inclusive
definition for the word “Securities”. According to the said
section, securities include—
(i) shares, scrips, stocks, bonds, debentures, debenture stock
or other marketable securities of alike nature in or of any
incorporated company or other body corporate;
(ii) government securities ;
(iii) such other instruments as may be declared by the Central
Government to be securities; and
(iv) rights or interests in securities.
Thus, the definition includes within its fold, any marketable
security in the nature of share, scrips, bonds, debentures,
debenture stock in an incorporated company or body corporate.
It also grants powers to the Central Government to declare such
other instruments to be securities.
1.2 KINDS OF SECURITIES
Broadly speaking securities are documents related to various
sources of corporate finance. Corporate finance is primarily
collected from two sources:
(i) through ownership rights in a corporate body commonly
known as stocks and shares or equity instruments;
(ii) through debt-instruments like debentures, notes,
commercial paper etc.
Let us examine the nature of some of these instruments.
1.3 OWNERSHIP INSTRUMENTS — NATURE AND
TYPE
Corporate ownership instruments are known as stocks and
shares. According to Sec. 2(46) share means share in the share
capital of a company and includes stock except where a
distinction between stock and shares is expressed or implied.
Commercially speaking a share is a unit of the share capital
which may be partly or fully paid. As for example, if A holds a
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share of Rs.100/- in ABC Ltd, A might not have paid the full
money on the share on account of the company not making a
call. May be he has paid Rs.75/- only which the company has
asked him pay. Therefore a share has a face value and a paid
value. A stock on the other hand is a smallest unit of share capital
which is fully paid. The concept of stock perhaps has arisen
from the idea of joint stock that used to mean total capital pooled
from the members. Generally speaking for shares people express
possession by number whereas in case of stock through amount.
As for example, one may say A has 5 shares of ABC or stock
worth Rs.10,000/- of DEF. Thus both stocks and shares relate
to share capital. A company has two types of share capital viz
equity share capital, and preference share capital. [See Sec. 86]
1. Equity Share Capital
Section 85(2) of the Companies Act, 1956 defines equity share
capital as one which is not a preference share capital. Equity
share capital is the most common form of capital issued by
companies to raise funds from the public, because of the
following reasons:
(a) it is a risk capital around which the entire investment
structure is built;
b) it ensures protection to creditors as it cannot be repaid easily;
c) it enhances the bargaining capacity of companies;
d) it does not carry any right as to a fixed rate of return;
e) as a holder of a equity gets the benefit of profits earned, the
stock market values it at a multiple of its earnings;
f) it insulates the company from the downturn in the business
because no return needs to be paid as in case of a loss.
2. Preference Share Capital
Section 85 of Companies Act, 1956 defines preference share
capital as to mean that part of the share capital which fulfils
both the following requirements :
(a) that as respects dividends, it carries or will carry a
preferential right to be paid a fixed amount or an amount
calculated at a fixed rate, which may be either free of or
subject to income tax ;
(b) that as respect capital, it carries or will carry on a winding
up or repayment of capital, a preferential right to be repaid
the amount of the capital paid up or deemed to have been
paid up, whether or not there is a preferential right to the
payment of either or both of the following amounts, namely
(i) any money remaining unpaid, in respect of the amounts
specified in clause (a), upto the date of winding up or
repayment of capital ; or
(ii) any fixed premium or premium on any fixed scale,
specified in the Memorandum or Articles of
Association of the Company.
Thus preference shareholders enjoy preferential rights to the
payment of dividend and capital.
Kinds of Preference Shares
Preference shares can be classified as :
(i) redeemable and irredeemable preference shares;
(ii) cumulative and non-cumulative preference shares; and
(iii) convertible and non-convertible preference shares.
(i) Redeemable and Irredeemable Preference Shares
Redeemable preference shares are those, which will be redeemed
by the company at the agreed time. They have a fixed maturity
period like that of debt securities. Issue of redeemable preference
shares are governed by the provisions of Section 80 of the
Companies Act, which are explained below:
(a) the company’s Articles of Association must authorise the
company to issue them;
(b) the shares shall not be redeemed, except out of the profits
of the company which are available for payment of dividend
to equity shareholders or out of the proceeds of a fresh issue
of shares made for the purposes of redemption;
(c) the shares are fully paid before they are redeemed;
(d) the premium, if any payable on redemption shall be provided
for out of the fresh issue or out of the company’s share
premium account;
(e) if the shares are redeemed otherwise than out of the proceeds
of a fresh issue, the company shall transfer a sum equal to
the nominal amount of the shares redeemed, to a reserve
fund called capital redemption reserve, out of the profits
which are available for distribution as dividend.
(f) the redemption of shares shall be effected on such terms
and in such manner as may be provided by the Articles of
Association of the company;
(g) the redemption of shares under the provisions of this section
shall not be taken as reducing the amount of share capital
of the company;
(h) the Capital Redemption Reserve, mentioned in (e) above,
may be applied by the company in paying up unissued shares
of the company to be issued to members of the company as
fully paid up bonus shares;
(i) no company shall issue any preference shares which are
irredeemable or redeemable after the expiry of ten years
from the date of its issue.
Irredeemable preference shares are the ones which will be in
existence with the company so long as the company is in
existence. They will be outstanding for ever, till the company is
wound up. They are like ordinary shares. The irredeemable
preference shareholders are entitled to dividend, either as a fixed
sum or a fixed percentage. The right of companies to issue
irredeemable preference shares was taken away by the
Companies (Amendment) Act 1988, by insertion of sub-section
5A to Section 80. Exisiting irredeemable preference shares were
made redeemable by insertion of Section 80-A.
1.4 DEBT INSTRUMENTS - NATURE AND TYPE
Debentures :
Debenture is the most common form of debt instrument in India.
Section 2(12) of the Companies Act, 1956, defines the term
“Debenture”, to include debenture stock, bonds and other
securities of the company whether constituting a charge on the
assets of the company or not. This definition of debenture is an
inclusive definition and one could debate which are the
instruments that could be construed as debentures. In the
absence of any precise definition for the term “Debenture”, we
will try to understand it in the manner in which it is issued by
companies. Hence debenture is a specie of debt securities, which
is an acknowledgement of debt, carrying a promise by the Issuer
to redeem the debt on maturity and, during its currency, to pay
interest at an agreed rate at agreed intervals.
Debenture is a prominent debt instrument in the corporate world.
It is favoured because of the following unique characteristics:
(a) debentures are generally secured by a charge on the assets
of the issuing company;
(b) it has in-built facility of redemption. This enables the issuing
company to buy back its own debentures, either as an
investment or for redemption. It is to be noted that a
company cannot buy its own shares.
(c) it supplements other sources of securing long term funds;
(d) interest paid on debentures is a deductible expenditure while
computing the taxable income, while the dividends paid by
the company is treated as an appropriation of profits and
hence not deductable. As dividend is taxable in the hands
of the recipients also it suffers dual taxation.
Characteristics of Debentures
Debentures and other similar debt instruments have the
following characteristics:
(i) as a result of its issue, there arises a contractual obligation
between the Issuer and the Debenture holder, for payment
of interest, redemption on maturity etc;
(ii) generally the debenture holders are not permitted to
surrender their debenture before it matures;
(iii) these instruments are generally secured by the assets of the
company, but unsecured debentures are also not uncommon;
(iv) it is the practice of the company to appoint an independent
agency, called Debenture Trustees, to ensure the compliance
of the terms and conditions of the issue by the company;
and
(v) they normally carry a fixed rate of interest to be paid till
they are redeemed. There are also debentures carrying a
variable rate of interest. Debentures without any interest
obligation such as zero coupon Debenture are also in vogue.
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Kinds of Debentures
Debentures could be classified as follows:
(i) secured or unsecured;
(ii) redeemable or irredeemable;
(iii) convertible or non-convertible; and
(iv) registered or unregistered;
(i) Secured and Unsecured Debentures
The very defintion of the term given by the Companies Act
conveys a meaning that debentures need not necessarily be
secured. If the debentures are backed by a charge on the assets
of the issuer company, such debentures are called secured
debentures. It is because of the security created by the issuer
that these debentures are relatively safe. The security can be of
any form, a floating charge on all the assets of the company, or
a mortgage or a hypothecation of assets of the company.
On the contrary, if the debentures are not backed by a charge on
the assets of the issuer, such debentures are called unsecured
debentures. They are also called as naked debentures, as they
are not covered by any assets of the issuer. The holders of
unsecured debentures are nothing but unsecured creditors of
the company. Since they are not backed by any security, these
debentures command less value in the market.
Previously, under the guidelines for issue of debentures by Public
Limited Companies, only secured debentures were allowed to
be offered to the public. But now, the SEBI’s Guideline of
Disclosure and Investor Protection provides room for issue of
unsecured debenture also.
(ii) Redeemable and Irredeemable Debentures
If the debentures are issued for a definite period, such debentures
are called redeemable debentures. These debentures will be
paid off on maturity. These debentures have a definite life
determined by the issuer. But it is also not uncommon to issue
another class of debentures called irredeemable debentures or
perpetual debentures. These debentures are perpetual, so long
as the company is a going concern.
(iii) Convertible and Non-convertible Debentures
A convertible debenture is one, which will be converted into
another instrument having different rights and privileges. The
convertible debentures are generally converted into equity
shares. Once they are converted, they loose the character of
debentures and the converted shares cannot be reconverted into
debentures. Companies issue convertible debentures for the
following reasons:
(a) dilution of ownership could be delayed by the conversion
period;
(b) since the debentures are to be converted into shares, the
company can offer a lower interest rate, than it would offer
if the debentures were not convertible; and
(c) in India, due to the lack of an active secondary market for
debt instruments, investors commonly do not favour such
instruments. The conversion clause in the debenture makes
it attractive for investors as it offers the chances of a capital
gain.
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Debentures which are not so convertible are called non-
convertible debentures.
Due to the lack of support from ordinary investors the non-
convertible debentures are often issued to institutional investors
by private placement.
(iv) Registered and Unregistered
This is a very peculiar classification. Once the debentures are
issued by a company, the names, address etc., are entered in a
register called Register of Debenture holders. These debentures
are called Registered Debentures.
On the contrary, if the debentures are not entered in that register,
such debentures are called unregistered debentures. This
generally arise when the borrower company issues debentures
to its bankers, as a security against the loans and advances
granted by it.
Issue Price
Debenture could be issued either at its nominal value, or at
premium or at a discount. The companies Act contains elaborate
provisions regarding issue of equity shares but there are no such
provisions regarding debentures. Hence there are no formalities
to be complied with to issue debentures at a premium or at a
discount. Likewise, companies are free to redeem the debentures
either at its nominal value, or at premium or at a discount.
1.5 NEW FINANCIAL INSTRUMENTS &
REGULATORY ENVIRONMENT
Historically, the range of instruments was limited due to a
regulated market, issues opted for pure equity or pure debt with
some hybrids known for variety. As the markets widened,
investors need also expanded and new instruments were needed
to meet their liquidity, risk and yield expectation. Pure equity
issues were subject to market risks, pure debt to interest rate
risks. The convertible Debenture offered a solution in the form
of convertibility and capital appreciation for the investor and a
lower interst to the issuer.
The innovation spawned by this lead to the creation of more
innovative instruments like Naked Warrants, Debentures,
convertible and non-convertible with warrants, optionally
convertible Debentures with warrants, Secured Premium Notes,
Deep discount bonds, Floating rate bonds and so on. These
instruments allowed the investors to hedge their risks. With
anticipated arrival of the options and future markets, innovation
is expected to increase and new instruments to proliferate.
Regulatory Environment for Issue of New Instruments
Issue of new Instruments are governed by the Guidelines for
Disclosure and Investor Protection issued by SEBI. Section G
of these Guidelines read as under :
Issuer of capital shall make adequate disclosures regarding the
terms and conditions, redemption, security, conversion and any
other relevant features of the instruments such as deep discount
bonds, debentures with warrants, secured premium notes etc., so
that an investor can make reasonable determination of the risks,
returns, safety and liquidity of the instruments. These disclosures
shall be vetted by SEBI. Thus a company may issue any new
financial instrument, to the public if:
(a) the issuer makes adequate disclosure of the following:
(i) all terms and conditions of Issue;
(ii) redemption of these instruments, if applicable;
(iii) security of these instruments, if applicable; and
(iv) all other relevant features of these instruments.
The disclosures to be made as aforesaid should be adequate so
that an investor can make reasonable determination of the risks,
returns, safety and liquidity of the instrument. The disclosures
so made shall be vetted by SEBI. It is also to be noted that
Section 86 of the Companies Act provides that companies shall
issue only two classes of share capital :
(i) Equity share capital, and
(ii) Preference share capital.
But there is no express prohibition or provision in the Act as to
the nature of debt instruments or derivatives that could be issued
by a company. Complying with these two provisions, the
guidelines of SEBI and the Companies Act, companies are
free to issue any new instruments or cluster the instruments which
are already known to the market, with additional features.
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2. MODES OF RAISING OF CAPITAL
SUB TOPICS
2.1 Introduction
2.2 Private Placement
2.3 Public Issue
2.4 Right Issue
2.5 Cost of Raising Capital
2.6 Share Issued at a Premium
2.7 Share Issued at a Discount
2.8 Raising of Loan Capital
(a) Debentures
(b) Public Deposit
2.1 INTRODUCTION
A public limited company can raise capital in the following
manner -
(i) by issue of securities on private placement basis ;
(ii) by issue of securities to the public ; and
(iii) by issue of securities to the existing shareholders of the
company on “rights” basis.
2.2 PRIVATE PLACEMENT
What is a Private Placement?
Private placement of securities means offering the securities of
the company directly to a select group of persons. This is an
issue of securities that excludes the public and is a privileged
offer made to a select group of persons. Though there is a limited
prohibition for issuing securities privately, the term private
placement is not defined anywhere. But the provisions of Section
67 of the Companies Act, 1956 are worth quoting here.
This Section reads as under —
(1) Any reference in this Act or in the articles of a company to
offering shares or debentures to the public shall, subject to
any provision to the contrary contained in this Act and
subject also to the provisions of sub-sections (3) and (4),
be construed as including a reference to offering them to
any section of the public, whether selected as members or
debenture-holders of the company concerned or as clients
of the person issuing the prospectus or in any other manner.
(2) Any reference in this Act or in the articles of a company to
invitations to the public to subscribe for shares or debentures
shall, subject as aforesaid, be construed as including a
reference to invitations to subscribe for them extended to
any section of the public, whether selected as members or
debenture-holders of the company concerned or as clients
of the person issuing the prospectus or any other manner.
(3) No offer or invitation shall be made to the public by virtue
of sub-section (1) or sub-section (2) as the case may be, if
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the offer or invitation can properly be regarded, in all
circumstances:
(a) as not being calculated to result, directly or indirectly,
in the shares or debentures becoming available for
subscription or purchase by persons other than those
receiving the offer or invitation; or
(b) otherwise as being a domestic concern of the persons
making and receiving the offer of invitation.
(4) Without prejudice to the generality of sub-section (3), a
provision in a company’s articles prohibiting invitations to
the public to subscribe for shares or debentures shall not be
taken as prohibiting the making to members or debenture-
holders of an invitation which can properly be regarded in
the manner set forth in that section.
(5) The provisions of this Act relating to private companies
shall be construed in accordance with the provisions
contained in sub-sections (1) to (4).
The effects of the section could be summed up as follows —
1. Offers made to any section of the public even if selected as
members or debenture-holders, would be construed as a
public offer.
2. The offer so made to any section of the public, even if
selected as members or debenture-holders will not be
construed as a public offer if the shares or debentures are
not made available for subscription or purchase by persons
other than those specifically receiving the offer or invitation.
Is Private Placement Prohibited?
Many investors would have received handouts, pamphlets and
other literature from companies and brokers inviting them to
subscribe for the shares and debentures of companies and
assuring them of firm allotment. Some issues are offered at a
premium also. This practice became more popular, with the
increase in stock market activities. Since these securities were
not subject to any statutory formalities, the information made
available to the prospective investors were minimal. As adequate
and proper information was not available many investors were
misled into investing, sometimes with disasterous consequences.
Since such malpractices were found to be an impediment to the
steady growth of the securities market, there was an obvious
need to keep such practices under check.
Securities and Exchange Board of India in its first circular on
'Guidelines for Disclosure and Investor Protection' came out
with a directive as follows:
In the case of first issues of new companies, no private
placement of the Promoters shall be made by solicitation
of share contribution from unrelated investors through
any kind of market intermediaries.
Thus this guideline prohibits private placement of securities by
the first Issue of new companies by solicitation of contributions
from unrelated investors through any kind of market
intermediaries.
Subsequent to this guideline, Department of Company Affairs,
Ministry of Law, Justice & Company Affairs released a ‘Press
Note’ on 6th July, 1992 (Press Note No.7/92; File No. 17-6-
1992 CLV dated 6th July, 1992), which states -
It has come to the notice of the Government that some companies
utilise the services of brokers and other intermediaries for private
placement of equity shares, out of Promotors’ quota or otherwise,
insert advertisements in the print media and also mass mail
literature/material/brochures superscribed by the caption
‘Confidential/For private circulation only’. It is also noticed
that the rights of renunciation are floated in the market by the
companies themselves, charging unofficial premium from the
investing public.
Then the press note referred to the provisions of Sections 67 (3)
(a) & (b) and stated-
In the context of the above provisions of law, such offers cannot
be treated as private placement and provisions relating to
prospectus under the Companies Act 1956 are applicable. The
companies concerned, their promoters and their intermediaries
are hereby warned that making of such so called private
placement of shares or collecting unofficial premia without
recording the same in the books of accounts of the company,
are serious contraventions of the Companies Act 1956 and will
invite penal action under the Act by the Government. It may be
noted that marketing of rights of renunciation by a private
company is prohibited under Section 3(1) (iii)(c) of the Act, as
it cannot make any invitation to the public to subscribe for its
shares.
The crux of the press note was to prohibit the private placement
of securities by sending literature/material/brochures etc., and
charging unofficial premia without accounting for the same in
the books of accounts of the company.
Thus private placement in certain forms and by certain
companies are prohibited and regulated, but there is no absolute
prohibition.
Advantages of Private Placements
(a) A quicker way to raise capital
Since it is not required to adhere to the statutory and procedural
formalities, the time for raising capital is remarkably low. It is
an efficient way of procuring long term funds.
(b) Ownership and control of the company will be intact
Since the offer is made to a select group of persons, generally
known, the ownership and control of the company will be intact
and the company will not be vulnerable to take-over bids.
(c) Issue cost is less:
A company that issues securities through a public offer would
need to expend around 10% of the issue by way of issue
managers’ fees, underwriting commission, brokers commission,
printing of application forms and prospectus, bankers’ collection
charges, campaign expenses to sell the issue, listing fees etc.
On the contrary, in the private placement process, since the
target investors are already identified in advance, the likelihood
of non-subscription is minimal and there is no need to incur
expenses as in the case of public offer of securities.
(d) Restrictions on issue size
As per SEBI guidelines and listing requirements of stock
exchanges, there is fixed minimum issue to be made and
maximum percentage of stock that could be held by the
promoters, ceiling on maximum allotment, minimum number
of shareholders etc. Private placement is not subject to these
restrictions.
(e) Minimum service cost
In public offers, due to the compulsion of wide spread
shareholding, the servicing cost is high, which is not so in the
case of private placements.
(f) Absolute freedom and flexibility
Since the issues are made on a case to case basis, there exists a
great extent of freedom and flexibility both for the investor as
well as for the issuer as to the terms of issue. It is to be noted
that in the case of deals involving huge amounts, the terms can
be tailor made.
Subscribers to Private Placement Market
(i) financial institutions;
(ii) mutual funds;
(iii) investment and finance companies; and
(iv) individual investors.
When Private Placement is advantageous
(i) Raising funds by private placement looks meaningful to
closely held companies and that too not involving substantial
sums. It is suitable for debt instruments rather than for equity
instruments and for investments by institutions like
insurance funds, mutual funds, unit trusts and investment
companies, where the placement could be structured
according to the needs of these investors.
(ii) Since the process of public offering takes considerable time,
involves statutory and other procedures, co-ordination of
agencies and involves considerable expenditure, private
placement is advantageous.
(iii) When the project is a greenfield project and undertaken by
unknown entrepreneurs it is considered more risky by the
public and if at the initial stage an issue is made, the success
of the issue may be in doubt. In such circumstances, it is
advisable to raise funds through the private placement route.
2.3 PUBLIC ISSUE
The increasing demand for capital by companies have made
them rearch out for investors throughout the country and even
to countries abroad. Unlike private placement of securities,
wherein the deals are concluded by face-to-face negotiation,
the same is not possible if the persons involved are large and
where the instruments offered are homogenous in all respects.
There should be some communication between the issuer and
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the prospective investors, which should carry the details about
the issue. This communication is not permitted to be oral, but
has to be written. Such written communication is called “Offer
Document”. Since this document is of concern for investors,
great importance is attached to the informations to be disclosed
therein to protect investor's interest. This part deals, inter alia,
with drafting of documents and liabilities involved.
Types of Offer Documents
Offer documents can be classified into the following:
(a) Prospectus,
(b) Letter of Offer.
(a) Prospectus
Module I has discussed in detail about the drafting of prospectus,
its issue to the public and registration. The contents of the
prospectus are also stipulated therein. Prospectus is not only
important as an offer document but has wider ramifications as
it concerns the investor’s interest. Some of the important issues
in connection with the protection of the investor’s interest relate
to disclosure of all material facts that are necessary for the
interested investors to apply for the shares. The standard of
disclosure as prescribed in Schedule II of the Companies Act
has already been stated. Some of the important issues relating
to prospectus require further explanations which are given below:
(i) Expert's Statement included in the Prospectus
A Prospectus cannot include a statement made by an expert who
is involved in promoting a company or its management [See
Sec.57]. An expert is supposed to be a person who has acquired
special skill in any branch of knowledge. [See Sec.45 of the
Indian Evidence Act] A statement of an expert as per Sec.58 of
the Companies Act is only to be made when he has given his
written consent and has not withdrawn his consent before the
prospectus is delivered for registration and the statement must
appear in the prospectus. Generally speaking prospectus
contains the following matters where the expert’s statement could
be given.
(1) The project report which has to include a report about the
nature of the project, locational advantages, infrastructural
facilities, technology process, implementation schedule and
marketing arrangements.
(2) Statement of accounts, assets and liabilities — all these are
required to be certified by an auditor who is considered as
an expert in the area.
(3) Any study of marketing prospects and arrangements.
(4) An evaluation of environmental impacts.
A prospectus may likewise contain expert's statement on
many other issues. Expert's statements are extremely
important because a Director and a signatory to the
prospectus may escape his civil liability if he can prove
that any statement found untrue has been made bonafide
relying on the statement of an expert. The signatory may
even escape criminal liability by way of suggesting a
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reasonable ground to believe what was certified by an expert
though it afterwards turns to be a mis-statement.
(ii) Underwriting
The prospectus contains names and addresses of the underwriters
and the amount underwritten by them. Underwriters are
intermediaries assuring the sale upto the underwritten amount
or number of shares shown against them for a commission.
Failure to sell the underwritten amount would make the
underwriter himself liable to subscribe up to those number of
shares.
A company may pay a commission to any person in consideration
of his subscribing or agreeing to subscribe or procuring or
agreeing to procure subscriptions for any shares or debentures
or on fulfilment of the conditions that :
(i) the commission is authorised by the Articles ;
(ii) the commission does not exceed 5% of the price at which
shares are issued and 2 1/2% of the price at which debentures
are issued;
(iii) the rate of the commission payable on the shares or
debentures offered to the public for subscription is disclosed
in the prospectus;
(iv) the number of shares or debentures agreed to be provided
or subscribed for is disclosed in the prospectus ; and
(v) a copy of the contract is delivered to the Registrar.
The advantages of underwriting is that the company is assured
about its subscription. The underwriters are efficient marketers
of corporate securities.
(iii) Listing
A company which is not listed earlier has to state in the
prospectus that an application has been made for permission
for the shares or debentures offered to be dealt with in one or
more of the recognised Stock Exchanges. The names of these
Stock Exchanges are also to be mentioned. Listing is important
for the investors because it ensures liquidity of the investment.
In case the permission has been refused before the expiry of 10
weeks from the date of the closing of the subscription list, any
allotment made becomes void [See Sec.73(1A) of the Companies
Act]. Of course if an appeal is made under Sec.22 of Securities
Contract (Regulation) Act of 1956 against such refusal such
allotment shall not be void until the dismissal of the appeal.
(iv) Special Provision for NRI Investment
In case of applications by overseas companies, and other
corporate bodies owned predominantly by non-resident
individuals of Indian nationality/origin, a certificate in the
prescribed form OAC/OAC1 from an overseas Auditor/
Chartered Accountant/Certified Public Accountant should be
submitted along with the application. Application forms from
non-resident investors, properly completed together with
cheques/bank drafts/stockinvest for the amount payable on
application at the rate of Indian Rs.10/- or equivalent remitted
through normal banking channels or funds held in Non-Resident
External (NRE) Accounts/Foreign Currency Non Resident
External (FCNR) accounts maintained with banks authorised to
deal in foreign exchange in India along with documentary
evidence in support of the remittance, must be delivered before
the close of the subscription list to such of the branch(es) of the
Bankers to the issue at places mentioned against their names in
the aplication form. All cheques drafts/stockinvest should be
made payable to the Bankers to the issue with whom the
application forms are lodged. All cheques or bank drafts should
be crossed ‘A/c Payee only”. All cheques/ bank drafts /stock
invest should be marked ....... Public Issue - NRI. A separate
cheque/bank draft/stock invest must accompany each application
form.
Reserve Bank of India - vide their letter No. EC AH/101/
06.04.1689/93 dated 23-1-93 - has given its approval for issue
of shares to non-resident Indians, and NRI investors are not
required to make separate applications for seeking permission
from the Reserve Bank of India. Under the existing Foreign
Exchange Control Regulations, such investment in shares by
non-resident investors will be allowed to be repatriated along
with the income earned thereon, subject to deduction of Indian
taxes provided the investment is made by inward remittance
from abroad through normal banking channels or out of funds
held in Non-Resident (External)/FCNR Accounts.
NRI applicants who have purchased Rupee drafts by debit to
their NRE/FCNR accounts maintained in India must enclose
the necessary certificate from the Banks to the effect that drafts
have been purchased out of funds held in NRE/FCNR account
on repatriation basis along with the application; otherwise such
application will be considered incomplete and will be liable for
rejection. Allotment of shares to non-resident investors shall
be subject to the company obtaining such permission from the
Reserve Bank of India or any other requisite authority as may
be necessary. Refunds, interest, dividends and other
distributions, if any, will be payable in Indian rupees only. In
case of applicants who remit their application money from funds
held in NRE/FCNR accounts, details should be furnished in the
space provided for this purpose. In case of applicants who remit
their money through Indian Rupee drafts from abroad, such
payments in Indian rupees will be converted in US dollars or
into any other currency as may be permitted by RBI at the rate
of exchange prevailing at the time of remittance and will be
despatched through post at the applicant’s sole risk, or at the
request of the applicants, will be credited to their NRE accounts,
details of which should be furnished in the space provided for
this purpose in the application form.
Applications made with Power of Attorney.
If an application is made by a person who holds a power of
attorney to act on behalf of another person who is the actual
investor, such applications have to be accompanied by the Power
of Attorney granted in favour of the former. Likewise if the
application is made in the name of a body corporate, the
application has to be accompanied by a Board resolution. Such
applications are liable for rejection, if they do not comply with
the above provision.
(v) Procedure for Obtaining Stockinvest
The prospective investor, at the time of request for issue of
Stockinvest to the issuing bank may have to :
(a) indicate that he agrees to abide by the terms of issue and
encashment of the Stockinvest.
(b) give irrevocable authority to his bank to mark a lien for the
value of the Stockinvest against the balance held in his
savings/current/other deposit account.
(c) agree for lifting of the bankers’ lien on expiry of the currency
of the Stockinvest or in case of intimation of partial/non-
allotment of shares/debentures/bonds ; and
(d) agree that the issuing bank will not be liable for any damage
or consequences arising out of the loss of these instruments.
The Stockinvest alongwith the application forms will remain
with the Registrar to the Issue and will be lodged in the bank
after the allotment in case of allottees and in case of non-allottees,
such Stockinvests will be returned to them. The Registrar to
the Issue would be authorised through resolution of the Board
to sign on behalf of the company to realise the proceeds of the
Stockinvest from the issuing bank or affix non-allotment advice
on the instrument, or cancel the Stockinvest of the non-allottees
or partially successful allottees who have enclosed more than
one Stockinvest. Such cancelled Stockinvests will be sent by
the Registrar directly to the investors.
(vi) Statement regarding Litigations
All outstanding litigations against the company which are likely
to affect the operation and finances of the company including
disputed tax liabilities are to be disclosed. Such litigations could
be in the nature of :
(i) trade disputes between the company and its customers;
(ii) trade disputes between the company and its collaborators
for breach of collaboration agreements;
(iii) labour disputes like workmen compensations, higher bonus
and amenities; and
(iv) disputed tax liabilities of any nature.
(b) Letter of Offer
A letter of offer is issued by a company when the securities are
issued on rights basis. Therefore it is discussed in detail in
connection with right issue.
2.4 RIGHT ISSUE
Where at any time after the expiry of two years from the
formation of the company or at any time after the expiry of one
year from the allotment of shares of the company made for the
first time, whichever is earlier, the company proposes to issue
further shares, then such shares are to be offered to the existing
holders of equity shares of the company. These issues are known
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as right issue. The company makes the offer by notice specifying
a period of not less than 15 days from the date of communicating
the offer for conveying acceptance. If it is not accepted within
time the offer is deemed to have been declined. [See Sec.81]
Letter of Offer
The document issued by a company offering its securities on
right basis is called a Letter of Offer. According to sub-section
(5) of Section 56 of the Companies Act, 1956, the provisions of
Section 56 relating to the matters to be stated and reports to be
set out in a prospectus are not applicable to a right issue.
Nevertheless, a company that offers its securities to its
shareholders or debenture holders should make fair and adequate
disclosures.
Schedule II to the Companies Act, 1956 does not provide for
matters to be stated in an offer document for rights issue. A
government notification provides details of the information to
be given in a letter of offer. Hence companies were adopting
their own formats and there was no uniformity in disclosure. In
order to streamline the format in which the offer document is to
be sent, SEBI has directed that the Letter of Offer should
conform to the disclosure requirements prescribed in Form 2A
- Memorandum containing salient features of the Prospectus.
Also the contents shall be in the same order as prescribed for
the Memorandum. In respect of financial results of the company,
the Letter of Offer should also contain the undermentioned
information:
1. Working results of the company under the following heads
(i) (a) sales/turnover.
(b) other income.
(ii) estimated net profit/loss.
(iii) (a) provision for depreciation.
(b) provision for taxes.
(iv) estimated net profit/loss.
These informations are to be made up to a date not earlier than
two months from the date of the letter of offer.
2. Material changes and commitments, if any, affecting
financial position of the company.
These informations are to be furnished for the period between
the last date of the balance sheet and profit and loss account
sent to the shareholders and the date preceding by a fortnight
the date of offer. Finally the undermentioned stock market data
are also to be furnished in respect of the shares of the company:
(a) week-end prices for the last four weeks;
(b) current market prices; and
(c) highest and lowest prices.
This information needs to be provided relating to the period
mentioned above.
3. Disclaimer clause
The offer documents and the abridged prospectus should contain
the following “Disclaimer clause”.
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‘It is to be distinctly understood that the vetting of the draft offer
document (Prospectus or the Letter of Offer as the case may be)
by SEBI should not in any way be deemed/construed as approval
from SEBI for the proposed issue. SEBI does not take any
responsibility for the financial soundness of the document. SEBI
merely ensures on the basis of information furnished to it, that
adequate disclosures have been made in the offer documents to
enable the investor to take informed investment decisions’.
4. Memorandum containing salient features of the
prospectus (Abridged Prospectus)
According to Section 56(3) of the Companies Act, 1956, no
one shall issue any form of application for shares in or debentures
of a company, unless the form is accompanied by a
“Memorandum containing such salient features of a Prospectus”,
as may be prescribed, which complies with the requirements of
this section.
The memorandum containing salient features of a Prospectus is
nothing but an abridged Prospectus and the same extent of care
and diligence is required for drafting this also. It should be in
the form prescribed. The memorandum should accompany each
and every application form.
Right issue of Shares
One of the rights that is enjoyed by the equity shareholders of a
company is right of pre-emption conferred under Section 81 of
the Companies Act, 1956. The procedure relating to rights
offering differs greatly from that involved in a public offering.
This part intends to provide insights into the various aspects
involved in such rights offerings, in an elaborate manner, with
commentary notes on each and every piece of activity involved.
A common manner of financing of an existing listed company
is by issue of further securities by way of rights to the existing
share-holders. This offer on rights basis is governed by Section
81 of the Companies Act, 1956 and the Stock Exchange listing
agreement.
Right of Pre Emption
According to Section 81 of the Companies Act, if a company, at
any time after the expiry of two years from the date of formation
or at any time after the expiry of one year from the date of
allotment of shares in that company made for the first time after
its formation, whichever is earlier, proposes to increase the
subscribed share capital of the company, by allotment of further
shares of the company, then the company has to adopt the
following procedure:
(a) such further shares shall be offered to the persons who, at
the date of the offer are holders of the equity shares of the
company, in proportion to the paid up capital at that date.
(b) the offer aforesaid shall be made by a notice specifying the
number of shares offered and limiting a time not being less
than fifteen days from the date of offer within which the
offer, if not accepted, will be deemed to have been declined.
(c) unless the articles of the company otherwise provide, the
offer aforesaid shall be deemed to include a right exercisable
 by the person concerned to renounce the shares offered to
him or any of them in favour of any other person and the
notice referred to in clause (b) above, shall contain a statement
of this right.
(d) after the expiry of the time specified in the notice aforesaid,
or on receipt of earlier intimation from the person to whom
such notice is given that he declines to accept the shares
offered, the Board of Directors of the company may dispose
them of in such manner as they think most beneficial to the
company.
This right of the equity share-holders is called “right of pre-
emption”.
However Section 81(1A) of the Act provides that further issue
of capital could be made to any persons other than the existing
equity share-holders, if a special resolution is passed by the
company in a general meeting, or if no such special resolution
is passed, if the votes cast in favour of the resolution, exceed
the votes cast against the resolution and the consent of the
government is obtained. This right is not applicable, if the
subscribed capital of the company is caused to be increased by
the exercise of an option attached to debentures issued by the
company or loans raised by the company, to convert such
debentures or loans into shares in the company or to subscribe
for shares in the company. These provisions are not applicable
in the following cases also:
(a) issue of shares which are forfeited by the company;
(b) allotment of shares which are already issued;
(c) issue of further shares made before two years from the date
of formation of the company or at any time before one year
from the allotment of shares in that company made for the
first time after its formation; and
(d) issues made by private companies.
The provisions of this Section are applicable to issue of
preference shares also but not to issue of debentures.
Pursuant to the listing agreement entered into with Stock
Exchanges, companies have to adhere to the following
formalities while issuing securities on rights basis:
(a) the Letters of Offer (LOO) should be issued simultaneously
to all the eligible shareholders;
(b) LOO should be numbered serially and printed on a good
quality paper;
(c) LOO should contain a provision for splitting;
(d) LOO should spell out as to how the next payment of dividend
shall be calculated, on the securities which are being issued;
(e) the company should not charge for renounceable LOO;
(f) to close the transfer books as from such date or to fix such
record date for the purpose in consultation with the
Exchange as may be suitable for the settlement of
transactions and to so close the transfer books or fix the
record date only after sanctions subject to which the issue
or offer is proposed to be made have been duly obtained
unless the Exchange agrees otherwise;
(g) to make such issues or offers in a form to be approved by the
Exchange and unless the Exchange otherwise agrees to grant
in all cases the right of renunciation to the share-holders and
to forward a copy of the renunciation forms promptly to the
Exchange;
(h) to give the share-holders reasonable time, not being less than
four weeks, within which to record their interest and exercise
their rights; and
(i) to issue LOO within six weeks of the record date and to
issue allotment letters/certificates within six weeks of the
last date fixed by the company for submission of LOO.
Some fundamental issues on Right Shares
1. Is issue of a prospectus necessary?
A Circular issued by the Department of Company Affairs,
bearing no.8/81/56-PR, says that the issue of further shares by a
company to its members with right to renounce them in favour
of third parties does not require an issue or registration of a
prospectus. Right issue under Sec.81 requires an offer by notice
to be issued to the share holders. It does not specify any
requirement of a prospectus. Under Sec.56 however, no form
of application for shares or debentures can be issued unless it is
accompanied by a prospectus. Of course this requirement is
not applicable when the shares or debentures are not offered to
the public. According to Sec.67(3), no offer or invitation shall
be treated as having been made to the public unless the shares
or debentures become available for subscription or purchase by
persons other than those receiving the offer or invitation. This
provision indicates that the right shares offered only to the
members does not require issue of a prospectus because no one
else other than the offeree can purchase it. But generally such
an offer carries the right to renounce the shares by the member
receiving the offer to any other person. This makes the offer
akin to a public issue. This opinion is in consonance with
Palmer’s [Company Law, 324] observation, ‘where the issue is
made to the existing holders of shares or debentures, much will
depend on whether the letters of allotment which the company
issues is renounceable or non-renounceable'. If as in most cases
the offer is renounceable the issue becomes 'public’. The
Supreme Court held in Needle Industries (India) Ltd v. Needle
Industries Newely (India) Holding Ltd [(1981)51 Comp.Cas.
743] that on offer “which gives the offeree the right to renounce
the shares in favour of the non-member is in truth and substance
an invitation to the public to subscribe to the shares in the
company”. Therefore, in such cases, issue of prospectus is
imperative.
2. Listing regulations regarding right issues
The Stock Exchanges have laid down the following requirements
regarding the right issues by listed companies :
i) the company has to close its transfer books or fix the record
date for the right issue in consultation with the Stock
Exchange;
ii) if the rights work out to a fraction of a whole share the
company should either issue coupons or fractional
certificates;
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iii) the Letter of Offer to be issued to the shareholder is required
to be approved by the Stock Exchange;
iv) the Letter of Offer should provide that shareholders would
be entitled to renounce their rights in favour of nominees;
v) forms of renunciation should be made available to the
shareholders;
vi) shareholders must be entitled to apply for additional shares;
and
vii) a specimen of the offer letter should be forwarded to the
stock exchange.
3. SEBI Gudielines on Rights Issue
The new guidelines issued by the SEBI on 11 June, 1992 on
capital issues deal with certain aspects of rights issues. Any
public company making a rights issue will have to observe and
comply with the relevant guidelines. It may be pointed out that
the guidelines issued by SEBI do not in many cases categorically
refer to rights issue while in certain case they use the expressions
“public issue” and “further issue” which create confusion as to
the applicability of the guidelines to right issues. It would,
therefore, be desirable to approach the SEBI either directly or
through a merchant banker for a clarification on the question as
to whether a particular requirement under the guidelines applies
to the rights issue or not. Sub clause (h) of clause ‘P’ of the new
guidelines empowers the SEBI to issue necessary clarifications
on these guidelines to remove any difficulty in the
implementation thereof. The first and foremost question that
arises is whether the new guidelines are applicable to all kinds
of companies, e.g., private companies, deemed public
companies, listed public companies, unlisted public companies,
government companies, etc. The guidelines are completely silent
on this point.
On 17 June, 1992 the SEBI issued clarifications on certain
aspects of the guidelines. An analytical study of the guidelines
read with the clarifications reveals that these guidelines shall
apply in the case of a rights issue of equity shares to the extent
and in the manner discussed below :-
Clause ‘A’ — The guidelines prescribed under this clause are
not applicable to the rights equity issue because they apply to
the first issue of new companies.
Clause ‘B’ — This clause has limited application in the case of
“first issue by existing private/closely-held companies”. The
words “first issue” are ambiguous, because where a private
company proposes to make an issue for the purpose of getting
its shares listed on a recognised Stock Exchange as per this
clause, such an issue cannot be said to be “first issue”. It would
obviously be its further issue. This clause has however, no
application in any other issue of equity.
Clause ‘C’ — The title of this clause, namely, “Public issue by
existing listed companies” indicates that it applies only to
“Public Issue” and not to "rights issues". But this is not free
from doubt owing to ambiguous language occuring in its sub-
clauses (a) and (c)(ii). In the former there occur the words
“further issues” (which seem to cover rights issue), and in the
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latter there are words “offer documents” (which may cover letters
of offer in the case of rights issue).
Clause ‘D’ — This clause deals with two things : underwriting
and minimum subscription. Prima facie the whole of this clause
does not apply to a rights issue in view of the words “issue of
capital to the public”. However in its clarifications on the
guidelines issued on 16 June, 1992, the SEBI has clarified that
the minimum subscription clause is applicable to a rights issue
with a right of renunciation. As such a company making a rights
issue will have to comply with the requirement as to the minimum
subscription as stipulated in this clause if the rights issue contains
a term giving the right of renunciation to the shareholders.
Clause ‘E’ —According to this clause, where a public and a
rights issues are made simultaneously or even as a composite
issue, the company will be free to fix different premia.
Clause ‘F’ — This clause applies only to debenture issues,
convertible or non-convertible; hence it does not apply to the
rights issue of equity shares.
Clause ‘G’ — This clause deals with new financial instruments,
hence it does not apply to the rights equity issue.
Clause ‘H’ — It appears that the reservation in an issue of
securities comtemplated in sub-clauses (c), (d) and (e) of this
clause can be made even in the case of a rights issue although a
plain reading of these sub-clauses do not expressly so indicate.
Sub-clauses (c) and (d) are ambiguous and hence confusing.
They seem to apply in the case of a public issue as well as rights
issue.
Clause ‘I’ — The word ‘deployment’ seems to have been used
to denote ‘utilisation’. This clause is not happily worded. The
intention appears to be to make the requirement of this clause
applicable to all the issues, public or rights, where the total
amount comprised in the application money and the allotment
money together exceeds Rs.250 crores. The clause says, in such
cases, “the issuer will voluntarily disclose and make
arrangements for the use of proceeds of the issue as per
disclosure to be monitored by one of the financial institutions”.
Where and how this disclosure should be made is not indicated.
Which financial institution should undertake the responsibility
of monitoring the utilisation of proceeds of the issue is also not
indicated. The financial institution doing the monitoring job
seems to be required to prepare a report on the monitoring but
there is no indication regarding contents of the report. Both the
concerned financial institution and the company are required to
send separately copies of the report to SEBI. Sub-clause (b) of
this clause requires that the amount to be called up on application,
allotment and on a call should not be on each occasion, be more
than twenty-five percent of the total quantum of the issue. In
other words, the amount payable on application, allotment and
a call should not exceed on each occasion, 25% of the total
amount payable on a share/debenture, that is, face value and
premium, if any. It may be noted that the aforesaid
condition would apply only in the case of an issue in which the
total amount on application and allotment is more than Rs.250
crores. (Significantly, sub-clause(a) uses the words “exceeding
Rs.250 crores” but sub-clause (b) uses the words “In issue of the
above size and beyond”. The two sub-clauses are, thus,
contradictory).
Clause ‘J’ — According to sub-clause (a) of this clause a company
cannot make a bonus issue within twelve months of a public or a
rights issue, but the converse is not true. In other words, a public
or rights issue can be made within twelve months of a bonus
issue.
Sub-clause (b) of this clause has no application to a rights issue.
It applies only in the case of a “public issue”.
Sub-clause (c) of this clause (which is not happily drafted and
which should have been included under clause “I” of the
guidelines) seems to be applicable also in the case of a rights
issue. It enjoins a company, which has made an issue, to make
the securities fully paid-up within twelve months from the date
of the issue, irrespective of whether the company is in need of
funds or not. In other words, the entire nominal value and
premium, if any, of the securities issued should be made fully
paid-up within the twelve months period. It should be noted
that the company’s duty is confined to taking requisite steps so
as to get the securities fully paid-up within the stipulated period.
If in spite of that some of the holders of the securities do not pay
the call money, this cannot be said to be a violation of, or non-
compliance with, the guideline.
Clause ‘K’ — Reservation of securities for subscription by the
employees of the company upto five per cent may be made in a
rights issue. In such a case, the issue and allotment of securities
to the employees will be subject to the conditions specified in
this clause. Any percentage less than the five percent is also
permitted. In any case, the reservation is voluntary and at the
discretion of the board of directors of the company. If the Board
decides to make the reservation, the compliance with the
provisions of Section 81(1A) will be necessary.
Clause ‘L’ — Sub-clause (a) of this clause makes it clear, by the
use of the words “in any issue to the public” that this clause
does not apply to a rights issue. In its clarifications issued on
16 June, 1992, the SEBI has stated that “in respect of further
issues, if there are no promoters, the promoters' contribution
will mean contribution by directors, friends, relatives, associates
and contribution from them shall not be less than 25 percent or
20 percent of the issue of equity capital as the case may be, with
lock-in-period of five years”. This clarification no doubt uses
the expression “further issue” (which is used in Section 81 of
the Companies Act); however it should be deemed to be referring
to further public issue and not a rights issue because in the case
of a rights issue there is no question of promoters’ contribution
at the fixed percentage in as much as in a rights issue, the existing
shareholders are offered new shares on rights basis in a certain
proportion.
Clause ‘M’ — This clause has nothing to do with the rights
issue.
Clause ‘N’ — This clause does not apply to the rights issue of
equity shares.
Clause ‘O’ — This clause does not apply to the rights issue of
equity shares.
Clause ‘P’ — The requirement stipulated in sub-clause (b), that
the rights issue should not be kept open for more than 60 days,
would seem to apply in all cases of rights offers including those
to non-resident shareholders.
Sub-clause (c) prohibits retention of over-subscription in all
cases of issue of securities, including rights issues.
Sub-clause (d) seeks to enjoin the lead managers to an issue to
forward to the SEBI a report together with a compliance certificate
from a chartered accountant in the prescribed form. The report
and the certificate are to be forwarded within 45 days of the closure
of the issue.
4. Procedure for Rights Issue
(i) The rights issue must be accommodated within the authorised
capital. If the authorised capital is inadequate it needs to be
increased by an amendment by an ordinary resolution under
Sec.94(1)(a) of the Companies Act.
(ii) The board has to decide on the quantum and proportion of
the rights issue; at par or at a premium; appoint underwriters
and managers for the issue; and approve the draft letter of
offer.
(iii) Open a bank account for the acceptance of applications.
(iv) Forward six sets of letter of offer together with the composite
application forms to the concerned Stock Exchanges.
(v) Convey a general meeting to get the requisite resolutions
passed, if necessary
(vi) File with the Registrar of companies within 30 days of the
general meeting, certified copies of the special resolutions
passed at the general meeting, alongwith Form No.23 in
cases where the authorised capital has been increased.
(vii) In case of a listed company, notify the Stock Exchanges
at which the company shares are listed.
2.5 COST OF RAISING CAPITAL
A company that raises money from the public has to incur
expenditure of the following nature —
(i) fees to the Managers, Registrars and other intermediaries
engaged for the issue;
(ii) underwriting commission and brokerage;
(iii) meetings and conferences to market the issue;
(iv) statutory and other advertisement costs;
(v) printing and stationery costs; and
(vi) postage and mailing costs.
2.6 SHARE ISSUED AT A PREMIUM
Shares could be issued either at its nominal value, or at a
premium or at a discount. While shares are commonly issued
at its nominal value, companies with a good performance and
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with growth potential, issue their shares at a premium. Initial
public issue of shares at a discount is not in vogue, though there
is no prohibition to do so.
While the Companies Act does not contain any restriction on
issue of shares at a premium, SEBI’s Guidelines on Disclosure
and Investors’ Protection permits only certain class of companies
to issue shares at a premium. The guidelines further require the
company to give the justification for the premium in the offer
documents. However Section 78 of the Companies Act, contains
certain provisions relating to the treatment of the premium
received by the company. These provisions are explained below:
(i) If a company issues shares at a premium, whether for cash
or otherwise, a sum equal to the amount of premium on
those shares should be transferred to a seprate account called
“Share Premium Account”.
(ii) The provisions of the Act relating to the reduction of the
share capital of a company shall apply to share premium
account also, except otherwise provided in the Act.
(iii) The amount standing to the credit of the share premium
account should be utilised only for the following purposes:
(a) in paying up unissued shares of the company to be
issued to members of the company as fully paid up
bonus shares ;
(b) in writing off the preliminary expenses of the company
; void if a specified act is performed or is not performed as
(c) in writing off the expenses of or the commission paid
or discount allowed on, any issue of shares or
debentures of the company ; or
(d) in providing for the premium payable on the
redemption of any redeemable preference shares or
of any debentures of the company.
2.7 SHARE ISSUED AT A DISCOUNT
According to Section 79 of the Companies Act, a company may
issue its shares at a discount, subject to the following conditions:
(i) the shares that are to be issued at a discount should be of a
class of shares already issued;
(ii) the issue at a discount is authorised by a resolution passed
by the company in a general meeting;
(iii) the issue is sanctioned by the Company Law Board;
(iv) the maximum rate of discount allowed should not be in
excess of ten percent or such other higher percentage that
may be allowed in the special circumstances of the case;
(v) a minimum of one year should have elapsed since the date
on which the company was entitled to commence business;
(vi) the shares are to be issued at a discount within two months
from the date of its sanction by the Company Law Board or
within such extended time as the Company Law Board may
allow; and
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(vii)every prospectus relating to the issue of shares shall contain
particulars of discount allowed on the issue of shares or of
so much of that discount as had not been written off on the
date of issue of the prospectus.
2.8 RAISING OF LOAN CAPITAL
(A) Power to issue debentures
The Board of Directors of a company has power to issue
debentures and/or to borrow monies otherwise than on
debenture,and/or to make loans and invest the funds of the
company. Such a power is to be exercised by a resolution passed
at the meeting of the Board. (See Sec.292). Of course, the
Board’s power to borrow money is restricted by Sec.293 (d) if
the monies so borrowed exceed the aggregate of the paid up
capital and its free reserves. In such a case the Board of a public
company or a private company which is a subsidiary of a public
company would need the consent of the public company or
subsidiary in its General Meeting.
Bond
Under Sec.2(12) of the Companies Act, Debentures include
‘Bonds’. According to Sec.2(5) of the Indian Stamp Act, a bond
means -
(a) any instrument whereby a person obliges himself to pay
money to another, on condition that the obligation shall be
the case may be,
(b) any instrument attested by a witness and not payable to order
of bearer whereby a person obliges himself to pay money
to another, and;
(c) any instrument so attested whereby a person obliges himself
to deliver grain or other agricultural produce to another.
A bond, therefore, is an instrument under seal whereby one
person binds himself to another for payment of a specified sum
at a future date.
Debenture as a Negotiable Instrument
A debenture payable to a bearer, or where registered, to a
registered holder, is by usage a negotiable instrument. A bearer
debenture as explaind by the Calcutta High Court is one which
is payable upon presentation thereof and upon the demand made
by the bearer. [Calcutta Safe Deposit Co. Ltd. v. Ranjit M.
Sampath (1971)41 Comp. Cases 1063 (Cal)]
Rights of a Debenture Holder
A debenture holder shall have the following rights :
(i) Every debenture holder is to be provided on demand with a
copy of annual accounts along with the auditor's report, [See
Sec. 219(2)].
(ii) A debenture holder has the right to obtain the copy of the
trust deed used for securing the issue of debenture. Within
7 days of such request made by the debenture holder the
company has to forward a copy of the trust deed. [See
sec.118(1)].
(iii) A debenture holder cannot have a voting right at any meeting
of the company. This is provided in Sec.117 perhaps with
a view to distinguish debenture holder with an equity holder.
It has been rightly pointed out by the Bombay High Court in
Narottam Das v. Bombay Dyeing & Manufacturing Co.
Ltd. [(1989)3 Comp.L.J. 179] that the rights of the debenture
holder and the corresponding obligation of the company,
excepting in the above statutory provisions, essentially
depend upon the terms of the agreement between the
debenture holder and the company.
(iv) A debenture holder can sue the company for the recovery of
the amounts payable to him as the holder of the certificate
provided there is a covenant to that effect. In absence of
such covenant the holders of the bond were not considered
as creditors but are settled as cestui que trust of a charge.
Similarly unless covenanted, debenture stock holders cannot
present a winding up petition as creditors for arrears in the
interest accumulated. Of course Bombay High Court in
Narohari’s case held that in view of clear provision of Sec.
439 of the Companies Act, a debenture holder is deemed as
creditor of the company for the purpose of presenting a
winding up petition.
Secured Debentures and the Trust Deed
Though in the Companies Act there is no provision requiring
that the debentures be secured, yet, it is common to secure the
debenture by a mortgage or charge on the company’s property.
The most common practice is to secure a debenture by a trust
deed, in order to ensure the payment of the debt. A debenture
trust has to be created expressly by an instrument of trust.
Advantages of such trust can be briefly outlined as :
(a) it constitutes trustees who are responsible to look after the
rights and interests of the debenture holders;
(b) the trustees can enforce the security on behalf of the holder;
and
(c) a legal estate is sometimes vested in the trustees.
The trust deed lays down the manner of appointing a receiver
and the trustees are given the power of interference in the event
of the interest of the debenture holders being at stake.
A Debenture Secured Under Charge
The debenture secured by a charge by any form of mortgage of
a company’s property may have ranking in charges. As for
example, a property already mortgaged to another institution
may be again mortgaged by creating a charge in favour of the
debenture holders. Such repetitive charges shall have sequential
preference based upon the agreement between the company and
the charge holders and the subsequent proposed charge holders.
Charge includes a mortgage according to Sec. 124 of the
Companies Act. It also includes a lien and an equitable
charge whether created or evidenced by an instrument in writing
or by deposit of title deeds or by an agreement to deposit.
Sometimes charges may be fixed or floating. Fixed charges are
created on properties which are fixed in nature, as for
example, on land, building, plant and machinery, fixtures etc.
Charges can also be created against assets which are floating in
nature, as for example, stock.
A charge created against all the assets taken together of a company
is a floating charge thereby meaning that the charge is not
crystallised or fixed until anyone of the following happens:
(i) the debtor company ceases to carry on the business, or
(ii) goes into liquidation, or
(iii) the debenture holder or any creditor in whose favour the
charge is created intervens by getting a receiver appointed,
or
(iv) the charge holder in doing some other acts affects the
company’s power of disposing the assets under charge.
An instrument creating the right in favour of the mortgagee to
recover the loan is required to be registered under Sec.17 of the
Registration Act. Where a mortgage is created by a registered
mortgage deed no further stamp duty is payable on the debenture,
as per the provision of Art 27 of the Schedule to the Indian
Stamp Act. i.e., once a duty is paid on the mortgage deed. In
Chief Controlling Revenue Authority v. Manager, State
Bank of Mysore [(1989)65 Comp.Cases 427 (Kar)], the
Karnataka High Court dealt with the question of correct stamp
duty payable on the debenture trust deed. The High Court held
that the debenture trust deed is not a deed of mortgage or bond
but a deed of trust and therefore the stamp duty chargeable may
be under Art 54(a) of the Schedule of the Act and not under Art
27 of the Schedule which contains the stamp duty payable on
debenture whether mortgage debenture or not.
Registration of Charge
According to Sec. 125 of the Companies Act, every charge
created by a company and being a charge to which the section
applies is required to be registered with the Registrar of
Companies within 30 days of the creation of charge. This section
applies to the following charges :
(a) A charge for the purpose of securing any issue of debentures;
(b) A charge on uncalled share capital of the Company;
(c) A charge on any immovable property;
(d) A charge on any book debt;
(e) A charge on any movable property, not being a pledge;
(f) A floating charge on the undertaking or any property of the
company including stock-in trade;
(g) A charge on calls made but not paid;
(h) A charge on a ship or any share in a ship; and
(i) A charge on goodwill, patent, license, trademark or a
copright.
Where any charge is required to be registered u/Sec.125 of
the Companies Act has been so registered, any person acquiring
the charged property shall be deemed to have notice of the
charge from the date of such registration. [See Sec. 126] Where
a company subject a property to a charge, a certified copy of
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the instrument by which the charge was created is to be delivered
to the Registrar for registration within 30 days from the day of
creation. [See Sec. 127]. The Registrar shall keep with respect
to each company a register in the prescribed form recording all
the charges registered. The record must contain the date of
creation, the amount secured, the particulars of the property
charged and the parties entitled to be charged. An index to
Register of charges must also be kept by the Registrar who shall
give certificate of registration of charge which shall be the
conclusive evidence as to the registration of charge. Whenever
a modification is made of the charges the company has to send
to the Registrar the particulars of modification. It shall be the
duty of every company to file to the Registrar for registration of
particulars of every charge created by the company and of every
issue of debentures of a series requiring registration. [See for
details Secs. 125 to 144 of the Companies Act].
SEBI Guidelines on issue of debentures
Securities and Exchange Board of India issued ‘the guidelines
for disclosure and investors’ protection on June 11, 1992 which
apply to those public companies whose shares or debentures
are listed on recognised Stock Exchange. Sec. F of the
guidelines stipulates the following requirements as regards issue
by the listed companies of fully Convertible Debentures (FCD),
Partly Convertible Debentures (PCD) and Non Convertible
Debentures (NCD).
(a) Issue of FCDs having a conversion period more than 36
months will not be permissible, unless conversion is made
optional with “put” and “call” option.
(b) Compulsory credit rating will be required if conversion is
made for FCDs after 18 months.
(c) Premium amount on conversion, time of conversion, in
stages, if any, shall be predetermined and stated in the
prospectus. The interest rate for above debentures will be
freely determinable by the issuer.
(d) Issue of debenture with maturity of 18 months or less are
exempt from the requirement of appointment of Debenture
Trustee or creating a Debenture Redemption Reserve
(DRR). In other cases, the names of the debenture trustees
must be stated in the prospectus and DRR will be created in
accordance with Section N.1. The trust deed shall be
executed within six months of the closure of the issue.
(e) Any conversion in part or whole of the debenture will be
optional at the hands of the debenture holder, if the
conversion takes place at or after 18 months from the date
of allotment, but before 36 months.
(f) In case of NCDs/PCDs credit rating is compulsory where
maturity exceeds 18 months.
(g) Premium amount at the time of conversion for the PCD
shall be predetermined and stated in the prospectus.
Redemption amount, period of maturity, yield on redemption
for the PCDs/NCDs shall be indicated in the prospectus.
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(h) The discount on the non-convertible portion of the PCD in
case they are traded and procedure for their purchase on
spot trading basis must be disclosed in the prospectus.
(i) In case, the non-convertible portions of PCD/NCD are to be
rolled over with or without change in the interest rate, a
compulsory option should be given to those debenture
holders who want to withdraw and encash from the
debenture programme. Roll over shall be done only in cases
where debenture holders have sent their positive consent
and not on the basis of the non-receipt of their negative
reply.
(j) Before roll over of any NCDs or non-convertible portion
of the PCDs, fresh credit rating shall be obtained within a
period of six months prior to the due date of redemption
and communicated to debenture holders before roll over
and fresh trust deed shall be made.
(k) Letter of information regarding roll over shall be vetted by
SEBI with regard to the credit rating, debenture holder
resolution, option for conversion and such other items which
SEBI may prescribe from time to time.
(l) The disclosures relating to raising of debentures will contain,
amongst other things, the existing and future equity and long-
term debt ratio, servicing behaviour on existing debentures,
payment of interest on due dates on term loans and
debentures, certificate from a financial institution or bankers
about their no objection for a second or pari passu charge
being created in favour of the trustees to the proposed
debenture issues.
(m) SEBI may prescribe additional disclosure requirement from
time to time, after due notice.
SEBI guidelines also provide that in case of convertible
debentures where price was to be determined by the Controller
of Capital Issues, the price for conversion now is to be
determined in a duly organised meeting of debenture holders
and share holders or in other words wherever the power regarding
price was given to the Controller of Capital Issue it is now being
given to the company itself, of course with the consent of
respective debenture holders
Protection of Debenture Holders’ Interest
SEBI guidelines has laid down the following measures to ensure
the protection of debenture holders’ interest.
(a) Trustees to the debentures issue shall be vested with the
requisite powers for protecting the interests of debenture
holders including the right to appoint a nominee director
on the Board of the company in consultation with
institutional debenture holders.
(b) Lead institution/investment institution will monitor the
progress in respect of debentures for project finance/
modernisation/expansion/diversification/normal capital
expenditure. The lead bank for the company will monitor
debentures raised for working capital funds.
(c) Institutional debenture holders and trustees should obtain a
certificate from the company’s auditors in respect of
 utilisation of funds during the implementation period of
projects. In the case of debentures for working capital,
certificate should be obtained at the end of each accounting
year.
(d) Debenture issues of companies belonging to the groups for
financing or acquiring shareholding in other companies
will not be permitted.
(e) The companies shall, along with their application, file with
SEBI, certificates from their bankers that the assets on which
security is to be created are free from any encumbrances
and the necessary permissions to mortgage the assets have
been obtained or a No Objection Certificate from the
financial institutions or banks for a second or pari passu
charge in cases where assets are encumbered. The security
should be created within six months from the date of issue
of debentures. If for any reasons the companies are not in a
position to create security within 12 months from the date
of issue of debentures the company shall be liable to pay 2
per cent penal interest to debenture holders. If security is
not created even after 18 months, a meeting of the debenture
holders should be called within 21 days to explain the
reasons thereof and the date on which the security would
be created.
(f) The trustees to the debenture holders will supervise the
implementation of the conditions regarding creation of
security for the debentures and regarding the debenture
redemption reserve.
(B) Public Deposit
Companies (Amendment) Act 1974 has inserted Sec. 58A,
enabling a company to invite and accept public deposits,
according to such rule as may be laid down in consultation with
Reserve Bank of India. Companies of course used to accept
public deposits earlier. After the Amendment Act of 1974, public
deposits cannot be invited and accepted without observing the
rules as laid down. Accordingly the Companies (Acceptance of
Deposits) Rules 1975 was made by the Central Govt. in
consultation with the RBI. The said rules have been amended in
1982. The rule has defined in details as to what a deposit means
and includes. The definition includes any deposit of money or
borrowings to a company but does not include amount received
from the governments; loans received from banking and other
financial institutions; amount received from employees as
security deposit; amount received in trust ; amount received on
bonds and debentures; etc.
The Rule 3 of the 1975 Rules has imposed the following negative
conditions on acceptance of public deposits by a company:
(a) no company shall accept public deposit which is repayable
on demand or on notice or repayable after a period, except
where the deposit is repayable after the expiry of 6 months
but not later than 36 months from the day of acceptance;
(b) the public deposit shall not exceed 25% of the aggregate of
the paid up share capital and free reserves;
(c) an interest rate exceeding 14% per annum cannot be offered;
(d) company cannot pay brokerage beyond 1% of the deposits
for a period of one year and 2% for deposits exceeding two
years; and
(e) deposits cannot be accepted against unsecured debenture.
Every company accepting public deposit must furnish to the
depositor a receipt for the amount received, signed by the duly
authorised officer of the company. Every company accepting
the deposits shall keep at its registered office, register of deposits
containing name and address of the depositor; date and amount
of its deposit; duration; rate of interest; date of payment of
interest and other particulars. [See for details Companies
(Acceptance of Deposits) Rules 1975].
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3. INVESTORS’ PROTECTION
SUB TOPICS
3.1 Introduction
3.2 Duty of disclosure
3.3 Liability for Mis-statement
3.4 Prevention of Insider Trading
3.5 Other Institutional Protection
(a) Listing in a Stock Exchange
(b) Credit Rating
(c) Investment through Mutual Fund
(d) Portfolio Management
3.6 Protection of Minority Interest
3.7 Protection against take over operations
3.1 INTRODUCTION
The realm of investment and its return is a private decision
specially in an open market economy. The State through a legal
and institutional process must ensure (a) complete freedom to
take all decisions and (b) ensure the protection of individual
rights through correspondingly fixing individual duties and
consequential liabilities. In a free market economy law has
generally three important roles to play — (i) it recognises all
players of the market and prevents any one from participating
without such recognition; (ii) it creates a level playing field by
ensuring equality of opportunities; and (iii) it prescribes rules
to be equally applicable against all players by ensuring a neutral
umpiring.
As such generally in a private contractual situation law does not
take side with one party unless there is an unconscionable
phenomenon.
In Corporate Law state has a special role to play because it is
the artificial creation of corporate personality which the law of
the land ensures, that empowers a group of people to organise
and run commercial projects and enterprises for the purpose of
earning profits with the help of investments made by a large
number of investors who do not have right to participate in the
management though undertaking the risks of investment. On
the other hand a group of entrepreneurs or promoters or business
organisers manage the whole affair by supplying sometimes a
very little part of the capital. These management groups, are
given wide protection by law. It is, therefore, encumbent upon
the state to also ensure that these vast number of investors
supplying the capital are protected against all unreasonable
and questionable if not unlawful activities of a few in the
company known as management. Investors invest money on
the expectation of best return but best return is not always the
outcome of best management. An investor requires protection
against several activities of the management. As for example:
(i) While investing in the company either in the share capital
or loan capital an investor requires all information in its
exact and true form which help the investor to take decisions
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both on qualitative as well as quantitative terms. Therefore
the legal system has to ensure in a free market condition
that all such informations are made available to the
prospective investors so that they freely and fairly take
decisions.
(ii) The arena of investment by nature has unevenness in the
playing conditions. As it is possible that the information
dissemination process may create greater access to a few
creating thereby inequality amongst the players in the
investment market based upon inequality of information,
the player having more access to information will command
the market and derive greater gain. Therefore, the law has
to ensure not only equal information dissemination but has
also a role to play in neutralising excess information
available to some in view of their status. Otherwise a code
of equal access cannot deliver justice in an inherent by
inequal situation. Here the role of law is extremely critical
because the task of neutralising the effect of advance
information or previleged information is not only difficult
but also extremely complicated. A simple example makes
the situation clear. A director of a company has access to
information about the company to which an outsider or even
a shareholder does not have any access. As such, in order
to ensure fair play in the capital market the director is
required to be disempowered by law so that his excess power
derived through advance knowledge does not allow him to
dominate the market.
(iii) An investor is in a disadvantageous position vis-a-vis the
management. As the management is in control of company
funds and assets,the potential for misuse is greater. It is also
possible for the majority of the investors to suppress the
minority based on voting strength. Hence investors need a
greater degree of protection in such an unequal relationship.
The degree of protection mentioned above can be discussed in
detail under the following heads:
(i) duty of disclosure;
(ii) protection against insider trading; and
(iii) protection against mismanagement and exploitation by the
majority group.
3.2 DUTY OF DISCLOSURE
Secs. 56, 58A, 58B and 66 of the Companies Act require
disclosure of informations to the intending share applicants,
debenture applicants and depositors. According to Sec. 56(3)
no one shall issue any form of application for shares in or
debentures of a company unless the form itself is accompanied
by a prospectus which contains the standard of information
specified in Part I and Part II of Schedule II of the Companies
Act. According to Sec. 58A (2)(b) a public deposit cannot be
invited and accepted without a public advertisement which has
to include a statement showing the financial position of the
company. These negative prescriptions emphasize that the
responsibility of issuing the prospectus or giving the
advertisement as the case may be is that of those who invite the
public to subscribe to the share capital or debenture or make a
deposit. Sec. 61 of the Companies Act affirms the importance
of the terms of contract referred to in the prospectus or statement
in lieu of prospectus. Though in terms of Common Law
principles of Law of Contract a prospectus is only an ‘invitation
to offer' but under company law a prospectus determines the
conditions of the contract. As such according to Sec. 61 a
company shall not at any time vary the terms of the contract
referred to in the prospectus or statement in lieu of prospectus,
except subject to the approval or except on authority given by
the company in General Meeting. Therefore stipulation in the
prospectus is deemed to be a term of the contract. The contents
of the prospectus which is specified in Schedule II has already
been mentioned in Module I. If one carefully notes the contents
of the prospectus, one shall come to understand that prospectus
is not a mere advertisement or a statement. It contains all
informations regarding : (a) management and organisation
structure, (b) extracts of all important contracts made so far by
the company, (c) statements certified by the auditor as regards
financial position , (d) statements of assets and liabilities, (e)
important historical data such as total turn over, net profit,
dividend declared in the past years, (f) amount to be raised by
way of public subscription and a statement of its utilisation, etc.
It may be noted that all this information is relevant for taking a
decision on investment. The law therefore prescribes that if
Sec. 56(3) is not observed all persons acting in contravention
shall be punishable with a fine extending upto Rs.5000/-.
Similarly if conditions stipulated under Sec. 58A(2)(b) are not
observed the company can be fined as well as the defaulting
officer shall be liable to imprisonment for a term which may
extend to 5 years and shall also be liable to fine. The obligation
of persons issuing the prospectus was laid down in New
Burnswick & Canada Railway and Land Co. v. Muggeridge
[(1860)1 Dr. & Sm. 363] thus : “Those who issue a prospectus
holding out to the public the great advantages which will accrue
to persons who will take shares in a proposed undertaking, and
inviting them to take shares, on the faith of the representations
therein contained, are bound to state everything with strict and
scrupulous accuracy and not to abstain from stating as fact that
which is not so, but omit no one fact within their knowledge,
the existence of which might in any degree affect the nature or
extent and quality of the privileges and advantages which the
prospectus holds out as inducement to take shares”. In
Pramatha Nath Sanyal v. Kali Kumar Dutt [AIR 1925 Cal
914] the Calcutta High Court very rightly observed that “every
statement made should be an honest one, no ambiguous
phraseology, unfair reservations or half truth should be allowed
to be used or to creep in”.
SEBI Guidelines on disclosure
In the SEBI guidelines relating to disclosure necessary during
first issue by existing private/closely held companies and on
public issue by existing listed companies it is provided that “the
draft prospectus will be vetted by SEBI to ensure adequacy of
disclosure”. In the case of first issue by existing private/closely
held companies, “the pricing would be determined by the issuer
and lead managers to the issue and would be subjected to specific
disclosure requirements including : (i) disclosures of the net
asset value of the company as per the last audited balance sheet
; and (ii) justification for the issue price”. The guideline on
public issue by existing listed companies stipulates that the offer
documents shall contain the net asset value of the company and
a justification for the price of the issue. The high and low price
of the shares for the last two years are also required to be
disclosed.
A separate guideline has been issued by SEBI on issue of
securities by Development Financial Institutions (DFI).
According to it the offer document of the DFI should contain
specific disclosure in respect of:
(a) the present equity and equity after conversion in case of
FCDs/PCDs;
(b) Debt Equity ratio, not to exceed 1.2:1;
(c) Debt Service Coverage ratio (DSCR) to be maintained at
minimum of 1.2:1
(d) Servicing behaviour of existing debentures;
(e) Outstanding principal/interest/lease rentals due from
borrowing companies; and
(f) assets representing loan and other assistance portfolio
classified into four broad groups as standard assets; sub-
standard assets; doubtful assets and loss assets.
SEBI may stipulate additional disclosure requirements from time
to time, after due notice, as may be considered necessary.
Through standard fixation about disclosure, SEBI has to ensure
adequate information in the primary market.
3.3 LIABILITY FOR MISSTATEMENT
It has been already stated that disclosure in a prospectus is
essential in order to enable the investor to make his offer.
According to Common Law there is no cause of action against
an ‘invitation to offer’. But a prospectus is treated as an offer
document prescribing the conditionalities of the offer to the
investor. These conditionalities are binding upon the company.
A prospectus is not to misrepresent actual and material facts or
conceal facts which may improperly influence and mislead a
prospective investor. If he is deceived thereby, he is entitled to
remedies. Of course a mere non disclosure of facts would not
be sufficient to result in an actionalbe claim unless such non-
disclosure is against a statutory responsibility to disclose or s
uch non-disclosure of facts ‘had the effect of making the
disclosed facts absolutely false’. [See Peek v. Gurney (1874)
LR 6 (HL)]. The liability is based upon the old Roman principle
“Suggestio falsi, Suppressio Veri’, i.e., ‘stating falsehood about
material fact or, suppressing material fact that is required to be
disclosed’ originate the liability of the party suggesting
falsehood or suppressing material facts. There are several types
of remedies.
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(a) Contractual Liability: Palmer (Company Guide, pp. 29-
30) stipulated the following contractual remedy for misstatement
or fraud in the prospectus:
(i) he may repudiate the contract (mis-statement or fraud makes
a contract voidable in Common Law as well as in Indian
Law under Sec. 19 of the Indian Contract Act) and require
repayment of his money with interest.;
(ii) he may take proceedings to enforce rescission of the contract
and repayment ; and —
(iii) he may bring an action for damages against the company,
its directors and other responsible persons. The measure
of damages is the loss suffered by reason of the untrue
statement, omission etc., the difference between the value
which the shares would have had but for such statement or
omission and the true value of the shares at the time of
allotment [McCounsel v. Wright (1903)1Ch 546].
(b) Civil Liability: Section 62 of the companies Act attaches
strict liability to the following persons for any untrue statement
contained in the prospectus.
(i) every person who is a director of the company at the time
of the issue of the prospectus;
(ii) every person who has authorised himself to be named and is
named in the prospectus either immediately or after an
interval of time;
(iii) every person who is a promoter of the company; and
(iv) every person who has authorised the issue of the prospectus.
These above persons are liable to pay compensation to every
person who subscribes for any shares or debentures on the faith
of the prospectus and suffered a loss or damages on account of
the untrue statement. It is not necessary to prove the frauduent
character of the untrue statement. It is enough to prove that the
statement was, in fact, untrue and that in relying upon them the
subscriber suffered damage. The untrue statement must be a
material one. A misleading statement in a prospectus is an
‘untrue’ statement attracted by this provision of the Act.
A fraudulent statement also entails civil liabilities besides
attracting contractual liability. A fraud or misrepresentation
makes a contract voidable. If a statement is untrue on account
of fraud or misrepresentation, the civil remedy of seeking
damages for the loss sustained shall also be available to the
party defrauded or mislead. In order to make a prospectus
fraudulent, it is not necessary that there should be a false
representation (suggestio falsi). Even if every word is true, the
suppression of material facts may render the statement fraudulent
(suppressio veri).
(c) Criminal Liability : According to Section 63 of the
Companies Act every authorised person issuing a prospectus is
liable to be punished with imprisonment upto two years and
fine upto Rupees five thousand or both for any misstatement in
the prospectus. An expert or a person making any report
required by Part II of Schedule II are not deemed to have
authorised the issue of a prospectus. A false statement made
with culpable negligence or with intention shall attract
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punishment under Sec.68 of the Companies Act, as well.
According to Sec. 68, any person who, either by knowingly or
recklessly making any statement, promise or forecast which is
false, deceptive or misleading, or by any dishonest concealment
of material facts, induces or attempts to induce another person to
enter into or to offer to enter into —-
(a) any agreement for, or with a view to, acquiring, disposing
of, subscribing for, or underwriting shares or debentures;
or
(b) any agreement, the purpose or intended purpose of which
is to secure a profit to any of the parties from the yield of
shares or debentures, or by reference to fluctuations in the
value of shares or debentures;
shall be punishable with imprisonment for a term which may
extend to five years or with fine upto Rupees ten thousand or
with both. Section 68 is applicable in the case of a fraud
committed in stating a fact in the prospectus either knowlingly
or recklessly. In R. v. Bares [(1952)2 All ER 892] ‘recklessly’
was interpreted so as to extend to a ‘high degree of negligence
without dishonesty’. The distinction between the provision of
punishment in Sec.63 and that of Sec. 68, is heartening to note.
Whereas any ‘misstatement’ in the prospectus is punishable
under Sec. 63, that is not so in Sec. 68, In Sec. 68 only those
misstatements are covered which are fraudulent or made with
culpable negligence. Negligence become culpable only when a
duty warranted either by law or in ordinary circumstances is not
cared to be implemented. For Sec. 63, use of the fact that the
statement is untrue is enough but for Sec. 68 the plaintiff has to
prove beyond doubt the existence of culpable negligence or
intention to commit fraud. Where as in the application of Sec.
63 a high standard of proof of a criminal proceedings is not
necessary, in Sec. 68 the plaintiff has to establish a proof of
high standard generally followed in a criminal case.
Whether a person has been induced to take shares by reason of
a misrepresentation in a prospectus, is a matter of fact. The
Supreme Court while deciding the case Larsen & Toubro Ltd
v. Haresh Jagtiani [AIR 1991SC 119] held that a prospectus
which merely specifies the dates and names of the parties to
contracts, does not give notice of circumstances contained in
the contracts which are material to be known and the omission
of such circumstances causes the prospectus to give a false
impression.
How to avoid liability under Sec. 62
According to Sec. 62 (2) of the Companies Act no person shall
be liable to pay compensation, if he proves —
(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 his authority or consent;
(b) that the prospectus was issued without his knowledge or
consent, and that on becoming aware of its issue, he
forthwith gave reasonable public notice that it was issued
without his knowledge or consent;
(c) that, after the issue of the prospectus and before allotment
thereunder, he, on becoming aware of any untrue statement
therein, withdrew his consent to the prospectus and gave
 reasonable public notice of the withdrawal and of the reason
therefor; or
(d) that —
(i) he believed, and had reasonable ground to believe,
that the statement was true, or
(ii) the statement was a correct copy or extract from a
report or valuation of an expert, whom he had
reasonable grounds to believe and did believe was
competent to make it and that the prospectus was
issued with the expert’s consent in writing, or
(iii) the statement was a correct copy or extract from an
official document.
As such in a civil action for obtaining compensation, a director
of a company can argue (i) bonafide belief ; (2) withdrawal of
consent and (3) not giving consent. The last two arguments
primarily concern documentary evidences whereas the first
argument depends on both evidencial and circumstantial
evidences. In Akerhielm v. De Mare [(1959)3 All ER 485
(PC)] the Privy Council held that it would be a good defence
that the director concerned honestly believed the statement to
be true in a sense in which it might reasonably be understood
even though it was erroneous.
An expert like, a Chartered Accountant, a Chartered Engineer, a
Solicitor or the like, who is required to give his consent to the
issue of prospectus, is also liable under Sec. 62 to give
compensation to a party suffering from mis-statement in the
prospectus. He can escape liability if he proves:
(a) that having given his consent under Sec. 58 to the issue of
the prospectus, he withdrew it in writing before delivery of
a copy of the prospectus for registration ;
(b) that, after delivery of a copy of the prospectus for registration
and before allotment thereunder, he, on becoming aware of
the untrue statement, withdrew his consent in writing and
gave reasonable public notice of the withdrawal and of the
reason thereof; or
(c) that he was competent to make the statement and that he
had reasonable ground to believe, and did upto the time of
the allotment of the shares or debentures, believe, that the
statement was true.
How to avoid liability under Sec. 63
In order to avoid criminal liability imposed under Sec. 63 for
misstatement in a prospectus a person authorised to issue such
prospectus is required to prove that —
(a) the statement was immaterial, or
(b) he had reasonable ground to believe and did believe, upto
the time of the issue of the prospectus that the statement
was true.
A statement is immaterial if it does not have any bearing on the
decision to make investment. In such a case, once the
misstatement is proved the burden of responsibility of proving
immateriality of the statement made or bonafide belief, lies on
the defence. The provision in Sec. 63 stating ‘unless he proves’
signifies the shifting of the burden of proof. Ordinarily in a
criminal proceedings the prosecution has to prove beyond any
doubt the charge against the accused. But under Sec. 63 the
defence (accused) has to prove the grounds on which he can be
excused. Any misstatement in the prospectus per se shall attract
the provision of Sec. 63 against all authorised persons having
authority to issue the prospectus.
But an expert required to make a statement under Sec. 58 or
Sec. 60 having given his expert's consent shall not be deemed
under Sec. 63 to have authorised the issue of the prospectus
though he is treated as such under Sec. 62.
In so far as ‘burden of proof’ is concerned there is a difference
between Sec. 63 and Sec. 68. As has been stated under Sec. 63
the burden of proof lies on the defence but in case of Sec. 68 the
‘burden of proof’ that the statement was made ‘knowingly’ or
‘recklessly’, lies on the plaintiff (prosecution). It may be noted
that a person responsible for making a false statement for a
wrongful gain or inflicting a wrongful loss on another may also
be prosecuted under the criminal law. In such a case the
prosecution has to prove the charge beyond any reasonable
doubt.
Liability of the Company for misstatement in the prospectus
A company acting through its board of directors is responsible
for a misstatement in the prospectus which forms the basis of
contract between the allottee of a share and the company. The
liability of the company in this regard depends upon the common
law development in the area of contract of agency. The general
principle is that a contract to take shares is voidable if it is
induced by misrepresentation, whether fraudulent or innocent.
Therefore, if there is a material misstatement in a prospectus
which induced a person to invest in the company, he can, if he
applies within a reasonable time and before the company goes
into winding up proceedings, get his contract rescinded [See
Sheromain Sugar Mills Ltd v. Debi Prasad AIR 1950 All
508]. It means the investor is entitled to get his money back
with interest if he rescinds the contract. He cannot keep his
share yet claim damages. The relief of rescission shall be
available provided —
(a) The statement inducing the shareholder to invest in the
shares or debentures, relates to a material fact ; and
(b) The statement is untrue.
Sec.65 explains the untrue statement as (i) a statement
misleading in the form and context in which it is included;
and (ii) where the omission of a matter is calculated to
mislead.
(c) The statement must have been actually relied upon by the
shareholder.
(d) The shareholder must proceed for rescission within a
reasonable time and before the company goes into
liquidation. A reasonable time shall be one calculated on
the basis of taking action soon after coming to know of the
misstatement. Where a person relies on a statement made
by an agent, he has to prove that the statement made was
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 false and made while acting within the authority before the
contract was made, and that the statement in fact was a
misrepresentation. The right to rescind is lost in the
following circumstances :
(i) if after discovering the misstatement, the shareholder
adopts the contract by paying calls or receiving
dividend or attending and voting in a general meeting;
or
(ii) rescission becomes impossible, say when the company
is in the winding up proceedings or suppose the
shareholder has sold the share; or
(iii) there is a lapse on the part of the shareholder in not
taking any action after discovering the misstatement.
3.4 PREVENTION OF INSIDER TRADING
What is insider trading?
The act of a director or an official or employee of the company
trading in his own company’s securities and stocks for personal
gain taking advantage of his access to price sensitive unpublished
information on account of his being an ‘insider’, is known as
insider trading. This is treated as the most henious corporate
offence in the twentieth century in the corporate directors’ or
officials or employees’ access to confidential information or price
sensitive information in advance is an essential necessity in
corporate management. Using these informations to the
disadvantage of the company for personal gain, is a breach of
fiduciary duties to the company. The ‘insider’ the concerned
director or manager of the employer is bound to account for the
profit and compensate the company. But unless law tries to
strictly deal with it, there is no such accountability or liability
of any ‘insider’ for his ‘trading’ on any of his own company’s
securities to an ‘outsider’. An insider, a market disturbance
through asymetry of information. As Gower (Modern Company
Law, p. 607) puts it : "This is a practice which most countries
have now recognised to be objectionable".
Who is an insider ?
The SEBI regulation on insider trading defines an insider to be
a person who during the preceeding 8 months, is connected with
the company and who may reasonably be expected to have an
access to unpublished price sensitive information in respect of
securities of that company or any other company and includes
any other person who has received or has had an access to such
unpublished price sensitive information. The regulation also
interprets that ‘a person’ means and includes (i) a natural person;
(ii) a body corporate; (iii) a HUF; (iv) a trustee and (v) a
partnership firm. Officers of a company who are generally the
persons having access to price sensitive unpublished
informations, means and includes (a) the managing director or
managing directors; (b) the whole time director or directors; (c)
the manager; (d) the secretary ; (e) any person in accordance
with whose directions or instructions the board of directors of
the company is accustomed to act; and (f) where any company
does not have any of the officers specified in clauses (a) to (e),
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any director or directors who may be specified by the board in
this behalf or where no director is so specified all the directors.
What is price sensitive information?
The regulation defines ‘unpublished price sensitive information’
as ‘any information which related to specific matters pertaining
to, or of concern directly or indirectly to a company and is not
generally known or published by such company for general
information, but which would if it were so published or generally
known to them, be likely to materially affect the price of
securities of that company or any other company in the market’.
The regulation gives an illustrative list to be of such information.
These are:
i) financial results (both half yearly and annual);
ii) declaration of dividends (both half yearly and annual);
iii) issue of shares by way of public, rights or bonus;
iv) any major expansion or execution of new projects;
v) amalgamation, mergers and take overs;
vi) disposal of the whole or substantially the whole of the
undertaking;
vii) policy and taxation changes of the Government prior to
announcement, and
viii)extraordinary events such as strikes, lock outs, fire in the
company, prohibition on dealings in securities,
How to prevent insider trading
According to Gower (Modern Company Law, p. 608) ‘general
equitable principle is, on its own, rarely an effective deterrent’.
Gower also pointed out that Stock Exchange regulation is not
directly binding on directors. SEBI regulation against insider
trading prohibited dealings of insiders in company securities.
It stipulates that no insider shall —-
(i) deal in securities of a company either in his own name or
on behalf of any other person, on the basis of any
unpublished price sensitive information; or
(ii) communicate such information to any other person with or
without his request for such information; or
(iii) counsel or procure any other person to deal in securities of
any company on the basis of information.
Any insider who violates the provisions of the regulation shall
be guilty of insider trading. SEBI may appoint one or more
competent persons as inspectors to investigate the insider trading.
These inspectors shall have the power to summon any person -
(a) to depose on oath any information concerning the allegation
of insider trading; and
(b) to produce any documents or books of accounts.
Failure to comply with the above requirement or giving false
information shall be punishable with a fine upto Rupees ten
thousand or imprisonment for a term which may extend to six
months or both.
Any person found to have indulged in insider trading shall be-
(a) liable to pay a civil penalty not exceeding three times of the
 profit gained or loss avoided as a result of the dealing ; or
(b) (i) punishable with rigorous imprisonment for a term not
exceeding 2 years or a fine not exceeding rupees five lakhs;
(ii) or with both.
In restricting insider trading it is necessary for the companies to
incorporate some of the provisions of the Companies Act in
England. These relate to (a) disclosure of dealings by directors
and their families. Directors are prohibited form buying put or
call options in the listed securities of the company or any other
company under the same group ; (b) disclosure by substantial
shareholders ; and (c) power of the Company to ascertain share
ownership. Ultimately England had to legislate the Insider
Dealing Act, 1985 by virtue of which insider trading has been
criminalised. In fact, the criminalisation of this act started from
USA. Gower also refers to the ‘Chinese Wall’ device invented
in USA primarily to protect multipurpose financial firms, against
liability for insider trading, by establishing arrangements
designed to prevent knowledge of price sensitive information
held by members of one branch of the business being passed on
to members of another branch and the firm itself being deemed
to have knowledge of it.
3.5 OTHER INSTITUTIONAL PROTECTION
(a) Listing: Listing means admission of securities of any
Company to be dealt with in a recognised Stock Exchange. The
term ‘securities’ has been defined under Sec. 2 of the Securities
Contract (Regulation) Act, 1956. It means and includes (a)
shares, scrips, stocks, bonds, debentures, debenture stock or
other marketable securities of a like nature in or any incorporated
company or any other body corporate ; (b) Government securities
; (c) such other instruments as may be declared by the Central
Government to be securities ; and (d) rights or interest in
securities. These securities can be listed in a recognised Stock
Exchange. A recognised Stock Exchange is a Stock Exchange
which is for the time being recognised by Central Government
under Sec.4 of the Securities Contract (Regulation) Act, 1956.
Types of Listing
Listing of securities is of 5 types. These are :
(i) Initial Listing — Initial Listing is made by companies of
securities not listed earlier by following procedure applicable
to initial listing. The company has to apply for listing its
securities in the prescribed form, alongwith a listing agreement
duly executed and stamped on a non-judicial stamp paper and
an application fee. A public company while applying for listing
its securities is also bound to submit alongwith the application
for listing and documents stated above, its memorandum of
association ; debenture trust deed, copy of prospectus or the
statement in lieu of prospectus; copies of offers for sale and
circulars for advertisement offering any securities during the
past 5 years; copies of balance sheet for the past 5 years; a
statement showing dividends and cash bounses; particulars of
shares and debentures issued; and shares forfeited; a list of ten
highest shareholders of each class or kind of securities; certified
copies of agreement between vendors and promoters,
underwriters and sub-underwriters, brokers and sub-brokers, and
selling agents, managing directors and technical directors etc;
and a brief history of the company since its incorporation.
(ii) Listing of public issues of shares and debentures — A
company whose shares are listed on a recognized Stock
Exchange has to submit necessary application to Stock Exchange
for listing of its securities before a public issue. However a
greenfield company may have to take all the steps of initial
listing.
(iii) Listing of rights issue — Companies whose securities are
already listed have to list shares and or debentures allotted by
way of rights.
(iv) Listing of bonus shares — Under the listing agreement
necessary application is to be made for official quotation of the
bonus shares.
(v) Listing of shares issued on amalgamation and merger
— Amalgamated companies which issue shares to the
shareholders of the amalgamating companies have to get their
shares listed on the Stock Exchange.
Conditions precedent for listing
The following conditions are generally imposed on companies
applying for listing of their securities. These are -
1) Minimum public offer - a company desiring to have its
securities listed has to offer atleast 60% of its listed securities
through the prospectus for public subscription [See Rule
19(2) of Securities Contracts (Regulation) Rules, 1957].
There has been a revision by relaxation of Rule 19(2)
recently for the Non-FERA companies, new companies with
foreign equity participation, joint sector companies, new
companies with NRI equity participation, and companies
promoted by one or more listed companies.
2) Minimum capital public offer and number of shareholders
— the company shall have a minimum issued capital of
Rs.3 crores and minimum public offer of equity of not less
than the limit stated earlier. It has also prescribed minimum
number of shareholders.
3) Cost of public issue — the cost of public issue has been
limited to 5% of the public issue upto Rs.5 crores and 2%
of the issue over Rs.5 crores.
4) Restrictions on transfers of shares belonging to promoters -
SEBI guidelines dated 11th June 1992 imposed a condition
of restrictions on transferability of shares issued in the
promoters quota for a stipulated period. A certificate in
this regard has to be furnished to the Stock Exchange.
5) Stock Exchange requirements relating to prospectus and
public issue — this has already been discussed earlier in
chapter 2.
Is Listing Compulsory?
According to Sec.73(i) of the Companies Act, it is obligatory
for public company intending to offer shares or debentures to
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the public, to make application to one or more recognised Stock
Exchanges for listing of its securities. The prospectus has to
contain details about the particulars of this application. Any
allotment made by a company whose application for listing has
been rejected within 10 weeks from the date of closing of
subscription list, is void in law & the application money has to
be returned.
Advantages of Listing
(i) Liquidity of investment by the investors is ensured.
(ii) Right entitlement can be disposed through the market.
(iii) Better loan facilities on listed securities.
(iv) Investors right is protected under the rules of Stock
Exchange.
(v) Better quality of disclosure through semi-annual financial
results.
(vi) Take over bids are required to be announced to the public.
(vii) Company gains national & international repute.
(viii) It helps the company in mobilising resources.
(ix) Tax concessions are available.
(b) Credit Rating:
The increase in the issue of Debt securities has led to a
proliferation of information. The investor does not have the time
or expertise to peruse the offer documents in order to determine
the safety of the offer. This gave rise to specialized companies
which studied the offer documents and gave an opinion on the
adequacy of the safety of the proposed debt instrument. This is
called as credit rating. Specialised companies make a credit
rating of a company after critically examining the financial
records of the company over a period of time. This type of credit
rating is based upon various criteria. There are several
managerial accounting methods including ratio accounting, to
ascertain financial strength of the company. This type of credit
rating initially started in USA according to the desire of
corporations. Presently, the credit rating is taken by most of the
public companies in the advanced world specially because it
shows credit worthiness and helps in building up a financial
stability and goodwill. Of course the standing of the credit rating
agencies help the public companies to build up a climate of
faith and trust by the investors. This credit rating is done
absolutely on voluntary basis and through disclosures. It must
be remembered that the public put faith on this certificate given
by professionals and therefore, any statement which is misleading
may be acted upon by the investors. In India, this type of credit
rating was started by Credit Rating Information Services of
India (CRISIL), an expert credit rating agency. Besides, big
investors take their help in ascertaining the credit rating of
companies with which they intend to establish relations by
supplying all required informations and financial statements.
But this type of credit rating is only privileged communication
and can not be used for public purposes unless the company
whose credit rating has been made gives its consent for public
disclosure of this credit rating. CRISIL employs for credit rating
both qualitative and quantitative criteria. The methodology
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includes analysis of the past performance and assessment of the
future prospects. Cash flow projections, working capital growth,
debt servicing obligation, chances of raising funds at the quickest
time etc.- these are taken into calculation. CRISIL looks as well
at the operating efficiency of the company, to sectoral
advantages, power and labour situations, nearest competitiors,
technology agreements and 'issues relating' to financial and
operational efficiency. At present, there is no legal regime in
India for dealing with problems and issues of credit rating.
c) Investment through Mutual Fund
Mutual Funds are institutions that collectively manage the funds
obtained from thousands of small investors. In the developed
countries, small investors cannot and do not indulge in
investment activities specially through share market. Capital
market has become famous for its notoriety in affecting the
investors interests. As such, big mutual funds and portfolio
managers manage the funds obtained from small investors. The
difference between mutual fund and portfolio management is
that, mutual funds invest in their own name in the securities of
public company. In exchange it issues shares, scrips or certificate
of the mutual fund to its investors. A small investor has the
protection against the capital loss because of superior
management and he has the assurance of return and capital
accretion. Besides the mutual fund’s stock, scrip or certificate
is also easily transferable. So, a small investor does not directly
invest in public companies. On the other hand, portfolio managers
represent the individual investor in designing the investment
pattern of his client. Portfolio managers therefore are essentially
agents. The relation between the investor and portfolio managers
is governed by the principles of Law of Agency, Mutual funds
have different proprietal interest — on the one hand it receives
the investable money from thousands of investors against its own
securities and on the other hand it buys securities of public
companies and public undertakings as the owner of those
securities. Many of these mutual funds are organised on the basis
of trust. A trust is generally created for the benefit of the investors.
A mutual fund can be formed by way of forming a company as
well. With a view to facilitate the development and orderly
functioning of the mutual funds in India, the Government of India
has issued the following guidelines:
I. Relating to establishment
(i) Excepting mutual funds established by statutes, all other
mutual funds require the approval of SEBI.
1A. All these mutual funds are to be constituted as trusts
under the Indian Trust Act, the sponsoring institution
will be free to work out the details regarding the
constitution of the trust.
11B. All mutual funds formed in whatever way shall be
required to register themselves with SEBI.
(ii) & (iii) .x x x x x x x x x
iv. The sponsoring institution must contribute atleast Rs.2
crores to the corpus of the mutual fund-
II. Relating to Management -
(i) Mutual funds are to be managed by professionals having
proper qualifications/experience of industry, capital market
or other relevant fields.
(ii) Atleast 40% of the trustees should be persons of eminence
in suitable fields and not associated with promoters.
III. Relating to investment objectives and policies —
(i) Mutual funds shall not encourage term lending, except in
case of consortium lending in associating with other
financial institutions.
(ii) It is expected to invest in stocks, bonds, securities and money
market instruments.
(iii) Money market instruments should normally be limited to
25% of the assets of the mutual fund for short term liquidity
requirement.
(iv) It should not invest in immovable property or undertake
any property dealings, but may subscribe to bonds and
debentures issued by institutions dealing in housing finance.
(v) Only foreign mutual funds located abroad may enter into
agency agreement with any foreign institution for a fund
activity to be carried out in India, but only with the prior
approval of RBI.
IV. Regarding investment limitation
(i) It shall not invest more than 5% of its assets in the shares of
any company.
(ii) It shall not invest in more than 5% of the shares of any
company under any one scheme.
(iii) The scrips purchased shall be registered in the funds name.
(iv) It shall not borrow money or pledge assets in the normal
course. If it is compelled to do so in an emergency situation,
it must be reported to the SEBI.
(v) It shall not normally keep deposits with companies.
(vi) It shall not normally invest in another mutual fund.
V. Regarding disclosure, pricing and valuation
(i) Each scheme should clearly disclose the investment
objectives.
(ii) The maximum spread between purchase and sale price of
units/shares of the scheme shall not exceed 7%.
(iii) The valuation method of investment should be announced
before hand. The time lag between successive valuations
should not exceed 6 months.
VI. Regarding distribution policy
(i) Depreciation on investment held and provision for bad and
doubtful debts should be adequately provided.
(ii) A dividend equilisation fund has to be created in order to
avoid sharp annual variations in dividends.
(iii) Mutual fund must distribute 90% or more of income earned
as dividends
VII. Regarding settlement of accounts
(i) Each scheme shall have separate accounts.
(ii) Each scheme must have separate statement of accounts
showing assets and liabilities, income and expenditure.
(iii) Affairs of the mutual fund shall be audited.
(iv) Accounting and disclosure requirements shall be prescribed
by SEBI.
(v) Disclosure guidelines issued by the government relating to
institutional transactions in shares shall be applicable to
mutual funds.
Guidelines has also been given on development and regulation
of Mutual Funds in order to develop and regulate Mutual Funds
for ensuring investors interest.
(d) Portfolio Management
The role of portfolio management and mutual fund has already
been discussed above. It has already been stated that portfolio
manager performs specialized agency functions, to properly
deploy the clients money maximally beneficial to him, which
includes decisions on buying and selling of shares, scrips and
securities at the most appropriate time in the open market. A
regulation has been made by SEBI on portfolio managers. The
regulation can be summarised as follows:
(i) On Portfolio Management- Merchant bankers of category
I & II are authorised to render portfolio management
services. The contract between the portfolio manager and
the client shall define the exact relationship including inter
alia the investment objectives; area of investments and
restrictions imposed. The portfolio management shall be
in the nature of investment consultancy and management.
The contract shall also deal with the procedure of settling
the clients accounts.
(ii) Client relationship - The relationship is fiduciary in
character. As such the portfolio manager acts both as an
agent and a trustee. He takes decisions as a man of prudence
who take decisions in regard to his own funds. He takes
instructions from his client and shall not deal on any security
on the basis of price sensitive classified information. He
shall observe a high standard of integrity and fair dealing.
He shall keep clients fund separate from his own funds.
Portfolio managers shall not pledge, or give on loan or
otherwise, securities held on behalf of clients to a third
person.
(iii) Investment tenure — The tenure shall not be less than a
period of 1 year. Any renewal shall be deemed to be a fresh
placement and shall again be deemed to be for a minimum
period of 1 year.
(iv) Investment of clients funds — This shall be made in
money market and capital market instruments. But the
funds must not be deployed in bill discounting, ‘badla’
financing or lending. Appropriate records must be
maintained. The portfolio manager shall not indulge in
speculative activities. Purchase and sale of securities must
be kept separate for each client. He shall ensure best
execution of clients’ deal, and avoid any conflict of interest.
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 Wherever necessary he shall take adequate steps for
registration of clients securities and for claiming and
receiving dividends, interest payments and other rights
accruing to the investors.
(v) Periodical reports — The contract shall include provisions
for submission of periodical reports to the clients, but not
exceeding a gap of 6 months between two reports. The
report shall comprise composition and value of portfolio ;
transactions undertaken during the period ; beneficial
interest received including bonus and rights and expenses
incurred. At the end of the period the portfolio manager
has to give a termination report settling the accounts. The
client shall have the right to inspect the books of accounts.
The books of accounts and other records shall be audited
yearly by an external auditor.
(vi) SEBI’s regulatory power — The portfolio manager shall
submit to SEBI such reports, returns and documents as has
been prescribed or called for SEBI may investigate the
affairs and contracts of the portfolio manager, and in the
event of violation of any provision suspend the portfolio
manager and cancel his regulation.
3.6 PROTECTION OF MINORITY INTEREST
Any memmber of a company who complains that the affairs of
a company are being conducted in a manner oppressive to any
member or members, may apply to the court for an order :
1. under Sec.397 for the redressal, or
2. under Sec.433 (f) for winding up of the company on just and
equitable grounds.
Under Sec.397 of the Companies Act, court may make such order
as it thinks fit with a view to bringing the oppression to an end.
Of course in order to make such an order the court has to come to
an opinion that -
(a) there is oppression to any member(s) ;
(b) that the winding up of the company would unfairly prejudice
such members though on the ground of just and equitable
principle, the company should be wound-up.
Who can apply under Sec. 397?
The right to apply is given to 100 or more members or 1/10th
the total number of members or any member(s) holding not
less than 1/10th of the issued capital of the company. Any
member(s) having obtained in writing the consent of the
requisite number of members may apply. Of course the right to
apply is not confined to an oppressed minority of shareholders
alone as under Sec.397, an oppressed majority may also apply.
It is also not necessary that the applicant has to suffer personal
prejudice. Bombay High Court in Killick Nixon Ltd v. Bank
of India [1982 Tax L.R 257] held that, no personal prejudice
need be caused to a member who applies for relief under this
section. The only cause of action which is required to be proved
is that the affairs of the company are conducted in a manner
oppressive to any member or members. Where after the
applicant having obtained the requisite number of consents
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institutes the proceedings, and later on some of the members
withdraw their consent, the right of the applicant to proceed with
the application before the court of law cannot be affected. In
Rajahmundry Electric Supply Corp. v. Nageshwara Rao
[AIR 1956 SC 213] the court held that ‘the validity of the
application must be judged on the facts as they were at the time
of presentation of application.
Requirements for an application U/Sec.397
In Shanti Prasad Jain v. Kalinga Tubes Ltd [(1965) 35
Comp.Cas 351] the Supreme Court after reviewing the leading
authorities has expressed the position thus: “it is not enough to
show that there is a just and equitable cause for winding up of
the company, though that must be shown as a preliminary to the
application of Sec.397. It must further be shown that the conduct
of the majority shareholders was oppressive to the minority as
members and this requires that events have to be considered not
in isolation but as a part of a consecutive story. There must be
continuous acts on the part of the majority shareholders
continuing upto the date of petition, showing that the affairs of
the company were being conducted in a manner oppressive to
some part of the members. The conduct must be burdensome,
harsh and wrongful, and mere lack of confidence between the
majority shareholders and the minority shareholders would not
be enough unless the lack of confidence springs from oppression
of a minority by a majority in the management of the company’s
affairs and such oppression must involve atleast an element of
lack of probity or fair dealing to a member in the matter of his
proprietary rights as a shareholder”.
The position has been made very clear in this case. “A conduct
which lacks in probity, a conduct which is unfair to and which
causes prejudice to the petitioner in the exercise of his legal and
proprietary rights as a shareholder” must be shown to exist. [See
Needle Industries India Ltd v. Needle Industries (Newly)
India Holding Ltd. [(1981) 51 Comp. Cas 743].
Meaning of the word “oppression”
Lord Keith understood the word ‘oppression’ as ‘a lack of
probity and fair dealing in the affairs of the company to the
prejudice of some portion of its members’. Lord Denning meant
‘oppression’ in a more wider way. According to him, “the affairs
of a company can in my opinion be conducted oppressively by
the directors doing nothing to defend its interests when they
ought to do something just as they can conduct its affairs
oppressively by doing something injurious to its interests when
they ought not to do it”. In Needle Industries India Ltd’s case
it was held as an obiter that unwise, inefficient or careless conduct
of a director in the performance of his duty cannot give rise to a
claim for relief under this section.
Oppression may take different forms, as for example, it may be
merely vindictive [See In re H.R. Hammer Ltd. (1958) 3 All
E.R. 689]; denial of rights [See In re Hindustan Cooperative
insurance society AIR 1961 Cal 443]; or exercise of force to
oust from power [See Ram Shankar Prasad v, Sindri Iron
Foundry Pvt. Ltd (1961)1 Comp. L.J. 310]}
One single unlawful act may not necessarily by itself create
oppression, but a series of illegal acts may constitute one. In Re
Five Minute Car Wash Service Ltd [(1966)1 All ER 242] it
was held that “unwise inefficient and careless in the performance
in his duties (duties of the Directors) do not make out a case of
oppressive conduct within the meaning of the section and a
petition limited to such allegations will be dismissed in limine”.
A conduct becomes oppressive if it is (i) continuous ; (ii)
burdensome, harsh and wrongful, and (iii) lack of probity and
fair dealing. These tests envisaged in Kalinga Tubes by the
Supreme Court of India, have been referred earlier. In Re
Hindustan Co-operative Insurance Society (AIR 1961 Cal
443) the directors of the company having the backing of the
majority shareholders did not call any general meeting of the
company, nor did they place the annual accounts before the
shareholders for the year ending 31.12.1955. Besides 1/3rd of
the directors required to retire by rotation did not do so and
continued wrongfully. It was held that such was the situation
required to be dealt with Ss.397 and 402. Similarly in
Gajarabar v. Patny Transport [AIR 1966 AP 226] two of the
three directors of the board withheld transfer of shares of one
party to the petition due to their personal disputes and
vindictiveness. It was held to be oppressive.
Court’s power to give order:
Under Sec. 397 the court may give any order as it may think fit.
Sec. 402 however has provided a list of order that the court may
give in this situation. These are not exhaustive but indicative of
the nature of order that the court may give. The court under the
order may provide for :
(a) the regulation of the conduct of the company’s affairs in
future ;
(b) the pruchase of the shares or interests of any member of the
company or by other members thereof or by the company;
(c) the reduction of the company’s capital where the company
purchases any such shares ;
(d) the termination, setting aside or modification of any
agreement howsoever arrived at, between the company and
its manager, managing director or any of its other directors;
(e) the termination, setting aside or modification of any
agreement between the company and any other person other
than referred to in (d) after due notice to the concerned
parties and in case of modification with the consent;
(f) the setting aside of any transfer, delivery of goods, payment,
execution or other act relating to property made or done by
or against the company within three months before the date
of application which would, if made, in an insolvency
proceedings, make a fraudulent preference;
(g) any other matter which, according to the court will be just
and equitable.
The court may also make an order altering in or adding to it. In
such a case, the company in question shall not be entitled without
the leave of the court, to make any further alteration in or
addition to the Memorandum or the Articles, as may be
concerned, which is inconsistent with the order. The alterations
or additions made thus by an order shall have the same effect as
if they were duly made by a resolution of the company.
A copy of the order is to be delivered by the company to the
Registrar for registration within 30 days from the date of the
order failing which a fine upto Rupees five thousand can be
imposed on the company and its defaulting officials.
Central Government’s power to prevent oppression
In addition to the court’s power to provide remedies against
oppression, the Central Government has also the power to
achieve the same object through different process. According
to Sec. 408 if at least 100 members or members holding 1/10th
of the total voting power apply to the Central Government on
the plea of oppression, or of its own motion the Central
Government is satisfied after an inquiry that instances of
oppression are present, it may :
(i) appoint such number of persons either from its members or
as it may think necessary, to hold office as directors of the
company for such period not exceeding three years on any
occassion; or
(ii) direct the company to make fresh appointment of directors
within such time as it may specify on the basis of
proportional representation provided in Sec. 265; and
(iii) until such appointment is made, specified persons shall hold
office as additional directors of the company;
Any such person appointed need not hold qualification
shares and are removable only by the Central Government;
and/or
(iv) issue such directions to the company as it may consider
necessary or appropriate in regard to its affairs; and
(v) direct submission of report to it from time to time.
The Central Government may also prevent a change in the board
of directors under Sec. 409 if such a change is likely to affect
the company prejudicially, on an application by the Managing
director or any other director or the manager of the company.
On such an application the Central Government shall have power
to make an interim order as well.
Under Sec. 388 B the Central Government has also the power
to refer to the High Court if there are circumstances to show
that the business of the company is or has been conducted and
managed in order to defraud members (majority or minority).
Sec. 388 B has specified several other grounds for referring to
the High Court against managerial personnel. Based on the
decision of the High Court, the Central Government shall remove
the director from his office or any other person from management
against whom there is a decision of the High Court.
3.7 PROTECTION AGAINST TAKE OVER
Easy transferability of shares is one of the basic characteristics
of public limited companies. The management and ownership
of the company therefore depends upon either corporate action
or shareholders transfering their shares through sale in the open
market. In open market purchases a party may gain controlling
shares of a company and take over its management. The word
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‘take over’ has been used in two senses in the Companies Act,
1956. In Sec. 108A, ‘take-over’ is used as bids by groups or
companies to take over control and/or management and/or
ownership of a company. In this sense take over is prejudicial to
the interest of promotional and managerial group and also of
non-controlling shareholders like public financial institutions.
A recent incident that generated debate related to the ‘take over’
bid of the Reliance group in Larsen & Toubro. The financial
institutions took the fight to maintain the professional
management structure of Larsen & Toubro. The second meaning
of ‘take over’ is taken from the spirit of Sec 395. According to
Sec. 395 majority shareholders may in certain situation ‘take
over’ the shareholding from the minority shareholders.
The main purpose of restricting 'take-over' through direct and
open market purchase of shares was prevention of monopoly
holding. But with the amendment of Monopolies and Restrictive
Trade Practice Act recently, prevention or regulation of take
over bids must have other objects. The previous Chairman of
SEBI while arguing for RBI norms for prevention of take-over
bids in private banks to be extended to the whole corporate sector
under-lined the purpose of such regulation. According to him
with the arrival of number of foreign institutional investors (FIIs)
a number of technically strong companies would face the real
threat of take over. Due protection to the management of these
strong companies, is needed against hostile or predatory
takeover. The fear of takeover has become a real threat to well
managed and comparatively small Indian industries. Two basic
questions therefore, come to terms. Firstly the efficient
management may ask for protection against ‘take over’ for short
term gains that may destroy an efficient organisation. Secondly,
the opposite question is why the law shall bring in regulation
and control over the free sale and transfer of shares? Indian
Companies Act, has so far, maintained mostly the anti-monopoly
holding to be the main objective of regulating takeover bids.
Sec. 108A which is inserted in the Companies Act by the
Amendment Act of 1974 provides that no individual, group,
firm body corporate or body corporates under the same
management can acquire more than 25% of the paid up equity
share capital of a company, unless previous approval of the
Central Government is obtained. The contravention of this
principle is a penal offence attracting imprisonment upto 3 years
or with fine upto five thousand. Government through circulars
clarified many of the issues. As for example : (1) Company or
group already holding 25% or more shares before the provision
is included in the Companies Act, is not required to seek
permission to continue to hold the same. (2) Such a company
acquiring further shares is required to take permission ; (3) Any
share transfer, within the group already holding 25% shares or
more, also requires approval; (4) No approval is necessary on
right share issue unless the right share is renounced in favour of
a person whose holding increases to the limit of 25% or more,
in which case permission is to be obtained.
The object of Sec. 108B is to prevent the change of management
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of a company which is prejudicial to the interest of the company
or to the public interest. In order to do this, Sec. 108B provides:
(1) Every body corporate or body corporates under the same
management singly or jointly holding 10% or more
subscribed equity share of a company has to inform the
Central Government before transfering any share or shares
specifying shares proposed to be transfered, shareholding
of the transferee and other particulars;
(2) Where such transfer is prejudicial as stated earlier the
Central Government may direct that no such shares shall be
transferred to the proposed transferee.
(3) If shares are transferred in contravention, every officer
responsible may be punished with imprisonment upto 3
years and the company shall be punishable with fine upto
five thousand.
In England, a Panel on Take Over and Mergers was constituted
at the request of the Bank of England. This panel overseas the
City Code which according to Lord Denning was ‘a guide to
good commercial practice’. The Code consisted of general
principles and Rules, that concerned the provision of ‘adequate
and timely information to the shareholders and the general
responsibilities of the boards of both the offeror and offeree
companies’. Shareholders must be in possession of all the facts
and information so that they are in a position to evaluate merits
and demerits of an offer. They must also have sufficient time
‘to make an assessment and decision’. It must be the object of
both the parties ‘ to use every endeavour to prevent the creation
of a false market in shares of either the offeror or the offeree
company’. 42 Rules in the Code are concerned about the
disclosure of identity of the parties; stages of the transactions,
consideration of the offer, documents and supporting
instruments, dealings etc. Since in India such a detailed self
regulatory prescriptions and a body overseeing the commercial
practices are absent, the RBI guidelines on take overs in banking
industries may need to be extended to all companies. A fair
trading and competition requires ‘take over bids’ to be regulated
and prevented because in most of the ‘take over bids’ there is
asymetry of informations and unreasonable commercial
advantages. Management of sound companies can be dislodged.
Sec. 108D of the Companies Act empowers the Central
Government to direct a company not to effect transfer where
the Central Government is satisfied that as a result of the transfer
of shares :
(a) a change in the controlling interest of the company is likely
to take place and that
(b) such a change is prejudicial to the interest of the company
or to the public interest.
On shares already transfered and registered, the Central
Government may direct the company not to permit the transferee
or any nominee or proxy to exercise any vote or exercise other
rights attached to such shares.
The other form of ‘take over’ specially provided for in Sec.
395 is the right of the majority shareholders to purchase the
shares of the minority in a given situation. Whereas in the
earlier prescription ‘take over’ is meant as a ‘coup’ and is
prevented on special grounds, in Sec. 395 such a take over of the
minority interest is specially provided for. According to Sec.
395 if under a scheme or contract a company is required to acquire
shares or any class of shares which is approved by at least 90%
of the shareholders of the transferor company, the transferee
company may by giving a two month’s notice to the dissenting
minority shareholders, shall be entitled and bound to acquire those
shares unless the court orders otherwise. Generally speaking in
amalgamation or absorbtion such a scheme is made to acquire
the shares of the transferor company or companies. At this stage
if at least 90% of the share holders agree to the proposal within
4 moths of proposing such scheme or contract, the transferee
company gets the special right to acquire the minority interests.
In amalgamation, two or more companies make resolutions to
merge into one to enjoy better economy of scale. Amalgamation
is merger of two or more companies, forming into a new
company by dissolving the earlier companies. Based upon the
agreements the shareholders of various companies receive
consideration in the form of shares of the new company. In
absorption one company purchases another company through
an agreement of ‘sale’ of the growing concern. The buying
company may by acquiring shares through the Stock Exchange
takeover the management of the absorbed company. Or the
absorbed company may sell itself to the absorbing company
through an agreement. In all such cases if a minority
shareholding class holding not more than 10% shares stand in
the way of this amalgamation or absorption, the majority shall
have the power to buy the shares of the minority insuch terms
and conditions as may be determined by the management. The
same may be prevented if such an action can be successfully
argued on the basis of ‘fraud on the minority’. As for example,
suppose a company has three interest groups viz, groups A B &
C. Suppose Group C held 10% interest. A and B can form another
company and the management of the company A B & C,
obviously regulated by AB may dispose the company to A & B
company, compelling C to sell its shares to A & B company.
This can be a fraud on the minority as ‘C’ has been asked to sell
the shares through a legal mechanism. In re Bugle Press Ltd.
[(1960)3 All.E.R 791 (C.A)] it was held that the court will see
that the scheme is not a mere device to enable the majority
holders to expropriate the minority, unless the article so provided.
In case where legal mechanism is applied to defraud the minority
or oppress the minority may bring an action for winding up of
the company on ‘Just and equitable’ ground.
According to Sec. 395 the ‘power’ and ‘duty’ to acquire shares
of dissenting shareholders arises when a scheme or contract
approved by majority which the minority shareholders do not
agree upon, on the following conditions :
(a) a scheme or contract involving transfer of shares or any class
of shares, has within four months after making of the offer
by the transferee company, been approved by the holders of
not less than nine-tenth in value of the shares of the transferor
company ;
(b) a notice has been given by the transferee company within
two months after the expiry of the said four months
specifying a desire to acquire the shares ;
(c) terms to all holders of the shares of that class are same ; and
(d) holders of the nine-tenth value of the shares or class of shares
are not less than 3/4th in number of the total holders of
those shares.
In the above situation the transferee company shall be entitled
and bound to acquire those shares. Of course a dissenting
member can make an application to the court within one month
from the date on which the notice is given and the court on such
an application may think fit to order otherwise. Of course in
calculating nine-tenth of the value of the shares, has already
held by the nomince for the transferee company or by the
transferee company shall not be taken into consideration.
The following provisions are applicable in relation to every offer
of a scheme or contract under Sec. 395:
(i) the offer must contain all information as may be prescribed;
(ii) a statement disclosing the steps to be taken or has been
taken to raise necessary cash will be made available;
(iii) acceptance to the offer must be presented to the Registrar
for registration and no circular containing or recommending
acceptance shall be issued until it is registered;
(iv) for inadequate information the registration may be refused;
and
(v) an appeal shall lie to the court against such refusal.
Valuation of such shares must be based upon certain principles.
If the transaction appears to be unjust, or unfair or
unconscionable or if the court is satisfied that the sanction of
the majority has been obtained by fraud or by improper means
the court will not make an order in favour of the transferee [See
Viswanathan v. East India Distilleries and Sugar Factories
Ltd (1957)27 Comp. Cases 175]. Since the terms must be
similar to all holders, the test of responsibility and fairness shall
depend upon whether it is fair to the shareholders as a whole.
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4. RAISING OF SHARE CAPITAL
SUB TOPICS
4.1 Types of Share Capital
4.2 Issue of Preference Shares
4.3 Frame-work for raising Capital: Law at a glance
4.4 Share issue, allotment, calls, forfeiture & re-issue
4.5 Commission and Brokerage
4.6 Regulation on purchase of own shares
4.1 TYPES OF SHARE CAPITAL
A Company limited by Share or limited by guarantee but having
a share capital is registered with a capital stipulated in the
Memorandum of Association. This sets the limit of the capital
that the company can raise from the public. This capital is known
as Authorised Capital or Registered Capital or nominal capital.
Share actually issued to the public for subscription determines
the issued capital. Obviously, the issued capital cannot exceed
the authorised capital. Out of the issued shares, shares actually
subscribed, by the shareholders determine the subscribed capital.
Subscribed capital may be either equal to the issued capital or
may be less. Money actually called up and paid up for each
share subscribed by the shareholders constitute the called up
and paid up capital. According to Schedule VI, Part I, the
Balance Sheet of a company has to divulge its various stages of
share capital, viz, authorised, issued, subscribed, called up and
paid up capital. Actually called up and paid up capital is the
share capital of the company. Other stages of share capital are
only for information. According to Sec. 148 where any notice,
advertisement or official publication of a company contains
authorised capital of the company, the document must also
contain information about the subscribed capital of the company.
Non compliance of this provision may entail a fine of Rupees
One thousand for every responsible officer of the company. Thus
the logic of corporate responsibility due to representative action
cannot be extended. Or in other words, the law has cracked the
corporate shell to fix up individual liability.
In India, a public limited company having a share capital
and a private limited company which is a subsidiary of a public
limited company can issue only two types of shares (Sec.86).
As such a company may have
(a) Equity share capital, and
(b) Preference share capital.
According to Sec. 85(2) equity share capital means all share
capital which is not preference share capital. A preference share
capital means, according to Sec.85(1) capital fulfilling the
following conditions:
i) that in respect of dividends, carry preferential right to be
paid at a fixed rate; and
ii) that in respect of the return of capital, in the event of winding
up of the company, a preferential right over the equity share
capital.
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Of course if a company registered before 1956 issued more than
two types of shares, the arrangement shall not be affected due
to the prescription of two types of shares under Sec. 86.
Presently, a debate has come to surface on the rationality of
restricting companies from issuing more than two types of shares.
In many countries company may issue deferred ordinary shares
with more voting rights. It is not understood as to why the
managerial promoters may not be allowed to float such shares
in order to protect themselves from the danger of over throwing
from the management by various take over bids under cover.
It is argued that companies must be free to issue any kind of
shares with disproportionate voting rights if the companies so
choose. Professional management groups can be encouraged to
be associated with company promotion and management with
such types of shares with disporoportionate voting rights. One
of the argument against such 'disproportionate voting right shares'
is that a small group may be allowed to monopolise its power
through this technique and have control over a large size of
public shareholders. This goes against the corporate democracy.
As against this argument, the counter-argument given is that
shareholders seldom, invest for participating in the democracy.
They invest to get better return. So long management can give
them adequate profit they are satisfed. Shares with
disproportionate voting rights like defered ordinary shares
ensures continuity of able management and makes take over
bids under cover impossible.
4.2 ISSUE OF PREFERENCE SHARES
Preference shares are, therefore, those where the holders have a
preferential rights to a fixed dividend and a preferential right on
the return of capital in the event of winding up against the equity
shareholders (see Sec. 85). The preferential shares may be
cumulative or non-cumulative. A cumulative preference
shareholder has a preferential right to be paid any arrears of
dividend due on shares for a number of years. As for example, a
cumulative share paying a dividend of 10 percent shall have to
be given 20 percent at the end of the second year if the company
could not give 10% at the end of the first year. It means that the
dividend cumulates over the period if it can not be paid every
year. A non cumulative share is one where the preference
shareholder cannot demand the arrears of dividend. In other
words, if in a year dividend cannot be paid for inadequate
income, the holder cannot demand the fixed rate of dividend
for that year in the next year when there may be sufficient income
of the company.
Preference share can be participatory or non-participatory. A
participatory preference share is one where the holder has a
right to share in surplus profits by way of additional dividend
(see Sec. 85 Explanation 1). As for example, if the preference
shareholder is given the right to share on the profit initially say
preferred dividend of 10% and then on profits in excess of
available after payment of 10% dividend to both preference and Sec. 77 :
Restriction to purchase of own shares
equity shareholders, such preference shares are known as Sec. 78 :
Share issued at a premium
participatory. A participatory shares has a right to share excess
Sec. 79 :
Share issued at a discount
amount available after paying all liabilities, with the equity
shareholders in the event of winding up. A non participatory Sec. 80 :
Power to issue redeemable preference shares
share does not have such rights. These rights are specified in Sec. 81 :
Further issue share forfeiture and reissue
the constitutional documents like Memorandum and Articles. Sec. 85 :
Kinds of share capital
These are also stated in the offer documents. If so authorised by
Sec. 86 :
Only two kinds of share capital
the articles, a company may issue redeemable preference shares
which means the company can pay off this preference Sec. 91 :
Calls
shareholders and take over those shares for cancellation. But it Sec. 92 :
Uncalled amount when acceptable
must be remembered that a preference shareholder is a Sec. 94 :
Alteration of share capital
shareholder and cannot claim a position of a creditor. "Preference Sec. 94A :
Stand altered
shareholders cannot sue for the money due on the shares
undertaken to be redeemed, and cannot, as a right, claim return Sec. 95 :
Notice to Registrar for consolidation or conversion
of their share money except in winding up" (Ramaiya, p. 228). of shares
Sec. 100 : Reduction of Share Capital Cancellation of
Specific issues to be noted in redeemable preference shares
unissued share.
One of the basic principles in capital formation is that capital
once formed cannot be reduced. Preference share capital is a 4.4 SHARE ISSUE, ALLOTMENT, CALLS,
part of the capital. Therefore, the redemption of preference share FORFEITURE & REISSUE
can be made possible only by repairing the deficiency in the
capital structure with: (a) Share Issue
(a) capitalisation of profit otherwise available for dividend by Under the Companies Act, a company is not deemed to have a
transferring the profit to the capital redemption fund; or share capital. In case a company has a share capital either limited
by share or guarantee, the company has to issue shares privately
(b) the fresh issue of shares which must take the place of the
or publicly or to the existing members themselves. We have
redeemed capital. (See for details Sec. 80).
already seen that a company cannot issue shares to the public
Profits which are otherwise available for dividend, are to be without issuing a prospectus. In case a public limited company
transferred to a capital redemption fund which shall form part having a share capital or a private limited company subsidiary
of the capital. Such fund can be used for issue of bonus shares to a public limited company, issue shares to private parties, a
to the existing shareholders prorata. This is known as statement in lieu of prospectus is necessary to be issued and
capitalisation of profit. As such the existing shareholders shall registered.
be receiving bonus shares instead of dividends. Preference
The said company has to issue share only by issuing a prospectus
shares may be redeemed at a premium. Premium payable in
or a statement in lieu of prospectus. In evey public issue the
redemption is a loss which must be provided from (1) profit of
company proposes the amount of the issue through the
the company or (2) share premium account or (3) both. If the
prospectus. An issued capital is one, as already stated, which is
preference shares in question were issued at a discount (under
offered to the public for subscription.
Sec. 79) the loss on the issue further rise with equal amount.
The loss on issue and on redemption, is required to be written (b) Allotment
off out of the profit and/or share premium account if any. Allotment is acceptance of offer to purchase a share/debenture
Redemption of preference shares should not be confused with expressed formally through an application for a share/debenture.
purchase of own shares. This we shall discuss later with some Allotment is agreement to issue a share/debenture generally
detail. communicated through a letter. Allotment is not defined in the
Companies Act. In Re Calcutta Stock Exchange Association
4.3 FRAMEWORK FOR RAISING CAPITAL: LAW AT Ltd [(1957) 27 Comp. Cases 559 (Cal)], the Calcutta High Court
A GLANCE explained allotment as "division of the share capital into definite
Sec. 60 : Registration of prospectus shares of a particular value, and assignment of such shares to
Sec. 72 : Application for and allotment of shares different persons". Some of the baisc rules of allotment are
explained below:
Sec. 69 : Prohibition of allotment if minimum subscription
not received (i) No allotment without application: According to Sec. 56(2)
no one shall issue any form of application for shares in or
Sec. 71 : Effect of irregular allotment debentures of a company, unless the form is accompanied
Sec. 75 : Return of allotment by a prospectus. It means that a formal application is needed
Sec. 76 : Power to pay Commission for applying a share. Besides as per Sec. 41(2) a person
becomes a member of a company if he agrees to become

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 the member (shareholder) in writing. This means that
allotment of shares/debentures cannot be made without a
formal application. The view given in Sree Ayyanar
Spinning & Weaving Mills Ltd v. V.V.V. Rajendran
[(1973) 43 Comp. Cases 225 (Mad)] is erroneous because
in this case Justice Ramanujam has expressed the view that
the Companies Act 1956 nowhere provided a written
application for the allotment of shares. It seems that the
judge did not take Sec. 41 (2) of the Companies Act into
consideration. In India, an oral offer to purchase shares/
debentures of a company does not have any value and
allotment cannot be made on oral offer.
(ii) No allotment unless minimum subscription raised: The
prospectus contains the statement of minimum subscription
that the company has to receive before it can allot shares.
'Minimum subscription' is the minimum amount that must
be raised to carry on the programme for which shares are
issued. If this suggested minimum subscription is not raised,
shares cannot be allotted. According to Sec. 69(1) no
allotment shall be made of any share capital of a company
offered to the public for subscription, unless the amount
stated in the prospectus as the minimum amount which, in
the opinion of the Board of Directors, mus be raised by the
issue of share capital in order to provide for the matters
specified in clause 5 of Schedule II has been subscribed,
and the sum payable on the company, whether in cash or by
a cheque or other instrument which has been paid.
(iii) No allotment unless statement in lieu of prospectus
delivered: A public company having a share capital may
not issue shares to the public. Such company may issue
shares on private placement. But it cannot allot shares or
debentures unless there has been delivered to the Registrar
for registration a statement in lieu of prospectus (See for
details Sec. 70).
(iv) Minimum time to proceed with allotment: No proceedings
can be taken on the application for shares or debentures in
order to allot shares or debentures as the case may be, until
the beginning of the fifth day after that on which the
prospectus is first so issued or such later time as may be
specified in the prospectus. When a prospectus is first issued,
generally a public notice is given by the person responsible
under Sec. 62 limiting his liability. Allotment cannot be
made until beginning of the fifth day after that on which
such public notice is given (See Sec. 72). This provision
require four clear days to the public for responding upon
the prospectus. Such minimum time is provided for in order
to check close holding on a public issue. Public in general
must be given sufficient opportunity to apply for the shares.
Irregular allotment and consequences
An allotment in contravention of any of the above requirements
shall make the allotment irregular. But all irregular allotments
do not follow with same consequence. It is therefore necessary
to understand the nature of irregular allotments to decide about
the fate of the allotment.
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(i) Irregular allotment on account of minimum subscription
being not raised before allotment of shares or where filing
of a statement in lieu of prospectus is necessary but not done
before allotment is made (irregular allotment under Sec. 69
and 70), the contract is voidable at the option of the
shareholder within two months after the holding of the
statutory meeting or where company is required to hold a
statutory meeting or allotment is made after holding the
statutory meeting, within two months from the date of
allotment (See Sec. 71). Now suppose the company goes
into winding up proceeding during this two months period
the contract remains voidable even during the course of
winding up. Besides, directors of the company who have
knowingly or wilfully contravene the provision by irregular
allotment are civilly liable to compensate the company and
the allottee any loss that may have been sustained.
(ii) Allotment to a person who has not applied for the shares or
debentures, is ab initio void because under Sec. 41(2) of
the Company's Act, a written agreement is necessary. Of
course in Sree Ayyanar Spinning and Weaving Mills Ltd
(cited earlier) Madras High Court has given an opposite
opinion but the statutory provision is clear requiring a written
application under Sec. 56(2) and a written contract under
Sec. 41(2). Of course it may still be agreed that Sec.56 has
not clearly indicated that application cannot be made
otherwise than applying through the 'application form' as
provided in Sec. 56(2). Similarly a written agreement may
not necessarily involve a written offer. Sec. 41(2) only
requires a written agreement. It has not mentioned about
written offer. An oral offer and acceptance written thereafter
into a document of agreement or memorandum of
understanding 'MOU' is a written agreement. Such type of
argument is unfounded because positive interpretation of
communication of prospectus in the application form itself
underlines that one cannot apply for shares and debentures
in any manner. It has to be only processed through an
application form.
(iii) Where the allotment is irregular because it is made within
five days after the prospectus is issued, the allotment is valid
but penal. Every officer of the company working in default
shall be punishable with fine upto five thousand rupees [Sec.
72(2)]. Jurisprudentially the argument seems to be a difficult
proposition to accept. An act which is penal cannot prouduce
a valid result. This is the fundamental basic proposition of
criminalization. In response to such an observation one may
argue that in so far as the agreement between the allotee
and the company is concerned, the agreement is perfectly
valid because there is no violation of contractual term. It is
in the interest of a third party (public in general) that the
prescription is made. As such, it is a statutory norm violation
inside the management of the company for which a penalty
is imposed on defaulting officials.
(iv) Allotment to be void in case of default in listing
requirement: Where a prospectus stipulated that application
has been made or will be made for listing of shares in one
 or more recognised stock exchanges, the prospectus must
contain the name or names of such recognised Stock
Exchange/s to which application has either been made or
shall be made. If permission has been refused before the
expiry of ten weeks from the date of the closing of the
subscription list the allotment becomes void (Sec. 73). If an
appeal is made under Sec. 22 of the Securities Contract
(Regulation) Act, 1956 against the refusal of the provision,
the allotment shall not be void until the appeal is disposed
of.
Where the application for permission under Sec. 73 is not made
or if made, refused by the concerned Stock Exchange, the
company shall forthwith repay the application money received
from the public. If such money is not paid within 8 days after
the company becomes liable to pay, the directors of the company
shall be jointly and severally liable to pay the amount with 12%
interest per annum. If permission is not granted within 10 weeks,
action shall be taken on the assumption that the permission is
not granted for the purpose of Sec. 73. Default under this section
attracts punishment to evey officer responsible for the default.
The punishment is fine extendable upto five thousand rupees.
But if the default continues over a period of six months it may
involve imprisonment upto one year. Sec. 73 is a complete code
on the issue and the readers are advised to read this section
critically.
Allotment of share in case of over-subscription
When total number of shares/debentures applied for is higher
than the number of shares/debentures offered to the public, it is
known as over-subscription. In such a case public policy
demands promotion of interest of the small investors and
ensuring widest possible dispersal of shareholding. That
prompted the Government to issue a circular (No. F1/25/SE/78
dated 26.7.78) asking the recognised Stock exchanges to settle
the matter for the listing of shares in the following manner:
(a) The allotment is made predominantly in favour of the
applicants in the lower categories of 50 to 200 shares of the
face value of Rs. 10 each. The allotment by drawal of lots,
wherever necessary, should begin with 25 shares and should
be increased progressively in multiples thereof. It should
be the effort to have about 200 shareholders for evey Rs. 1
Lakh. Share capital issued/offered for sale; specially in case
of issues over-subscribed by more than 10 times.
(b) The allotment per applicant does not in any event exceed
500 shares of the face value of Rs. 10 each. In case of
excessively heavy over- subscription, say issue over-
subscribed by more than 20 times, the celing can even be
reduced to 250 shares per applicant.
(c) If allotment of more than 500 shares per applicant is
essential, prior permission from the government be taken:
Two types of questions may be raised in this regared. Firstly, is
such a circular instruction binding? Secondly, should the policy
determination be not left with the company instead of taking it
from government? The first question related to administrative
law. Whether a circular, guideline or instruction has the validity
of law is to be examined in the light of whether the same act is
covered by delegated legislation i.e., whether, under the statute,
government is empowered to issue the same. If it is not covered
by delegated legislation, the action remains as an executive
instruction. The second question relates to policy issues. How
far freedom is to be allowed to individuals to take a decision on
public policy? Can a government absolutely abdicate itself from
guiding individuals on public policy issues?
Return as to allotment
After making allotment of shares, the company shall within 30
days thereafter, file with the Registrar a return of the allotment
stating the number and nominal amount of the shares allotted,
names, addresses and occupation of the allottees and the amount
paid and/or payable on each share. A share issued in discharge
of a debt is considered as share issued in cash [circular No. 8/
4/69 dated 18.11.1969; see Sec. 75 also]. The return must not
include a share as allotted for cash where the cash has not been
received. The return has also to include shares allotted as fully
or partly paid otherwise than in cash. Number and nominal
amount of the shares so allotted, the extent of which they are to
be treated as paid up and the consideration for which they have
been allotted are also to be stated. The company has to produce
for inspection and examination of the Registrar a contract in
writing constituting the title of the allottee. In case the shares
are issued at a discount, the return has to accompany a copy of
the resolution passed authorising the issue at a discount, a copy
of the order of the Company Law Board sanctioning the issue
and where the discount rate is more than 10%, a copy of the
order of the Central Government authorising the rate. In case of
issue of bonus shares, the return statement shall contain number
and nominal value of the shares, names, addresses and
occupation of the allottees and a copy of the resolution
authorising the issue. The Registrar may extend the time in case
he is satisfied on an application that 30 days’ time is inadequate.
If default is made in filing the return, every officer is punishable
with a fine of Rupees five hundred for every day, during which
the default continues (Sec. 75).
The Registrar cannot refuse to accept a return perfectly in order
on the substantial question of legal validity of allotment. As for
example, he cannot raise issues like share allotted to a minor or
shares allotted within 5 days from the date of issue of prospectus
etc. If the return is in order under Sec. 75, the obligation of the
Company in so far as submission of return is discharged. In
Golkonda Industries (P) Ltd v. Registrar of Companies
[(1918) 1 Comp. L.J. 245] the full bench of the Delhi High
Court held that where a return of allotment is made and it is
otherwise in order the Registrar cannot enquire into the legal
validity of the matters concerned in the return.
Is share allotment a transfer of property?
A company creates shares. Can it be called owner of these shares
before allotment? In re Calcutta Share Exchange Association
Ltd [(1957) 27 Comp. Cases 559] allotment has been
understood as creation of lots of shares and then the division of
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them into value and classes and lastly allocation of them to various
persons? Understanding ‘share’ in this section brings
confusion. Shares are not something as a property created a priori
and then selling them. It is not like a furniture that is created and
then sold. Therefore, the person who creates it has a proprietary
interest. A share is a certificate acknowledging that the holder
whose name is inscribed in it has contributed the stated amount
towards the capital of the company. Therefore, ‘share’ is not
something created a priori. Unless anyone subscribes towards
the capital, those certificates already printed without having any
specific name inscribed remain as merely scrap of papers or
stationery. Only when the appropriate portion of capital is
contributed by a shareholder, the certificate gets into a
proprietorial document in the hand of the shareholders. In Raj
Sachdeva v. Board of Revenue [AIR 1959 All 595] the matter
was debated. It was held that an agreement to allot shares or an
allotment of shares is not a transfer of property, as the company
which allots the shares is not in any sense an owner of the shares
which it creates. The agreement will therefore, cannot be liable
to stamp duty as a conveyance.
(c) Calls on shares
‘Calls’ has not been defined in the Companies Act. Generally
speaking the nominal value of the shares and the share premium
if any, are collected from the shareholder in some instalments.
The amount fixed to be paid at the time of application is known
as application money. When the share is allotted the allotment
letter asks the allottee to pay the second instalment, known as
allotment money. Subsequently as and when company requires
further sum, company asks its shareholders by a call to pay a
part of the balance amount on the shares. These cases are known
as 'Call on shares'. It is a call to pay an instalment. The final call
with which share becomes completely paid, is known as final
call. Calls are generally numbered. As for example, instalment
called after receiving allotment money, is known as first call.
The next is known as second call. The final instalment, is known
as last and final call. As for example, suppose the nominal value
of a share is Rs. 100. Suppose twenty rupees are asked to be
deposited along with application. This application money is
required to be kept in a bank. The money cannot be used until
shares are allotted. Suppose, the allotment letter asks to pay
another twenty rupees. This amount is known as allotment
money. On each share balance due is (Rs. 100-40) Rs. 60.00.
Suppose after three months company required a further sum and
gives a call to pay another twenty rupees, this call is known as
first call. Following call for another twenty rupees is the second
call and the last twenty rupees could be asked for by the last and
final call.
Regulations for management of a company limited by shares
provided in Table A of Schedule I contain regulation about
calls in Regs. 13 to 18.
These regulations provide:
(a) no call shall exceed one-fourth of the nominal value of the
share or
(b) payable at less than one month from the date fixed for the
payment of last proceeding call;
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(c) a fourteen days notice specifying the time or times and place
of payment.
The Board of Directors shall authorise the call. Joint holders of
a share are jointly or severally liable to pay all calls. If payment
is not made in time, the shareholders shall pay the sum with
interest at five percent per annum. For non payment of calls and
interest, shares are liable to be forfeited. If a call is made in
contravention of the regulation provided in the articles, it may
become invalid. In Re Cawley & Co (42 Ch.D 209) the diretors
passed a resolution fixing the amount of the call but omitted to
fix the date of payment. It was held that there was no valid call.
A share holder is not liable to pay against a call not valid. He
can obtain an injunction restraining the directors to forfeit his
shares for non payment of a call not validly given.
According to Sec. 91 any calls for further share capital shall be
made on a uniform basis on all shares falling under the same
class.
If a partly paid up share is transferred the transferor transfers
his rights to future payments and liability for the future calls.
But If a call is given before a share is transferred the transferor
apparently remains liable in absence of a specific contract
otherwise between the transferor and the transferee.
Power of the Company to receive uncalled amount
According to Sec. 92 a company may receive the amount
uncalled if the company is so authorised by its articles. The
amount is kept in a 'calls in advance’ account as a part of the
share capital account.
(d) Forfeiture of share: The power to forfeit shares is provided
in the articles of a company. Regulation 29 of Table A, Schedule
I of the Companies Act, stipulates that if a member fails to pay
any call, or instalment of a call, the Board may serve a notice of
forfeiture calling the shareholder to pay the call money and the
interest thereon within a specified date failing which the share
would be forfeited. If the requirements of the notice are not
complied with, the Board of Directors may forfeit the shares by
a resolution of the Board. Can the articles of a company provide
for forfeiture of a share for any other debt? In the Calcutta
Stock Exchange Association Ltd v. S.N. Nandy & Co [ILR
(1950) Cal 235] the Calcutta High Court held that a company
may by its articles provide for grounds of forfeiture other than
non-payment of calls. While approving this decision Supreme
Court of India held in Naresh Chandra v. The Calcutta Stock
Exchange Association Ltd (AIR 1971 SC 422) that articles
22, 24, 26, 27 and 29 of the Articles of Association of the
Calcutta Stock Exchange which expressly provided that in the
event of a member failing to carry out the engagement and the
conditions specified in those articles, his share would stand
forfeited, were valid. Forfeiture of share in this manner is
inconsistent with the philosophy of limited liability In Corporate
System. Reason demands that forfeiture is allowed according
to the provision of the articles only for non-payment of calls
and not for any other dues. The Company court in England in
Hopkinson v. Martiner Harley & Co [(1917)1 Ch 646] rightly
observed that forfeiture of share for any other debt is in excess
of authority and such power is invalid as an unauthorised
reduction of capital.
Forfeiture of share is a very delicate issue as it may involve
permanent reduction of capital. The articles must include a clear
procedure and the shareholder can insist on the strict
implementation of the procedure before the shares are forfeited.
A procedural justice is required to be ensured failing which the
forfeiture may be rendered null and void. In Re New Chilie
etc, Co. [(1890)45 Ch.D 598] the Court suggested that in case
of irregularities in forfeiture, the aggrieved shareholder may sue
the company for damages. According to the decision of the
Supreme Court in Public Passenger Service v. M.A. Khader
(AIR 1966 SC 489) the Board has to exercise the power of
forfeiture like a trust, for the benefit of the company. A share
forfeited for a personal gain of a director is considered an abuse
of power.
If a share is forfeited the shareholder ceases to be a member
with effect from the date of forfeiture. He cannot be asked to
pay unpaid calls on the shares in future. Unless the article provide
for it, the dues on unpaid calls becomes an ordinary debt [See
Indian Cooperative Navigation Co v. Padamsey (36 Bom.
L.R. 32).
Reissue of forfeited shares: A share forfeited becomes the
property of the company. The company may, if provided in the
articles :-
(a) reissue the shares on such terms and in such manner as the
Board thinks fit; or
(b) cancel the forfeited share.
In fact, cancellation of forfeited share reduces the share capital.
In Bishhambharan v. Agra Electric Stores Ltd (AIR 1954
All 541) the Court held that the company is not bound to reissue
a share forfeited for non-payment of calls. But if the articles
provide for any other ground for forfeiture without providing
for reissue of the same the forfeiture shall amount to reduction
of capital. Since the forfeited share becomes the property of the
company, the company has reissued the share in favour of the
person to whom it has been resold. The company may resell the
partly paid up share at any price which may be less than the
amount actually paid up on such shares. But the new holder has
to pay the amount due on the share because the company sells
the share free from that liability. Thus the company’s total receipt
on the share cannot in any way be less than the original value of
the share (with share premium if any). Reissue is not an allotment
as per Sec. 75(5) and no return is required to be filed with
registrar on such reissue of the forfeited shares.
4.5 COMMISSION AND BROKERAGE
In the Corporate world many specialised financial agencies
started operating during the twentieth century as intermediaries
specially in securing public subscriptions and ensuring easy
transferability of shares and stocks. Some of these intermediaries
institutions are:
i) Underwriters,
ii) brokers and
iii) portfolio managers.
i) Underwriters: Persons who run an agency to procure
subscriptions and give an assured public subscription in the event
of issue of shares or debentures of a company are called
underwriters. They subscribe to the share/debenture if it fails to
secure the assured quota of public subscription. In India many
public institutions like LIC, GIC or UTI carry on this type of
activity along with many private underwriting agencies. In Nani
Gopal Lahiri v. State of U.P. [(1965) 35 Comp. Cases 30 (SC)]
the Supreme Court narrated the job of an underwriter and
advantages of underwriting. According to the Court
"Underwriting is in the nature of an insurance against the
possibility of inadequate subscription. A public company cannot
proceed to allot shares offered to the public, unless the amount
specified in the prospectus as the minimum subscription is raised
by the issue of shares ... an underwriter is entitled to enter into
subsidiary agreements with which the company is not concerned.
....... The underwriting agreement being a contract that the
underwriter will either himself purchase or procure purchasers
for the shares underwritten by him, it is no concern of the
company as to how the underwriter procures the purchasers".
As per SEBI guidelines, underwriting is mandatory for the full
issue i.e., to net offer to the public. The lead manager to the
issue must satisfy himself about the net worth of the underwriters
and the outstanding commitments and disclose the same to SEBI.
A statement to the effect that in the opinion of the lead managers,
the underwriters’ assets are adequate to meet their obligation
should be incorporated in the prospectus.
Underwriting Commission
According to Sec. 76(1) a company may pay a commission to
any person in consideration of his :
(1) subscribing or agreeing to subscribe or
(2) procuring or agreeing to procure
for any shares in or debentures of the company subject to the
following conditions -
(i) the payment of commission must be authorised by the
articles,
(ii) commission must not exceed 5% in case of shares, 2 1/2%
in case of debentures or the amount authorised by the
articles, whichever is less;
(iii) the rate of commission to be disclosed in the prospectus or
in the statement in lieu of prospectus, as the case may be;
(iv) the underwritten amount of shares or debentures must be
stated in the prospectus or in the statement in lieu of
prospectus, as the case may be;
(v) a copy of the contract for the payment of the commission to
the underwriters is delivered to the Registrar.
No company can pay any commission or discount directly or
indirectly save as aforesaid, on the issue of shares or debentures.
Of course over and above, brokerage can be paid. In Sec. 76(4A)
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it has been further prescribed that no commission shall be paid
on shares or debentures to any person not offered to the public
for subscription.
The Central Government vide its letter No F/14/1/ SE/85 dated
7 May 1985 to recognise Stock Exchanges stipulated the
maximum underwriting Commission as follows :
Types of Shares/debentures On share amount On public
devolved to subscription
underwriters
(a) Equity Shares 2.5% 2.5%
(b) PreferenceShares/
Convertible and
non-Convertible debentures
(i) amounts upto 5 lakhs 2.5% 2.5%
(ii) exceeding 5 lakhs 2.0% 1.0%
No underwriting commission is payable on share-amounts taken
by promoters’ group, employees, directors and their friends,
relatives and business associates. The above rate is maximum
within which negotiation may be made.
The government has issued the following guidelines relating to
underwriting of capital issues by members of the Stock
Exchanges:
(1) The Stock Exchange will satisfy themselves that the
company’s securities which are being underwritten would
be officially quoted on a recognised Stock Exchange;
(2) The members of the Stock Exchange desiring to underwrite
will satisfy themselves that the company duly complied with
the listing regulations;
(3) The Governing body of the recognised Stock Exchanges
shall have the discretion to refuse permission or impose
such conditions in respect of underwriting of securities by
members of Stock Exchanges as they may deem necessary
in the special circumstances of any given case;
(4) The underwriting of public issues should be distributed
amongst the members of the Stock Exchanges as widely as
possible.
(5) No member should be allowed to undertake an underwriting
commitment of more than 5% of the public issue; (Banks
generally underwrite 10%. There is no limit for financial
institution);
(6) The Stock Exchange should prescribe procedures for
advance action to be taken by the companies, merchant
bankers, etc. for making underwriting arrangements so as
to ensure that all the relevant Information is furnished in
the draft prospectus which is submitted to the Stock
Exchange for approval (See for details "Stock Exchange
Listing", a Bombay Stock Exchange publication, p. 20).
However, any attempt to issue at a discount is prevented. If the
commission to a subscriber of shares is not accountable under
Sec. 76, it becomes in fact 'Shares issued at a discount'. In
Keatings v. Paringa Mines Ltd [(1902) W.N. 15] the
Company’s £ 1 share stood at 3s. in the market. The Company
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proposed to issue 1,20,000 shares of £ 1 each on the term that a
bonus of 7% would be returned to the applicants and a
commission of 10% would be paid to the guarantors. It was
held that it was an issue of shares at a discount and illegal. As
such commission payable on share issue must strictly come
within the perview of Sec. 76.
ii) Brokers to an issue
A broker is a intermediary, who arranges for or manages a bargain
between a vendor (the company or an underwriter) and a
purchaser (an applicant for a share) for which he is paid a
commission, known as brokerage. Both the parties to the contract
pay for the brokerage.
According to Sec. 76(3) the right of paying brokerage is not
affected by the provision of Sec. 76(1). Names of brokers to an
issue are published in the prospectus. The manager of the issues
and the brokers arrange for direct dealings, as much as possible,
between the general applicants for shares and the company. The
present tendency in corporate management is to appoint a bank
as the Banker to an issue and leading brokers of Stock Exchanges
as official brokers. These brokers try to motivate their customers
to buy shares of the company directly. The Stock Exchange bye-
laws prohibit members from acting as brokers to the issue unless:
(a) the Stock Exchange to which they are members approves;
and
(b) the company conforms to the prescribed listing requirement,
and
(c) the company undertakes to have its securities listed on a
recognised Stock Exchange.
Of course appointment of official brokers is not obligatory.
However, the conditions prescribed regarding brokerage by the
Central Government vide its letter no. F.14/1/SE /85 dated 7th
May, 1985 are as follows:
(a) Brokerage is fixed at 1.5% on all public issues;
(b) All mailing cost and other expenses are to be met by the
Stock brokers;
(c) Listed companies may pay brokerage on private placement
at a maximum rate of 5%;
(d) Brokerage will not be allowed in respect of promoters’ quota
including the amounts taken up by the directors their friends
and employees;
(e) Brokerage is not payable on applications made against
underwriting commitments.
The rate of brokerage payable must be disclosed in the
prospectus.
Managers to the issue
A merchant banker is generally engaged as manager to the issue
to advise the promoters on the composition of the capital
structure of the company and the manner in which the funds are
to be raised. The manager also assists in drafting of the
prospectus and in its publication, as well as taking all steps
necessary to raise the funds which includes, appointment of
underwriters and brokers with suitable terms and arranging for
listing of the shares. The manager of the issue, in fact, takes a
complete charge in managing the whole affairs. The ministry of
finance issued guidelines providing merchant bankers to take
authorisation from SEBI. The Registrar of Companies are
advised to see that merchant bankers acting in any capacity as
lead managers, co-managers, advisers or consultants, are
authorised by the SEBI. According to the guidelines the fees
payable to lead managers are fixed at 0.5% when the issue is
upto Rs.5 crores and 0.2% when it is more than Rs.5 crores. No
fees are payable on financial institutions’ subscription or
underwriting amounts’ promoters’ quota and right issues.
Banker to the issue
A Company raises its capital from the primary market through a
Bank or Banks named in the prospectus. Therefore banker has
a very important role to play in issues of shares and debentures.
The banker is to be very carefully selected. Collecting branches
of the Bank/s are nominated taking into consideration of the
convenience of the public, distribution of the investment
throughout the country and the convenience of the NRI if NRI
investment is desired. So the Banker to the issue shall have
facility of overseas branches. Functions of the collecting
branches, inter alia are (1) collecting applications, passing daily
informations about collection to the controlling branch, receiving
and implementing instructions from the controlling branch; (2)
collecting stationeries like share applications, prospectus and
other documents from the issuing company; (3) clearing cheques
and drafts promptly; (4) acknowledge the receipt of the
application; (5) remit the proceeds periodically; and (6) issuing
certificate testifying no application pending with it.
On the other hand, regulating or controlling branch shall (1)
prepare instruction to collecting branches and send them; (2)
issue consent letter for acting as the manager to the issue; (3)
finalising the list of names of collecting branches in consultation
with the company; (4) inform all collecting branches as to
opening and closing subscription list; (5) open separate bank
accounts; (6) hold in trust applications; (7) liaison with the
registrar etc.
Registrar to the issue
Another institution in a public issue is Registrar to the issue. The
registrar to the issue must have many internal agency facilities
that are extended to the company. The registrar to the issue
receives all applications from the collecting banks; duly process
the applications for allotment; issue certificate or refund orders;
maintains necessary issue registers and submits returns. The
registrar to the issue has number of functions starting from
designing the application form to attending to enquiries of the
investors.
4.6 REGULATION ON PURCHASE OF OWN SHARES
The share capital of a company once planned and formed, cannot
be reduced in any way other than the way of reduction of share
capital under Sec. 100. As such, according to Sec. 77 a company
limited by shares or limited by guarantee and having a share
capital cannot purchase its own shares because this in fact reduces
the share capital. The basic philosophy of keeping the capital
intact is based on the need of protection of the creditors. Besides,
a company is a body corporate constituted by shareholders. If
the company is allowed to purchase its own shares, the
constituting element shall be lost. According to British &
American Trustee & Finance Corporation v. Couper (1894
AC 399) the court underlined the reason for not allowing a
company to purchase its own shares. According to the court if
such purchases are allowed, it would result in 'trafficking’ in its
own shares thereby enabling the company, in an unhealthy
manner, to influence the price of its own shares or it operates as
a reduction of capital. A company is also prevented to give any
loan or any security or any financial assistance to anyone for
purchasing its shares or shares of its holding company. According
to Sec. 77(2) this type of transaction is prohibited. Whereas Sec.
77(1) is applicable to all companies, Sec. 77(2) is applicable only
in case of public companies and private companies which are
their subsidiaries giving financial assistance to persons purchasing
their shares. Sec. 77(2) does not apply to a holding company for
directly buying shares of its subsidiaries or providing financial
assistance or granting loan to anybody to purchase shares of its
subsidiaries. Most of the litigation on the issue centres round
what is 'financial assistance’. In re G.M. Holding Ltd [(1942
ch 225] it was observed that where a company makes a gift of its
money, or grants a loan, or sells property to a person at a fradulent
consideration, there is financial assistance. In case of default under
this section, the company and all officers of the company
responsible for the contravention shall be punishable with fine
upto Rupees one thousand.
Of course this section i.e., prohibition of (1) purchasing own
shares and (2) giving loan to purchase the company’s shares
thereby reducing, in fact, the share capital of the company, shall
not apply in the following cases:
(i) a company can forfeit its shares as per the provision of its
articles for the non-payment of dues on the share. If the
same share is reissued the capital is repaired. But company
may cancel the shares. This is, in fact, a reduction which is
allowed.
(ii) lending of money by a banking company in the ordinary
course of business;
(iii) provision of money according to a scheme for purchase of
shares by trustees for the benefit of employees of the
company;
(iv) making by the company of loans within the prescribed limit
of 6 months salary to any employee, not being a Director or
Manager, to purchase or subscribe for shares of the company
(v) reducing preference shares issued under Sec. 80.
(vi) obtaining a share through a bequest of his share by a
shareholder.
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5. SHARE, SHAREHOLDER AND MEMBER
SUB-TOPICS
5.1 Shares and Stocks
5.2 Types of Shares
5.3 Share certificates & Share warrants
5.4 Lien of Shares
5.5 Shareholders: rights and duties
5.6 Joint Shareholding
5.7 How to become a member
5.8 Who can be a Member
5.9 Cessation of Membership
5.10 Liabilities of Members
5.11 Register and Index of Members
5.1 SHARES AND STOCKS
1. Shares and Stocks defined
Sec. 2 (46) defines share as ‘share in the share capital of a
company, and includes stock except where a distinction between
stock and shares is expressed or implied’. In CIT v. Standard
Vacuum Oil Company [(1966) 1 Comp. 'L.J. 187 (SC)], the
court tried to appreciate ‘share’ in the sense of property and
meant by it 'not any sum of money but an interest measured by
a sum of money and made up of diverse rights conferred on its
holder by the articles of the company, which constitute a contract
between him and the company’. In Bacha Gazdar v. CIT [57
Bom. LR 617] shares are considered as right to participate in
the profits of the company while it is a growing concern, and in
its assets when the company is wound up. In Press Tools
Corporation v. M.R. Patney [AIR 1968 AP 320] share is
considered not a sum of money. ‘Stock’ is not defined in the
Companies Act. In fact' the definition of share both includes
and excludes stock according to express provision of the
Companies Act. According to the universal dictionary of the
English language edited by Wyld, Stock means 'capital of a
company or corporation divided into units, often of £ 100,
entitling holders to a proportion of profit’. The dictionary gave
a brief historical background of the term. It started with a
‘wooden tally’ representing a sum of money lent to the King.
Later on money lent to the government at a certain rate of interest,
divided into units of £ 100 came to be known as stocks.
Ultimately when Joint Stock Company came into being, it used
to pool the total capital from various persons for which the total
capital was divided into units. Each unit was called a Stock.
Several Stocks jointly used to build up the capital of the Joint
Stock Company.
A company may issue debenture-stock. Debenture stock is also
not defined in the Companies Act though according to Sec.
2(12) debenture includes debenture-stock. Debenture-stock is
itself the debt due from the company secured by a document
called a ‘debenture stock certificate’. Debenture stock is
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generally created by a trust deed. The difference between
debenture and debenture stock is like difference between share
and a stock. A debenture is always for a fixed sum and is
transferable in its entirety and not in fraction. But debenture-
stock is transferable in parts.
2. Values of Shares and Stocks
Shares and Stocks have face value i.e., the value shown in scrips.
As for example, a share of Rs. 100 means the certificate shall
show the face value of Rs. 100. This share may be sold at a
premium or at a discount or at par. A share of Rs. 100 sold at
Rs. 100 shall mean, share sold at par. If it is sold at a higher
price than Rs. 100, it is said that shares are sold at a premium
and if it is sold at a price less than Rs. 100, it is said that the
share is sold, at a discount. The legal provision of share sold at
a premium or discount has been explained earlier.
In a subsequent sale or transfer, this valuation of the share or
stock is necessary because the seller shall try to realise his capital
appreciation and the buyer is required to be assured about the
real worth of the share. Such a valuation can be made in different
ways as follows:
Valuation of Share
Fair Value (X+Y)
2
Market Value (X) Intrinsic Value (Y)
(Calculated on Income/yield basis) (Calculated on net
worth or break up basis).
The market value of a share is not necessarily reflected in the
share market price. It is expected that share or stocks having
high rate of capital appreciation shall be on high demand and as
such, the market price shall show higher value. But the demand
on a share on which market price in the share market is
determined depends on many factors, capital appreciation rate
being only one of those factors.
5.2 TYPES OF SHARE
It has already been explained that shares may be either
preference or equity. In India a company cannot issue any other
type of shares like deferred equity or ordinary shares generally
issued in favour of the promotional and managerial people with
discriminatory voting right. But in India, according to Sec. 88
of the Companies Act, no company shall issue any shares (not
being preference shares) which carry voting rights in the
company as to dividend, capital or otherwise which are
disproportionate to the rights attaching to the holders of other
shares. In case shares were issued with disproportionate voting
rights before the Act of 1956, the company would reduce the
voting right of such shareholders to the equality of voting rights
of all equity holders within a year. Of course the provision is
not applicable in case of a private company unless it is a
subsidiary to a public company.
A scrip is the written document called share certificate. It is
also designated as the preliminary certificate as for shares
allotted.
5.3 SHARE CERTIFICATES AND SHARE WARRANTS
1. Share Certificate
A share certificate is defined as "a declaration by the company to
all the world that the person in whose name the certificate is
made ‘out and to whom it is given, is a shareholder in the
company and it is given by the company with the intention that
it shall be so used by the person to whom it is given, and acted
upon in the sale and transfer of shares”. According to this
definition, the requirements of a share certificate are (i) a
declaration by the company to the effect that the person named
in the declaration is the shareholder of the company; (ii) Stamp
duty (varied from state to state) to be affixed to make the
declaration a certificate of title on the property, and (iii) giving
the certificate to the person in whose name the declaration is
made by the company. But the Calcutta High Court held in re.
Asiatic Oxygen Ltd [(1972) 42 Comp.Cas 602] that duty of
the company is to keep ready the certificate within the time
prescribed in Sec. 113 and the duty does not extend to deliver
the same. This is too narrow an interpretation of the words
‘complete and keep ready’ specified in Sec. 113. Acccording to
Sec. 113, the share/debenture certificate is to be completed and
kept ready for delivery :
i) within three months after the allotment, or
ii) within two months after application for the registration of
tranfer as the case may be.
Conditions for issue of share certificate
According to Rule 4 of the Companies (Issue of Share
Certificate) Rules 1960 no certificate of any share shall be issued
unless the following conditions are fulfilled:
(i) a resolution is passed in the Board for issue of the certificate;
ii) the letter of allotment or fractional coupon of requisite value
[excepting in case of issue against letters of acceptance or
of renunciation or bonus shares];
iii) the earlier certificate is surrendered where replacement is
required to be made for consolidation, or due to worn out,
torn out or where spaces in the reverse for recording transfer
have been duly utilised, and
iv) a resolution is passed to issue duplicate for lost or destroyed
certificates.
A certificate issued under the common seal of the company is
prima facie evidence of the title of the member to the shares of
the company. Particulars of every share certificate shall be
entered in the Register of Members. Every certificate shall
specify the name of the person in whose favour it is issued and
the share to which it relates and the amount paid up thereon.
2. Share warrants
According to Sec. 114 a public company limited by shares may
issue under its common seal a share warrant stating that the bearer
is entitled to the shares specified therein, if:
(a) such issue is authorised by its articles;
(b) prior permission from the Central Government is obtained.
The Share warrant is transferable document by delivery. The
bearer of the warrant is entitled to the share as well as dividends
and provided with specified coupons. The warrant requires
adequate stamp duty on the basis of value of the shares entitled
and the rate varies from state to state. On the issue of warrant
the company shall strike out the name of the member as if he
has ceased to be a member. Instead the register has to now contain
the date and the fact of issue of warrant and the statement of
shares specified in the warrant.
A ‘share warrant’ though not a negotiable instrument but is
transferable on delivery. The bearer of the warrant is entitled to
register his name as the member of the company subject to the
regulations prescribed in the articles of the company, on
surrendering the warrant and cancellation thereof. If a company
registers the name of a person without the warrant being
surrendered and cancelled, the company shall be liable to
compensate the loss incurred by any person.
The bearer of the warrant may, if the articles so provide, be
deemed to be a member of the company for the purposes
mentioned in the articles.
5.4 LIEN ON SHARES
According to Regulation 9 of the Regulations for Management
of a company limited by shares provided in Table A under
Schedule 1 of the Companies Act a 'first and paramount’ lien is
provided in favour of the company on all shares for all money
called and payable. It means the company has first charge on
the shares for the unpaid amount on the shares. The company
right of lien is paramount against all other creditors. The right
of lien is not automatic. Unless the articles of the company
provide for it, a company has prima facie no lien on the shares
of the members. (For details See, Canara Bank Ltd. v.
Tribhuvandas [AIR 1957 Trav. Co. 183]). In the same case the
Court has also directed that a company may so adopt its articles
as to give it a lien on fully paid shares, as regards any money
due to it from the shareholders. But clause 34(a) of the Listing
Agreement prohibits a lien on fully paid shares. It also does not
allow the exercise of the right of lien in respect of partly paid
shares except in case of moneys called or payable at a fixed time.
Generally speaking 'articles’ of a company provide for the right
of lien of the company on the unpaid calls.
In Champagne V. Perrier Janet v. H.H. Finch Ltd [(1982) 3
All ER 713] the article of the company provided for first and
paramount lien. The shareholder created an equitable charge
on the shares against a debt to another person. It was held that
the company’s lien was to have priority over the equitable
charge. In India against all legal charges created, the company
shall have its priority on lien. Where 'articles’ of a company
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have been altered to provide the right to lien for the company a
shareholder can argue that he purchased the shares with the
knowledge that there was no lien. The company can waive the
right expressly or impliedly.
After exercising the lien, the company, if authorised by the
articles, may sell those shares. Regulation 10 provides some
conditions for such a sale. According to Reg 10, such a sale
cannot be made unless (1) a sum in respect of the concerned
share is presently due and until (2) the expiration of fourteen
days after a notice in writing has been given demanding the
money. Unless the articles so provide there is no right of the
company to sell the share after exercising lien unless specifically
permitted by the court.
Acording to Sec. 181, the articles may provide that no member
shall exercise any voting right in respect of any shares registered
in his name and on which lien has been exercised by the
company.
5.5 SHAREHOLDERS: RIGHTS AND DUTIES
The term 'shareholder’ has not been defined in the Companies
Act probably because the term is self-explanatory. A person
who is the holder of a share is known as ‘shareholder’ of the
company. A shareholder is one of many owners of the company.
But in effect, he is only an investor investing towards the capital
of the company. He has the following rights:
(1) To be a Member: In case of a company limited by share or
guarantee and having a share capital and an unlimited
company having a share capital, the only shareholders are
members of the company. Of course a company not having
a share capital can have members but not a share holder
(See Killick Nixon Ltd. v. Bank of India 1982 TaxL.R.
2547).
(2) To share profit: When the company earns profit,
shareholders are entitled to the dividend as and when the
company declares the same. It may be pointed out that
unless and until the company declares the dividend, a
shareholder does not have the automatic right to demand
share of profit.
(3) To participate in the distribution of assets: In the event
of winding up, a shareholder has a right to participate in the
distribution of the company’s assets in accordance with the
rights given to him under the articles.
(4) To further issue : A shareholder has a pre-emptory right
to subscribe to further issue of capital where the company
issues any further capital after the expiry of two years from
the formation of the company or at any time after the expiry
of one year from the allotment of shares. The existing
shareholder may renounce the shares offered to him in
favour of any other person unless the articles otherwise
provide.
(5) To vote on any special resolution: Right to vote is
essentially concerned with the corporate democracy. This
right is given to the members. But some special category
shareholders like preference shareholders shall have a right
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to vote on any resolution directly affecting their interests.
[See Sec. 106].
(6) To transfer share: There cannot be any restriction on the
transferability of shares.
(7) To apply for winding up: A shareholder may also apply to
the court for winding up of the company as a contributory
subject to conditions laid down in Sec. 434.
Shareholders have certain duties as well. As for example, a share-
holder has a duty of
(1) paying calls on the shares within the stipulated day;
(2) specifying in writing to become member of the company;
(3) attending meetings personally or through proxy and
participate in voting as and when required;
(4) informing the Central Government in buying and selling
shares wherever required.
5.6 JOINT SHAREHOLDING
Two or more persons owning a 'share’ are called joint-holders.
It may happen in different ways, viz;
(a) Through joint application: two or more persons may
jointly apply for and are allotted shares in their joint name;
(b) Through firm holding: a firm cannot be registered as a
member. Partners are registered as joint holders.
(c) Through succession: two or more persons may succeed
the right of holding a share and are registered as joint
holders.
Joint holders can insist on having their names registered in such
order as they may require their holdings to be split into several
joint holdings with their names in different orders so that all of
them may have a right to vote as first name holder in one or
other joint holdings. According to the Company Law Department
change in the order of names of joint holders does not need
transfer deeds provided the request is made by all joint holders
to the company. But if change in the order of names is required
in respect of part of the holding, execution of a transfer deed
will be required. The following positions of joint holders are to
be noted:
(i) For the purpose of determining number of members for
different purposes like, number of members of a private
limited company; requisition meeting, making application
under Secs. 397 and 398 etc., all the joint holders of a share
are counted as one member.
(ii) Notices to be served by the Company, shall be deemed to
have been served if it is served on the first name of the joint
holders [See Sec. 53(4)].
(iii) For the purpose of payment of dividend under Sec.
205(5)(b), the company is to pay the amount to the first name
of the joint holders unless instruction in writing is given
otherwise by all joint holders.
(iv) Joint holders are individually entitled to be present in the
meeting. take part in the deliberation but in poll the voting
right can be exercised together. For the purpose of quorum,
all joint holders together shall be taken as one.
(v) For holding position like director in the company, joint
holders are to be considered as sufficient qualification unless
the articles otherwise provide.
(vi) In the absence of any provision in the articles, the liability
for paying calls on the shares are joint and several in India
unlike England where it is only joint.
5.7 HOW TO BECOME A MEMBER
A person may become a member of a company in any of the
following ways
1) by subscribing the memorandum of association, on
registration of the company;
2) by agreeing to become a member of a company in writing
by subscribing to shares of the company and placed in the
register of members;
3) by purchasing a share and registering the name as a member:
4) by taking a share on transfer by way of assignment or
succession and registering the name;
5) by allowing name to be recorded in the register of members
of a company.
According to Sec. 41, the subscriber of memorandum of
association, on registration becomes a member of a company.
A person agreeing in writing and whose name is registered in
the register of members becomes a member. In fact excepting
(1) in the above list all others become members by consent and
registration. In case of a company limited by shares or guarantee
and having a share capital and in case of an unlimited company
having a share capital, a person can become a member of a
company only by being a shareholder. In the case of a company
not having a share capital, a person can become a member of
the company according to rules adopted by the company. The
special features of the following members are required to be
noted:
(a) Promoter member
In U.P. Oil Mills v. Jamna Prasad [AIR 1955 All 417] the
Court held that those who signed the memorandum of
association are deemed to have agreed to become members of
the company by reason of being the signatory to the
memorandum. Their names, of course, are required to be entered
into the register of members. A signatory to the memorandum
cannot after the incorporation of the company, withdraw by
repudiating the consent on the ground of misrepresentation [See
for details, In re Metal Constituents Co (1902) 1 Ch 707].
Besides, a subscriber to the memorandum is liable to pay for
his shares in cash even if he has entered into an arrangement
with the promoters under which he received the shares for his
services as legal consultant in promotion of the Company
[Kanduri Chetty v. Adoni Electric Supply Co Ltd [AIR 1944
Mad 322]. Though the signature to the memorandum can be
repudiated before the incorporation of the company it cannot
be revoked after incorporation.
(b) Member by application
According to Sec. 41(2) a person must agree in writing to become
a member of a company. Generally speaking an intending investor
applies for shares through an application form supplied by the
company. He offers to purchase shares in the company. The
company accepts the offer by sending a notice of allotment. The
applicant may of course revoke his offer before notice of allotment
is communicated [Hobb’s case (1867) LR 4 Eq. 6]. The company
may not communicate through writing. What is necessary is
communicating the acceptance of the Company to allot shares to
the offeror [Gum’s case (1867), LR 3 Ch. App 60]. An acceptance
by telex is a valid communication [Entores Ltd (1955) 2 All E.R.
493]. Shares allotted to an applicant are deemed to have been
issued to the applicant on the date of allotment and not when
certificates are issued [Shri Gopal Paper Mills Ltd v. CIT,
AIR 1970 SC 1750]. In re. Saloon Steam Packet Co. [(1867)
WN 259] the share applicant was present at the Board meeting
which made the allotment to the applicant. It was held that notice
of allotment was served even though formal notice was not posted.
In view of the present legal development this decision is doubtful
to be applicable in similar situation. Application shall become
lapsed if allotment is not notified within a reasonable time
[Ramsgati Victoria Hotel Co. Ltd. v. Montefiore (1866) L.R.
1 Exch 109].
Applicant may waive the notice of allotment. Generally an
agreement of reconstruction or amalgamation results into such
type of waiver in serving notice. It may be noted that with written
consent of becoming a shareholder in the newly reconstructed
company, a person does not become a member of that company.
He becomes a member as per Sec. 41(2) when his name is entered
in its register of members.
(c) Member by transfer
A person may become transferee in several occasions. As for
example, he may purchase the share; share may be assigned to
him against a loan or it may be gifted. According to Sec. 82
shares of a public limited company are freely transferable. It is
natural that on transfer the shareholder becomes member of the
company on his name being entered into the register of members.
Rules regarding transfer and mode of registering the name as a
member is specified in the articles of the company.
(d) Member by succession
Succession is one mode of transfer, and this transfer is usually
known as transmission of shares; Successors, executors or
administrators getting the share at the death of a shareholder
are entitled to register their names as members. Similarly an
official assignee is entitled to be a member in the case of a
shareholder becoming insolvent. The successors are bound to
pay the calls on the shares.
(e) Member by estoppel
A person may be deemed to be member if he allows his name
to be recorded in the register of members. A minor after
obtaining majority and thereafter receiving dividend may be
estoppel to deny that he has become a member.
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5.8 WHO CAN BE A MEMBER
Any person who is capable to enter into a contract can become a
member of a company by agreeing in writing to become a member
and allowing the name to be recorded in the register of members.
The Companies Act does not prescribe any disqualification.
(a) Company: A company may become a member of another
company if it is so authorised by its memorandum through
the object clause. Of course the Companies Act has
stipulated certain restrictions. As for example, a subsidiary
company cannot be a member of its holding company and
any allotment of share to such a subsidiary company by the
holding company is void. Exceptions are of course there,
such as:
(i) a subsidiary company may be the legal representative
of a deceased member of a holding company
(ii) a subsidiary company is a trustee where the holding
or subsidiary company is not a beneficiary
(iii) a subsidiary used to hold shares of its holding company
at the commencement of the Act of 1956 and
continuing as such.
(b) Minor : In India a minor is completely incompetent to enter
into the contract. Hence he cannot be a member of a
company. In Palaniappa v. Official Liquidator [AIR 1942
Mad 470] the father applied for shares in the name of his
minor daughter and registered the shares in her name. The
transaction was held to be ab initio void. If the company
allot shares in the name of a minor in ignorance of the fact,
the company can repudiate the contract. The minor can also
repudiate the allotment at any time during minority and also
within a reasonable time after becoming major. But if after
attaining majority the person receives the dividend on the
shares, it may be deemed that the person has accepted to
become a member.
But where a signatory to a memorandum is a minor and the
company is already registered, the registration cannot be
invalidated on the ground that one of the signatory to the
memorandum is a minor even though only minimum
number of persons floated the company and one of them
being minor.
(c) Lunatic: In Morgan v. Gray [(1953)Ch 83] it was held
that as long as the name of the lunatic is in the register of
members, he is a member and is entitled to vote at the
meetings of the company. A lunatic or a person of unsound
mind can enter into a valid contract at the lucid interval
when the mind is sound. Therefore, a lunatic remains a
member as long as his name is there in the register of
members. But if it is proved that at the time of allotment of
the shares he was insane, the company can rescind the
contract.
(d) Bankrupt: As long as the name of an insolvent member
remains in the register of members, he is a member and he
is entitled to exercise vote. The property of an insolvent is
transferred to an official assignee who Is entitled to get his
name registered as member.
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(e) Benamdar: A person who takes shares in the name of a
fictitious person would be liable as a member in respect of
the share and his name may be entered in the register of
members. He is also liable to be punished for impersonation
under Sec. 68A. Under Sec. 187C a holder of a share not
having beneficial interest in the share must submit a
declaration to the company within the time prescribed,
specifying name and other particulars of the beneficial
holder. Similarly within 30 days from the commencement
of the Companies (Amendment) Act 1974 all beneficial
owners shall have to declare to the company the nature of
their interest, particulars of the person in whose name the
shares stand registered. Whenever there is a change in the
beneficial interest the beneficial owner shall submit a
declaration to the company regarding the date and nature
of the change. On such declaration the company makes a
note of such declaration and within 30 days from the date
of receipt of the declaration submit a return to the Registrar
with regard to such declaration. If the beneficial owner fails
to give the declaration, for every day’s delay he shall be
punished with fine upto Rupees one thousand.
Besides, Sec. 189(e) declares a beneficial owner of a share
or any person claiming under him from enforcing any charge,
promissory note or any other collateral agreement, created,
executed or entered into by the ostensible owner if the
declaration is not made. As such benami has become a
distinct disincentive.
(f) Trustee: Where any shares in or debentures of a company
are held in trust by any person, he shall make a declaration
to the public trustee appointed by the Central Government
under Sec. 153A, within such time and in such form as may
be prescribed. A copy of such declaration is to be sent to
the company by the trustee within 21 days of such
declaration. Failure to submit such declaration attracts fine
upto Rupees five thousand and for continuation of the
offence upto Rupees one hundred for everyday’s delay.
According to Sec. 187B the voting rights on these shares
became exercisable by the public trustee or by his appointed
proxy. According to Sec. 153 no notice of any trust, express
or implied or constructive, shall be entered on the register
or be receivable by the Registrar. It implies that if the trustees
transfer shares to a person other than the one for whom
they were held in trust, the company will not be liable to the
latter. Another effect of Sec. 153 is that the shares may be
held in the cover of a trust. Fraud can be practised in regard
to the management of the company.
Member and Shareholder
From the above discussion it is clear that equity shareholders
are ordinarily the members of the company having a share
capital. In case of a company not having a share capital, the
membership is determined according to the articles of the
company. Though shareholders are members but there may be a
situation when a shareholder is not a member or a member is
not a shareholder. As for example:
(a) Shareholder but not a member: A shareholder having
received a share warrant is not a member though he is a
 shareholder. A person purchasing a share has to apply for
registering his name in the register of members under Sec.
108. Until such registration is made, the shareholder does
not become a member.
(b) A member but not a shareholder: A signatory to
memorandum becomes a member before shares are allotted
to him. Similarly, a person agreeing in writing to become a
member and allowing his name to be recorded in the register
of members, becomes a member though no shares were yet
allotted. A shareholder whose name is registered as a
member, remains a member until the new holder applies
and gets his name recorded as member. Until then the old
shareholder remains a member though he has actually sold
his share.
There may be several such situations where a shareholder is not
a member or a member is not a shareholder. But generally
speaking a member becomes a member of a company only
through shareholding.
5.9 CESSATION OF MEMBERSHIP
A person may cease to be member in the following
circumstances:
(a) on forfeiture of his shares due to non payment of dues;
(b) by valid surrender of his shares;
(c) by transferring his shares when the new holder registers his
name as a member;
(d) on his death;
(e) in case of his insolvency, on the disclaimer by the official
assignee;
(f) on winding up of the company;
(g) on grounds of rescision of the membership contract like
misrepresentation or fraud or mistake.
5.10 LIABILITY OF MEMBERS
(1) According to Sec. 36(2) all money payable by any member
to the company under the memorandum and articles shall
be a debt due from him to the company. Articles of a
company generally provide that calls and instalments
payable shall be paid when due. It may be noted here that
the member whose name is entered in the register of
members is only liable to make the payment. It makes no
difference whether he is beneficial owner or a trustee.
(2) A member of a company is liable to pay the whole nominal
value of the share unless it is expressly provided otherwise.
The payment is required to be made in cash. The liability is
not discharged until the whole amount is paid up.
(3) A member who ceased to be a member within one year prior
to the winding up, is nevetheless liable to pay the unpaid
amount on the shares. His name is included in ‘B’ list, to
pay, if necessary
(a) debts incurred when he was a member,
(b) debts not specified by members in ‘A’ list.
5.11 REGISTER AND INDEX OF MEMBERS
(a) Register of Members
According to Sec. 150 every company shall keep in one or more
books a register of members and keep therein the following
particulars of each member;
(a) the name and address, and occupation of each member;
(b) in the case of a company having a share capital, shares held
by each member, and the amount paid or agreed to be
considered as paid on those shares;
(c) the date at which each person was entered in the register as
a member; and
(d) the date at which any person ceased to be a member.
In the event of share converted into stock, the register shall show
the amount of the stock held, by each member. If default is made
in keeping the records as mentioned above, every responsible
official and the company are punishable with a fine upto Rupees
fifty per day during which the default continues.
A minor cannot enter into a contract. As such, his name cannot
be entered in the register of members. The name of the guardian
on behalf of the minor can be recorded. A firm cannot be taken
as a member because a firm is not an incorporated body. As
such, name of a firm cannot be entered as a member. Name of
the partners must be entered as joint holders.
The register must be kept up to date incorporating all changes
in the holding of the shares due to transfer and transmission of
the shares. According to Sec. 164 a register is a prima facie
evidence, but not conclusive, of matters directed or authorised
by the Act to be entered therein.
A company having foreign members shall keep in its foreign
branch a register to enroll members of that state or country
outside India. The Company shall file with the Registrar within
30 days from the date of opening such a foreign register, a notice
stating the situation of the office where the register is kept (See
Sec. 157). In default a fine upto Rupees fifty per day may be
imposed on every responsible official and also on the company
for every day during which the default continues.
According to Sec. 152 the company must have to keep register
of deben- ture holders with similar particulars.
(b) Indexes of members
According to Sec. 151 every company having more than fifty
members shall keep an index of members unless the register of
members is maintained in such form that it contains an Index.
With changes in the register, the index is also required to be
amended within 14 days. The index has to contain sufficient
indication to enable the entries relating to each member to be
readily found in the register. The index is to be kept at the same
place where register of members is kept. Similarly index of
debenture holders is also to be prepared and kept at the place
where the register of debenture holders is kept.
(c) Location, inspection and closing of the register
According to Sec. 163 the register of members, debenture
holders and the indexes are to be kept in the registered office.
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If these are to be kept in any other place within the city in which
the registered office is located, it has to be approved by a special
resolution and the Registrar is given an advance copy of the
proposed special resolution. Central Government may make
rules for the preservation and for disposal of the registers and
Indexes. The Registers and Indexes shall remain open for
inspection during the business hours excepting during the time
when Registers and Indexes are closed for inspection under the
provision of the Act. Such inspection can be made by any
member or a debenture holder without any fees and any other
person on payment of a fees of one rupee for each inspection. A
member or creditor may inspect the registers and other
documents by his solicitor or agent as well [Bevan v. Webb
(1901) 2 Ch 59]. Any member, debenture holder or outsider
may make extracts from the Register or can have a copy by
paying required fees.
According to Sec. 154, a company may, after giving not less
than seven days’ notice, close the register of members or
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debenture holders for any period or periods not exceeding in the
aggregate in a year forty-five days but not exceeding 30 days at
any one time. Such a closure is necessary at beginning of the
AGM to ascertain the members for the purpose of serving notice.
This is also necessay for the purpose of paying dividends. A
person whose name appears in the register of members at the
time of closure, remains a member until the opening of the
register for revision even though he has transferred the share to
another person. Register is also closed before the right or bonus
shares are issued in view of ascertaining the member to whom it
must be issued. In each or such cases of closure at least a 7
days’ notice must be served by advertising in some newspaper
circulating at the city of the registered office of the company.
Any violation of such norms shall attract fine upto Rupees five
hundred per day during which register remains closed in violation
of the law, to be imposed on every defaulting official of the
company and also on the company.
6. TRANSFER AND TRANSMISSION
SUB-TOPICS
6.1 Introduction
6.2 Private Companies and Transfer of Shares and Debentures
6.3 Public Companies and Transfer of Shares and Debentures
6.3(A) Procedure for transfer of shares & debentures
6.3(B) Power of Central Government to direct companies
6.3(C) Refusal to Transfer Shares and Debentures
6.4 Effect of Transfer before Registration
6.5 Some forms of Transfer & Problems
6.1 INTRODUCTION
The great advantages of being a joint stock company form of
organisation is its perpetual life. The Members or Shareholders
of the Company may get changed, but the company retains its
identity, until it is wound up under the provisions of the
Companies Act. The right to transfer the shares serves certain
distinct advantages, which are mentioned herein below:
(i) it provides liquidity for the shares and the holders of shares
could sell their shares;
(ii) it becomes the permanent capital for the company as the
transfer of shares does not affect the share capital of the
company;
(iii) the capital of the economy becomes mobile, which is a very
important parameter for the economic growth of a country.
6.2 PRIVATE COMPANIES AND TRANSFER OF
SHARES AND DEBENTURES
In order to confer “Privacy", Section 3(i) (iii) (a) of the Companies
Act, 1956, provides for compulsory restriction of the right to
transfer its shares. But, it is to be noted that, this restriction is
applicable only in respect of shares and not to other forms of
securities like debentures, etc. According to Section 43 of the
Act, if a private company defaults in complying with the
provisions contained in Section 3(i) (iii) of the Act, then it shall
cease to be entitled to the privileges and exemptions conferred
on private companies under the provisions of the Act. However,
a proviso to the section grants the Company Law Board the power
to relieve the defaulted company from the said consequences, if
it is satisfied that the failure to comply with the conditions was
accidental or due to inadvertance or some other sufficient cause
or if it is just and equitable to grant such relief. A private company,
even on becoming public company by virtue of Section 43A of
the Act, could still restrict the right to transfer its shares.
6.3 PUBLIC COMPANIES AND TRANSFER OF
SHARES AND DEBENTURES
Sec. 82 of the Companies Act makes property in share, movable
and transferrable in the manner prescribed in the Articles. It
may be noted here that 'right to transfer’ a share/stock is a
statutory right and cannot be altered by the ‘articles’. The
‘articles’ may only prescribe the ‘manner’ in which by the transfer
is to take place. According to the definition of ‘goods’ under
Sale of Goods Act, goods include stocks and shares of a company.
As such, when the nature of the property as enunciated in Sec 82
to a share or stock being 'movable’, it is very complementary. In
Borland’s Trustee v. Steel brothers Co. Ltd [(1901)] Ch 279]
a share has been defined as ‘a right to a specified amount of the
share capital of a company carrying with it certain rights and
liabilities, while the company is a going concern and in the
winding up’. ‘Share represents the interest of the holder measured
for purposes of liability and dividend by a sum of money’.
A share or a stock being movable can either be mortgaged or
pledged. Whether a transaction is a mortgage or a pledge depends
upon the intention of the parties while making it [See for details,
Shahzadi Begum Saheba v. Giridharilal Sanghi AIR 1976
AP 273]. A share is freely transferrable and there cannot be any
absolute restriction imposed by articles. Articles may prescribe
the mode of transfer and procedural restrictions.
Setions 108 to 112 of the Companies Act, 1956, govern the
matters relating to transfer and transmission of shares and
debentures.
6.3 (A) PROCEDURE FOR TRANSFER OF SHARES
AND DEBENTURES
(i) Every request for transfer of shares and debentures has to
be accompanied by the following, viz -
(a) certificate relating to the shares and debentures; if no
certificate is in existence, the letter of allotment
thereof;
(b) proper instrument of transfer vide Form 7B, prescribed
under the Companies (Central Government’s) General
Rules and Forms, 1956.
In case, the instrument of transfer is lost, then the
Board of Directors of the company if satisfied, may
proceed to transfer the underlying shares and
debentures, if the parties give an indemnity.
(ii) the instrument of transfer has to be duly stamped and
executed, both by the transferor and by the transferee or on
behalf of them.
(iii) (a) in case of shares dealt in or quoted on a recognised
Stock Exchange, the transfer documents are to be
delivered at anytime before the date on which the
register of members is closed for the first time after
the date of presentation of Form 7B to the authority
or within twelve months from the date of presentation
of such Form 7B whichever is later;
(b) in any other case, within two months from the date of
such presentation.
A transfer becomes effective upon its registration in the register
of the company.
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6.3 (B) POWER OF CENTRAL GOVERNMENT TO
DIRECT COMPANIES NOT TO GIVE EFFECT
TO TRANSFER OF SHARES
Section 108D of the Companies Act, 1956 grants power to the
Central Government to direct Companies not to give effect to a
transfer of shares in certain circumstances.
If the Central Government is satisfied that, as a result of the
transfer of any share or block of shares of a company, a change
in the controlling interest of the company is likely to take place
and that such change would be prejudicial to the interest of the
company or to the public interest, then the said Government
may direct the company not to give effect to the transfer of any
such share or block of shares. In case, such transfer of shares or
block of shares has already been registered, then the Central
Government may direct that the transferee or nominee or proxy
of the transferee should not be permitted to exercise any voting
or other rights attached to such shares or block of shares. Further,
the section also provides that, if the transfer of shares or block
of shares has not been registered, then the Central Government
shall direct that the transferor or his nominee or proxy should
not be permitted to exercise any voting or other rights attached
to such shares or block of shares. [Section 108D(1)].
Sub-section (3) of section 108D provides that, if any direction
is given by the Central Government under sub-section (1), the
shares or block of shares shall stand retransferred to the person
from whom it was acquired and thereupon, the amount paid by
the transferee for the acquisition of such shares or block of shares
shall be refunded to him by the person to whom such shares or
block of shares were retransferred.
If the refund of the amount paid by the transferee is not paid
within thirty days from the date of the direction referred to in
sub-section (1), then, on the application of the person who is
entitled for the refund, the Central Government may direct the
refund of the amount. Any order so passed by the Central
Government may be enforced as if it were a decree made by a
Civil Court.
The provisions of Section 108D are not applicable to transfer
of share by the undermentioned persons, viz -
(i) any company in which not less than fifty one percent of the
share capital is held by the Central Government;
(ii) any corporation, not being a company, established by or
under any Central Act; or
(iii) any Financial Institution.
6.3(C) REFUSAL TO TRANSFER OF SHARES AND
DEBENTURES
Sec 111 of the Companies Act gave a wide power to the company
to refuse registration. According to this provision, nothing in
Sec. 108, 109 and 111 shall prejudice any power of the company
under its articles to refuse to register the transfer of, or
transmission by operation of law. This unrestricted power of
the company to refuse registration stands in the way of free
mobility of capital and on different occasion protects managerial
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incompetence and inefficiency. The only avenue to obtain justice
against the arbitrary decision the company, under the Companies
Act, is an appeal to be made to CLB thin the time mentiond
below:
(i) in case, notice of refusal has been sent by the company, within
a period of two months from the date of receipt of such notice;
ii) in case, the company did not send the notice of refusal, within
a period of four months from the date of lodgement of the
instrument of transfer.
The above protective arrangement was amended in order to
restrain the
veto power of the company and for ensuring free transferability
of securities public limited companies Sec. 22A has been inserted
in the Securities Contract (Regulation) Act in 1985. According
to this provision excepting as provided in the section, securities
of companies shall be freely transferrable. A company may refuse
to register the transfer only on the following ground of-
(a) procedural defects: that the instrument of transfer is not
proper or has not been duly stamped and executed or that
the certificate has not been delivered or any requirement
under the law relating to registration of transfer not being
complied with; or
(b) contravention of law: that the transfer is in contravention
of any law or rules or any administrative instructions or
conditions of listing agreement laid down in pursuance of
such law or rules; or
(c) composition of the board to be affected: that the transfer
of the security is likely to result in such change in the
composition of the board of directors as would be prejudicial
to the interests of the company or to the public interest; or
(d) transfer prohibited by court order: that the transfer is
prohibited by any order of any court, tribunal or other
authority.
Sec. 22A (4) of the Securities Act further provides that the
company shall, before expiry of two months from the date on
which instrument of transfer is lodged must either:
(a) effect registration on forming opinion that registration ought
not to be refused; or
(b) intimate the transferor and the transferee by notice as to what
is required to be done to effect registration under the law; or
(c) make a reference to the CLB and forward reference to the
transferor and the transferee.
Where on a reference under Sec. 22A(4) of the securities
(Regulation) Act is made and the CLB
(a) directs the security to be registered in favour of the transferee,
it must be done within 10 days of the receipt of the order;
(b) opined that it need not be registered, the company shall within
10 days intimate the transferor and the transferee accordingly.
Under Sec. 111(3) there is an additional right of the transferee to
appeal to the Central Government against the refusal to register
a transfer. Every appeal under Sec. 111(3) shall be made by a
petition in writing and shall be accompanied by such fee not
exceeding fifty rupees as may be prescribed by the Central
Government. Before making an order, the Central Government
may require the company to disclose to it the reasons for such
refusal.
In Kinetic Engineering Ltd v. Sadhana Gadia [(1992) 7 CLA
8; (1992) 1 Comp. L J 62], Regulation 47A of the Articles of
the company provided that “the directors shall not accept an
application for transfer of less than 5 equity shares ......". In
exercise of the power the company refused to split the share
certificate comprising of 50 shares, for the purpose of
transferring 8 out of 50 shares, in favour of the transferees who
were not members of the company. The CLB held, that articles
of association are not only contract between the company and
its members but they also constitute contract between the
members to regulate their rights inter se. But that does not mean
that the articles or memorandum has the force of law, If any
provision of articles or memorandum is contrary to any provision
of law it shall be invalid, ab initio. While deciding the case,
CLB held "since there is a specific provision which seeks free
transferability and registration of transfers of listed securities,
any provision which puts any restriction on free transferability
of shares would be in the negation of expressed provisions of
law and would be self defeating”.
If there is any delay in filing the application, the Limitation Act
is not applicable in the case of Securities (Regulation) Act since
it is a special statute. In Carbon Corporation Ltd. v. Abhudaya
Properties (P) Ltd [(1992) 73 Comp. Cas 572] it was held that
the Company Law Board has no power to extend the time limit
for filing a reference as prescribed in Sec. 22(A)(4).
The most important ground of refusal to request a transfer
apprehension of take over’. The apprehension must be real. In
Bajaj Tempo Ltd. v. Bajaj Auto Ltd. [(1991) 2 Comp LJ 393]
it was found that transfer of 1% of shares in favour of BAHL
and BAL two existing shareholders of Bajaj Tempo Ltd holding
22% was unlikely to change the composition of the Board. As
such, one cannot refuse registration on the apprehension of take
over under 22(A)(3) of the Securities (Registration) Act. But
where over 31.7 percent of the shares of the company were
acquired by a number of parties allegedly connected with each
other and controlled by one person (M.R. Chabria), it was held
that the material before the board of directors was more than
enough to come to a conclusion that transfer was likely to change
the complexion of the Board. The board of directors considered
the shareholding pattern, the high-tech nature of jobs undertaken
by the company and the track record of Chabria and bona fide
decided to refuse registration which was held justified.
[Gammon India Ltd v. Hongkong Bank (P) Ltd [(1992) 7
CLA 124].
6.4 EFFECT OF TRANSFER BEFORE
REGISTRATION
Where the transferor completes his responsibility to effect all
actions necessary to register the name of the transferee as laid
down in Sec. 108, the transfer is complete in so far as the transferor
is concerned but it is really not complete in respect to the
transferee until the transfer is registered and the tansferee’s name
is entered in the register of members. What is the responsibility
of the transferor to effect registration of the transferee? A
transferor has obligation under Sec. 108 to take all steps and to
follow all procedure for registration. He is not expected to go
beyond. He does not undertake to secure registration. He does
not have obligation to record the transfer. His obligation is to do
nothing to prevent registration of the transfer. If the transferee
wishes to protect himself from the consequences of a possible
non-registration of the transfer of shares by the company, he has
to take the shares with ‘registration guaranteed’. In the absence
of such a condition the transferor is not liable and the transferee
cannot recover the price of the shares from him on the ground of
no consideration.
6.5 SOME FORMS OF TRANSFERS AND PROBLEMS
(a) Blank transfer: Shares may be mortgaged by depositing the
share ertificate with the creditor along with the Instrument of
transfer signed by the transferor without mentioning the name of
the transferee and the date transfer. In such a case the mortgagee
is given the right to fill up the banks and get it registered. In this
case the transferee gets an equitable right on the shares. He may
sell the share in the event of the mortgage failing to pay for them
after giving them a reasonable notice.
Blank transfer for effecting sale of shares can obviously be
misused for speculative purposes. In order to prevent this
practice, Sec. 108(1A) stipulated that every instrument of transfer
should be in the prescribed form and every such form should
be presented to the prescribed authority, being a person already
in the service of the government, for stamping or otherwise
endorsing thereon the date of such presentation, before it is
signed by the transferor and even before any entry is made
therein. After the form is submitted being stamped, endorsed,
executed and delivered, the registration is to be made:
(i) in the case of shares dealt in or quoted on a recognised
Stock Exchange at any time before the closing of the register
of members or within one year from the date of presentation,
whichever is later; and
(ii) within two months from date of presentation in any other
case.
(b) Forged transfer: A share certificate is not a negotiable
Instrument and as such, no defective transfer can take effect so
as to give a better title to the transferee. Where a transfer was
forged, and a company issued a certificate, the Court held that
the title of the original holder was not defeated. [Barton v. L &
N.W. Rly Co 24 BD 77]. If such a certificate is transferred to a
bona fide purchaser for value, he does not get any better right
to be registered, but he is entitled to claim damages.
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7. RESTRUCTURE OF SHARE CAPITAL
SUB TOPICS
7.1 Introduction
7.2 Increase of Share Capital
7.3 Conversion and consolidation
7.4 Alteration of Members’ rights
7.5 Reduction of Share Capital
7.1 INTRODUCTION
A company may restructure its share capital in different ways.
This restructuring of capital to be noted at a glance is given
below:
(1) Increase its authorised capital [Sec. 94(1)(a)]:
(2) Consolidate and redivide in shares of higher amount [Sec.
94(1)(b)];
(3) Convert share into stock or stock into shares [Sec. 94(1)(c)];
(4) Subdivide shares into smaller value [Sec. 94(1)(d)];
(5) Cancel unissued shares and thereby reduce share capital
[Sec. 94(2)];
(6) Conversion of debentures and loans into shares [Sec.
81(3)(b) and Sec. 94A(1)];
(7) Reduction of Share Capital [Sec. 100]
(8) Alteration of rights of shares [Secs. 106-107]
(9) Facilitating under Sec. 391 for reconstruction and
amalgamation which can be stated as external reconstruction
[Sec. 394]
7.2 INCREASE OF SHARE CAPITAL
According to Sec. 94(1) a limited company having a share capital
may, if so authorised by the articles, alter the conditions of the
memorandum by increasing its share capital by such amount as
it thinks expedient by issuing new shares. Since the share capital
mentioned in the memorandum is the authorised capital of the
company it is therefore contemplated that the change mentioned
here is a change in the authorised capital. Such an increase is to
be made by issue of new shares. So in order to increase the
authorised capital of a company the conditions needed to be
followed are :
(a) Such an alteration [increase of capital) must be authorised
by the article:
(b) Such an alteration can be made by the company in the
general meeting [Sec. 94(2)];
(c) a notice of such alteration is to be filed with the Registrar
[Sec. 97(1)]
As such, authorised or nominal share capital of a company can
be increased only if such an increase is authorised by the articles
of the Company. If articles do not permit any such alteration,
the articles are required to be altered first before any step is
taken for increasing the authorised capital. In re North Cheshire
Brewery Co. [(1920) W.N. 149] it was held that there is no
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reason as to why in the same general meeting a special resolution
cannot be taken at first to alter the articles and then a resolution
taken to increase the authorised capital. The resolution is to be
taken bona fide for the interest of the company and not for
benefitting any group of interest.
It may be noted that increase of authorised capital is really an
alteration of memorandum. But Sec. 94(2) does not require a
special resolution for this purpose. Besides, in case the capital
is increased and new shares are issued, those can be issued only
according to the prescription given in Sec. 81 i.e., existing
shareholders will have a pre-emptory right to purchase those
shares. The general body cannot give any decision against the
statutory prescription. In this regard therefore, the decision of
the Rajasthan High Court in Mahalakshmi Mills v. State [AIR
1968 Raj 331] holding that it is not necessary that the new shares
should have been offered or allotted to the existing members is
inapplicable.
7.3 CONVERSION AND CONSOLIDATION
A company having a share capital may according to Sec.95(l):
i) consolidate and redivide its share capital into shares of larger
amount than its existing shares;
ii) convert any shares into stock;
iii) reconvert any stock into shares;
(iv) subdivide its shares or any of them;
(v) redeem any redeemable preference shares or
(vi) cancel any shares otherwise than in connection with a
reduction of capital under Sec. 100-104.
Provided that within 30 days of doing so, the Company has
to give a notice to the Registrar regarding such consolidation,
division, conversion, redemption or cancellation. The last
relating to conversion are specified below:
(a) Shares into stock: If articles so permit a company may
convert fully paid shares into stock if the company in its general
meeting resolves to do so. It may be noted that a partly paid
share cannot be converted into a stock because a stock is always
fully paid. A stock denotes an amount which can be divided and
a part sold. A share even if fully paid cannot be divided and
sold in parts.
(b) Stock into Shares: Stock of an amount can be converted or
reconverted into a share fully paid. For such reconversion, (a) a
general meeting has to pass a resolution, and (b) it must be
authorised by the articles of the company.
(c) Debenture into Stock: Presently, debentures are issued on
terms that these shall be converted into equity shares after some
time. Such conversion has three primary conditions on which
the conversion is dependant:
(1) A special resolution to this effect is required to be taken in
a general meeting unless the debenture holder or the creditor
is the Government;
(2) Such a term of conversion is approved by the Central
Government or be in conformity with the rules made by the
Central Government; and
(3) As stated earlier, the term of issue of debenture included the
option.
Section F of SEBI guidelines issued on June 11, 1992 on
"Disclosure and Investor Protection” contains the following
requirements as regards issue by the listed companies of Fully
Convertible Debentures (FCD) and Partly Convertible
Debentures (PCD)
(a) Issue of FCDs having a conversion period more than 36
months will not be permissible, unless conversion is made
optional with ‘put’ and ‘call’ option
(b) Compulsory credit rating will be required if conversion is
made for FCDs after 18 months.
(c) Premium amount on conversion, time of conversion, in
stages, if any, shall be predetermined and stated in the
prospectus. Thus interest rates for above debentures will
be freely determined by the issuer.
(d) * * * * * FCDs/PCDs falling due for conversion within a period of 12
(e) Any conversion in part or whole of the debenture will be
optional at the hands of the debenture holder, if the
conversion takes place at or after 18 months from the date
of allotment, but before 36 months.
(f) In case of ..... /PCDs credit rating is compulsory when
maturity exceeds 18 months.
(g) Premium amount at the time of conversion for the PCD
shall be predetermined and stated in the prospectus.
(h) * * * * * *
(i) * * * * * *
(j) * * * * * *
(k) * * * * * *
(l) * * * * * *
(m) SEBI may prescribe additional disclosure requirement from
time to time, after due notice.
In clarification I dated 11-6-1992 on the guidelines....SEBI
stipulated in 'L' relating to Promoters’ Contribution and lock-in
period as follows:
In the case of FCDS, the intention is that over and above the
proposed issue amount of FCDS, the promoters, directors,
friends, relatives and associates should bring in by way of
contribution to equity, amount equivalent to one-third of the
amount proposed to be issued as FCDs. Likewise in case of PCDs,
one third amount of equity should be with reference to convertible
portion of PCDs.
In section L(e) of the clarification II dated June 17, 1992 on
guidelines for disclosure it is stipulated that :
Where the PCDs/FCDs are issued, the promoters may bring in
their contribution either by way of additional equity or by way
of subscription to FCDs/PCDs so that total contribution of the
promoters is not less than 50%, 25% or 20% as the case may
be, of the equity after the conversion of FCDs/PCDs. If the
contribution is by way of equity, the promoters may subscribe
to such equity at par, if the first conversion of the FCDs/PCDs
is to take place after 18 months from the date of allotment
irrespective of the terms of conversion of debentures. In other
cases, viz., if the conversion is to take place at 18 months or
less. the promoters’ contribution towards equity shall be at the
same price at which subscribers to FCDs/PCDs are entitled to
conversion. The lock-in period of 5 years shall apply from the
date of allotment of debentures and in respect of the shares
accruing on conversion of such debentures from the date of
allotment of debentures. If the contribution is brought in advance
by way of equity, the lock-in period shall commence from the
date of allotment or commencement of commercial production
(in case of a manufacturing company), whichever is later.
Section M(ii) stipulates that:
No company may, pending conversion of FCDs/PCDs, issue
any bonus shares by way of rights or bonus, unless similar benefit
is extended to the holders of such FCDs/PCDs through
reservation of shares in proportion to such convertible part of
months from the date of rights or bonus issue. The shares so
reserved may be issued at the time of conversion of such
debentures on the same terms on which the rights on bonus issue
were made.
Section P (ii) stipulates that:
Where in terms of the consent issued by the Controller of Capital
Issues, the price of conversion of PCDs/FCDs is to be determined
at a later date by the Controller, it would be sufficient, if such
price and timing of conversion are determined at a general
meeting of the shareholders subject to-
(a) the consent of the holders of PCDs/FCDs for the conversion
terms being obtained individually and conversion is given
effect to only if the concerned debenture holders send their
positive consent and not on the basis of non-receipt of their
negative reply;
(b) Such holders of debentures, who do not give such consent,
are invariably given an option to get the convertible portion
of debentures redeemed or repurchased by the company at
a price, which shall not be less than the face value of the
debentures; and
(c) Where the consent from the Controller stipulates cap price
for conversion of FCDs/PCDs, the Board of the company
may determine the price at which the debentures may be
converted.
Besides the above classification IV; guidelines H, K & L on issue
securities by development financial institutions (DFI), also
include certain explanation and principles on FCDs/PCDs.
7.4 ALTERATION OF MEMBERS’ RIGHTS
According to Sec. 106 where the share capital of a company is
divided into different classes of shares, the rights attached to
the shares of any class may be varied with the consent in writing
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of the holders of not less than three-fourths of the issued shares
of that class or with the sanction of a special resolution passed at
a separate meeting of the holders of the issued shares of that
class:
(a) if provision with respect of such variation is contained in
the memorandum or articles of the company, or
(b) in the absence of any such provision in the memorandum or
articles; If such variation is not prohibited by the terms of
issue of the shares of that class.
The variation referred to in this section is variation affecting the
interest or right of any class of shareholders. In case the variation
is to the advantage of any class it is not expected that anyone
belonging to the class of shares shall have objection. As such,
the presumption is that where a variation involves the curtailment
of the rights of any class or classes of shareholders, the consent
or sanction of such class or classes will be necessary. In re
Hindustan General Electric Corporation [(1959) 29
Com.Cases 144] it was held that a variation which merely affects
the enjoyment of a right without modifying the right itself does
not come within the scope of Sec. 106. In re Saltdean Estate
Co. Ltd [(1968) 3 All E.R. 829] it was held that repayment of
preference shares in terms of conditions attached to the issue of
preference shares was not a variation of rights. Similarly
increasing the voting power of the equity holders by issue of
‘right’ or bonus shares does not affect the rights of the preference
shareholders. As such no application lies even though the
importance of the preference shareholders in relation to total
capital may be decreased.
In case the variation is due to a scheme under Sec. 391
(arrangement with creditors) or Sec. 394 (amalgamation or
absorption), Sec. 106 is not applicable.
One of the defects of Sec. 106 is that it does not require any
notice to be served on the shareholders of the class whose rights
are affected. It only prescribes that 3/4th of the shareholders of
that class in a meeting have to approve the variation. Variation
in India includes cancellation and as such a company cannot
cancel a class of share without following the provision prescribed
in Sec. 106.
Remedy available to the minority holders
Sec. 107 provides for the protection of the interests of the
minority shareholders of the class of shareholders the rights of
whom are affected due to variation of rights by the company.
The minority holders holding not less than 10% of the issued
shares of that class may apply to the court to have the variation
cancelled. Where an application is made under this section the
variation shall not have effect unless and until it is confirmed by
the Court. This application is to be made within 21 days from
the date of the consent being taken or the resolution being
approved for the alteration. On such application the Court shall
hear all interested parties and decide as to whether the variation
would unfairly prejudice the shareholders of the class
represented by the applicant or not. The decision of the Court
shall be final and within 30 days from the date of the order, a
copy of it shall have to be forwarded to the Registrar. In re
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Suburban and Provincial Stores [(1943)1 All ER 342] where
an applicant filed an application challenging the variation, the
court held that he has to show that he was authorised by the
required percentage of dissenting shareholders.
Variation can be effected therefore, in two ways, viz., (a) by
consent given by three fourth of the class of shareholders or (b)
by a resolution passed in the meeting with three fourth majority.
The "Variation" is effective as soon as any of the above takes
place. It can, of course, be stayed if an application is made
preventing the variation within 21 days from the day of the
consent or resolution passed in the meeting. In Sitaram Reddy
v. Bellary Spg. & Wvg Co. Ltd. [(1984) 56 Comp. Cas 281] it
was observed that a resolution, which is not passed by the three
fourth majority as required under Sec. 106, cannot be acted upon
by the company.
7.5 REDUCTION OF SHARE CAPITAL
One of the cardinal principle of corporate finance is that capital
once formed cannot be reduced because of representation to
investors and creditors. Replacement of one form of capital by
another is permissible but not the reduction. Under the
Company’s Act the following types of reduction of capita is
allowed:
(a) Reduction of Preference Shares : According to Sec. 80(1)
a company may issue redeemable preference shares if so
authorised by the articles. According to Sec. 80(3)
redemption shall not result into reduction of the authorised
capital. In order to replace the amount of capital in place of
the preference shares redeemed, either a fresh issue of capital
is necessary or a part of the undistributed profit can be
transferred to a Capital Reserve in order to redeem the
preference shares. The whole procedure has already been
discussed earlier. It is sufficient to note here that the
authorised capital of a company cannot be reduced though
one form of capital may replace another. As such, either a
new issue is necessary or profit has to be capitalised in order
to redeem preference shares. This type of reduction does
not require the procedure laid down in Ss. 100-103.
(b) Cancellation of shares: A limited company having share
capital, if authorised by its articles, may alter the condition
of the memorandum in so far as diminishing the amount of
share capital by cancellation of shares not taken or agreed
to be take by any person. This is an instance of decrease of
capital but according to Sec. 94(3) not a reduction of share
capital within the meaning of the Act.
(c) Forfeiture of Shares: If so authorsed by articles a company
may forfeit shares on account of non payment of calls, as
already been discussed earlier. Unless the forfeited shares
are reissued the capital is reduced though according to the
Act, this is not deemed as the reduction of share capital.
(d) Reduction of Capital : A company can reduce its share
capital according to Sec. 100 & 101 if:
(i) the company is either limited by shares or guarantee;
(ii) it is so authorised by the articles;
(iii) a special resolution is passed to this effect;
 (iv) a court order confirming the reduction is obtained; and
(v) a certified copy of the court order is given to the
registrar for registration.
Reduction of capital may be in any of the following ways:
(a) extinguish or reduce the liability on any of its shares in
respect of share capital not paid up;
(b) either with or without extinguishing or reducing liability on
any of its shares, cancel any paid up share capital which is
lost, or is unrepresented by available assets;
(c) either with or without extinguishing or reducing liability on
any of its shares, pay off any paid-up share capital which is
in excess of the wants of the Country.
Why is Capital required to be reduced:
A company’s capital may be wasted on account of different
reasons, say for example:
1) A capital intensive industry requiring a long gestation period
may have taken a longer period than anticipated. As a result,
losses continued to accumulate which is shown as an asset
in the company’s books of account but really stands for
capital wasted.
2) A company with inadequate working capital may be
compelled to not utilising the installed capacity and remain
much below the break-even point resulting in sickness and
wasting capital.
3) If a company continue to under-depreciate its assets thereby
artificially jacking up the profit, the capital may be wasted
by paying dividend not actually out of profit.
4) Inefficient management may resort to window-dressing in
the accounting practice in order to cover up the inefficiency.
As a result. the capital is wasted firstly by showing asset
with no real worth and secondly paying dividend actually
from capital;
5) Due to technological change, manufacturing assets of any
company may become useless and with outdated production
technique it is unable to compete with other industrial units.
As a resplt, suddenly its assets may be required to be reduced
resulting into wasting of capital.
In many cases a sick industry before BIFR finds any or many of
the above reasons making its asset-liability position highly tilted
in favour of liabilities. Assets are built up some worthless; some
with some worth, some doubtful and yet some nonrealisable.
Similarly liabilities may be understated. The reason may be
longer gestation time, inefficient management, or acute under
capitalisation resulting into shortage of working capital. Over a
period of time, the asset-liability equation is disturbed and the
book figures become simply an eye-wash and window dressing.
In such a case, the first task is to prepare a scheme of
reconstruction through which -
(a) capital is reduced by making the size of it actually
representing the real worth, and
(b) liability of secured and unsecured creditors reduced by
agreement.
The amount thus available is 'offset' by:
i) reducing assets to real-worth:
ii) writing off all fictitious, doubtful and unrealised assets; and
iii) writing off all accumulated loss.
The financial statement then is brought to the line of actual worth
at the ground level. The scheme, thereafter, contains ways of
finding capital for rejuvenating the industry and the required
working capital. In fact reduction of capital is attempted to
administer 'oxygen' to an acute patient as the last chance. In
order to prevent wasting of capital in a systematic manner due
to inefficient management, there is credit rating system available
in advanced countries. Professional agencies make grading by
examining the accounts of the concern. But in many cases such
a position becomes inevitable and as such, reduction of capital
is necessary.
If a company raises more capital, it has to keep a part of the
capital idle. This results in low yield on capital. This also require
reduction.
What is reduction
According to the decision in re Panruti Industrial Co. (P)
Ltd [AIR 1960 Mad 537] the expression 'reduction of share
capital' applies to all cases of reduction, whether of nominal,
issued or unissued and if issued, whether paid up or not. But a
judgment of Patna High Court suggesting cancellation of illegal
allotment is a reduction of capital under Sec. 100 is unfounded
because an illegal allotment is ab initio void. (See Rupak Ltd
v. Registrar of Companies (1976) 46 Comp. Cas 53].
Surrendering shares to the company by way of settlement of a
dispute or for any other reason, is a reduction. But share
transferred to a nominee of the company is not reduction of
capital. In re Castigloane's Will Trusts [1958) 28 Comp. Cas
365] it was observed that shares bequeathed to the company
will be reduction of capital.
Procedure of reduction
Reduction of share capital can be one in case of existence of
some a priori conditions. These are as stated in Sec. 100: (a)
the company must be limited by share or guarantee and (b) the
articles must provide the power of reduction. In re Dexine
Patent Packing & Rubber Co [1903 W.N. 82] the
memorandum of the company provided the authority. The court
held that it was of no consequence. The 'articles' have to provide
the authority. If it does not, if has to be altered first.
Once these a priori conditions exist, the company has to pass a
special resolution in order to reduce the capital in any manner
as mentioned earlier. Ss 101, 102 & 103 which provide the
detailed procedure as:
(1) A petition is to be made to the court for obtaining a
confirmatory order.
(2) Every creditor of the company is entitled to object to the
reduction.
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(3) A list of these creditors shall be prepared and the court may
publish notices fixing a day or days to creditors not enlisted
for enlistment.
(4) A creditor in the list on dissenting the reduction, the court
may dispense with his consent if the company secures the
payment of the creditor.
(5) Having regard to some special circumstances the court may
direct enlistment of creditors but securing payment in case
of objection shall not apply.
(6) If the court is satisfied that either the consent of the creditors
is taken or the debt is discharged or made secured, the court
may make an order confirming the reduction on such terms
and conditions as it thinks fit.
(7) Where the court makes the order, the company has to add
to its name as the last words thereof, the words 'and reduced'
until expiration of the period for which the order is made.
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(8) Where the company makes such orders the company has to
give proper information to the public by publishing
information as to the reduction of capital and the
circumstances leading to such reduction.
(9) The Registrar on production of a copy of the court order
confirming the reduction and a certified copy to be delivered
to him, shall register the order and minutes of the meeting
as approved by the Court.
(10)On such registration the memorandum of the company shall
stand altered.
In Scotish Insurance Corporation v. Wilsons & Clyde Co.
Ltd [(1949) 1 All E.R. 1068], it was held that in the case of
reduction of capital 'the task of the Court is not only to see that
the procedure by which reduction is carried through is formally
correct and that the creditors are not prejudiced but it has the
further duty of satisfying itself that the scheme is fair and
equitable between the different classes of shareholders'.
8. CASE LAW
Canara Bank Ltd v. Tribhuvandas Jath Bhai & another [Air
1957 Trav-Co. 183]
The Canara Bank Ltd are the appellants in this suit for money
due from defendants 1 & 2. The bank claimed a paramount lien
over some shares of a company (deft. 3) in their name. The
Company also wanted to exercise its right of lien over these
shares for amount due to it from defendants 1 & 2. The shares
were in the possession of the defendant 3 i.e. the company. The
trial court held that the 3rd defendant who was in prossession of
these shares had a prior charge over that of the plaintiff.
On appeal, the Court quoting from Palmer's Company Law (19th
Edn. P. 134) held, "A Company has, prima facie, no lien on the
shares of members; but the Articles may, and usually do provide
that the company shall have a paramount lien on the shares of
each member for his debts and liability to the company, whether
matured or not. Such a provision is effective and its efffect cannot
be destroyed either by the fact that shares are brought and sold
in the open market or that they are fully paid up or because of
company's failure to obtain custody of the shares. The
controversy that has engaged the attention of courts has never
been on the existence or validity of such a lien but its availability
after notice in respect of transactions subsequent to the receipt
of the notice...... we entertain no doubt that as regards the two
heads of claim in respect of which priority is claimed before us
the Bank is entitled to succed on the basis of Art. 36 of Articels
of Association of the Bank. Appeal allowed.
Shahzadi Begum Saheba v. Girdharilal Sanghi [AIR 1976
AP 273]
B pledged certain shares of a company with N to whom he had
to pay Rs. 54,000/-. B requested the plaintiffs to redeem these
shares from N by paying him Rs. 54,000 and to keep the shares
as pledge against the loan thus advanced to B. Accordingly, the
plaintiffs paid the money and redeemed the shares, and B
executed an instrument of pledge. As per the agreement, the
plaintiffs were to lodge the shares for transfer in their names
immediately. B was given the right to pay the amount including
the transfer fee and take delivery of all these shares within a
period of 2 years from that date. A further period of 1 year was
also given to him to take back these shares after paying the entire
amount plus 9% interest. If the amount was not paid even after
this, the plaintiffs were given the right to dispose of the shares
in open market at the risk and responsibility of B, after giving B
prior information of sale. The plaintiffs were also given full voting
rights on these shares. When B failed to pay the amount and
redeem the shares even after several notices, the shares were sold
off at public auction. After deducting the amount realised by the
sale of shares, the principal amount and the interest due was
sought to be recovered by the plaintiffs.
Held, that the suit transaction constituted a mortgage. In bringing
the shares to sale, the plaintiffs had only exercised their right
under the agreement and not because they were pledgees. The
main point of distinction between a pledge and a mortgage is
that the right of enjoyment of the property is not given to a
pledgee, but that right vests in a mortgage. ..... The transferees
enjoyed cetain rights with respect to the shares which were given
in their possession. Something more than mere delivery of shares
with blank forms was intended by the parties, the right to
enjoyment of the shares was bestowed on the plaintiff which is
in consistent with an agreement of pledge; and consistent with
mortgage. A mere power of sale conferred by the express terms
of the agreement between the parties does not make it a pledge
inasmuch as the right of enjoyment of the shares is also created
under the agreement in favour of the plaintiffs.
Peek v. Gurney [(1861-73) All ER rep 116]
A deceitful prospectus was issued by the defendants on behalf
of a 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 in the stock exchange. His action against the
directors for deceit was rejected.
The Court said that, "the office of a prospectus, is to invite
persons to become allottees, and, the allotment having been
completed, such office is exhausted and the liability to allottees
does not follow the shares into the hands of 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".
Needle Industries India Ltd. v. Needle Industries Newely
(India) Holding Limited [1981) 51 Comp. Cas 743]
The articles of a private company contained a clause that when
the directors decided to increase the capital of the company by
the issue of new shares the same should be offered to the
shareholders proportionately and, if they failed to take, they
may be offered to the others in such manner as may be most
beneficial to the company. The company was a wholly owned
subsidiary of an English company. Government of India adopted
a policy of diluting foreign holdings. The company accordingly
issued new shares to its employees and relatives reducing the
foreign holding to sixty percent. When Section 43-A came into
operation, the company became a deemed public company
because more than 25% of its share capital was held by a body
corporate. The company, however, chose to remain a private
company for all other purposes. The leader of the Indian 40%
holding was the chief executive and the managing director of
the company. The company was further required to reduce its
foreign holding to 40%. At this stage in the English and Indian
blocks developed a difference. The English block wanted that
the 20% reduction of their holding should be allotted to one of
the Indian companies in which they had substantial interest. A
meeting of the company's board of directors, on the contrary,
adopted the policy of issuing new rights shares to the existing
members, which the English company would not be able to
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subscribe and thereby its holding would be reduced to 40%. Under
the resolution 16 days time had to be given to the members to
take their proportion. The letter offering its proportion to the
holding company was sent only 4 days before the last date and
it received the letter after the date for exercising the option had
already expired. Similarly, the notice of the meeting of directors
for completing the allotment was sent to them with so short a
gap of time that they received it in England only on the day on
which the meeting was being held in India. Neither was it able
to exercise the option of buying its block of rights shares nor
was it able to attend the crucial meeting of the board. Its block
of shares was allotted to Indian shareholders.
The holding company complained of oppression on these facts.
But the court was not convinced that there was any such thing
as a continuous policy of oppression. The ultimate purpose of
the scheme was Indianisation to the extent of 60%. This could
be achieved either by buying the excess holding of the English
company or by increasing the Indian shareholding. The latter
course was adopted in the interests of the company of its
opportunity of participating in the rights issue. But the facts
were such that even if proper notice was given the English
company could neither have subscribed for its proportion nor
renounced it to any one else. There was not right in the company's
articles in favour of any member enabling him to renounce his
rights shares in favour of others. In the case of a private company
there simply cannot be the right of renouncing rights shares in
favour of nominees because that would make it impossible for
the company to restrict the number of members. The real loss
suffered by the holding company was the loss in terms of the
market value of the shares which fell to its share. The market
value of the shares was much higher than their nominal value.
The allotment was at nominal value. The loss of the holding
company was the "unjust enrichment" of those whom the block
of rights shares was allotted which, but for the policy restriction,
belonged to that company. The Supreme Court accordingly held
that the Indian allottees of those shares must compensate the
holding company to the extent to which the market value was in
excess of the nominal value.
Dealing with the argument that the illegal nature of the board
meeting should itself be an indication of the repressive policy.
Chandrachud, C.J., said:
The question sometimes arises as to whether an action in
contravention of law is per se oppressive. It is said, that, "a
resolution passed by the directors may be perfectly legal and
yet oppressive, and conversely a resolution which is in
contravention of the law may be in the interests of the shareholders
and the company".
Marwari Stores Ltd. v. Gouri Shanker Goenka [AIR 1936
Cal. 327]
The defendant company had a capital of Rs. 1,92,000 divided
into 1,920 shares of Rs. 100 each. By a special resolution the
company resolved to reduce the capital to half, that is, to Rs.
95,000 divided into 1,920 shares of Rs. 50 each. In other words,
the paid-up capital was to be cancelled to the extent of Rs. 50
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each share. The petitioner, a shareholder, opposed the reduction
on the ground that there had been no loss of capital and, therefore,
the reduction was unwarranted.
The question was whether a scheme of reduction can be
confirmed only on the proof of the fact that there has been a real
loss of capital. This fact was, however, provied by the company
and, therefore, the court did no hesitate in confirming the scheme
but cited with approval the opinion of Lord Macnaghten, in Poole
v. National Bank of China Ltd., [(1904-7) All ER Rep 138]
where he said: "The condition that gives jurisdiction is not proof
of loss of capital or proof that capital is unrepresented by any
available assets or that capital is in excess of the wants of the
company. The jurisdiction arises whenever the company seeking
reduction has duly passed a special resolution to that effect",
Life Insurance Corporation of India v. Escorts & Others
[(1986) 59 Com. Cas 548]
In this case, several principles relating to shares and their transfer
have been laid down, as given below:
Share is movable property, with all the attributes of such property.
The rights of a shareholder are: (i) to elect directors and thus to
participate in the management through them; (ii) to vote on
resolutions at meetings of the company; (iii) to enjoy the profits
if the company in the shape of dividends; (iv) to apply to the
court for relief in the case of oppression; (v) to apply to the
court for relief in the case of mismanagement; and (vi) to apply
to the court for winding up of the company; (vii) to share in the
surplus on winding up.
A share is transferrable but while a transfer may be effective
between the transferrer and transferee from the date of transfer,
the transfer is truly complete and the transferee becomes a
shareholder in the true and full sense of the term, with all the
rights of a shareholder, only when the transfer is registered in
the company’s register. A transfer effected between the
transferror and the transferee is not effective as against the
company and persons without notice of the transfer until the
transfer is registered in the company’s register.
Until a transfer of shares is registered in the books of the
company, the person whose name is found in the register alone
is entitled to receive the dividends, not with standing that he has
already parted with his interest in the shares. However, on the
transfer of shares, the transferee becomes the owner of the
beneficial interest though the legal title continues with the
transferor the relationship of trustee and "cestui que trust” is
established and the transferor is bound to comply with all the
reasonable directions that the transferee may give. He also
becomes a trustee of the dividends as also of the right to vote.
Where the transfer of shares is regulated by a statute, as in the
case of transfer to a non-resident which is regulated by the
Foreign Exchange Regulation Act, the permission, if any,
prescribed by the statute must be obtained. In the absence of the
permission, the transfer will not clothe the transferee with the
right "to get on the register" unless and until the requisite
permission is obtained. A transferee who has the right to get on
the register, where no permission is required or where permission
has been obtained, may ask the company to register the transfer
and the company which is so asked to register the transfer of
shares may not refuse to register the transfer except for a bona
fide reasons, neither arbitrarily nor for any collateral purpose.
The paramount consideration is the interest of the company and
the general interest of the shareholder.
The only effective way the members of a company in a general
meeting can exercise their control over the directorate in a
democratic manner is to alter the articles of association so as to
restrict the powers of the directorate and appoint other directors
in their place. The holders of the majority of the stock of a
corporation have the power to appoint by election, directors of
their choice and the power to regulate them by resolution for
their removal. An injunction cannot be granted to restrain the
holding of a general meeting to remove a director and appoint
another.
When the State or an instrumentality of the State ventures into
the corporate world and purchases the shares of a company, it
assumes to itself the ordinary role of a shareholder, and dons
the robes of a shareholder, with all the rights available to such a
shareholder. There is no reason why the State as a shareholder
should be expected to state its reasons when, like any other
shareholder, it seeks to change the management by resolution
of the company.
Every shareholder of a company has the right, subject to
statutorily prescribed procedural and numerical requirements,
to call an extraordinary general meeting in accordance with the
provisions of the Companies Act. He cannot be restrained from
calling a meeting and he is not bound to disclose the reasons for
the resolutions proposed to be moved at the meeting.
The principal object of Section 29 (of FERA) is to regulate and
not altogether ban the carrying on In India of the activity
contemplated by clause (a) and the acquisition of an undertaking
or shares in India of the character mentioned in clause (b). The
ultimate object is to attract and regulate the flow of foreign
exchange into India. Parliament did not intend adopting too rigid
an attitude in the matter and it was, therefore, left to the Reserve
Bank than whom there could be no safer authority and in whom
the power may be vested, to grant permission, previous or ex
post facto, conditional or unconditional. The Reserve Bank could
be expected to use the discretion wisely and in the best interests
of the country and in furtherance of declared
Government fiscal policy in the matter of foreign exchange.
Deccan Farms and Distilleries Ltd. v. Velabai Laxmidas,
Bhanji [(1979) 49 Comp. Cas 321 (Bom)]
The petitioner had given a loan of Rs. 2,500 to a company named
D.F.D. Private Ltd., repayable on August 31, 1974, with interest
at 15 per cent per annum. The said company was converted into
a public limited company and certificate of change dated
November 19, 1973, was duly obtained from the Registrar of
Companies. The company offered 3,00,000 equity shares of Rs.
10 each to the public and received Rs. 15,00,000 on the basis of
money paid on application and on allotment in respect of the
said 3,00,000 equity shares. The company was granted
permission to list the shares on the Bombay Stock Exchange
but the said permission was withdrawn on April 26, 1975, on
account of the failure on the part of the company to fulfil the
various requirements. Out of the Rs. 15,00,000 received pursuant
to the issue of shares, the company utilised about Rs. 8,00,000
for making payments to M/s. T.I.C. for the purchase of
machinery. The managing director of the company and his
brother who was also a director of the company, were interested
in the said T.I.C. The funds of the company were frozen on a
complaint given by some of the directors of the company.
As the amount of the loan given by the petitioner was not repaid
in time. the petitioner by a letter dated September 25, 1974,
demanded repayment of the loan amount with interest and also
gave a statutory notice under Sec. 434 of the Companies Act,
1956. The company sent reply that it was trying its best, and it
would repay as soon as funds were available.
On October 28, 1974, the petitioner presented a winding-up
petition under S. 433 (e) of the Act on the ground that company
was unable to pay its debts. This petition was duly admitted and
advertised. At the hearing of the petition, the company raised
various objections. Three other petitions were also filed by other
persons for winding-up of the company on the ground that it
was unable to pay its debts, and one other petition No. 14 of
1975, was filed by a director of the company to wind up the
company on the ground that it was just and equitable to do so.
The company preferred an appeal to the High Court against the
order of winding-up.
The Court held that, in the present case there was no evidence
at all to show that the creditors were opposing the winding-up.
It is, not an absolute rule of law that the court is bound to make
an order for winding-up even when the conditions required for
winding-up exist. It is entirely a matter of judicial discretion....
There was no prospect of the company doing any business.
There was a complete deadlock among the directors. These
directors have filed a winding-up petition on the ground that it
was just and equitable that the company be wound up. The
majority of the directors did not have confidence and faith in
the managing director and another director. Large amounts had
been paid by them to a concern in which both of thern were
interested. In these circumstances, it was desirable that the assets
of the company should be protected. The object of winding-up
by the court is to facilitate the protection and realisation of the
assets of the company with a view to ensure an equitable
distribution thereof among those entitled. The winding-up order
was in the general interest of all the creditors. The appeal was
dismissed.
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9. PROBLEMS
1. B.K. Holdings (P) Ltd of Calcutta purchased some shares of crores to the shareholders. Some creditors contested the
Prem Chand Jute Mills Ltd of Calcutta. Shares were not decision. How can the company do the same?
quoted or dealt with on any recognized stock exchange. This 6. An Indian company proposes to make a EURO issue and
was an agreement sale with the vendor of the shares which seeks your advice for suggesting the steps to be taken in
provided that the price was to be the face value of Rs. 100 conformity with the present legal requirement. Give your
each, 50% of which was to be paid against the delivery of advice.
blank transfer deed duly signed by the vendor and the balance
7. In a General Body Meeting of a company, a resolution was
50% was to be paid within nine months from the date of
passed removing three directors of a company and electing
agreement. On the application of B.K. Holdings (P) Ltd, the
new ones to replace them. This representation could not be
Prem Chand Jute Mills Ltd refused to register the shares.
given immediate effect to because of the order passed by a
B.K. Holdings files a suit against the Jute Mill. You are asked
court. Later on the sitting directors moved for quashing the
by the Prem Chand Jute Mills Ltd to prepare a brief for them
resolution on the ground that the management and control of
arguing justification of the action by the company.
the company will go to the hands of the opposite parties. Can
2. Raymond Synthetics Ltd issued a prospectus inviting the resolution be quashed on this ground - decide.
applications for equity and preference shares both at a
8. A petition under Ss 397 and 398 of the Companies Act was
premium of 10%. The company did not seek permission of
filed by a member who was not acting in his own right but at
any recognised Stock Exchange for listing of the shares. You
the behest of the transferee who was not yet a registered
are the Company Secretary. The BOD wanted your opinion
shareholder. The respondents contented that, "every member
on (1) allotment of shares presuming the offer has been over-
who came before the court must have a grievance, either that
subscribed; (2) what would have happened if the company
he has been oppressed or that the company is being conducted
applied for listing before the Issue of prospectus; (3) Suppose
in a manner prejudical to the interests of the company. This
the company proceeds to allot the shares, can the company
grievance must be a personal grievance of a member. It cannot
retain the oversubscribed amount?
be a vicarious grievance, a grievance of his beneficiary". Is
3. A company refuses to register the name of three companies this contention valid? Decide.
purchasing shares equal to about 6% of its total shares on the
9. Charles is a director of Panorama Development and has just
plea that these three companies are all controlled by only
received a letter from Prestown Council informing him that
one person, M and it is against the interest of the company to
the company has been awarded a contract worth Rs. one
register these three companies as its members. About 75%
million to build the new Preston Polytechnic. He carelessly
of the shares of that company are held by LIC, IFC, IDBI,
leaves this letter on his desk. Florence, the office cleaner,
ICL and UTI. An application is made against the decision to
reads the letter when she is cleaning the office that night, and
CLB. Prepare a list of arguments for and against. Give your
informs her husband Jack of the contents of the letter. Jack
decision as well, with reasoning.
decides to invest Rs.500 in the shares of Panorama
4. A HUF purchased a few shares of Vickers Systems Development. When the news of the contract is announced,
International Ltd. But the company refused to register in the the shares of the company increase in value by 50p. Discuss
name of HUF represented by its Karta, K. The company’s if the SEBI regulations on Insider Tradings have been
plea is that HUF is not a judicial body and a legal entity and violated.
the transfer deed executed by in favour of the HUF
10.Finlex Ltd. is a company specialising in property development
represented by it is not a valid transfer deed because a
and it needs to acquire new land. It is also the subject of a
company cannot take notice of any trust on its register of
take-over bid by Essel Ltd. The take over is opposed by all
members. Critically examine the arguments of the company
directors of Finlex except Mr. Menon. Kanchan Ltd. wants
and give proper advice to the BOD of the company.
to acquire a shareholding interest in Finlex, but lacks sufficient
5. (a) St. James Court Estates Ltd. wants to redeem its funds to do so.
preference shares to the tune of Rs. 6 crores. But creditors
An agreement is reached whereby Finlex purchased land
of the company threaten to take the matter to the Court
owned by Kanchan Rs. 10 million, and the directors of
on the plea that such an act amounts to reduction of
Finlex were to allocate to Kanchan 1 million shares of Rs.
capital. Decide.
10 each. Kanchan pays for these shares from the proceeds
(b) A shareholder holding 1000 shares in the company left a of the sale of its land. All the cheques for the transaction
will on the death gifting all these shares to the company pass through State Bank of India, the manager of which is
itself. A creditor contested the transfer on the plea that it assured that Finlex funds are not being misapplied.
amounts to ‘acquiring of own shares’. Decide. Mr. Menon resigns and is paid Rs. 2,50,000 as compensation.
(c) A company raised a capital of Rupees 100 crores but Essel discovers that the land acquired by Finlex is really
found that presently the company can use only 50 crores. valued only at Rs. 2.5 million. Discuss the lawfulness of
The company passed a resolution to refund Rupees 50 these actions.
[Note: Specify your Name, I.D. No. and address while sending answer papers]
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10. SUPPLEMENTARY READINGS
1. Companies Act, 1956.
2. Gupta, B.K.S., Company Law; 2nd edn: 1990 Eastern Law House. London.
3. Gower, L.B.C., Principles of Modern Company Law, 5th edn: 1992, Sweet and Maxwell Ltd., London.
4. Kim-Lane Scheppele, ‘It’s Just Not Right’: The Ethics of Insider Trading; Law and Contemporary Problems Vol. 56 (Summer
1993) p. 122.
5. Ramaiya, A., Guide to the Companies Act, 11th edn (rep.): 1991 Wadhwa & Co. Pvt. Ltd., Nagpur.
6. Sen, S.C., New Frontiers of Company Law, 1 edn (rep): 1971, Eastern Law House, Lucknow.
7. Shah, A.L. Lectures on Company Law, 19th edn: 1990. N.M. Tripathi Pvt. Ltd., Bombay.

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 Master in Business Laws

Corporate Law

Course No: III

Module No: VII

Monopolies & Restrictive Trade Practices

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in

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Materials Prepared by:
Dr. P.C. Bedwa
Mr. Sudhir Kumar
Materials Checked by:
Ms. Sudha Peri
Materials Edited by:
Prof. N. L. Mitra

© National Law School of India University

Published by:
Distance Education Department
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.

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 INSTRUCTIONS

MRTP Act has given new dimension to the economic legislation of the post-Independent era.
This enactment imbibes social and economic philosophy enshrined in the Directive Principles
of State Policy contained in the Indian Constitution, which lays down that the state shall
strive to promote the welfare of the people by securing and protecting as effectively as it may,
a social order in which justice - social, economic and political, shall inform are the institutions
of the national life, and the state shall, in particular, direct the policy towards ensuring that
the ownership and control of the material resources of the community are so distributed as
best to subserve the common good and that the operation of the economic system does not
result in the concentration of wealth and means of production to the common detriment. The
state policy has to ensure economic and industrial growth consistently with reduction in
concentration of wealth and economic power. While the growth factor has to be taken care of
by the state, the MRTP Act is designed to take care of the second important aspects of economic
growth, namely, the benefits of growth should belong to the public at large and not merely to
a handful of industrial houses. The three declared objectives of the MRTP Act. 1969 as
envisaged are - (1) that the operation of the economic system does not result in the concentration
of economic power to the common detriment. (2) for the control of monopolies, and (3) for
the prohibition of monopolies and respective trade practices and for the matters connected
therewith or incidental thereto. The Act has been amended number of times keeping in view
the need of the society and after the amendment of 1991 the following objects are intended to
be achieved:

1. Controlling monopolistic trade practices (section 31 & 32).

2. Controlling restrictive and unfair trade practices (section 33 to 41).
3. Making provision for registration of agreements relating to restrictive
trade practices (section 33 to 36).
4. To regulate unfair trade practices (section 36A to 36E).
5. Control of certain restrictive trade practices (section 37 to 41).
Now the emphasis has shifted to controlling and regulating the monopolistic,
restrictive and unfair trade practices rather than making it necessary for certain undertakings
to obtain prior approval of the Central Government for expansion, establishment of new
undertakings, merger, amalgamation, takeover, etc.

In this module you are required to study the law as it works and how the MRTP Commission
and the judiciary reacts towards achieving the goals set by the Constitution in the light of the
above objectives. It would be helpful if you could read a good commentary on the Act so that
you can have a good analytical basis of the Act as it originally was and as it is now and the
effect cause and of the repealed provisions of the Act, as also the importance of the MRTP
Act in the light of liberalization and globalization.

N. L. MITRA
Course Coordinator

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 MONOPOLIES & RESTRICTIVE TRADE PRACTICES

TOPICS

1. Introduction .................................................................................................................. 284

2. MRTP Commission ...................................................................................................... 286

3. Concentration of Economic Powers ............................................................................ 295

4. Monopolistic Trade Practices ..................................................................................... 297

5. Restrictive Trade Practices & Unfair Trade Practices .............................................. 299

6. Offences & Penalties ...................................................................................................... 312

7. Case Law ......................................................................................................................... 314

8. Problems ......................................................................................................................... 315

9. Supplementary Readings .............................................................................................. 316

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1. INTRODUCTION
SUB-TOPICS
1.1 History of MRTP Legislation in India
1.2 Enactment of MRTP Act, 1969
1.1 THE HISTORY OF THE MRTP LEGISLATION IN
INDIA
The problem of concentration of economic and monopolistic
power is an economic phenomenon, which transcends the
borders of economics, and assumes significant importance in
the realms of politics, and jurisprudence.
The earliest writing in India on this subject was by Mahatma
Gandhi himself, when writing in the newspaper Young India on
23-3-1921, he wrote that: “What India needs is not the
concentration of capital in a few hands, but its distribution so as
to be within easy reach of the 7 1/2 lakhs of villages that make
this continent 1900 miles long, and 1500 miles broad”. Again
he wrote in the news paper Harijan on 22-6-1938 to say that “I
can have no consideration for machinery which is meant to enrich
the few at the expense of the many”. Again on 2-11-1934 in the
same paper, he wrote “I hate privilege and monopoly. Whatever
cannot be shared with the masses is taboo to me”. On 28-7-
1946, again in “Harijan”, he wrote that “Nor would there be
any room in his picture of Indian independence for machines
that would concentrate power in a few hands”. Therefore, as a
political and economic thinker and philosopher, Gandhiji was
influenced by the implication of machinery and large scale
production on social justice. From this concern arose his theory
of Trusteeship, whereby he invited the capitalist to regard himself
as a trustee for those on whom he depends for the making, the
retention and the increase of his capital. He was prepared to
advocate the implementation of measures to make the rich to
change their attitude, and to become trustees in the public
interest, instead of continuing as exploiters, and to trusteeship a
statutory form, and make it a legalized institution through the
process of an appropriate legislation.
However, the visionary that Mahatma Gandhi was, he wrote the
following prophetic paragraphs in “The Modern Review”,
October, 1935:
“I look upon an increase in the power of the State with the
greatest fear, because, although while apparently doing good
by minimizing exploitation, it does the greatest harm to mankind
by destroying individuality which lies at the root of all progress.
“The State represents violence in a concentrated and organized
form. The individual has a soul, but as the State is a soulless
machine, it can never be weaned from violence to which it owes
its very existence.
"It is my firm conviction that if the State suppressed capitalism
by violence, it will be caught in the coils of violence itself, and
fail to develop non-violence at any time.
What I would personally prefer, would be not a centralization
of power in the hands of the State, but an extention of the sense
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of trusteeship; as in my opinion, the violence of private
ownership is less injurious than the violence of the State.
However, if it is unavoidable, I would support a minimum of
State-ownership.
"What I disapprove of is an organization based on force, which
a State is. Voluntary organization there must be”.
Similarly, in his later writings, Gandiji’s thoughts came closest
to practical economics. He conceded the place of machines,
electric power, large industries, individual initiative, and key
industries in the economy, but he subjected his acceptance of
these realities to several severe conditions, and his twin concepts
of “Sarvodaya” and “Trusteeship”.
He felt that machines must not deprive people of employment,
they must not exploit the villages or compete with village crafts,
they must help the village artisan to reduce his drudgery and
improve his efficiency, but they should not tend to make
atrophied the limbs of man. They must not lead to monopoly or
concentration of wealth-power in a few hands, and they must
not lead to exploitation, either national or international. And,
when the machines involve large capital or large number of
employees, they must be owned by the State, and administered
wholly for the public good.
With “Satyagraha” as the means and socialism as the objective
to be achieved, Gandhiji offered an alternative to the class war
and proletarian dictatorship as the means for achieving western
kind of socialism. His goal was “Sarvodaya”, the welfare of
all; and this included not only the humble, the lowly, and the
lost, but also the capitalist and the landlord, if they forswear the
use of capital and land for their personal ends, in excess of their
basic needs. He was for a classless society based on destruction
of the classes, but not on the destruction of the individuals who
constitute the classes, a system of production that does not fail
to make use of science and technology for creating an economy
of abundance, but does not in the process either kill individual
initiative or freedom for development, and a system of
distribution that will ensure a reasonable minimum income for
all and, while not aiming at a universal equality of an arithmetical
kind, will nevertheless ensure that all private property or talent
beyond the minimum will be used as a trust for the public good
and not for individual aggrandizement, and a social order where
all will work but there is no inequality, either in status or in
opportunity for any individual.
While the concepts of “Monopoly” and “Concentration of
economic power” as well as “Restrictive Trade Practices” have
been present in Western Economic Thought and jurisprudence
for more than two centuries, these words and phrases started
acquiring a meaning, relevance, and importance in India only
in the twentieth century. After Mahatma Gandhi’s political and
economic thoughts on this subject came to be widely discussed
and debated during the period between the two World Wars, the
first substantive Economic theorization on this subject was
provided by Sri Ashoka Mehta in the late 1930s and early 1940s.
Immediately after India attained independence on August 15,
1947, at the political level, the then Prime Minister Sri Jawahar
Lal Nehru himself chaired the Economic Programme Committee
of the Indian National Congress, and its 1948 report
recommended the establishment in India of an “economic
structure which will yield maximum production without the
operation of private monopolies and the concentration of
wealth”. This report of the Economic Programme Committee
of the political party in power then provided the basis for the
first Industrial Policy Resolution of the Government of India,
adopted on April 6, 1948, which laid down the major policy
objectives to be pursued by the Government in the field of
industry and industrialization, and propounded the theory of
imposing social control on private economic activity, and
promoting the desired goal of the prevention of concentration
of economic power. Even at this stage, there was no clarity of
thought and perception as to how to go about imposing social
control on private economic activity, and as to the nature of
legislative framework required for this purpose.
1.2 ENACTMENT OF MRTP ACT, 1969
The first definitive parameters of the philosophy of the Indian
State were provided by the Constitution of India, which came
into force on January 26, 1950. The preamble to the Constitution
mentioned “social and economic justice” as one of its declared
objectives, and two of the Directive principles, contained in
Articles 38 & 39, require the State Policy to be directed towards
securing the political and economic philosophical objectives
earlier propounded by Mahatma Gandhi in his writings, that (i)
the ownership and control of the material resources of the
community are so distributed as best to subserve the common
good, and that (ii) the operation of the economic system does
not result in the concentration of wealth and means of production
to the common detriment. Still the picture as to how and to
what extent the Indian State would intervene by way of regulation
of the economic processes to achieve these objectives was not
clear. Even the First Five Year Plan launched on 1st April,
1951, did not lay down the nature and extent of State intervention
in this field.
In December, 1954, the Parliament of India adopted the
socialistic pattern of society as the objective of its social and
economic planning. This was followed soon by the Second
Industrial Policy Resolution of the Government of India, adopted
on 30th April, 1956, replacing the first (1948) resolution. This
Second Industrial Policy Resolution specifically emphasized the
policy of prevention of private monopolies and concentration
of economic power in different fields in the hands of a small
number of individuals, but stopped short of suggesting the
modalities for such policy interventions.
The industrial progress achieved by the end of Second Five Year
Plan (1956 - 61) showed that in the time period of the two five
year plans, the national income had increased by around
42 percent, and the per-capita income had increased by a lower
percentage of only 20 percent. Around the same time, the
Industrial Licensing Policy Inquiry Committee (widely known
as the Hazari Committee), chaired by professor R. K. Hazari of
the Bombay University, submitted its report in July 1960, and
came to the conclusion that the benefit of the industrial licensing
procedure had gone only to a few business houses, and this had
resulted in their disproportionate growth. As a result, when the
Prime Minister Sri Jawahar Lal Nehru presented on August 22,
1960, the draft outline of the Third Five Year Plan, he
volunteered to get an enquiry conducted about who had
benefitted from the additional income generated in the country
as a result of the first 9-10 years of planned economic
development, and to appoint an expert committee for this
purpose.
As a follow up action on the commitment given by the Prime
Minister, in October 1960, the Planning Commission appointed
an expert committee under the Chairmanship of Prof. P. C.
Mahalanobis, which was known as the “Committee on
Distribution of Income and Levels of Living”, which submitted
its report in February, 1964. In pursuance of the report of
Mahalanobis Committee, in April, 1964, the Government of
India appointed a five member “Monopolies Enquiry
Commission” under the Chairmanship of Justice D. C. Das
Gupta, a sitting Supreme Court Judge. This commission gave
its report in October, 1965.
Consequently, the Monopolies and Restrictive Trade Practices
Act was passed by both the houses of parliament on May 28,
1969 and it was notified later on 30th May, 1970 to come into
force from June 1, 1970.
The Monopolies and Restrictive Trade Practices Commission
(MRTP Commission), which was envisaged to be established
under the Act, was later constituted by a Government notification
dated August 1, 1970, on which date the first Chairman of the
Commission was administered the oath of office and secrecy by
the President of India, the other two members being sworn in
later on August 6, 1970.
In the first 6-7 years of implementation of the MRTP Act, certain
difficulties were encountered, and several suggestions for making
amendments in the Act were made, including some by the MRTP
Commission itself. In June, 1977, the Government appointed a
High-powered Expert Committee to examine the changes
necessary in the MRTP Act and Companies Act, 1956,
which committee was headed by Mr. Justice Rajinder Sachar,
and submitted its report in August, 1978. Recommendations
of the Sachar Committee led to the first amendments of the Act
in 1980. The MRTP Act has since been amended five more
times, in 1982, 1984, 1985, 1988 and 1991, the last amendment
being the most significant, which has retracted the position to
such an extent that the very wisdom of continuation of the rest
of the legislation now appears to be questionable and in doubt.
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2. MONOPOLIES & RESTRICTIVE TRADE PRACTICES
COMMISSIONS
SUB TOPICS
2.1 Establishment & constitution
2.2 Powers & functions
2.3 Orders
2.4 Enforcement of orders
2.5 Procedure
2.6 Officials, duties & functions
2.1 ESTABLISHMENT & CONSTITUTION
Sec. 5(1) of the Act enjoins upon the Central Government to
establish by notification a quasi judicial tribunal known as the
Monopolies and Restrictive Trade Practices Commission
comprising of a Chairman and not less than two and not more
than eight members.
Qualifications
The Chairman is to be a person who is or has been or is qualified
to be a judge of the Supreme Court or of a High Court and the
members of the Commission must be persons of ability, integrity
and standing who have adequate knowledge or experience of or
have exhibited capacity in dealing with the problems relating to
economics, law, commerce, accountancy, industry, public affairs
or administration [S 5(2)]. It is incumbent upon the Central
Government to ascertain before appointing the members that
none of members has financial or other interests which may
prejudice his functioning as a member of the Commission. So
to say a member must not be a person whose interests may come
in conflict with his duties as a member of the Commission [S
5(3)].
Terms and conditions of appointment
The term of appointment of every member of the Commission
is five years at a time, not exceeding a total period of ten years
or till he attains the age of 65 years, whichever is earlier [S.6(1)].
The Chairman & every member of the Commission before
entering upon his office, make and subscribe to an oath of office
and of secrecy in such manner and before such authority as
provided. When a Chairman or any other member ceases to
hold his office, he is debarred for a period of five years from
holding any appointment or connection with any industry or
undertaking to which this Act applies [Sec. 6(7) & (8)]. A
member may resign his office at anytime by written notice, served
on the Central Government and for that matter no period of
notice is required. Similarly the Central Government may also
remove a member on grounds of insolvency, conviction,
involving moral turpitude and physical or mental incapability.
A member may also be removed on grounds of acquiring
financial or other interests which prejudicially affect his
functioning as a member of the Commission or for having
abused his position which renders his continuance in office
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prejudicial to the public interest, but he cannot be removed by
the Central Government after a reference to the Supreme Court
is made and the Supreme Court after holding due enquiry reports
that the member should be removed on the grounds alleged against
him [S.7(1) & (2)]. The casual vacancy so caused on resignation
or removal is filled by the Central Government by fresh
appointment [S.6(3)]. When a vacancy occurs in the office of
the Chairman, the senior-most member is to discharge the
functions of the Chairman till a person is appointed and assumes
the charge of the office of the Chairman of the Commission.
Similarly when the Chairman is unable to attend to his work
owing to absence, illness or any other reason, the senior-most
member is to act as the Chairman, if he is so authorized by the
Chairman in writing and he will continue to work as such till the
Chairman resumes his duties [S.6(3-A) & (3-B)].
The acts of the Commission cannot be brought in to question
only by reason of any vacancy or any defect in its Constitution
[S.6(4)]. In re Bengal Potteries Ltd., & Allied Distributors
& Co., V MRTP Commission, [(1975) 45 Comp Cas 697]
where the issue raised was that the Commission was not validly
constituted as it had less than three members including the
Chairman at the relevant time, the court held that under Sec.
6(4) of the Act no act or proceeding of the Commission shall be
invalid by reason only of the existence of any vacancy among
the members of the Commission and further that Sec. 16(2)
provides that powers or functions of the Commission may be
exercised or discharged by the Benches formed by the Chairman
of the Commission from among the members. Provision has
been made in the Act itself for contingencies when the Chairman
or some of the members may not be available, either because
one of them resigned or retired or because some members are
on leave or busy else where [DGIR v. Cement Mfrs. Assn.
(1991 71 Comp Cas 46 (MRTPC)].
There is specific provision u/s 16(2) that the functions of the
Commission are to be discharged by the Benches constituted
by the Chairman from among the members. At the same time
we can refer to Sec. 18 (1) which empowers the Commission to
regulate the procedure and the conduct of its business, procedure
of Benches and delegation of powers or functions to the
members of the Commission. MRTP (Amendment) Act, 1984
specifically classifies that any order by a member of the
Commission, under delegation, shall be deemed to be the order
of the Commission.
Remuneration
The remuneration and other allowances of the Chairman of the
Commission and other members shall be governed by such rules
and conditions of services which have been prescribed in the
MRTP Commission (Conditions of Service of Chairman and
Members) Rules, 1970. The remuneration and allowances of
the Chairman or any members of the Commission cannot be
reduced or varied to his disadvantage after their appointments
[S.6(5)].
Sittings of the Commission
The Central office of the Commission is in Delhi. But the
commission can hold its sittings at any place in India and at
such time as may be most convenient to the Commission in
exercise of its functions. Its powers and functions may be
exercised by Benches which can be formed by the Chairman
among the members [S.16].
Hearing before Commission
Generally the proceedings before the Commission are held in
public. But where for some reason, like the confidential nature
of the offence under enquiry, it is necessary to maintain secrecy,
the Commission is competent to -
(a) order that the proceedings, or any part of it, shall be in
camera;
(b) give necessary directions to the persons present there;
(c) prohibit or restrict the publication of evidences given before
the Commission (whether in public or private) or of matters
contained in documents filed before the Commission [S.17].
Members, etc., to be public servants
Every member of the Commission, the Director General and
every member of the staff of the Commission, and of the Director
General, shall be deemed, while acting or purporting to act in
pursuance of any of the provisions of the Act, to be public servant
within the meaning of Sec. 21 of the India Penal Code, 1860.
Protection of action taken in good faith
No suit, prosecution or other legal proceedings shall be against
the Commission or any member, officer or servants of the
Commission, the Director General, or any member of the staff
of Director General in respect of anything which is in good faith
done or intended to be done [S.64 (1)].
2.2 POWERS & FUNCTIONS
(1) Power of Inquiry
The Commission has been vested with powers of a Civil Court
under the Code of Civil procedure, 1908. These powers shall
be in respect of the following matters:
(a) the summoning and enforcing the attendance of any witness
and examining him on oath;
(b) the discovery and production of any document or other
material object producible as evidence;
(c) the reception of evidence on affidavit;
(d) the requisitioning of any public record from any court or
office;
(e) the initiating of any Commission for the examination of
witnesses.
These powers of the Commission as aforesaid are the same as
those of a Civil Court, and through any regulation or otherwise
the Commission cannot enlarge those powers over those of the
Code of Civil Procedure, 1908 [In re Atul Products, RTPE
No.24A of 1974; PRTA V. Escorts Ltd., RTPE No.87 of 1975].
Above mentioned powers u/s 12(1) have been conferred on the
Commission for the purpose of any inquiry under the Act and
the provisions of the Civil Procedure Code in relation to the
matters referred to in this Sec. are -
(a) Summoning & examination of witnesses: Sec. 31 & Orders
16 & 18
(b) Discovery & production of documents : Orders 11 & 13
(c) Proof of Affidavits : Order 19
(d) Summoning records from Courts : Orders 13 & 16
& Public Offices
(e) Issuing Commission for : Order 26
examination of witnesses
Though the Commission has the powers of a Civil Court, but it
is not strictly bound by the rules of evidence provided in the
Indian Evidence Act. Under Sec. 18(1) Commission is vested
with the power to regulate the procedure and conduct of its
business. Therefore opinion evidence may be produced,
particularly in the case of expert witnesses and exchange of
evidence by way of affidavits between parties may be permitted
by the Commission so that at the hearing proof need be adduced
on the contested facts alone. Likewise, the Commission may
frame issues after endeavouring to arrive at the agreed or proved
facts. The procedure that may be followed by the Commission
in conducting inquires under the Act, is regulated by the MRTP
Regulations framed by the Commission under Sec. 66 of the
Act (empowers the Commission to make regulations for the
efficient conduct of its functions under the Act) and the
provisions of the Civil Procedure Code, would apply to the extent
provided in the regulations.
Sec. 12(1) refers to the powers as are vested in a Civil Court
under the Civil Procedure Code and Sec. 12(2) provides that
any proceeding before the Commission shall be deemed to be a
judicial proceeding for purposes of punishment in case of false
evidence or contempt committed by way of insult or interruption
of its proceedings within the meaning of Sec. 193 and 228 of
the Indian Penal Code and that the Commission shall be deemed
to be Civil Courts for the purposes of Sec. 195 and chapter 35
of the Criminal Procedure Code, 1973. It means that the
proceedings before the Commission shall be judicial
proceedings for the limited purpose of empowering the
Commission to award punishment as provided in Sec. 193 of the
Indian Penal Code.
Sec. 12(3) confers special powers which are not available to Civil
Court. The powers, however circumscribed in as much as it has
been related to ‘trade practice’. A ‘trade practice’ becomes subject
matter of examination only when it is in the nature of
monopolistic, restrictive or unfair trade practice. Hence the
provisions of Sec. 12(3) are applicable only for inquiries under
the Act pertaining to the above matters. The power of
examination of trade practice is exercisable by the Commission
for investigation also, before formal enquiry is instituted [In re
Nylon Filament Yarn Case, (l975) 45 Comp Cas 646
(MRTPC); In re Indian & Eastern News Papers Society, (l976)
46 Comp Cas 165 (MRTPC)].
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The authority of the Commission u/s 12(3) is confined to require
any person:
(a) to produce such books, accounts or other documents in the
custody or under the control of the person so required as
may be specified or described in the requisition.
The documents required to be produced shall relate to any trade
practice, the examination of which may be required for the
purposes of the MRTP Act. The books or documents are
required to be produced before an officer of the Commission in
this behalf. The officer may examine and keep these books or
documents.
(b) to furnish such officer with such information as may be
specified by the Commission in respect of the alleged trade
practice or such other information as may be in his
possession in relation to the trade carried on by any other
person.
Commission has been empowered u/s 12(4) to enforce the
attendance of witnesses and for this purpose the jurisdiction of
the Commission extends to the whole of India including Jammu
& Kashmir though the other provisions of the Act are not
applicable to this State since there is no exclusion to such effect
Sec. 16(4) Codes:
“For the purpose of enforcing the attendance of the witnesses
the local limits of the Commission’s jurisdiction shall be the
limits of the territory of India”
During the enquiry under the Act, if the Commission has grounds
to believe that the owner of the undertaking in respect of which
enquiry is being made if required to produce certain books,
orders etc., may destroy, mutilate, alter, falsify or secrets,
Commission by written order may authorize any officer of the
Commission to exercise the powers of entry, search and seizure
of the books or papers [S.12(5)].
(2) Power to grant temporary injunction
Sec. 12-A of the Act empowers the Commission to grant
temporary injunction during the course of inquiry relating to
any monopolistic, restrictive, or unfair trade practice. Such an
order granting temporary injunction can be passed by the
Commission only after an enquiry has been instituted under the
Act. The object of the injunction is to prevent any resort to
monopolistic, restrictive or unfair trade practices. Such an
injunction was issued in Director General of Investigations
& Registration v. Truck Union [(1988) 63 Comp Cas 340
(MRTPC)] against operators who were trying to impose higher
freight rates in their operation in mines. The Commission can
pass the injunction order, if it is proved, by way of an affidavit
or otherwise, that the person or undertaking or any person is
carrying on, or is about to carry on, any monopolistic or any
restrictive or unfair trade practice which is likely to effect
prejudicially the public interest or the interest of any trader,
class of traders or traders generally or of any consumer or
consumers generally [See A.K.K.Nambiar v. Union of India,
AIR 1970 SC 652; DGIR v. Cement Manufacturers
Association, (1991) 71 Comp Cas 46]. For the purposes of this
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function the Commission has been vested with the same
powers as are enjoyed by a Civil Court under Rules-2-A to 5,
Order XXXIX of the first Schedule of the Code of Civil
Procedure. The Commission has been empowered u/s 12A(2)
to grant temporary injunction so as to prevent injuiry to public
interest or to any party. This certainly helps the cause of justice.
In this regard we can refer to the case Indo-Japan Photo Films
v.Indian Newspaper Society [(1990) 67 Comp Cas 573
MRTPC] where the Commission issued an ad interim injunction
to save the complainant from an irreparable loss. In this case
the complainant developed a dispute with his advertising agency
over poor quality service. The complainant offered a
compromise payment by means of a cheque and demanded the
return of its material if the cheque was to be accepted. The
agency did not return materials and consequently the payment
of the cheque was stopped. The agency retaliated by exercising
its power under a clause of the agreement by advising media
members not to accept any advertisement of the complainant
released directly or through any other source. The Commission
while granting ad interim injunction observed; “The rule is prima
facie violative of Sec. 33(1) (d) of the Act and is prima
facie a restrictive trade practices. If an ex parte injunction is not
issued immediately, it may result in irreparable loss to
complainant as his total advertisement and publicity would come
to a stand still”. The operation of Rule 56 of the rules and
regulations framed by the Indian News Paper Society enabling it
to impose embargo on advertisements of the complainants was
stayed [see Indo-Japan Films Co.Ltd. v. Indian News Paper
Society Ltd., (1990) 68 Comp Cas 134 MRTPC; DGIR v. Nalli
Silk Traders, (1988) 63 Comp Cas 44 MRTPC; DGIR v.
Kamlesh Thapar, (1988) 84 Camp Cas 109 MRTPC; Avtar
Singh, , pp 31-32].
(3) Power to award compensation
Sec. 12 B (1) says that where any monopolistic, restrictive or
unfair trade practice had caused damage to any government, or
trader or class of traders or any consumer, application may be
made to the Commission asking for compensation from the
undertaking or owner there of or the person causing the loss or
damage without prejudice to their rights to institute a suit for
the recovery of any compensation for the loss or damage so
caused. The amount of compensation for the loss or damage so
caused is to be determined by the Commission : It is significant
to note that Central or State government is not empowered to
apply for grant of a temporary injunction as per the reading of
S 12 A(1) but they can still apply for award of compensation
under Sec. 12(B)(1). It therefore appears that before the
Commission awards such compensation after due inquiry, the
existence of monopolistic trade practice must be established by
the Commission’s findings, as communicated by the
Commission to the Central Government. While the Central
Government may pass orders for prohibition of a monopolistic
trade practice, the Commission may after due enquiry and
hearing, award compensation for loss or damage already s
uffered as a result of such monopolistic trade practice. It is
significant that while the Central Government may pass orders
prohibiting a monopolistic trade practice, it has to apply the
Commission for compensation for any loss or damage suffered
by it owing to such monopolistic trade practice.
Representative or class action
By Sec. 12 B (2) where numerous persons are affected by loss or
damage as referred to in Sec. 12 B (1), one or more persons
having the same interest may make a representative application,
with the permission of the Commission, on behalf of and for the
benefit of the persons so interested. For this purpose the
provision of Rule 8 of Order I of the First Schedule of the Civil
Procedure Code, 1908, would become applicable. One aspect
of the matter is worth noting that under Sec. 12 A any person
entitled to make application may apply for injunction, but u/s
12 B (1) any person who can establish loss or damage caused to
him by the resort to monopolistic, restrictive or unfair trade
practices by the defendant can file an application for damages.
But such a person is also competant to make an application u/s
12 A, for grant of an injunction for the benefit of others in public
interest.
Consideration for Compensation
In Bandana Chadha V. Sheri-Louise Slimming Centre,
[(1991) 70 Comp Cas 712 MRTPC] where a claim for
compensation arose out of slimming services which proved
injurious to the client, the Commission adopted the following
view as to the ‘concept of compensation’:
“Compensation” in Sec. 12 B is used in the sense for reparation
for the loss or damage caused. Compensation is thus a monetary
equivalent of any loss or damage and may include-
(i) the actual pecuniary loss sustained which can be quantified
with precision;
(ii) the indirect loss which nevertheless is consequential to the
alleged indulging in of an unfair trade practice, i.e., loss of
profit, loss of reputation, loss of business or loss of credit;
(iii) the mental suffering like anxiety, worry, tension;
(iv) bodily suffering like pain, illness, loss of limb etc.,
In this case the slimming service was so incompetent that a
number of ailments was caused to the client producing mental
pain, physical suffering and unfitness for work. Nobody
appeared for the side of the slimming centre to controvert the
claim. The Commission accordingly allowed Rs.4,07,110 by
way of compensation on the basis of the claim submitted by the
complainant. The Court noted that the Act nowhere provides
any suitable yardstick to measure compensation for loss or
damage envisaged under Sec. 12B. It is well settled law that all
losses or damages are not capable of being compensated. Only
those which have a causal connection with the unfair trade
practice or which are the proximate (and not remote)
consequences of an unfair trade practice are compensable [Avtar
Singh p 35; see also India Book House Re. (1989) 65 Comp
Cas 36 MRTPC].
(4) Power to find out defiance
Sec. 13-A empowers the Commission to find out by means of
investigation by Director General or by any Officer of the
Commission if any order made by it under the Act has not been
complied with. For the purpose of investigation when so
authorized by the Commission, the Director General or any other
Officer of the Commission to undertake such investigation shall
be entitled to exercise all or any of the powers conferred on the
Director General under Sec. 11 of the Act, i.e., the powers of a
Inspector under Sec. 44(2) and any order or requisition made
by a person making an investigation, shall be enforced in the
same manner as if it were an order or acquisition made by an
Inspector appointed under Sec. 240, or Sec. 240-A of the
Companies Act, 1956. Sec. 240 of the Companies Act makes it
a duty of the officer of the Company, its employees or agents to
preserve and produce books and papers relating to the affairs of
the Company to the Inspector and Sec. 240-A provides for
seizure of documents by the Inspector. On the completion of
the investigations entrusted by the Commission the Director
General or any other officer of the Commission as the case may
be shall submit his report to the Commission for such action by
the Commission as it thinks fit. At the same time it is worth
noting that no provision has been made in the Act for any time
limit within which the investigating officer is to submit his report
(Sec. 13-A(1) and (2)].
(5) Power to punish for Contempt
Sec. 13-B vests the Commission with the same power, jurisdiction
and authority in respect of contempt of itself as a High Court has
and for this purpose the provisions of the Contempt of Courts
Act, 1971 have been made applicable subject to the modification
that reference in that Act to a High Court is to be construed as a
reference to the Commission and references to the Advocate-
General in Sec. 15 of that Act are to be construed as a reference
to such law officer as the Central Government may specify by a
notification in Official Gazette [Avtar Singh, pp.40-41].
(6) Power to constitute Benches and regulate Procedure
Sec. 16(2) empowers the Chairman of the Commission to form
Benches from among the members. The powers or functions of
the Commission may be exercised or discharged by these
Benches. There is no statutory bar for conducting a proceeding
or hearing a matter by a Bench formed by the Commission with
one member of the Commission [Bengal Potteries Ltd. v.
MRTP Commission, (1975)45 Comp. Cas 697 (cal.)].
The Commission in its order in Avery India Ltd. [MTP Enquiry
No.01/75] took the view that one member can constitute a Bench
provided he is so appointed by the Chairman under Sec. 16(2)
and the Commission has assigned this position to him under
Sec. 18(1)(c).
According to Sec. 18 which empowers the Commission to
regulate its procedure, the Commission shall have the power,
to - (a) lay down regulations, for the procedure and conduct of
its business for carrying out its function, (b) the procedure to
be followed by the Benches constituted by the Commission,
and (c) to delegate its powers or functions to member subject to
any general or special direction. Sec. 18(c) states that such
member shall perform or discharge those functions in the same
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manner and with the same effect as if such powers or functions,
have been directly conferred on such member, directly under the
Act itself, and not as delegation of authority to such member,
and orders made by such member shall be deemed as orders made
by the Commission. Thus, such powers conferred by the
Commission under Sec. 18 and the functions which such
members or member is required and empowered to perform is
not a case of delegated responsibility or exercise of delegated
responsibility [Mitra, p.164].
Sec. 18(2) empowers the Commission to decide about the
participation of person or persons in the proceedings before it
[Sivakasi Chamber of Match Industries v. Western India
Match Co. Ltd., (1979) 49 Comp Cas 836 MRTPC]. The
Commission has the entire discretion to determine the extent to
which any person claiming to be interested in the subject matter
of any proceeding before it would be allowed to be present, or
to be heard either by themselves or by their representatives or
to cross-examine witnesses or otherwise take part in the
proceedings. Thus Sec. 18(2) provides the complainant with
full rights of participation in the proceedings [See In re
Ballarpur Industries Ltd. v. DGIR, Civil Writ Petition No.707
of 1986 (Delhi High Court].
(7) Power to make Regulations
Sec. 66 of the Act empowers the Commission to make
regulations for the efficient conduct of its functions under the
Act. Regulation making power may relate to matters relating -
a) the conditions of service, as approved by the Central
Government, of persons appointed by the Commission;
b) the issue of the process to the Government and to other
persons and the manner in which they may be served;
c) the manner in which the special Sec. of the register kept by
the Director General under Sec. 36 shall be maintained and
the particulars to be entered or filled therein;
d) deleted by the Amendment Act of 1984;
e) the payment of costs of any proceedings before the
Commission by the parties concerned and the general
procedure and conduct of the business of the Commission;
and
f) any other matters for which regulations are required to be
or may be, made under the Act.
Under Sec. 66(3) the Central Government shall cause every
regulation made under this Sec. to be laid, as soon as may be
after it is made, before each house of Parliament, while it is in
session, for a total period of thirty days which may be comprised
in one session or in two or more successive sessions, and if
before the expiry of session immediately following the session
or the successive sessions aforesaid, both houses agree in making
any modification in the regulation, or both houses agree that the
regulation should not be made, the regulation shall thereafter
have effect only in such modified form or be of no effect, as the
case may be; so however, that any such modification or
annulment shall be without prejudice to the validity of anything
previously done under that regulation.
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(8) Power to Compound Offences
The power is conferred on the Commission by Sec. 53-A in the
following words:
“53-A. Power to compound offence - The Commission may,
for reasons to be recorded in writing either before or after the
institution of proceedings, compound any offence under Sec.
48-C or Sec. 50 relating to contravention of any order made by
it.”
Sec. 48-C deals with penalty for contravention of the orders of
the Commission relating to unfair trade practices. Thus, the
Commission has the power to accept compounding of unfair
trade practices. This may be done either before or after the
institution of proceedings. Reasons for compounding have to
be recorded in writing.
Sec. 50 deals with the punishment for disobedience of the orders
of the Commission under Sec. 13, and punishment for
contravention of orders relating to monopolistic and restrictive
trade practices. Thus all offences relating to monopolistic,
restrictive and unfair trade practices have been made
compoundable [Avtar Sing, p.203].
2.3 ORDERS
Orders may be conditional, particular or general
Sec. 13(1) empowers the Commission to provide in the order
made by it under the provisions of the Act that it may stipulate
such condition, which are not inconsistent with the provisions
of the Act, as it may deem necessary, for the proper execution
of the order. The Commission should however, make such
stipulation or provision consistent with observance of natural
justice. The failure to comply with the obligations or stipulations
imposed on any person by the Commission shall be deemed to
be guilty of an offence under the Act punishable with
imprisonment for a term which may extend to three years, or
with fine which may extend to 50,000/- rupees, or with both,
and where the offence is continuing one, with a further fine which
may extend to 5,000/- rupees for every day, after the first day,
during which such contravention continues [S 50 (1)].
The Commission’s orders may be general in its application or
may be limited to any particular class of traders or a particular
class of trade practice or a particular trade practice or a particular
locality. Thus under this provision an order of the Commission
may prima facie appear to be discriminatory but is within its
statutory powers and such orders would not be discriminatory
of the order be in personam [Mitra p 152; S 13 (3)].
Amendment or Revocation of Orders
The Commission is empowered u/s.13 (2) to amend or vary any
order made by it in the same manner in which it was made. This
includes the scope for the Commission to make suo motu
amendment or variation or revocation of such an order already
passed by it. Such amendment or revocation etc. may also be
ordered by the Commission on an application made u/s. 13 (2)
of the Act read with Regulation 78 and the provisions of Sec.
114 and order XLVII of the Code of Civil Procedure referred to
in the said regulation. An order made by the Commission can
be amended or revoked in appropriate circumstances, i.e., when
there is any material change in the situation which was the basic
foundation of the Commission’s decision [Delhi Pipe Dealer’s
Association v. India Tube Co.Ltd. (1975) Tax LR 2034
MRTPC] or when there has been some mistake or error of fact
apparent on record, or if there is discovery of new matter or
evidence of substantial importance which despite due diligence
the applicant could not be produced by him at the hearing. Also
in the event an ex parte order is passed by the Commission on
the failure of a person to attend the hearing, if the person is able
to show that he was prevented by sufficient cause from being
present, e.g., his council was grossly negligent and/or he failed
to inform the respondent about the date of hearing whereby he
was precluded from submitting this case before the Commission,
the Commission may, in view of Regulation 15 of MRTPC
Regulations read with Order IX, rule 13 of Code of Civil
Procedure, revoke its ex parte order [In re Ramgopal
Maheshwari & Sons, (1979) 49 Camp Cas 202 MRTPC]
Though the power of the Commission to redress the grievance of
any of the parties affected by any of the orders of the Commission
is very wide but it could not be construed to be so wide as to,
permit a de novo hearing on the same material without anything
more, with a view to showing that order was wrong on facts.
This is the only limitation that could be read in Sec. 13(2), apart
from the consideration that the Commission has to exercise its
discretion judicially or quasi-judicially in exercise of its powers,
and not in an arbitrary manner. Further the Commission must be
guided by relevant considerations as may be applicable in
individual cases on merits. The fact that an appeal which lies
under Sec. 55 against the order has not been preferred, would
be no ground for refusing to exercise power under Sec. 13(2),
nor will failure to prefer an appeal be construed as acquiescence
on its part [Mahendra and Mahendra Ltd. v. Union of India,
AIR 1979 SC 798].
Also any contention of the respondent that the direction given
or obligation imposed by the Commission in its order has or
would have caused difficulties in carrying on the business by
him would not warrant for revision of the order, in as much as
such difficulties, could have been visualized when the order has
been passed [Telco Ltd. v. PRTA, (1977) 47 Comp Cas 520
(SC)]. Where, however, an order passed by the Commission
runs contrary to a view taken in any other case by the Supreme
Court (to which appeal lies from the orders of the Commission),
the Commission may revoke its orders. On the mere fact that
the order passed by the Commission was a consent order would
not, however, deprive the respondent of his remedy of to seek a
revision of the order under Sec. 13(2) but then he would have to
justify the circumstances warranting such a course of action by
the Commission [In re Anil Hard Boards Ltd., (1979)49 Comp
Cas 278 MRTPC] .
Order awarding compensation
The Commission u/s.12 B (3) has to make an enquiry as provided
in the Act in to the allegations made in the application
u/s.12 B (1), before making an order on the undertaking or owner
thereof to pay the applicant the amount determined by it as
realisable as damages or compensation for the loss or damages
caused to the applicant by reason of the monopolistic, restrictive
or unfair trade practice resorted to.
2.4 ENFORCEMENT OF ORDERS
Under s. 12 C every order made by the Commission u/s.12 A
(granting a temporary injunction) or u/s.12 B (directing the owner
of an undertaking or other person to make payment of any
amount) may be enforced by the Commission in the same manner
as if it were a decree or order made by a Civil Court. In case the
decree on order passed by the Commission could not be executed
by the Commission, the same can be sent by the Commission to
the Civil Court having jurisdiction overr the Registered office
of the Company or the place where the person concerned resides
or carries on its business, as the case may be, for execution.
There upon the Court to which the order is so sent shall execute
the orders as if it were a decree or oder sent to it for execution.
Under S 38 of Civil Procedure Code, a decree may be executed
by the Court which passed it, or by the Court to which it is sent
for execution. Sec. 39 of the Code provides for transfer of a
decree to another Court for execution-
(a) if the person against whom the decree is passed actually
and voluntarily resides or carries on business, or personally
works for gain, within the local limits of the jurisdiction of
such other court, or
(b) if such person has no property within the local limits of the
jurisdiction of the Court which passed the decree sufficient
to satisfy such decree and has property within the local limits
of the jurisdiction of such other court, or
(c) if the decree directs the sale or delivery of immovable
property situated outside the local limits of the jurisdiction
of the court which passed it, or
(d) if the court which passed the decree considers for any other
reason, which it shall record in writing, that the decree should
be executed by such other court.
2.5 PROCEDURE
As envisaged under regulation 84 B of the MRTPC Regulation,
1974 every application u/s 12 A of the Act must be supported
by an affidavit of the person making the application stating
specifically the facts which constitute such trade practices and
the circumstances whereby the intention is to prove that the said
trade practice is likely to affect the public interest, or the interest
of any trader, class of traders, or traders generally, or any
consumer or consumers generally. Under regulation 84 D, the
Commission may, before making any order u/s. 12 A, direct the
Director General to make investigation into such allegations
and submit a report there on. It is worth noticing that by virtue
of regulation 13(2) of the MRTPC Regulations, 1991 an ex parte
injunction can be issued only if the delay in issuing the same
would defeat the purpose for which the application is made u/s
12 A of the Act. Where adulterated butter being supplied to the
inmates of the hospital, it was considered to be fit case for an
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immediate interim preventive order because no one can be
permitted for a day larger to make a fun of people’s health
particularly those who are suffering and are at the mercy of trust
of the hospital authorities [DGIR V. N.Shanta Kumari, (1987)
62 Camp Cas 157 MRTPC; DGIR V. Manjog Builders, (1987)
62 Camp Cas 845; DGIR V. Universal Luggage Mfg., Co.Ltd.,
(1987) 62 Camp Cas 275]. At the same time concerning the
grant of ex parte injunction the Gauhati High Court in Aparjita
Mukherjee V. Anil Kumar Mukherjee [AIR 1990 Gau 73],
by way of caution observes “Injunction by court not be a matter
of course. Although an ex parte injunction operates for a short
period, that is, until the other side appears and contests the matter,
if the ex parte injunction is vacated afterwards, by that time
irreparable damage might have been caused. There is real risk
of causing injustice while granting or refusing injunction at the
interlocutory stage. Therefore, at the stage of granting injunction
court should not act casually i.e., the court should pass an order
only after considering all the facts and circumstances of the
case”.
Set off of amount of compensation awarded by Commission
against any decree
In case a decree is passed by any court also for the recovery of
compensation in favour of any person or persons who have
approached the Commission, the amount recovered by the person
or persons concerned pursuant to the Commission’s order shall
be set off against the amount recovered under the decree. The
decree shall, notwithstanding anything contained in the Civil
Procedure Code, 1908, or any other law for the time they in
force, be executable for the balance, left after such set off [S 12
B (4)]. This is a safe guard against unjust enrichment, and is a
provision for fair play and to avoid double jeopardy.
Procedure for application for review, amount, or revocation
of Commission‘s order:
Regulation 78 deals with an application made u/s 13(2) of the
Act for amendment or revocation of an order of the Commission.
But Regulation 78 does not say that an application made u/s
13(2) shall be entertained only on certain specific grounds. That
regulation only provides that the new developments that make
the order irrelevant must be stated in the application and the
Commission should serve notice on all the parties who appeared
at the previous proceedings and all of them must be given an
opportunity to be heard, and that the provision of Sec. 114 of
the Code of Civil Procedure, Order XLVII, Rule 1 shall apply
insofar as they are applicable. Sec. 114 provides for review of
a decree or order from which no appeal is allowed under the
Code. Similarly Order XLVII, makes provision for any person
considering himself aggrieved may make any application for
review on ground of a clerical or arithmetical mistake or error
or where new and important matter or evidence, which offer
the exercise of due diligence was not within his knowledge or
could not be produced at the time when decree or order was
passed; Rule 1 also speaks to this effect. This does not have the
effect of saying that an application under Sec. 13(2) can be
maintained only on the grounds mentioned in Sec. 114. Even
if a case is not covered by Sec. 114, the Commission would
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have the power to grant relief under Sec. 13(2). Regarding the
grant of review application the Supreme Court observed in Sow
Chandra Kanta v. Sheik Habib [AIR 1975 SC 100] thus -
“A review of judgment is serious step and reluctant resort to it is
proper only where a glaring omission or patent mistake or like
grave error has crept in earlier judicial fallibility.”
Provision for appeal
As already stated, an order under Sec. 13(2) of the Act, may be
appealed against, Under Sec. 55 of the Act with Supreme Court
on any ground specified in Sec. 100 of the Code of Civil
Procedure 1908. Under Sec. 55 any person aggrieved by any
decision can appeal to Supreme Court on -
a) any question referred to Sec. 2-A (which deals with power
of the Central Government to decide certain matters), or
b) any order made by the Central Government under Chapter
III (which deals with “Division of Undertaking”, ‘Severance
of Inter-connection’), or Chapter IV (dealing with
monopolistic trade practices).
Within 60 days from the date of the order on one or more of the
grounds specified in Sec. 100 of the Code of Civil Procedure
1908.
The MRTP Commission can also prefer an appeal to the Supreme
Court under-
a) Sec. 13 (according to which order of the MRTPC may be
subject to condition, etc.), or
b) Sec. 36-D (which deals with powers of the MRTP
Commission to enquire into an unfair trade practice), or
c) Sec. 37 (which deals with investigation into restrictive trade
practices by the MRTP Commission).
2.6 APPOINTMENT OF DIRECTOR GENERAL AND
STAFF
Director General
Sec. 8(1) provides for the appointment of Director General by a
notification by the Central Government and as many Additional,
joint, Deputy or Asstt Directors General of Investigation and
Registration as the Central Government may think fit for carrying
out investigations for the purposes of the Act and including
maintenance of Register of agreements which are registerable
under the Act [Sec. 33 and 35] and perform such other functions
as are or may be, provided by, or under the Act [Sec. 8(1)].
Registrar of Agreements
Under Sec. 8(2) Director General is empowered to authorize by
written order one of the additional, joint, deputy or assistant
director generals to carry out the functions as the Registrar of
agreements subject to registration under Sec. 33 and 35 of the
Act.
Powers and functions of officers
The Registrar of agreements and every Additional, Joint, Deputy
or Assistant Director will exercise his powers and discharge
his functions, subject to the general control, supervision and
directions of the Director General [sec 8(3)].
Staff of the Commission
The Central Government may provide for the staff of the
Commission. It may, in addition, make provisions for the
conditions of service of the Director General, Additional, Joint,
Deputy, or Assistant Director General and of the members of
the staff of the Commission [Sec.s 8(4) 8(5)]. These conditions
of service shall not be varied to their disadvantage. This is very
extraordinary protection which is generally reserved for
constitutional, judicial or similar high posts where it is desirable
that the holder of such posts should not be vulnerable to pressures
from the executive by way of adverse revision of their
emoluments. This protection is also available to Chairman and
the members of the Commission u/s 6(5).
Salaries, allowances etc.
Though statutorily constituted, the MRTP Commission is an
organ of the Central Government. All its expenses including
salaries, allowances and pensions of the members of Commission
and its staff are met out of the consolidated fund of India, in
conformity with Article 266 of the Constitution [sec 9].
Duties and functions of Director General
1. To represent the Commission: In the event of an appeal u/
s 55, or application for grant of special leave to appeal under
Article 136 of the constitution, or a writ petition under article
226 or 32 of the Constitution, the Director General is to represent
the Commission before the Supreme Court or the High Court,
as the case may be, except in those cases where he himself has
filed an appeal or special leave to appeal against the order of
the Commission.
2. Filing application with Director General: The application
filed before the Director General u/s 36(3) of the Act must be
accompanied with five additional copies thereof, besides as many
additional copies as is the number of respondents.
3. Filing application by Director General: Where Director
General files an application for seeking any directions of the
Commission for disposing of any application under sec 36(C),
he shall make an application along with four extra copies there
of to that effect and such an application shall contain information
and be accompanied by the following documents:
(a) a copy of the application of the party concerned;
(b) a copy of agreement in (quadruplicate); and
(c) comments of Director General on the application.
4. Disposal of application: On the receipt of the application,
the Commission may, if it considers necessary, give the applicant
an opportunity of being heard in such proceedings and for this
purpose intimation about the date of hearing shall be sent to
him.
5. To undertake primary investigation: Sec. 11(2) provides
that director General may upon his own knowledge and
information or on a complaint received by him undertake a
preliminary investigation to satisfy himself whether or not an
application should be made by him to the Commission.
6. Order of investigation: Commission may in the matter of
restrictive or unfair trade practice u/s 10(a)(i) or u/s 36-C order a
preliminary investigation to be conducted by the Director General
in case of a complaint of an association. this investigation is to
be made by the Director General.
7. Submission of Preliminary report: Director General will be
required to submit report with in such time as fixed by the
Commission.
8. Further investigation: Where the Commission on perusal
of report of Director General is of the view that a further
investigation is necessary, it may order the Director General to
make such further investigation, as the Commission may think
necessary, and submit a further report.
Powers concerning preliminary investigation
The power of the Director General or any other person authorized
by him to undertake preliminary investigation are those as
provided in Sec. 240 and 240A of the Companies Act, 1956.
Power to obtain information: If the Director General has
reasons to believe that a person is a party to an agreement
concerning a restrictive trade practice which is registrable u/s
35, he may give a notice to that person requiring him to furnish
to the Director General such particulars of the agreement as
may be specified in the requisition if he is a party to such an
agreement with in a period of not less than 30 days [sec 42(1)].
At the same time such a person or any other person who is also
a party to the agreement containing restrictive trade practice
can be required to furnish to the Director General further
documents or information in his possession or control which
the Director General considers expedient in connection with
the registration of agreement [sec 42(2)]. Where the party is a
trade association, notice is to be served upon the secretary,
manager, or other similar officer of the association and any such
association will be treated as a party to the agreement to which
the members are parties as such [sec 42(3)].
In case the particulars called for are not furnished, the Director
General would apply to the Commission and the Commission
may —
(a) order the person or the association to furnish these
particulars within such time as may be specified in the order;
or
(b) authorize the Director General to treat the particulars or
information in his possession as the particulars relating to
agreement; or
(c) restrain wholly or partly the parties to the agreement and
from making an other agreement to that effect, if the
Commission is satisfied that the failure to furnish particulars
is wilful [sec 42(4)].
Thus sec 42, specifically empowers the Director General to
obtain information in connection with, and for the purpose of,
registration of an agreement.
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Function
Sec. 36 requires the maintenance of a register of agreements by
the Director General, which are subject to registration u/s 33 and
in respect whereof particulars have been furnished to him u/s 35.
The Director General has to maintain a special Sec. or part of the
register for the purpose of filing such particulars as the
Commission may direct. Such particulars may contain
information about which the Commission is of opinion that its
publication would be contrary to the public interest, or their
publication would substantially damage the legitimate business
interests of any person.
Where a party to an agreement which requires registration feels
that the agreement or part of it should be excluded from
registration because it is of no substantial economic significance
or that an agreement should be included in a special part of the
Sec. of the register, he may make a request to the Director
General accordingly. The Director General has to dispose of
the matter in conformity with any general or special direction
issued by the Commission for that purpose.
In this regard the case RRTA v. Baroda Rayon Corpn Ltd
[(1976) 46 Comp Cas 192], is worth noticing. An inquiry was
started in this case upon an application by the Registrar [Now
Director General since 1984]. The company wanted to inspect
the documents on the basis of which the inquiry was held.
Registrar claimed privilege to disclosure. The Commission
allowed the privilege in respect of documents which contained
secret information and which were submitted in confidence, such
as the information submitted by the actual users of the goods
and by the Ministry of Foreign Trade. Explaining the position
of the Registrar [now Director General] the Commission said:
“The Director General is a public servant appointed under the
Act for maintaining a register of agreements and for performing
the other functions imposed upon him by the Act. One of the
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functions imposed upon him by Sec. 10 of the Act is to make
applications to the Commission about restrictive trade practices.
The Director General has, therefore, to perform certain statutory
functions. If the information given to him about restrictive trade
practices was liable to be disclosed, it might be withheld and the
Director General would thereby be hampered in the discharge of
the duty imposed on him by the statute to make applications to
the Commission in respect of restrictive trade practices. There
are acute shortage of consumer goods and raw materials in the
country and any person furnishing information to the Director
General is liable to be victimized by the producers and suppliers
by withholding supplies from him. In our opinion, public interest
requires that the complaints made by such informants should
not be produced for inspection if the Director General does not
rely upon such communications as evidence in the hearing. If
he produces the complaint in evidence, the respondents will
certainly be entitled to inspection of it.”
Appointment of Inspectors
Sec. 44 empowers the Central Government to appoint one or
more inspectors for making an investigation into the affairs of
any undertaking, if there are circumstances suggesting that the
undertaking is indulging in monopolistic, restrictive, or unfair
trade practice or trying to acquire control over any dominant or
interconnected undertaking.
For purposes of investigation the powers and privileges of the
Inspector would be same as are enjoyed by the Inspector under
Sec. 240 and 240-A of the Companies Act, 1956 i.e., he will
have all the powers of investigation including production of
documents, examination on oath and search and seizure of
documents.
3. CONCENTRATION OF ECONOMIC POWERS
SUB-TOPICS
3.1. Introduction
3.2. Division of Undertakings
3.3. Severance of Inter-connection
3.4. Manner of Carrying out Orders
3.1 INTRODUCTION
Big businesses by its very highness sometimes succeeds in
keeping out competitors. It can do so by reason of its financial
strength and that the very presence of big business in an industry
is likely to have a deterrent effect on the entry of small units,
even in industries without any special scope of economies of
scale. Hence the provisions of Chapter III of the Act are meant
to regulate concentration of economic power. Ss 27, 27-B and
27-C empower the Central Government to order the sub-division
or delinking of inter-connections of enterprises whose working
is prejudicial to public interest or which are indulging in
monopolistic or restrictive trade practices. The purpose of the
provision is not to frown upon big business per se It only
attempts to regulate the working of large size business in public
interest.
3.2 DIVISION OF UNDERTAKINGS
When the MRTP Commission is of opinion that the working of
any undertaking is prejudicial to the public interests, or has led,
or is leading, or is likely to lead, to the adoption of any
monopolistic or restrictive trade practices, it may inquire as to
whether it is expedient in the interests to make an order.
a) for the division of any trade of the undertaking for the sale
of any part of the undertaking or assets thereof; or
b) for the division of any undertaking or interconnected
undertakings into such number of undertakings as the
circumstances of the case may justify.
When to enquire
The Commission may proceed to enquire with the matter -
i) upon receiving a complaint of facts from any trade
association or from any consumer or registered consumers’
association, whether such consumer is a member of that
consumers’ association or not; or
ii) upon a reference made to it by the Central Government or
the State Governments; or
iii) upon its own knowledge or information.
The Commission after such hearing as it deems fit may report
to Central Government or his opinion in regard to the division.
Where it is of the opinion that the division is imperative, he
may specify the manner of division and compensation, if payable
for such division [Sec. 27(1)]. For purposes of enquiry and
forming an opinion, all activities carried on by way of trade by
an undertaking or two or more inter-connected undertakings
are to be treated as a single trade [Jiyajee Rao Cotton Mills v.
Deputy Secretary, (1989) 65 Comp Cas 525 (Delhi)]. If the
Commission recommends division, the Central Government may
by an order in writing, direct the division of any trade of the
undertaking or of the interconnected undertakings [Sec. 27(2)].
Matters to be provided in the order [Sec. 27(3)]
An order for the division of any trade of the undertaking may
provide for all matters necessary for the purpose including:
a) The transfer or vesting of property, rights, liabilities or
obligations.
b) The adjustment or discharge of the contracts of the
undertaking.
c) The creation, allotment, surrender or cancellation of any
shares, stock or securities.
d) The payment of compensation.
e) The formation or winding up of an undertaking or an
amendment of its foundation documents such as the
memorandum or articles.
f) The extent to which the provisions of the order can be altered
by the undertaking.
g) The continuation of any pending proceedings with such
changes as may be necessary.
Where such an order is in the contemplation of the Government
and the Government is afraid that the implementation of the
order may be obstructed and, therefore, to assure that the purpose
or the order shall be satisfactorily achieved, the Government
may prohibit the doing of anything which may impede the
operation of the order. For this purpose also the Government
may impose any obligation on a person for the purpose of
carrying on any activity or safeguarding of any assets. The
Government may even appoint a person to look after the
activities or safeguarding of the assets [Avtar Singh, p.75]. If
any officer is undertaking ceases to hold office by reason of its
division, he shall not be entitled to any compensation [See Sec.
27(4) and (5)].
Penalty for contravention
If any person contravenes the provision of Sec. 27 he is
punishable with a fine extending upto one lakh of rupees or
with imprisonment extending to 5 years or both, and in case of
continuing default, the fine will be Rs.1,000/- for every day of
default under Sec. 46 of the Act.
3.3 SEVERANCE OF INTERCONNECTION
Sometimes MRTP Commission may be of opinion that the
continuance of inter-connection of an undertaking (called the
principal undertaking) with any other undertaking is detrimental
to -
a) the interest of the principal undertaking; or
b) the future development of the principal undertaking; or
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c) the steady growth of the industry to cover the principal
undertaking pertains; or
d) the public interest.
In such a case the MRTP Commission may enquire as to whether
it is expedient in the public interest to make an order for the
severance of such inter-connection on one or more of the aforesaid
grounds. The Commission may proceed to inquire into the matter
-
i) upon receiving a complaint of facts from any trade association
or from any consumer or a registered consumers’ association,
whether such consumer is a member of that consumer
association or not; or
ii) upon a reference made by the Central Government or a State
Government; or
iii) upon its own knowledge or information.
Commission may after such hearing as it thinks fit, report to the
Central Government its opinion regarding severance of inter-
connection. Where it is of opinion that the severance of the
inter-connection of the principal undertaking with an undertaking
ought to be made, it shall include in its report a scheme with
respect to such severance providing for the matters specified in
Sec. 27-A(2) [Sec. 27-A(1)].
Matters to be provided for in the scheme of the MRTP
Commission
The scheme of the Commission with reference to the severance
of inter-connection shall provide for the following matters -
1. The manner and period of severance,
2. The appropriation and transfer of the interest of the owner
of the principal undertaking in the other undertaking and
the termination of any office or employment held by the
owner in that concern;
3. Compensation which ought to be paid;
4. incidental, consequential and supplemental matters.
The Government may then order severance in accordance with
the report and recommendation of the Commission. The
Government may, for the purpose of the implementation of the
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scheme, prohibit or restrict the doing of anything that might
impede the operation of the order, or may require a person to
carry out an activity or safeguard any assets or may appoint a
person to some position for any of the purposes of the scheme.
Any officer who ceases to hold office by reason of severance
will not be entitled to compensation for loss of office [Kapoor,
p.29-30, Avtar Singh, p.76; Sec. 27-A(4) and (5)].
3.4 MANNER OF CARRYING OUT ORDERS
Sec. 27-B extends the scope of the power exercisable by the
Central Government under Sec. 27 or 27-A. It provides that if
the Commission in its report under Sec. 27 or 27-A recommends
division of any undertaking or severance of inter-connection by
disinvestment or sale of undertaking, the whole or in part, or
any part of the assets of such undertaking, then the Central
Government is empowered to pass an order to give effect to
such recommendation within the time prescribed, inter alia, in
one or more of the following modes:
a) by making a public offer for sale of shares held by the person
in the company, owning the undertaking.
b) by making further issue of equity capital to members of
public by the company, owning the undertaking;
c) by public auction of assets of the undertaking;
d) by any other method specified by the Central Government.
In case of any need the prescribed time may be extended by an
other order by the Commission on its own motion or on the
application of the person concerned. The order of the
Government will be effective even if there is some contrary
provision elsewhere in the Act or in any other Law for the time
being in force or in the memorandum or articles of the body
corporate owning the undertaking. If the person concerned omits
or fails to disinvest his shareholding, the company concerned
may be ordered not to permit him to exercise any voting right or
other rights attached to those shares.
Penalty for Contravention
Varying degrees of punishment have been provided for violation
of the provision under Sec. 27-B vide Sec. 48-A and 48-B which
have been discussed under “Offences and Penalties”.
4. MONOPOLISTIC TRADE PRACTICES
SUB-TOPICS
4.1 Definition
4.2 Investigation
4.3 Power of Government
4.4 Penalty
4.5 When MTP not prejudicial to public interest
4.1 DEFINITION
The expression “monopolistic trade practice” is defined in sec
2(i) of the Act. It means a trade practice which has or is likely
to have the following effects:
(1) A practice which has the effect of maintaining prices at an
unreasonable level. This may be attained by any method,
for example, by limiting, reducing or controlling the
production of goods or services.
(2) A practice which has the effect of unreasonably preventing
competition in the production, supply or distribution of
goods or services.
(3) A practice which has the effect of limiting technical
development or capital investment or causing deterioration
in the quality of goods or services and all this to the common
detriment.
(4) A practice which has the effect of increasing unreasonably
the cost of production of any goods or charges for the
provision or maintenance of any service.
(5) A practice which has the effect of increasing unreasonably
the prices at which goods may be sold or resold or the
charges at which services may be rendered, or the profits
which may be derived by the production, supply or
distribution of any goods or the rendering of any services.
(6) A practice which will prevent or lessen competition in the
production, supply or distribution of goods or the provision
or maintenance of services by the adoption of unfair methods
or unfair or deceptive practices [Avtarsingh pp.79-80].
The definition would apply to the practices of the kind described
whether they be resorted by a monopolistic or non-monopolisitc
undertakings. But it is difficult to think of an undertaking being
able to influence a market without possessing some sizeable
market power. It is difficult to concieve of a monopolistic trade
practice indulged in by an undertaking, having a small or
marginal share in market, to the exclusion of a monopolist or
oligopolist with substantial market power [Duggar, 53].
The goal of this law is to ensure that the competitive economic
system works and achieves its goals of lower prices, product
innovation and equitable diffusion of real income among
consumers and the factors of production. In other words, anti-
trust laws (anti-monopoly laws) are designed to ensure a system
of workable competition [Corley, p252].
4.2 INVESTIGATIONS
According to sec 31(1) of the Act, where the Central Government
is of the view that the owners of one or more undertakings are
indulging in any trade practice which is, or, which may be, a
monopolistic trade practice, as defined in sec 2(i) of the Act, or,
that monopolistic trade practice was already prevailing in respect
of any goods or services, then the Central Government may refer
such matter to the Commission for inquiry. The Commission
after such hearing as it may deem fit, shall report to the Central
Government its findings thereon. The Commission may also,
on an application from the Director General of Investigation and
Registration or on its own motion, and not withstanding that no
reference has been made to it by the Central Government u/s
31(1) make an inquiry into the matter [Proviso to sec 31(1)].
Thus the power of the Commission to conduct an inquiry can be
exercised suo motu, an application from DGIR, or on reference
by the Central Government.
The Commission after inquiry and holding of a public hearing
and having given reasonable opportunity of hearing to the parties
has to take into account the economic conditions prevailing in
the country, a trade practice operating or likely to operate which
is against public interest, and to all other matters which appear
in the particular circumstances and then to submit its findings
to the Central Government. The Government can pass any order
which may be necessary to prevent the mischief. The
Government may order the owners to discontinue the practice
[sec 31(2A)] and the owners in turn would be required to inform
within 30 days of the order of their compliance thereto. [sec
31(4)(a)]. The Government may have the fact of compliance
investigated by the Director General and may then take suitable
action on the report [sec 31(4)(b)].
4.3 POWER OF GOVERNMENT
The power of the Central Government is of general nature but it
is provided in sec 31(3) that without prejudice to the generality
of the power Central Government may order concerning the
following matters:
(a) Regulating the production, shortage, supply, distribution or
control of any goods by the undertaking or the control or
supply of any service by it and fixing the terms of sale
(including prices) or supply thereof.
(b) Prohibiting the undertaking from resorting to any act or
practice or from pursuing any commercial policy which
prevents or lessens or is likely to prevent or lessen,
competition in production, storage, supply or distribution
of any goods or provision of any services.
(c) Fixing standards for the goods produced or used by the
undertaking.
(d) Declaring unlawful, except to such extent and in such
circumstances as may be provided by or under the order,
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 the making or carrying out of any such agreement as may
be specified or described in the order.
(e) A party to any such agreement may be ordered to put an
end to the agreement within the time as may be specified in
the order.
(f) Regulating the profits which may be derived from the
production, storage, supply, distribution or control of goods
or from the rendering of services.
(g) Regulating the quality of any goods or services in such a
way that there is no deterioration in standards.
4.4 PENALTY
If any person contravenes, without any reasonable excuses any
order of the Central Government under sec 31 for prevention of
monopolistic trade practices then he shall be punishable with
imprisonment which shall be 6 months and not more than 3
years for the first offence and 2 years and not more than 7 years
for second or subsequent offences. Where the contravention is
of continuing nature, a further fine of Rs.5000/- for every day
would be imposed during which the contravention continues
[sec. 50(2)].
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Where a person carries any trade practice which is prohibited
by the Act, the punishment is imprisonment for a term which
may extend to six months or fine which may extend to Rs.5000/
- or both and where the offence continues, a further fine of
Rs.500/- for every day, after the first, during which the offence
continues [sec. 50(3)].
4.5 LAWFUL MTP - WHEN
The provision contained in sec 32 of the Act is that every
monopolistic trade practice is prejudice per se to the public
interest excepting cases mentioned under the Sec.. Thus a
monopolistic trade practice will not be prejudicial to the public
interest in the following cases:
(1) where it is specifically authorized by any law;
(2) where it is permitted by the Central Government by written
orders for:
(a) meeting the requirement of the defence of India or
any part there of, or for the security of State; or
(b) ensuring the maintenance of supply of goods and
services essential to the community; or
(c) giving effect to terms of agreement to which the central
Government is a party.
5. RESTRICTIVE & UNFAIR TRADE PRACTICES SUB-TOPICS
5.1 Meaning: restrictive trade practices
5.1.1 Trade practices
5.1.2 Application to services
5.1.3 Exempted agreements
5.2 Meaning: unfair trade practices
5.2.1 Enquiry commission
5.2.2 Powers of commission
5.3 Control of restrictive trade practices
5.4 Protection of public interest
5.5 Resale price maintenance
5.1 RESTRICTIVE TRADE PRACTICES
Meaning
The restrictive trade practice, means a trade practice which has
or may have the effect of prevailing, distorting or restricting
competition. Any practice which tends to obstruct the flow of
capital or resources in production of goods and services is
construed as restrictive trade practice. Likewise, manipulation
of prices, conditions of delivery or flow of supplies in the market,
which may have the effect of imposing on the consumers
unjustified costs or restriction is also regarded as restrictive
trade practice [S2(o)]. Thus any agreement which is restrictive
of competition, whatever may be the manner of restriction, it is
a restrictive trade practice. The special feature of the MRTP
Act is that enquiry into restrictive nature of the trade practice is
related to the effect on competition. The whole thurst of S.2(o)
is on the effect of the trade practice on the relevant competitive
situation. Thus, effect on competition is the touch stone under
the Sec. [RRTA v. Usha Sales P. Ltd., (1977) 47 Comp Cas
480 MRTPC]. Therefore, before any trade practice can be
regarded as restrictive in nature, some damage, however slight,
must be indicated in the context of the relevant competitive
situation.
In Telco Ltd v. PRTA [AIR 1977 S.C. 973], the MRTP
Commission held that the trade practices referred to in S.33(1)
which require registration of agreement in respect thereof, are
ipso facto restrictive trade practices and they need not be tested
on the touch stone of S.2(o) before they are so held. But the
Supreme Court did not agree with this view and laid down that
“every trade practice in restraint of trade is not necessarily a
restrictive trade practice. The definition of restrictive trade
practice is exhaustive and not an inclusive one. The decision
whether a trade practice is restrictive or nor has to be arrived at
by applying the rule of reason and not on the doctrine that any
restriction as to area or price will per se be a restrictive trade
practice”.
Now after the Amending Act of 1984, trade practices
enumerated in S.33 do not require to be examined with reference
to the definition in S.2(o). They have all ingredients of
Restrictive Trade Practice and by law have become statutory
illustrations of restrictive trade practice. The trade practices
enumerated in amended S.33(1) and per se restrictive trade
practices and the law laid down by the Supreme Court in Telco’s
case has because infructuous. The definition of restrictive
practices in S.2(o) is now of little use as the definition only seeks
to be referred to for testing the trade practices, other than those
enumerated in Sec. 33(1) [Duggar, p.70].
5.1.1 TRADE PRACTICES
Trade practices set out in Sec. 33(1) of the Act are restrictive
trade practices and the agreements relating to these matters are
required to the registered under the Act, and following are these
practices.
(1) Any agreement which restricts, or is likely to restrict by
any method the persons or classes of persons to whom
goods are sold or from whom goods are bought
[clause (a)]
Under this sub-clause cases are covered where attempt is made
to require a person by employing any method to buy and sell
goods to given persons or classes of persons. Thus where
stockists could be appointed area wise only with the consent of
the district or the state associations and they could sell only
within the allotted area, it was held that it amounted to restricting
the persons to whom the goods could be sold and was a restrictive
trade practice within the meaning of sec 33(1)(a) [DGIR v. All
India Organisation of Chemists and Druggists, (1992) 73
Comp.Cas 668 MRTPC].
(2) Any agreement requiring a purchaser of goods, as a
condition of such purchase, to purchase some other
goods [clause (b)].
This type of agreement is called a tying arrangement, i.e. where
the purchaser of a product is coerced by his supplier to buy the
complete range of his products, though he does not desire to do
so. Such practices though widespread in trade are prima facie
reprehensible, as they force the buyers to forgo their choice
among products which compete with the tied product. They
also deny competitors free access to the market for the tied
product. Requiring the buyers of cars to pay towards the
servicing of the cars with the sale price is a case of such tie up
[In re Hindustan Motors Ltd and another, RTP Enquiry No
17(1983)]
In re Asu Agency [RTPE 76 of 1985] a complaint was received
from a person that Asu Agency, Bombay is indulging in
restrictive trade practice of forcing the former to purchase a
gas stove from the latter for getting a gas connection. It was
held that the respondant shall not repeat the practice of tie up of
gas stoves with the installation of gas connections because such
tie up is a restrictive trade practice within the meaning of sec
2(0)(ii) of the MRTP Act. It means changing the conditions of
delivery in a such a manner as to impose unjustified costs on
the consumer [Hindustan Lever Ltd v. MRTPC, AIR 1977
SC 285].
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However a case can be made out for some justifiable tying up
arrangements such as providing for after sales service to ensure
efficient maintenance and repair and provision of genuine spares,
thereby also protecting the goodwill of the manufacturer as well
as for achieving economics of scale for such other allied products
or accessories or ancillaries. But such justification have to be
established under the provisions of gateway u/s 38 of the Act
[Mitra, p.441] The essence of the Sec. is that when it is found by
the Commission that the restrictions imposed by an agreement
are justified, they would be allowed. The balancing clause after
clause (h) in Sec. 38 indicates when the restriction is not
unreasonable having regard to the balance between the
circumstances mentioned in the Sec. and the detriment to the
public interest resulting from the operation of the restriction
[Tata Engg and Locomotive Co v. Registrar (1977) SCC 55
at 59].
(3) An agreement restricting in any manner the purchaser
in the course of his trade from acquiring or otherwise
dealing in any goods other than those of the seller or
any other person [clause (c)]
The clause refers to ‘exclusive dealings’. “Exclusive dealings”
is a contract where the buyer agrees to purchase all his business
needs of a products supplied by a seller during a certain period
of time, or where by a buyer agrees not to purchase an item or
items of merchandise from the competitors of the seller. Such
a contract might take the form of a franchise, in which a dealer
agrees to sell only the product manufactured or distributed by a
seller. Exclusive dealing agreements originate principally to
cater to the manufacturer’s need to promote his brand products
at all stages of distribution, down to the consumer. Where a
manufacturer indulges in the practice of exclusive dealing, his
competitors are prevented access to that market and the dealers
are denied the freedom to handle competing products. In this
process, the consumer is also restricted in his choice among the
number of competing products. This type of arrangements,
which are bilateral and are linked up with territorial restriction,
are mostly prevalent in India. [Duggar, p 523]. In RTA v.
Usha Sales Pvt Ltd [RTPE, No 8/1974], the commission while
holding that the stipulation regarding exclusive dealing in
agreements with its dealers amounted to restrictive trade practice,
allowed gateways under clause (b) and (h) of Sec. 38(1), in
respect of sewing machines and diseal engines in view of nature
of products, and the need for after sale service. The same was
the view of Commission in RRTA v. Swadeshi Mills Co. Ltd
and others [RTPE No 19/1974] and PRTA v. Standard Mills
Co. Ltd and others [RTPE No 5/1976].
(4) Any agreement to purchase or sell goods or to tender
the sale or purchase of goods only at prices or on terms
or conditions agreed on between the sellers or
purchasers [clause (d)]
Such arrangements could be in terms of bilateral agreements
between an individual buyer and an individual seller in respect
of goods or services which are for sale. But this may not affect
or prevent competition unless such agreement is between parties
who have significant control over a substantial portion of the
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market or supply of goods. It is more significant of collective
agreement between one dominating buyer with a number of
sellers, or, one dominating seller with a number of buyers or
between a group of buyers and a group of sellers. This may
then give rise to price cartels or discriminatory or favourable
prices, or terms and conditions of sale or purchase between
members of such associations, which would not be available to
others or which would thus prevent, distort or restrict competition
and be prejudicial to public interest.
In RRTA v. In Check Tyers and Others [RTPE 1 of 1971] the
Commission had for consideration the general code of conduct
among companies manufacturing tyres. The salient features, as
noted by the Commission, were that the respondents could
maintain at a reasonable level the prices of and profits derived
from production, supply and distribution of goods, or from
performance of any service. It also provided for joint action
wherever any respondent was threatened with or suffered from
boycott. The agreement also provided for collectively fixing
prices, for limiting output and production range of and arranging
the pattern of production of tyres in a mutually agreed manner,
as well as, provision of joint action in case of any move of boycott
against any of its members.
The Commission held that the above provisions of the general
code of conduct constituted restrictive trade practice and were
void and the respondents were restrained from indulging, in such
restrictive trade practices in the future [Mitra, p.454].
(5) Any agreement to grant or allow concessions or benefits,
including allowances, discount, rebates or credit in
connection with, or by reason of dealings [clause (e)]
This restrictive trade practice involves an agreement or
agreement at the instance of the manufacturer or a distributor
providing for differentiation or discrimination in granting or
entitlement of rebates, concessions, discounts, allowances or
credit to customers in view of part dealings, business relations
or transactions. Such rebates, discounts, etc., are distinct from
any quantity or turnover or discount on a graduated scale,
according to different slabs of turnover, (provided that such
differentials of discounts were small and would not materially
affect competition), or discounts for payment made in cash or
rebates, as incentive for payments made within a stipulated
period of time, or credit allowed at the discretion of the supplier,
in view of the quantum of turnover or incentive, bonus or
commission for promoting sale of new product. It is clear that
any concession or benefit, to be construed a restrictive trade
practice, must satisfy the following two tests:
(i) that differential concessions or benefits must have been
allowed or granted in connection with, or by reason of,
dealings. Dealings suggest regular course of transaction of
sale or purchase, or the provision of service. An individual
or isolated transaction does not fall within the scope of
restrictive trade practice; and
(ii) that they are injurious to the competition.
In Registrar v. Carona Sahu Ltd., [(1976)46 Comp.Cas 431,
MRTPC], Commission held that allowing discriminatory or
differential incentives bonuses by a manufacturer to dealers on
the basis of turnover is a restrictive trade practice as it may
have the effect of preventing smaller dealers from being able to
compete with bigger ones. Likewise in Nylon Filament Yarn,
Re., [(1976)46 Comp.Cas 357] where four major spinners of
nylon yarn entered into an agreement with 18 weavers’
associations which contained a number of clauses, some were
considered as restrictive trade practice and were declared void.
But in Registrar v. Tata Oil Mills Co. [(1977)47 Comp.Cas
287] it was held that where differential Commission paid is so
negligible that it would have no material effect on competition,
it would non offend the Act.[In re Poona Beverages Pvt Ltd,
[RTPE No 24/1981]
(6) Any agreement to sell goods on condition that the prices
to be charged on resale by the purchaser shall be the
prices stipulated by the seller unless it is clearly stated
that prices lower than these prices may be charged
[clause (f)]
A price list which does not permit the seller by means of a
specific stipulation in the list itself to sell at a price lower than
those mentioned is violative under clause (f) of Sec. 33 (1)
[DGIR v. Drill Co., Metal Carbides Ltd, (1990) 3 Comp.LJ
173]. In Registrar v. Bata India Ltd, [(1976)46 Comp.Cas
441 MRTPC] the following practices were regarded as
unreasonable :
(1) A clause fixing resale prices for the whole country without
indicating that the seller was entitled to sell below the price
fixed;
(2) A clause requiring the buyer to purchase up to a certain
gross value if he wanted a variety;
(3) Clause prohibiting the dealers from purchasing raw
materials from unapproved persons, enlarging production
without approval; changing machinery for production, or
increasing production and in case their production increased,
requiring then to sell to the company only;
(4) Clauses restricting use, number, selection and disposal of
moulds.
The Commission has also held in Registrar v. Steel Age
Industries, [(1976)46 Comp.Cas 607 MRTPC] that where
distributors are merely required to stock and display goods of
certain minimum value, but without any restriction as to what
kind of goods shall be stocked, does not amount to a full line
forcing or a tie up. The practice does not offend the Act [Avtar
Singh, P.123].
This sub clause is based on the concept of “Resale Price
Maintenance” (RPM) which has been explained thus:
“Whenever a manufacturer sets the price at which the retail shop
which he does not own must resell his products to the public, or
at which the wholesale business he does not own must resell
that product to a retailer, the practice is known as resale price
maintenance”. [Andrew & Franse 1960].
The Commission while dealing with the resale price
maintenance in RRTA v. Amar Dye Chem. Ltd, [RTPE 51 of
1975] by its order inter alia, restrained resale price maintainence
and stipulated that in all price lists issued by the respondent it
must be clearly stated that the prices relating to the consumers
are maximum prices and the distributor was free to charge lower
prices [See also RRTA v. Bajaj Electricals, (RTPE 6 of 1975);
RRTA v. Bata India Ltd; (1976)46 Comp.Cas 441]
(7) Any agreement to limit, restrict or withhold the output
or supply of any good’s or allocate any area or market
for the disposal of the goods [clause (g)]
Clause (g) sets out two categories of restrictions, the first relating
to production or supply of goods, and the second relating to
area or market for the disposal of goods. The underlying object
of such agreements is to regulate the flow of supply of goods or
services of a particular kind in the market, so that the producers
engaged in that line of activity may benefit equally in times of
prosperity or may face the set back uniformly in adverse market
conditions. Various measures may be adopted for the purpose
i.e, size of capital investment, installed capacity, quality or value
of existing production or sale. Proper appreciation of the scope
of this provision can be had from of the case Hindustan
Pilkington Glass Works Ltd and Windows Glass Ltd [RTPE
2 of 1972] which entered into an agreement with Surat Cotton
(Proprietors of Navin Glass Products), by which Surat Cotton
agreed not to make or sell certain glass products except existing
stocks and it shall keep its plant idle in consideration of payment
of an agreed compensation by Pilkinigton Glass Works. Also,
Pilkington and Window Glass entered into a common marketing
arrangement through Associated Patterned and Wired Glass
(APWG) a company promoted by them for the purpose of
procuring orders and distribute the products on uniform basis.
On an application by RRTA, the Commission held that the
agreements were meant to restrict output and supply of glass
products and eliminate competition. The Commission passed
cease and desist orders.
The territorial or market restrictions imposed by the
manufacturer may result in imperfect competition, and thereby
reduces the consumer’s choice. Often it might be used by the
manufacturer to enhance the monopoly power of his dealers so
that the manufacturer, in turn, could extract higher pricess from
them. It may also enable the dealers to engage in price
discrimination and on the other hand, this practice could be
usefully employed by a manufacturer to increase the efficiency
of his operations and that of his dealers by providing certain
measures of product production, by increase in the range of
customers to be contacted by the dealer and cost reduction for
self at the dealers.
In India, the practice of area allocation is widely prevalent. In
DGIR v. All India Organisation of Chemists and Druggists
[(1992)73 Comp.Cas 668 MRTPC], according to an agreement
between manufacturers of pharmaceutical products and their
distributors’ association only one stockist was to be appointed
for each geographical district who was to confine himself to
that district and a new stockist could be appointed only with the
consent of the association. The agreement was held to be
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restrictive trade practice [See also RRTA v. Usha Sales Pvt
Ltd (RTPE No.8 of 1974)]
(8) Any agreement not to employ or restrict the employment
of any method, machinery or process in the manufacture
of goods [clause (h)].
Clause (h) is consistent with restrictive trade practices as defined
in the Act, and sets out an example of classical theory of
monopolistic competition where there may be a small group of
major producers, who are in the position to make large
investments on research and development in their undertakings.
There are different ways, direct and indirect, for eliminating
competition. The imposition of restriction on the deployment
of any machinery or the use of any manufacturing process, for
production of goods is a direct way to achieve this purpose.
Such restriction can be put by an enterprenuer, who has a
dominant say and/or share in the market for goods of any
particular description, and who either provides his technical
knowledge to other, or avails of the production facilities of other
similar units engaged in the some line of activity. Such
arrangements are, however, too conspicious and are rarely
resorted to openly. But there have been instances where under
contract manufacturing arrangements the manufacturer
dominates on small scale or ancillary unit which are mainly
dependent on such larger undertakings for bulk of there business.
In RRTA v. Bata India Ltd [(1976)46 Comp.Cas 441] the
respondent had stipulated in their agreements with small scale
industrial units which undertook manufacture for them that such
small industrial units would neither purchase raw materials from
parties other than those approved by the respondent nor
manufacture, sell their footwear products, for other. The
Commission prohibited such restrictive trade practices, and the
clause was modified so that such small manufacturers, did not
use the same moulds as provided by the respondents for
manufacture and supply to others [See also, In re Sarabhai
Chemicals Pvt. Ltd; (1979)49 Comp.Cas 145]. In the matter
of All India X-ray and Electro Medical Trades Association
[(1977)47 Comp.Cas 237] the Commission struck down an
agreement which contained clauses to the effect: (a) that the
purchaser would get the equipment installed by the supplier;
(b) that the equipment would be guaranteed for 12 months against
manufacturing defects and (c) that during the period of guarantee
there would be only one routine service and that too would be
confined only to oiling, cleaning and adjustment excluding
attendance for repairs, breakdowns or normal wear and tear [See
also Registrar v. Usha Sales Pvt Ltd (1977) 47 Comp.Cas
472; Registrar v. Tata Engineering and Locomotive Co.
(1976)46 Comp.Cas 470].
(9) Any agreement for the exclusion from any trade
association of any person carrying on or intending to
carry on, in goodfaith, the trade in relation to which
the trade association is formed [clause (i)]
The object of such an agreement is to restrict the membership
of the association to a few persons for mutually sharing the
benefits which may arise from the membership. Trade
associations enforce their discipline by boycotts, black-listing
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or shop-listing or refusal to deal with competitors, who do not
observe rules of their assocation. This practice of boycott is
not widely prevalent in India. Not many cases have came up
for enquiry before the Commission. In re Ghee Merchants’
Association [RTPE No 23/1976] it was observed that the
constitution of this association, which was registered for doing
the business of selling ghee on wholesale basis in Greater
Bombay, inter alia, contained unduly wide powers in the matter
of admission to membership. Holding it as a restrictive trade
practice the Commission declared the impugned conditions void.
Thus collective boycott is not available as an instrument to
discipline unethical business practices. The Monopolies
Commission of Enquiry (1965) had cited two cases of such
practices on which clause (i) regarding instance of boycott based
(1)a already manufacturer of pistons stipulated with his
distributors that he may maintain a list of persons called ‘shop-
list’ and the distributors shall not sell to any person in that shop
list any of the products covered by the agreement; (2) a similar
list was prepared by one oil company prohibiting the supply of
oil to persons on the list. At the same time it is worth mentioning
that the individual trader’s choice to deal with a certain person
or not, is something different.
(10) An agreement to sell goods at such prices as would have
the effect of eliminating competition or a competitor
[(clause (j)]
This clause covers predatory pricing agreements to eliminate
competition or to destroy a competitor. Predatory pricing means
selling at a lower price than customary profits - maximising
consideration would dictate, for purpose of driving a competitor
out of business or crippling his competitive power [Dugger.,
p.281]. However predatory pricing arrangements are strategies
adopted by undertakings in a position of strength to increase
their share of the market. This is similar to ‘loss lenders’ [In re
Johnson & Johnson Ltd & another, (1989)64 Comp.Cas 394
where the Commission did not agree with the complianants and
held that both clause (h) and the balancing clause of Sec. 38
would apply even if the charges of predatory pricing could be
proved].
(11)Any agreement restricting in any manner, the class or
number of wholesellers, producers or suppliers from
whom any good may be bought [clause (ja)].
What is mentioned in this clause is also covered by clause (a) of
Sec. 31(1) i.e., as an agreement which restricts or is likely to
restrict, by any method, the persons or classes of persons to
whom goods are sold or from whom goods are bought. In
Barnala Truck Union and others [CompanyLaw Digest Vol
XVII, Vol.II] where the trade practice of fixing of uniform and
exorbitant freight rates and not allowing non-members to load/
unload goods in and around Barnala prevented, distorted and
restricted competition in rendering transportation services to
the consumers and imposed unjustified cost on the consumers -
it was held of the Commission that there is a prima facie case
against the respondents for having indulged in the restrictive
trade practices.
(12)Any agreement as to the bids which any of the parties
thereto may offer at an auction for the sale of goods or
any agreement where any party thereto agrees to abstain
from bidding at any auction for the sale of goods
[clause(jb)]
By virtue of this clause such collusive agreements can be held
to be void unless they are necessary in public interest within the
meaning of Sec. 38. The clause is wide enough to cover cases of
search agreements as to participation in an auction according to
pre-planned terms. Though collusive tendering has not been
specifically included in the clause, it is likely to be covered by
the wide ambit of the clause because it is often difficult to
distinguish an auction from a tender where secrets bids are
invited in the shape of tenders. For example, in Perfect Circle
Victor Ltd. case [RTPE, 120 of 1984] the Commission issued
cease and desist orders against three respondents manufacturing
gaskets who were acting in concert by quoting the same or
identical prices against tender orders floated by the Director
General of Supplies and Disposals [Avtar Singh, p.150]
(13)Any agreement not herein before referred to in this Sec.
which the Central Government may, by notifications,
specify for the time being as being one relating to a
restrictive trade practice within the meaning of this sub-
Sec. pursuant to any recommendation made by the
Commission in this behalf. [clause (k)].
This is a residuary clause. It enables the Central Government,
on the recommendation, of the Commission, to include by a
notification in the Official Gazette, any other restrictive trade
practice not already listed u/s 33(1).
(14) Any agreement to enforce the carrying out of any such
agreement as is referred to this sub-Sec. [clause(l)].
This clause requires the registration of even an agreement which,
though by itself does not relate to restrictive trade practice, but
which seeks to enforce any agreement relating to any of the
restrictive trade practices enumerated in clauses (a) to (jb).
5.1.2 APPLICATION TO SERVICES
The provision of Sec. 33 shall apply in relation to agreements
making provision for services as they apply in relation to
agreements connected with the production, storage, supply,
distribution or control of goods [Sec. 33(2)]. Thus an agreement
under which a buyer has a voice in the manufacturing programme
would fall under Sec. 33(2) [See Registrar RTA v. Allied
Distributors & Co , 1976 Tax LR 1280]
5.1.3 EXEMPTED AGREEMENTS
Any agreement falling within Sec. 33 of the Act shall not be
subject to registration if -
(a) it is expressly authorised by or under any law for the time
being in force; or
(b) it has the approval of the Central Government; or
(c) the Government is a party to such agreement [Sec. 33(3)].
5.2 UNFAIR TRADE PRACTICES
Meaning
Protection of the people in their capacity of consumers is a
manifestation of progressive social and economic policy aimed
at enhancing the quality of life and thereby to promote the higher
standards of living...... and conditions of economic and social
progress and development [UN Charter, Articles 55 and 1(3)].
This is the same object of the MRTP Act, which aims to protect
the consumer from the business community by providing modes
to deal with the unfair practices perpetuated by the business
community. Sec. 36-A of the Act elaborates what unfair
practices means for the purposes of the Act. Hence under the
Act anything which is an unfair method or a deceptive practice
for the purpose of promoting sale etc., of goods or provision of
services may amount to an unfair trade practice whether it falls
in the list of categories(1) to (5) detailed u/s 36A or not. These
listed categories are merely illustrations of the unfair practice
under the MRTP Act. The unfair practices mentioned in Sec.
36-A can be grouped under five headings, viz.:
1. Misleading advertisements and false representations.
2. False offer of bargain price.
3. Offering of gifts or prices with the intention of not, providing
them and promotional contests.
4. Non-compliance of product safety standards.
5. Hoarding or destruction of goods.
(1) Misleading advertisements and false representations
The practice of making any statement, whether orally or by
writing or by visible representation which:
(i) Falsely suggests that the goods are of a particular
standard, quality, grade, composition, style or model;
False representation’s connotes that which is untrue, whether
the person making the representation is aware of the
untruthfulness or not. Where a tape recorder is sold under a
representation that it is of Japanese make it would be a false
representation of standard, if it is not in fact of Japanese make.
Where cotton garments are sold as made of Eygptian cotton, it
would be a false representation as to grade. Where readymade
garments are sold with a representation that they are currently
in style in U.S, it would be false representation if they are infact
out of style in U.S at the material part of time. The description
as ‘port’ what was infact ‘Tarrangona wine’ and the description
as ‘non brewed vinegar’ what in fact was a solution of acetic
acid and caramel were held to be false description [Akai v.
Dumet, (1951) 1 KB 34], Sandeman v. Gold, (1924)1K 107].
A placard advertised a computer with a software package
including a number of games. This package was incomplete
and it was held to be false representation as to composition
[Denard v. Smith 1991 Crim LR 63 DC].
(ii) Falsely represents that the services are of a particular
standard or grade;
Where a Health Club advertises that it can help achieve
‘slimming’ in a month and thereby indicates that the services
are of a particular quality and standard, it would be a false
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representation if in fact, ‘slimming’ cannot be rendered possible
in a month's time by the advertiser. Likewise a false
representation regarding excellent facilities at a hotel which in
fact are not there; false representation as to one’s professional
qualification which he in fact has not got [R v. Breeze, (1973)2
All ER 1141].
(iii) Falsely represents any re-built, second-hand, renovated,
reconditioned, or old goods as new one;
Where a motor car is sold as new, when in fact it is second
hand, or accidented and repaired or repainted one, or where a
house is sold as having been newly constructed a year back,
when it is in fact more than a year old it is unfair trade practice
u/s 36-A(i)(iii). Similarly when repaired, reconditioned and
renovated furniture is sold as a new furniture, or when retreaded
tyres are sold as new tyres, this sub clause stands attracted.
(iv) Represents that the goods or services have sponsorship,
approval, performance, characteristics, accessories, uses
or benefits which such goods or services do not have ;
Where a seller or supplier of shock absorbers represents that
they have been certified by the I.S.I, when in fact the certification
is under consideration, it is a false representation as to approval
and characteristics which such certification normally carries.
Where a dealer in scooters or motorcycles represents that
complete accessories for the vehicle would be supplied
alongwith the vehicle, but he charges for them separately or
does not supply the entire range, Sec. 36-A(i)(iv) would be
applicable.
(v) Represents that the seller or the supplier has the
sponsorship or approval or affiliation which such seller
or supplier does not have;
Where a correspondence school advertises that it is affiliated to
the London University and its LL.M. courses are therefore
recognised, it would be a false representation, if no such
affiliation is with the school at the material point of time.
Likewise where a supplier advertises as:
“Mafatlal, Binny, OCM
Mill approved show-room”
it could be a false representation as to approval where no such
approval has been granted by these mills.
(vi) Makes a false or misleading representation concerning
the need for or usefulness of any goods or services ;
A representation which gives rise to two meanings or
interpretation one of which is not true, is misleading
representation. Where a dealer in motor vehicles represents that
the fixing in of a particular device would save petrol, it could be
a false representation as to the need for the use thereof, if there
is no saving of petrol infact. Similarly, where an institute
advertises that its special computer course fetches employment,
carrying fabulous salary, it could be a false or misleading
representation where the course is very truly like the one offered
by other institutes. Likewise where a tyre manufacturer
advertises that the steel belting of the tyres increases the
longitivity of tyers by 200%, averts skidding of the vehicle on
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application of brakes, it would be a false representation as to
the need for the tyre, if the claimed properties of the tyre are
absent.
(vii)Gives a warranty or guarantee as to the durability,
performance or efficacy of the goods which is not based
upon adequate or proper tests; the burden of proof will
be upon him to show that the goods were adequately or
properly tested.
What is adequate or proper tests would depend upon the facts
and circumstances of each case. The opinion expressed by any
laboratory established for such testing and certification of by or
at the instance of the Government may be taken as authentic in
case the questions arises whether a particular test is adequate or
proper.
(viii) Materially misleading warranty or guarantee of a
product or goods or services as well as promises to
replace, maintain, or repair an article or any part thereof
or to repeat or continue a service until a specified result
has been achieved;
Where a representation is not materially misleading, as opposed
to misleading simpliciter the case cannot be brought under this
clause. Warranty has to be understood in the sense in which it is
understood under the Sale of Goods Act, namely, breach of a
particular term of sale which gives rise to a claim for damages,
and not avoidance of the contract as a whole. The guarantee
would be materially misleading if it does not disclose - (i) what
products or part of the product is guaranteed? (ii) what parts
are excluded from the guarantee? (iii) what is the duration of
the guarantee? (iv) what any person claiming under the
guarantee should do? (v) what manner would guarantor fulfil
the guarantee (vi) identity of the guarantor - whether
manufacturer, wholesaler, or retailer.
For instance where a particulr device is advertised as -
“Satisfaction or your money back” or "one week free trial” the
advertisement would be misleading materially unless the terms
and conditions of the guarantee are also disclosed
simultaneously. Where the representation purports to be a
promise to replace, maintain or repair an article or any part
thereof or to repeat or continue a service until it has achieved a
specific result, this clause (viii) of Sec. 36-A(1) shall be attracted,
if such caluse is (a) materially misleading, or (b) there is no
reasonable prospect of the promise they carried out. Where the
dealer in tyres represents that he would replace a particular brand
of tyres found defected within one year of purchase, he would
be hit by the clause if he does not have a long term continuing
arrangements with the manufacturer for carrying out the promise
[Duggar, p.306-7].
(ix) Materially misleads the public about the prices at which
such goods or services are available at the market;
This sub-clause is aimed at prohibiting misleading
representation of prices. For example, there is a seller/retailer
who gets his supply of flasks at Rs.30/- in which his normal
margin is 20%, and he offers for sale the flask at Rs.45/-. fully
realising that he would not be able to sell the flask in competition
with others at this price. After a few days he announces “Terrific
cut in flask prices previously sold at Rs.45, and now they are
only for Rs.36/-.” This is materially misleading as to the price at
which flasks have been sold previously, and this method may
mislead the consumers in believing that the price reduction is
quite substantial and a good bargain. However this prescription
is rebuttable if the seller/retailer shows that he had earlier sold
number of flasks at Rs.45. [Duggar, p.308]
(x) Gives false or misleading facts disparaging the goods,
services or trade of another person [S.36.A(1)].
False representation may also be by way of giving false or
misleading statements as facts which are intended to be
disaparaging by representing that the goods or services provided
by other in the same trade to be of inferior quality, characteristic
or performance or after sales service warranties. For example:
This is ‘Insta’ spark plug; it is always troublesome”. This
statement by a competing brand of spark plug manufacturer or
dealer is disparaging if the fact is otherwise.
The explanation to sub-sec.(1) classifies as to under what
circumstances a statement may be said to be made to the public.
The explanation is not exhaustive of the various forms in which
the statement may be expressed but provides that the statements
in the manner said there in, or advertisements by means of
banners, placards, cinema slides, handouts, broadcasts on the
T.V and radios etc., would very much amount to statements made
to public. If such advertisements influence significantly the
buyer behaviour by their exalted appeals, metaphorical
phraseology, and animated visuals, various such clauses of sub-
sec. (1) would be applicable to all such advertisments. All false
or misleading advertisements intended to deceive the consumers
would be attracted by this clause, and hence it would be
appropriate to refer to some cases. In DGIR v. M.S. Resorts
Ltd [(1987) 61 Comp.Cas 592, MRTPC] an advertisement for
sale of holiday resorts held out promises as to appreciation box
in terms of value and snet and offered “free holiday for ever”
comparing then with commissioned complexes like those in
Connought place, the promises and comparisons were found to
be false, the Commission prohibited any further portrayal of the
advertisement [See also DGIR v. Manjog Builders, (1987)62
Comp.Cas 823 where false claims as to sites were restrained]
In Bandana Chodha v. Sherie Louise Slimming Centre
[(1991)70 Comp.Cas 712 MRTPC] the slimming service was
so incompetent that a number of ailments were caused to the
client producing mental pain, typical suffering and unfitness for
work, the Commission put similar restraint on the slimming
centre and also allowed compensation of Rs.4,07,110 to the
complainant. These provisions are applicable to educational
institutions also which advertise with their guaranteed success
and high sounding promises [Bhartiya Veterinary College,
Bangalore, (1988) 63 Comp.Cas 3].
2. False offer of bargain price
Caluse (2) of Sec. 36-A deals with advertisements by publication
in newspapers or otherwise, by which the sale or supply of the
goods or services are offered at bargian price. As defence in
explanation to caluse (2) compared to the usual prices for such
goods or services offered for sale by the manufacturer, which is
not acutally true, that is, what is being represented, as a bargain
price or reduction sale is not actually so, would be an unfair
practice. A common method is to display as the usual price that
which is crossed out (though these are not the actual prices but
an inflated price), and along side the bargain price or reduction
sale price is shown and thus, the unwary customers is enticed
into buying such goods or services, such as clothes, shoes etc.,
in the false belief of having bought some goods or services at a
bargain. Such display of a purported reduction in price would
be unfair trade practice. It is worth noting that such purportedly
bargain prices became possible because of imperfect knowledge
or ignorance of the prevailing prices at which such goods or
services are already available, which is a characteristic of
imperfect competition. In Bharati Devi, re [(1987)61 Comp.Cas
734 (MRTPC)] it was held by the MRTP Commission an
announcement for sale of textiles at a throwaway prices, which
were not verifiable because neither the quality of goods was
mentioned nor their prices, to be unfair trade practice. Similarly
an advertisement was restrained by the Commission because it
purported to offer 50% discount whereas it was offered only on
a few items, no indications of original prices and quality was
mentioned [Inter Shoppage, re, (1988)63 Comp.Cas 286
(MRTPC)].
Similalry, it would be an unfair trade practice to publicise by
publictions of an advertisement in a newspaper or by pamphlets,
or leaflets sent by mail or personally delivered which states that
such reduction or bargain price will be valid for a limited period
and that such stock are limited, and then inducing the public to
buy such goods in a hurry so as not to lose such opportunity. By
such sale promotion tactics the seller seeks to induce and
influence the public to make such purchases in haste without
deciding on the merits of the products vis-a-vis, other competitive
or substitute products available in the market ignoring the other
needs [Mitra p.525].
(3) Schemes offering gifts, prizes, etc.
(a) Clause 3(a) of Sec. 36A covers cases were gifts, prizes or
other items are offered with an intention of not providing
them or creating an impression that something is being
offered free of charge when it is fully or partly covered by
the amount charged in the transaction as a whole. In such
cases Commission enquires whether the prizes or gifts were
reasonable from the standpoint of the cost to the consumer,
and actually given, as set out in the advertisement and that
there were no false or misleading representation as compared
to what was actually given. [In re Kochar Mills Ltd, (UTPE
53/1985]. In some cases the Commission has also taken
into consideration as to whether the cost of prizes which
were awarded, if passed on among all consumers would
result in any significant reduction in prices of the goods to
all or larger interests of consumers could be better served
[In re Avon Cycles Ltd, (1986) 60 Comp.Cas 1036]. In
Khetan Electricals Ltd., [UTPE, No.15 of 1986] gift
scheme against increased prices was restrained and in
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 Oswal Agro Mills Ltd, Re [UTPE, No.25 of 1985]
participation housing gifts scheme against purchasing two
washing soap cakes restrained.
It would be better to understand the meaning of ‘Bait and Switch’
selling which is being used relating to clause 2 of the Sec.. Bait
advertisement is an alluring but insincere offer to sell a product
or service which the advertiser in truth does not intend or want to
sell. The purpose is to switch consumers from buying the
advertised merchandise, in order to sell something else, usually
at a higher price as a basis more advantageous with advertiser.
The primary object of a bait advertisement is to obtain leads as
to persons interested in buying merchandise of the type so
advertised. Advertising includes any form of public notice
however disseminated or utilized. The MRTPC Commission
restrained a prize scheme which was desired to boost the sale of
cycles during the rainy season when sales would otherwise be
sluggish. The Commission required the producer that instead of
biating customers like that he should have given the benefits of
price reduction. The Commission was of the view that although
the intention was to confer benefits upon some consumers who
would be selected by chance, it was not in the interest of all in as
much as it would deprive them of the benefits of competition
offered by an affluent market [Avon Cycles Pvt. Ltd., Re,
(1986)60 Comp.Cas 1036 MRTPC].
(b) Clause 3(b) of Sec. 36 A covers the conduct of contest, lottery,
game of chance or skill for purpose of promoting directly or
indirectly - (a) the sale, use or supply of any product ; or (b)
the business interest. The sponsored quiz programmes in
televison and radio, monthly lottery at the showroom or shop,
publication of cross-word puzzles and the like in the
newspapers, a scheme whereunder the customer is required
to affix certain labels normally to be found in the product
under sale, would come under this sub clause. The schemes
may either be used to promote the sale of any product or to
promote the business of a particular person, firm or company
as has been said above. [Avon Cycles P Ltd., Re (1986)60
Comp.Cas 1036 MRTPC; In re Kochar Oill Mills, 4PTE
No.53 of 1985 MRTPC].
A restraint order was issued under the provisions of Bombay
Lotteries (Control and Tax) and Prize Competition (Tax) Act,
1958, by the Gujrat High Court in Wimco Ltd., v. Liberty
Match Co., [(1991)70 Comp.Cas 620] where a manufacture of
match boxes having factories at various parts of India prayed
for an injunction, ad interim as well as permanent, against
another manufacturer of match boxes who had introduced a
scheme effective in the city of Ahmedabad for purpose of
attracting wholesalers, retailers and consumers. A person
purchasing a container of sixty dozen match boxes was to get
according to his luck a gift or prize, coupon of denomination
between Re 1 to Rs.25. The complainant, Wimco, showed that
there had been a substantial decrease in its sales in Ahmedabad
after the introduction of the scheme.
The Court held that the scheme was a lottery and therfore,
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unlawful. Under the Bombay Lotteris (Control and Tax) and
Prize Competition (Tax) Acts, 1958. The appellant company
had locus standi to pray as such .
Soceity Foot Civic Rights v. Colgate Palmolive Jute Ltd
[(1991)72 Comp.Cas 80 MRTPC], in a scheme induced the
contestants to buy a minimum of two trigaurd toothbrushes to
enable him to participate in the contest. If he wanted to send
more than one entry, he had naturally to purchase greater number
of tooth brushes. The early “bird prizes” were to be awarded for
entries received first. Early had nothing to do with skill. It was a
matter of chance as to whose entry reached earlier. This was
purely in the nature of lottery. The fact that a large number of
persons were persuaded to part with their money in the hope of
getting some prices was not in public interest and the commission
restrained the scheme [See Achal Kumar Galhotra v. Byford
Motors Ltd, (1991) 72 Comp.Cas 702 MRTPC].
But the question for consideration, at the same time, is whether
in certain situations promotional contest (prizes schemes) can be
regarded in the public interest, the answer is in the affirmative in
view of the following cases. In British Airways Board v. Taylor
[(1975)3 All ER 307] an announcement was made that students
traveling to USA by British Airways before 15.9.86 would have
the opportunity to win one of the free tickets valid for travel
from India to USA till 31.3.1988. The contestant was required
to write a paragraph of not more than 50 words on “how he
believed his studies in the USA will help.” The scheme was
held to be beneficial to consumers. Similar views were expressed
in Mid Day Publications (P) Ltd., Re [(UTPE)No 50 of 1925];
Competition Success Review (P) Ltd, Re [UTPE No 7 of
1985]; Santosh Kalro v. India Book House (P) Ltd, [(1988-
89) MRTP 477].
(4) Non-compliance of product safety standards
Clause (4) of Sec. 36-A would rope in cases where certain goods
are knowingly being allowed to be sold as complying with
standards prescribed by a competent authority. Even where a
person does not know, it is sufficient if he has reasons to know
that sales are being so made. For example, unauthorised use of
I.S.I mark on the goods or any other mark not permitted by the
State Govenment, would be hit by this clause. Clause(4) reads:
The practice of making any statement, whether orally or in
writing or by visible representation which “permits the sale or
supply of goods intended to be used, or are of a kind likely to
be used, by consumers, knowing or having reason to believe
that the goods do not comply with the standards prescribed by
competent authority relating to performance, composition,
contents, design, construction, furnishing or packaging as are
necessary to prevent or reduce the risk of inquiry to the person
using the goods”
In DGIR v. Ford Specialities Ltd, [(1987) 62 Comp.Cas 122
MRTPC] the respondent company manufactured and marketed
Tomato Ketchup in packages of 400 gms. The Director General
contended that this was in contravention of the Standard of
Weights and Measures Act, 1976/Packaged Commodity Rules,
1977, which did not earlier allow such packages of 400 gms,
and likely to mislead the public into thinking of the package to
be of 500 gms and therefore it was an unfair trade practice under
Sec. 36-A(4). The Commission held that in packages of 400
gms could not be assured to be necessated to prevent or reduce
the risk of injury to the customer. Therefore the provisions of
Sec. 36-A(4) of the Act were not attracted [See also similar
case In re ; Messrs Kissan Products Limited, [IA 79/86 In
UTPE 73 of 1986]. The Commission had adopted the view that
there was no risk of injury when the contents was less in wieght
or quantity than that mentioned in the packing.
(5) Hoarding or destruction of goods
The last categoy of unfair trade practice includes cases of
hoarding or destruction of goods or refusal to sell the goods, or
to make them available for sale, if such hoarding or distruction
or refusal raises or tends to raise or is intended to raise the cost
of those or other similar goods or service [S.36.AC5)] [S.36-A
(5)].
5.2.1 ENQUIRY BY COMMISSION
Sec. 36-B empowers the Commission to enquire into any alleged
unfair trade practice in the following situations :
1. Upon receiving, a complaint of facts which constitutes such
practice from any trade association or from any consumer
or a registered consumers’ association, whether such
consumer is a member of their consumers’ association or
not ;
2. Upon a reference made to it by the Central Government or
a State Government ;
3. Upon an application made to it by the Director General; or
4. Upon its own knowledge or information.
Where a complaint is made u/s 36-B by consumers or
consumers’ association, the Commission before proceedings
against anybody, will require the Director General u/s 36-C
to hold preliminary investigation in to the truth of the
complaint so made to it. The object of preliminary inquiry
is to satisfy itself that the complaint is genuine and deserves
to be probed into deeply.
5.2.2 POWERS OF THE COMMISSION
The Commission may inquire into any unfair trade practice
which may come before it for enquiry. If upon enquiry
Commission finds that the unfair practice in question is
prejudicial to the public interest or the interest of any consumer
or consumers generally, the Commission can pass final orders
of the following nature under Sec. 36-D (i) :
(a) that the practice shall be discontinued or shall not be
repeated;
(b) that any agreement relating to such trade practice shall be
void or shall stand nullified in respect thereof in the manner
specified in the order ; and
(c) that any information, statement or advertisement relating
to such unfair trade practice shall be disclosed, issued or
published as the case may be, in such manner as may be
specified in the order.
The Commission may, instead of making any order u/s 36-D,
permit any party to carry on any trade practice, if it applies to the
Commission. The Commission will grant the permission if the
party takes such steps within the time specified by the
Commission as may be necessary to ensure that the trade practice
is no longer prejudicial to the public interests or the interests of
any consumer or consumers generally. If the Commission is
satisfied that necessary steps have been taken within the time
specified, it may decide not to make any order under Sec. 36-D
in respect of that practice [S.36-D(2)].
Where any trade practice is expressly authorised by any law for
the time being in force, no order will be made by the Commission
in respect of such trade practice [S.36-D(3)]. Subject to this
exception, however, the Commission and Director General have
the same powers in reference to an unfair trade practice as they
have in respect of restrictive trade practice [S.36-E].
Exclusive Jurisdiction
The power of enquiry into unfair trade practices is exclusively
vested in the Commission [ITC v. Shri Krishna Moktan, AIR
1992 Sikkim; See also ITC v. Phusba Lama AIR 1992 Sikkim
34]. The Court opined :
“The aforesaid Act (MRTP) empowers the Commission to
inquire into any unfair trade practice and to make necessary
orders. Rights and obligations relating to unfair trade practices
have been created by the MRTP (Amendment) Act, 1984, and ,
therefore, one who feels aggrieved has to pursue the remedy
provided [by] the Acts, with the result that the Civil Court does
not have the jurisdiction to deal with the matters brought before
it by virtue of Sec. 36-A of the Act”.
Among various allegations against the ITC, one was that by
using the “WD & HO Wills” mark on their brands the company
was erecting the false impression that their production belongs
to the ‘Wills” family, and that use of foreign brand names was
against Government guidelines and that thereby they had
increased smoking habit which is against public health, and
therefore, it was an unfair trade practice. It was held that the
use of that mark was there even before the Government
guidelines were notified and, therefore, it was not affected by it.
Furthermore, the guidelines had already been revised and
exclusive foreign marks had been allowed and the damage to
health by smoking was a general feature and not the contribution
of any particular brand [Avtar Singh, p.179].
5.3 CONTROL OF RESTRICTIVE TRADE
PRACTICES
Investigation by Commission
The Commission has jurisdiction u/s 37 to enquire into all
restrictive trade practices whether or not a practice emanates
from an agreement or not. Thus the termination or expiry or
lapse of an agreement containing a restrictive trade agreement
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would not mean that enquiry proceeding cannot be held.
Likewise registration of an agreement u/s 35 is not a condition
precedent for an enquiry u/s 37 by the Commission. A trade
practice devoid of an agreement, could be as much a subject of
inquiry by the Commission, as one flowing from an agreement.
The Commission, in an inquiry u/s 37, is not at all concerned
with the question of registrability of an agreement [J K
Synthetic Ltd v. Director of Investigation (1977) 47 Comp
cas 323 (All)]. The inquiry of the Commission is into a
restrictive trade practice, and not of the agreement relating to the
restrictive trade practice. The agreement, if any, comes up
for scrutiny incidentally for ascertaining the true nature, scope
and impact of the practice. Also it serves as evidence in the
course of inquiry. Where a restrictive trade practice flows from
an agreement, it of course, becomes necessary for the Commission
to order modifications of the agreement or to declare it void.
The scope of inquiry by the Commission goes beyond an
agreement, and even if the impugned agreement did not fall under
any of the categories of Sec. 33(1) it could still amount to a
restrictive trade practice under Sec. 2(0) and , hence liable for
inquiry [General Electric Company of India v. MRTP
Commission (per Calcutta High Court), RTPS in India, Vol. III;
p.351]. In essence, an inquiry u/s 37 is in the nature of disciplinary
proceeding against a business undertaking alleged to be indulging
in anti social practice and the consequence of the enquiry is an
injunction restraining the continuation of the anti social act [All
India Motor Transport Congress v. Goodyear India Ltd,
(1976) 46 Comp Cas 315].
Alternatively an opportunity could be granted by the Commission
to the delinquent party if it is ready to take steps that the trade
practice is no longer a restrictive trade practice prejudicial to
public interest [37(2)]. The requisite permission could be granted
only to a party to a restrictive trade practice [Bengal Potteries
Ltd v. MRTPC, (1975) 45 Comp Cas 697 (Cal)]. The stage for
considering application u/s 37(2) arises only after an inquiry into
the existence of a restrictive trade practice has been made and
the restrictive trade practice has been established and is considered
prejudicial to the public interest. It is at this stage, that the
Commission instead of making an order u/s 37(1) may act u/s
37(2). The expression’ S37(2) is not limited to an order under
S.37(1). The Commission can, however, entertain an application
u/s S37(2), instead of making an order under this Sec.’, without
first holding an inquiry u/s 37(1), on the assumption implicit in
the application in this regard that a restrictive trade practice in
existence is prejudicial to public interest; and instead of making
an order under Sec. 37(1), a scheme, which would eliminate the
restrictive trade practice or make the trade practice no longer
prejudicial to the public interest, could be offered by the
Commission [Delhi Pipe Dealers’ Assn. v. Indian Tube Co
Ltd, (1977) Tax LR 2159 MRTPC].
The Commission has absolute discretion whether it should,
instead of passing an order under sub-Sec. (1), allow the
delinquent party to take recourse to sub-Sec. (2). Even if an
inquiry u/s 37 has been started on a complaint u/s 10(a)(i) or on
a reference or application by the Government or the Director
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General u/s 10(a)(ii) or (iii), the Commission, if it so chooses,
may dispose of the case under sub-Sec. (2) [Duggar p.351]. In
this way, case can be disposed of by the Commission only when
the respondent party applies to the Commission to remedy the
restrictive practice, so that it is no longer prejudicial to public
interest.
No order can be made by Commission in respect of an agreement
for sale of goods which are bought, not for resale, but for self-
consumption and also irnespective of a practice which is
expressly authorised by any law for the time being in force [s
37(3)]. This would imply that on repeal or modification of such
law or the relevant provision of it, such trade practice shall be
open to inquiry from the date of such repeal or modification.
But this will not affect any such trade practice already existing.
Under Sec. 37(4) Commission has been vested with the powers
to inquire into any monopolistic trade practice being indulged
in by the owner of the undertaking which comes to his notice
during the inquiry u/sub-Sec. (1) or (2). The Commission after
passing orders under sub-Sec.s (1) and (2), in respect of
restrictive trade practice may submit the case to the Central
Government in respect of such monopolistic trade practice along
with his findings for such action as the Government may take u/
s 31 of the Act. It is worth mentioning that under proviso to S
31(1), on receiving information that owner of an undertaking or
owner of two or more undertakings, are indulging in
monopolistic trade practice, the Commission may on its own
motion and not withstanding that no reference has been made
by the Central Government under this sub-Sec., make an inquiry
into the matter. At the same time sub-sec. (2A) of Sec. 31
provides for the Central Government, on receiving a report from
the Commission to take steps to remedy or prevent the mischief
which has resulted, or may result from such monopolistic trade
practice. Thus the authority of the Commission to inquire into
a monopolistic trade practice under sub-sec. (4) of Sec. 37 and
for the Central Government to act upon such findings of the
Commission is consistent with the proviso to subSec. (1) and
sub-sec. (2A) of Sec. 31, and does not attract any of the
exceptions specified in Sec. 32 of the Act [Mitra, p. 594].
5.4 PROTECTION OF PUBLIC INTEREST
Gateways
Though Sec. 38(1) provides that a restrictive trade practice shall
be deemed to be prejudicial to public interest for the purposes
of an inquiry before the Commission u/s 37, but any agreement
is not per se treated as against public interest even if it contains
any number of restrictive trade practices. Reasonable restrictions
considered to be a balance between circumstances are permitted.
This is called the rule ‘of reason’, as against rule of per se
circumstances. Where reasonable restrictive agreements would
be allowed are called “GATEWAYS” and are given hereunder
[sec 38(1)]:
(a) Protection of public interest against injury: Where
restriction is reasonably necessary having regard to the character
of goods and the need to protect public injury, whether to persons
or premises, in connection with the consumption, installation or
use of those goods.
(b) Denial of benefit to public: Where the removal of
restriction would deprive the public or the users of such goods
which they are enjoying as a result of the restriction or
arrangement.
(c) Counter measures against competitive activities of
another: Where the restriction is reasonably necessary to
counteract measures taken by any one person not party to the
agreement to prevent or restrict or compete in the particular
trade or business.
(d) Countervailing force: Where the restriction is reasonably
necessary to enable the parties to the agreement to deal on fair
terms with a person who is not a party, but alone or in continuation
with other controls a preponderant part of the trade to which the
agreement relates.
(e) Adverse effect on employment: Where the removal of the
restriction would be likely to have a serious and persistent
adverse effect on the general level of unemployment to any area
or areas in which a substantial proportion of the trade, or industry
to which the agreement relates, is situated.
(f) Reduction in exports: Where the removal of restriction
would be likely to cause a reduction in the volume or earnings
of the export business substantially.
(g) Secondary restriction: Where the restriction is reasonably
required for maintaining any other restriction accepted by the
parties, whether under the same agreement or under any other
agreement between them which the Commission feels or has
found in a previous proceeding is not contrary to public interest.
(h) Harmless restriction: Where the restriction does not
directly or indirectly restrict or discourages competition to any
material degree in any relevant trade or industry and is not likely
to do so.
(i) Restriction authorized by Government: Where restriction
has been expressly authorized and approved by the Central
Government.
(j) Restriction for Defence of India: Where restriction is
necessary to meet the requirement of the defence of India or
any part thereof, or for the security of state.
(k) Restriction for maintenance of supply of essential goods
and services: Where the restriction is necessary to ensure the
maintenance of supply of goods and services essential to the
community.
It is therefore for the purposes of any proceedings before the
MRTP Commission under Sec. 37, a restrictive trade practice
shall not be deemed to be prejudicial to the public interest if the
Commission is satisfied of any one or more of the circumstances
referred to above. In addition to the satisfaction of the MRTP
Commission on the points referred to in Sec. 38(1), the
Commission should be further satisfied that the restriction is
not unreasonable having regard to the balance between
circumstances and any detriment to the public or to persons not
parties to the agreement (being purchasers, consumers or users
of goods etc.) resulting or likely to result from the operation of
the restriction. Thus balancing process means whether on the
whole the restriction will advance public interest or be
detrimental to it. In Telco Ltd v. Registrar of Restrictive Trade
Agreement [AIR 1977 SC 973], Telco had an agreement with
its dealers, of which some of the clauses were: (17 A) dealer
will not directly or indirectly sell the Tata trucks outside the
territory assigned to him. (2) He will maintain organization for
sales and services within his territory to the satisfaction of Telco.
(3) He will not sell, directly or indirectly, trucks of other
manufacturers.
The Supreme Court stated that any trade which restrain and binds
persons or places or prices would be per se bad if it destroys
competition and (a) facts peculiar to business, (b) condition
before and after restraint, and (c) porbable affects of restraint,
will have to be considered (This is a ‘rule of reason’).
Telco stated that they had to ensure equitable distribution of trucks
so that the trucks reach even remote places like Nagaland, Tripura
etc. Otherwise, these trucks will be concentrated in large metro-
centres only, where demand is heavy. Prompt and efficient after-
sale service is vital for the truck user. The dealer has to maintain
stock of spares and good service facilities with adequate
equipment and trained mechanics. The dealer would not be able
to maintain these facilities if it is not sure of business from the
area. Consumer interest demands that he gets after-sale service.
After-sale service needs specialization which would not be
possible if the dealer deals in trucks of other makes. Thus,
ultimately consumers will suffer.
The Supreme Court accepted the above contention and declared
that restrictions imposed by TELCO do not amount to restrictive
trade practice. The Court further observed that the Registrar
[now DGIR] should explain while applying to the MRTP
Commission, the facts or features which make the trade practice
restrictive and he should not just repeat bald paragraphs from
agreement.
The above view was confirmed in Mahindra & Mahindra Ltd
v. Union of India [AIR 1979 SC 798].
Role of public interest is well illustrated by the case of Indian
Ferro Alloy Producers’ Assn. Re [(1987) 62 Comp Cas 522
MRTPC] thus: “The producers of ferro manganese were facing
the problem that they were not able to stand competition in the
export market and in India the only bulk purchaser was the Steel
Authority of India Ltd (SAIL). Consequently, when this
authority invited tenders for its requirements for 1981, the
association of ferro producers, in order to assure that none of
them would be thrown out of business, resolved to allocate
supplies to members and fixed the price. The authority, on the
other hand, invited individual producers for negotiations. The
question of the validity of the association’s attempt to regulate
the business arose. It was held by the Commission that the
regulation adopted by the association was of restrictive nature
because it restricted competition as to quantity and price, but it
was not against public interest because it was necessary for the
survival of the trade.
Sec 38 is so presented as to indicate the type of business practices
which can be lawfully adopted. Its categories are open to
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practices which not being prejudicial, are available for use. That
is why these are called “Gateways” [Avtarsingh, p.184].
5.5 AVOIDANCE OF STIPULATIONS OF RE-SALE
PRICE MAINTENANCE
(1) Stipulations for maintaining resale prices
Sec. 39(1) renders any term or condition of a contract for the
sale of goods in India which provides for minimum resale price,
void and the contravention of the provisions of Sec. has been
made punishable u/s 51 of the Act. Thus, establishment of
minimum resale prices, a specie of restrictive trade practices,
through any contract for sale of goods has been made per se
illegal under the MRTP Act. This Sec. deals with avoidance of
condition or stipulations for maintaining resale price. Sec. 33
which deals with categories of restrictive trade agreements as
laid down in subSec. (1) of that Sec. which includes resale price
maintenance as a restrictive trade practice under clause (f) of
that subSec. and as such was registerable u/s 33(1). Under Sec.
33(1)(f) resale price maintenance was a trade practice contented
in ‘any agreement’ to sell goods on condition’ that the prices to
be charged on resale by the purchaser shall be the prices stipulated
to have been fixed by the seller, unless it is clearly stated that
prices lower than those prices may be charged. In RRTA v.
Amar Dye Chem. Ltd, [RTPE of 1975], the Commission by its
order inter alia restrained resale price maintenance and stipulated
that in all price lists issued by the respondent it must be clearly
stated that the prices relating to the consumers are maximum
prices and the distributor was free to charge lower prices.
In RRTA v. Bata India Ltd, [(1976) 46 Comp Cas 441] the
complainant included inter alia allegations of resale price
maintenance in the price list calculated by the manufactures
stipulated the whole sale and retail price lists, and retail price
was also stamped on the footwear. The Commission directed
the respondents to conspicuously mention in the price lists that
dealers are free to charge prices lower than these prices and the
prices embrossed on the footwear should read “price not to
exceed ——”.
The position would be more clear if we dictomize the provisions
of Sec. 39 vis-a-vis Sec. 33(1)(f). Sec. 39 gives special treatment
to contracts which seek to establish minimum resale price [in
contra distinction’ to ‘resale price’ as understood with reference
to provisions of Sec. 33(1)(f)]. Such arrangements are void ab
initio and illegal per se. On the other hand, any agreement to
sell goods on the condition that the prices to be charged on
resale by the purchaser shall be the prices stipulated by the
seller though restrictive in nature, is not per se illegal. The
distinction appears to be that in the type of agreements covered
by Sec. 33(1)(f), no minimum price, as such, is prescribed for
resale of the goods to buyer. In other words, the arrangements
falling under Sec. 33(1)(f), inter alia, would be those where
under a fixed or maximum resale price or recommended retail
price is prescribed; such arrangements, though deemed to be in
the nature of restrictive trade practice, would still be permissible
till they are subjected to a ‘cease and desist’ order of the
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Commission. In the course of the inquiry by the Commission,
before ‘cease and desist’ order is passed, the respondent may
even plead any of the gateways specified in Sec. 38(1). An
arrangement, through fixing a fixed or maximum resale price or
recommended retail price, would not be treated as relating to
restrictive trade practice within the meaning of Sec. 33(1) and/
or Sec. 2(0), provided it is clearly stipulated that prices lower
then those prices may be charged [Duggar, p.376].
(2) No supplier to notify to dealers or public, the minimum
prices to be charged
While Sec. 39(1) deals with resale prices maintenance as a
restrictive trade practice adopted by an individual person
including single manufacturer or wholesaler to be void, Sec.
32(2) deals with stipulation of minimum resale price maintenance
by supplier directly or through an association or group of persons
acting on his behalf as agents and collectively adopt a resale
maintenance, by way of minimum price which may be charged
on the resale of the goods in India at the instance of the supplier
(i.e., which according to Explanation to Sec. 39 refers to a person
who supplies goods to any person for the ‘ultimate purpose’ of
resale and includes a wholesaler) and the term dealer includes a
supplier or retailer.
Sec. 39(2) mandatorily provides that after the commencement of
the Act, no supplier of goods, (as defined in the explanation)
shall notify, or otherwise publish, any price stated or calculated
or understood to be a minimum resale price to be charged within
India for such goods. The clause does not make any provision
for the dealer or retailer to charge lower prices, but provision of
Sec. 40(1) provides for prohibition of with holding supplies to
a dealer or retailer on ground of having sold such goods below
the minimum resale price. For example, in DGIR v. Warisi
Sales Corpn, [(1988) 63 Comp Cas 878 MRTPC] verbal
directions to dealers not to sell the product of milk marketing
federation below the maximum recommended price and to
withhold supplies if they did so was held to be violative of the
Act.
(3) Resale price maintenance allowed for patented articles
Sec. 39 shall also apply to patented articles (including articles
made by a patented process and articles made under any trade
mark) as it applies to other goods. However, nothing in sec 39
shall affect the validity of any terms or conditions of a licence
granted by the proprietor of a patent or trade mark, so far as it
regulates the price at which articles produced or processed by
the licensee or the assignee may be sold by him. Thus the dealer
is free to sell product at any price he likes even though he had
notice of any terms or conditions as regards the price of patented
articles. However, the validity of any term or condition of a
licencee granted by the proprietor or licensee or assignee of a
patent, in so far as it regulates the prices of any patented articles
as between themselves, is not effected by this provision. In
Dunlop Rubber Co Ltd v. Longlife battery Depot [(1958)
LR IRP 65] it was held that “ever since the decision in
Incandescent Gas Light Co Ltd v. Bragden there has been no
question that a purchaser who buys with knowledge of the
conditions under which the vendor is authorized to deal in a
patented article is bound by such conditions, not because such
conditions are contractual, but because they are incident to and
a limitation upon the grant of the licence to deal in the patented
article, so that if the conditions are not complied with, there is
no grant at all”. In Dunlop v. Longlife Battery, Dunlops made
the tyres under patent and sold them subject to a licence which
prohibited resale below Dunlop’s current price list. Longlife
Battery, who had notice of the condition, resold below Dunlops’
price. An injunction was granted against Longlife Battery
[Duggar, p.380].
(4) Prohibiting a supplier from withholding supplies
In order to make the provision u/s 39 really effective, Sec. 40(1)
provides that a supplier shall not withhold supplies to a seller
only on the ground that he has resold goods below resale price or
is likely to do so if the goods are supplied to him. A refusal to
supply on any other ground will not be regarded as refusal [sec
40(4)]. Explaining as to when it can be said that supplies have
been withheld, Sec. 40(3) says that supplies shall be deemed to
be withheld from the dealer if the supplier:
(a) refuses or fails to supply those goods to the order of the
dealer; or
(b) refuses to supply those goods to the dealer except at price,
or on terms or conditions as to credit, discount or other
matter which are less favourable than those at or on which
he normally supplies those goods to other dealers carrying
on business in similar circumstances; or
(c) treats a dealer, inspite of a contract with such dealer for the
supply of goods, in a manner less favourable than that in
which he normally treats other dealers in respect of time or
methods or delivery or other matters arising in the
performance of the contract.
Under Sec. 40(1) expression “resale price” means any price
notified to the dealer or otherwise published as the price or
minimum price which is to be charged or which is recommended
or prescribed as appropriate for resale of goods. Sec. 40(2)
uses the expression “loss leaders” and makes an exception. Sec.
40(2) allows the supplier to take measures to protect himself
against his goods being used as “loss leaders” and such measures
are not actionable under sub-Sec. (1). This is an exemption
under which supplies can be with held with impurity.
Explanation II to Sec. 40 defines “loss leaders”, as goods
deliberately offered for sale at a price which shows a loss to the
seller in order to attract customers to buy other goods of the
seller and thereby make overall profit. “Loss leaders” is the
name frequently applied to an article sold at a price cut drastically
below the established retail price. It is used as a
form of advertisement to approch customers into a shop in the
hope that they will at the same time, purchase articles
showing a high rate of profits, or that the increase in turnover
articles showing a normal rate of profit will outweigh the losses
sustained on sales of the leading goods. Very often well known
proprietary articles appear to be used for this purpose; their
established price provides a standard against which the public
may immediately appreciate the extent of the price reduction.
In J J B (Sports) Ltd v. Millero Sport Ltd [(1975) ICR 73
(CA)], the plaintiff was a retailer operating largely by mail orders
and a substantial part of the business consisted of the sale of
fishing tackle and accessories. Manufacturers sold their fishing
tackles including Mitchell reels with a recommended minimum
resale relief price involving approximately a 50 per cent makeup
on the wholesale price. The plaintiff retailed the reels at a mark-
up which was considerably less than the recommended price.
The defendants, encouraged by the manufacturers, refused to
supply Mitchell reels to the plaintiff. In an action against both
the defendants, the plaintiff alleged that they had unlawfully
witheld the supply of goods contrary to Sec. 2(1) of the English
resale Prices Act, 1964. The defendants, had cause to believe
that for a period of 12 months previous to their withholding the
plaintiff had been using the goods as “loss leaders”. No relief
was allowed [Avtarsingh, p.193].
(5) Exemption from the Operation of Sec. 39 AND 40
Sec. 41 of the Act empowerss the Commission on a reference
made by the Director General or any other person interested,
(who may be so interested as a manufacturer, supplier or a trade
associate of such persons, or a consumer or user or a consumers’
or users’ association) to make an order that goods of any class,
as specified in such order shall be exempt from the operation of
Sec's 39 and 40, if the Commission is satisfied that, if such
minimum resale price maintenance is not allowed, public or
consumer interest of the class of goods in question would be
affected because:
(1) the quality of the goods or their variety would be
substantially reduced to the detriment of the public as
consumers or users;
(2) the retail prices would generally and in long run go up to
the public or consumer detriment;
(3) the necessary services actually provided with sale of goods
by retail would cease or be reduced to the public or consumer
detriment.
In Registrar v. Bennet Colman & Co Ltd [RTPE 30/1979]
the MRTP Commission held that news papers are exempted
from the operation of sec 39 and 40 in public interest by way of
surveying of public news and news of current affairs. Thus they
(news papers) can prescribe minimum price. This is because
speed is the essence of publishing a newspaper. Allowing retailer
or vendor to bargain the price would delay the process of
reaching consumers fast. This will reduce circulation, which
will lead to reduction in quality and also increase in costs. This
will not be long term interests of public.
Onus of proof: It is to be noted that the onus of proof or of
satisfying the Commission would lie on the interested person
or the Director General or such other person or persons
interested making such application to prove and establish that
exemption of such minimum resale price maintenance was in
the interest of consumers in terms of clauses (a), (b) and (c) of
sec 41(1). Where goods of any class have been the subject of
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proceedings before the Commission under Sec. 31 of the Act,
the Commission may treat as conclusive any evidence of fact
made in those proceedings [sec 42(2)].
6. OFFENCES AND PENALTIES
SUB-TOPICS
6.1 Offences and penalties
6.2 Jurisdiction of courts to try offences
6.3 Cognizance of offences
6.1 OFFENCES AND PENALTIES
Chapter III of MRTP Act deals with the provisions relating to
offences under the Act and penalties prescribed for such offences.
In case of several of the offences, penalty for a ‘continuing
offence’ has been provided. It may be noted that a continuing
offence may be viewed as one, the continuance of which continues
to hamper public interest and public policy. In continuing offences
limitation under the Criminal Procedure Code does not apply.
Usually where continuing offence is provided for, it is so stated
in the section prescribing the penalty for such continuance of the
offence. Hereunder we may study the various offences and
consequences thereof entailing penalty under various Sec.s of
the Act:
(1) Contravention of Sec. 27 [Sec 46]: Any contravention of
the provisions relating to division of undertakings [sec 27], is
punishable u/s 46 of the Act with a fine extending up to one
lakh rupees or with imprisonment extending to 5 years or both
and in case of a continuing default, the fine will be Rs. 1000/-
for everyday, after the first day, during which the contravention
continues.
(2) Contravention of Sec.s 33 & 35 [Sec 48]: Sec. 48 provides
punishment for failure on the part of a person to register an
agreement which includes restrictive trade practices and is thus
subject to registration under Sec.s 33 and 35 of the Act, if such
failure is one without any reasonable excuse. The punishment
is fine extending upto Rs.5000/- or imprisonment upto 3 years
or both and, where the default is continuing one, Rs.500/- for
every day, after the first day of default.
(3) Contravention of orders under Sec. 27-B [Sec 48]: Sec.
27B is designed to break concentration on monopoly by
requiring a person to disinvest or transfer his holdings. Non
compliance may consist of failure to give effect to the order or
concealing, or obstructing the transfer of property, etc. The
punishment is imprisonment upto 2 years and or with fine upto
Rs.10000/-
(4) Non compliance of orders under Sec.s 42 & 43 [Sec 49]:
If a person fails, without reasonable excuse to submit any
information required by the Central Government u/s 43 or
required by the Director General u/s 42, he is punishable with
imprisonment upto three months or with fine upto Rs.2000/- or
both, and Rs.100/- for every day of default, where the offence is
of continuing nature.
If a person makes false statement or furnishes false document,
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withholds any material fact, or alters, suppresses or destroys
any document he is punishable with imprisonment up to six
months or with fine which may tend to Rs 4000/-, or both.
(5) Non compliance of orders u/s 13 [Sec 50]: A failure to
comply with the orders of the Commission issued u/s 13, is
punishable with imprisonment for a term which may extend to
three years, or with fine which may extend to Rs.50000/- or
with both, and where the offence is continuing one, with a further
fine which may extend to Rs.5000/- for everyday after the first,
during which such contravention continues.
N.B. Earlier we have mentioned about the penalties for the
offences committed under Sec.s 31 and 37.
(6) Violation of provisions of Sec.s 39 and 40 [Sec 51]: Sec.
51 provides penalty for contravention of the provisions of Sec.s
39 and 40 of the Act relating to minimum resale price
maintenance. The punishment for violation is imprisonment
upto three moths or fine upto Rs.1000/- or with both.
(7) Contravention of restriction under Sec. 60 [Sec 52]: Sec.
60 seeks to ensure that the information obtained by the
Commission in respect of any undertaking is not to be
unauthorisedly disclosed to others except for the purposes of
the Act or with the consent in writing of the owner of the
undertaking. Any other disclosure would be wrongful and is
punishable with fine up to Rs.5000/- or imprisonment upto 6
months or both.
(8) Penalty for contravention of conditions etc [Sec 52A]:
Where alongwith any approval, sanction, direction or exemption
in relation to any matter, any restrictions or conditions have
been imposed, the penalty for contravention is fine upto Rs.1000/
- and where the offence is of continuing nature, Rs.100/- for
every day after the first, during which such contravention
continues.
(9) Penalty for false statement [Sec 52B]: If in any application,
return, report, certificate, balance-sheet, prospectus, statement
or other document made, submitted, furnished or produced for
the purpose of any provision of the Act, any person makes a
statement, (a) which is false in any material particular, knowing
it to be false, or (b) which omits to state any material fact,
knowing it to be material, he shall be punished with
imprisonment for a term which may extend to 2 years and shall
also be liable to fine.
(10) Offences by Companies [Sec 53]: Sec. 53 states that
where an offence is committed by a company, (by an explanation
to the Sec. a company also means a firm, or an association of
individuals), every person who at the time when the offence
was committed was incharge of, and was responsible to the
company, for the conduct of its business shall be deemed to be
guilty of the offence and shall be liable to be proceeded against
and punished accordingly, unless as stated in the proviso, any
such person concerned proves that the offence was committed
without his knowledge, or that he had exercised due diligence
to prevent the occurrence of the offence [sec 53(1)].
Where it is proved that the offence was committed due to
negligence or connivance on the part of any director (by the
explanation to this Sec. ‘director’ includes a parner of a firm),
manager or secretary or other officer of the company, then any
such officers of the company shall be liable to be proceeded
against and punished accordingly [sec 53(2)].
It will be necessary for the prosecution to identify and establish
the person or officer due to whose negligence or with whose
connivance that is willful or deliberate such act or consent, the
offence has been committed and it will be for such officer in his
defence to prove that such offence was committed without his
knowledge, or despite due diligence exercised by him, to prevent
the commission of such offence. The trial court will have to be
satisfied that the officer whose negligence or connivance or
consent is established after considering the defence that such
officer has exercised due diligence against the offence being
committed or that it was committed without his knowledge.
However sec 630 of the Companies Act, 1956 provides for relief
and protection to be sought by any officer of the company from
the court against any charge of negligence, default, breach of
duty, if the court is satisfied that such breach or default occurred
in good faith and honestly and reasonably and not due to wilful
neglect or from any malafide purpose [Mitra, p.669].
6.2 JURISDICTION OF COURTS TO TRY OFFENCES
No Court inferior to a Court of Session shall try any offence
under this Act [sec 56].
6.3 COGNIZANCE OF OFFENCES
Under Sec. 57 no court shall take cognizance of a complaint
under the Act unless it is made in writing by a public servant as
defined in Sec. 21 of the Indian Penal Code. Under Sec. 63 of
the MRTP Act, every member of the Commission, Director
General and every member of the staff of the Commission and
of the Director General shall be deemed to be public servants,
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while acting or purporting to act, under the provisions or in
pursuance of any of its provisions. It is implied that such
complaint should be made in the form and in accordance with
the Code of Civil Procedure [Mitra, p.675].
7. CASE LAW
(1) Achalkumar Galhotra v. Byford Motors Ltd, [(1991) 72
Comp Cas 702 MRTPC].
The advertisement which was restrained by the Commission
was that the dealer was offering Premier Padmini at Rs.28,000
less than Maruti. There was no indication of the market price
of Maruti. The offer of a free stereo was also false because the
cost was recovered by inflating the registration charges. The
scheme of replacing the car of a lucky purchases with a new car
every year by drawing lottery was held to be untenable by virtue
of the provisions of Sec. 36(3).
(2) Hindustan Lever Ltd. v. Monopolies and Restictive
Trade Practices Commission, [AIR 1977 Sc 1285]
Hindustan Lever is the manufacturer of a variety of consumer
goods from toiletteries to toothpaste. Their agreement with
redistribution stockists contained a number of clauses in a
standard form, two of which were questioned before the
Commission. One of them required the stockists to purchase
and accept from them such stocks as they might, at their
discretion, send to the stockists for fulfilling their obligations
under the agreement. The other clause required the stockists
not to make the stocks outside their towns except with the written
consent of Levers. The clause also required the stockists to return
from the stock purchased by them such parts as levers may direct
them to do for purposes of resale.
Both these conditions were held to be void as restrictive trade
practices. The first clause empowered the manafacturer to thrust
upon the dealer any stock of their choice and the dealer was
bound to accept it if he wanted to remain on their list. This
violated Sec. 33(1)(b) which provides that an agreement
requiring a purchaser of goods, as a condition of such purchase,
to purchase some other goods, would be a restrictive trade
practice. The clause in question "clearly makes it necessary for
the stockist to purchase such goods and in such combination as
the company may decides. Hence it would be struck by
Sec. 33(1)(b) of the Act:
(3) In re: Gripp System Ltd., (UTPE 214 of 1987).
It was complained that the respondnt company was selling
Pyramid Brand TV sets using advertisments that these were
manufactured in technical association with Toshiba of Japan
and that the respondent company had also advertised that it was
a member of the Lalbhai group. It was found on the Director
General's investigation that the Department of Electronics,
Government of India, had not approved of any foreign
collaboration of the respondent company with Toshiba nor did
the respondent company belong to the Lalbhai group. The
Commission held that the respondent company was indulging
in unfair trade practice which was hit by clauses (i), (iv) of Sec.
36A(1) of the MRTP Act and cease and desist orders were
passed.
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(4) In Re: Kaleen Furnishers & Decorators, [UTPE 208 of
1986]
The respondent dealt in carpets. For sales promotion he
advertised a festival discount upto 40% in Diwali. No reason
was given for allowing discount. Preliminary investigations were
held to the points (i) written 40% discount was offered as
advertised, (ii) whether the rate of discount was related to the
conditions of goods, demand of them, etc. The investigation
showed that discount actually allowed was within the range of
25-40% and there was no change in prices two month prior or
during the sale period. The criterion for discount was that the
discount was higher on smaller sizes and lower on large sizes.
Range of discont was not determined by the quality or age of
carpets.
The commission stated that the descriptions of the discount sale
period as till Diwali was quite specific. The Commission held
that the discount range was not specifically indicated in the
advertisement or criterion given but no element of deception
was noticed in the course of investigations. The range of
discounts 25% to 40% was not so wide and was commensurate
with the sizes of the carpets and the quality of carpets was not
inferior to the usual qualities sold at other times. Hence, the
enquiry proceedings were dropped.
(5) In re : India Tobacco Co. Ltd., [UTPE 50/86]
Twenty seven consumers had made a complaint to the
Commission under Sec. 36B(a) of the MRTP Act that the
respondent had practised deception on them, as well as, a large
number of other smokers of cigarettes by a massive misleading
campaign launching and promoting the sale of cigaragees with
the brand name NOW, which is infact an international renowned
and favourite brand of cigarettes manufactured by R.J. Reynold
Tobacco Co. of USA (RJR), and had sought an interim injunction
against use of this brand name.
The respondent claimed that it had not made any misleading or
false representation of any affiliation or sponsorship of their
brand of cigarettes by RJR, and had independantly conceived
of the brand name after intensive market research and analysis.
The brand name was printed in a style and lay-out of colour
scheme etc. and was quite distinct from the brand name
manufactured by RJR and had distinctly advertised this brand
of cigarettes as its own product, as opposed to several other
cigarattes being marketed by other manufactures with foreign
brand names under license arrangements with the foreign
manufacturers, in the same style and with the same lay-out colour
scheme etc.
It is significant that the respondent pointed out that 22 out of 27
complaints were directly or indirectly connected with Golden
Tobacco Co. Ltd., a competitor of the respondent.
The Commission was required to weigh in whose favour the
balance of convenience went, and generally, it had been seen
that after consideration of balance of convenience it was in
favour of the complainant. The interim injunction was granted
restraining the respondent from indulging in such restrictive or
unfair trade practice. In this case Commission found that the
respondent had come out with a new advertisement showing
that ITC Logo more prominently and an undertaking was given
that the old advertisements will not be repeated. Hence no interim
injuction was granted.
8. PROBLEMS
1. X, a respondent Company was making and supplyng
graphite electrodes, anodes and carbon plates. A notice
was issued to them that they were indulging in certain
restrictive trade practices in respect of graphite electrodes.
Later it was sought to amend the reference by including
anodes and plates also. This was challenged by
respondent(X) company with the contention that the
Commission was incompetent in as such as the Chairman
having retired, the Commission was left with only two
members whereas the Act required that there shall be three
members. Is the contention valid? [See Graphite India
Ltd, Re, (1979)49 Comp.Cas 212 MRTPC].
2. Commission passed an ex parte order against the proprietor
of an undertaking because of his failure to attend on the
successive dates fixed for hearing. He applied for revocation
of the order on the ground that his advocate had not
communicated to him any orders and that he came to know
[Note: Please specify your name, ID number and address while sending answer papers].
of the order only from a news item. Is the contention
sustainable under the MRTP Act ? [See Maheshwari &
Sons Re, (1979)49 Comp.Cas 212 MRTPC].
3. A school is charging an interview fee of Rs.50/- in addition
to registration fee of Rs.10/- and there is no evidence to
show that the sum so charged is being spent on interviewing
the applicants or that the school is incurring any expenditure
for the purpopse of admitting students to KG class. Is the
manipulations of prices of the services justified cost of
education? [See DGIR v. St. Francis De-Sales Senior
Secondary School, (1992) 73 Comp.Cas 117 MRTPC]
4. X undertaking were producers of tomato ketchup. They
were marketing the same in bottles of 400 grams. Under
the provisions of standards of Weights and Measures
(Packed Commodities) Rules, 1977 it was not permissible
to sell tomato ketchup in bottles of 400 grams. It could be
sold only in bottles of 500 grams. Is the action of X
undertaking in the purview of unfair trade practice ? [See
DGIR v. Food Specialists Ltd (1987)62 Comp.Cas 122
MRTPC].
5. A pumpset was sold with one year warranty for satisfactory
performance and assurance of repair or replacement in case
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 of defects arising during the period. The pump failed within a few months. Manufacturer did not honour the waranty.
Does the action tantamount to unfair trade practice? [See Jamila Knatoon v. Jaymco Engineering Co., (1992)75
Comp.Cas 648 MRTPC].
9 SUPPLEMENTARY READINGS
1. Avtar Singh, Law of Monopolies, Restrictive and Unfair Trade Practices, (1993), Eastern Book Company, Lucknow.
2. Duggar, S.M., MRTP Law & Practice, (1984) Taxation Publishers, Pvt. Ltd, New Delhi.
3. Mitra, K.K., Commentaries on the MRTP Act 1969, (1990) Book-N-Trade, Calcutta.
4. Kapoor, N.D., Business and Economic Laws, (1995), Sultan Chand & Sons, New Delhi.

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 Master in Business Laws

Corporate Law

Course No: III

Module No: VIII

Corporate Accounts and Audit

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in

317

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Materials Prepared By :
1. Mr. Mohandas Pai, F.C.A.
2. Dr. N.L. Mitra

Materials Checked By :
1. Prof. V. Vijayakumar
2. Prof. T. Devidas
3. Mr. S. Dasgupta

Materials Edited By:

1. Mr. Krishnaswami, F.C.A.

2. Mr. Sundarajan, A.C.A.

© National Law School of India University

Published By
Distance Education Department
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.

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 INSTRUCTIONS
Basic Readings
The materials given in this course are calculated to provide exhaustive basic readings on topics and sub-topics
included in the course. Experts in the area have collected the basic information and thoroughly analysed the same in
topics and sub-topics. Lucid/supportive illustrations and leading cases are also provided. Relevant legislative
provisions are also included. Care has been taken to communicate basic information required for decision making
in problems likely to arise in the course-area. The reader is advised to read atleast three times. In the first reading
information provided are to be selected by making marginal notes using markers. The first reading, therefore,
necessarily has to be very slow and extremely systematic. While so reading the reader has to understand the
implications of those informations. In the second reading the reader has to critically analyse the material supplied
and jot down in a separate note book points stated in the material as well as the critical comments on the same. A
third reading shall be necessary to prepare a Check List so that the check list can be used afterwards for solving
problems like a ready reckoner. (The reader is required to purchase a Bare Act and refer to the relevant sections at
every stage.)
Supplementary Reading
Several supplementary readings are suggested in the materials. It is suggested that the reader should register with
a nearby public library like the British Council Library, the American Library, the Max Muller Bhavan, the National
Library, any University Library where externals are registered for the purpose of library reading, any commercial
library or any other public library run by Government or any private institution. Readers in Metropolitan and other
big cities may have these facilities. It is advised that these basic materials be photocopied, if necessary, and kept in
the course file. Supplementary readings are also required to be read more than once and marginal notes, marking
notes, analytical notes and check lists prepared. Any reader requiring any extra readings not available in his/ her
place may request the Course Coordinator to photocopy the material and send it by post for which charges at the rate
of .50 paise per page for photocopying and the postage charge shall be sent either by M.O. or by Draft in advance.
The Course Coordinator shall take prompt action on receiving the request and the payment.
Case Law
The course material includes some case materials generally based upon decided cases. These cases are to be studied
several times for,
(a) understanding the issues to be decided (b) decisions given on each issue (c) reasoning specified
It is advised that while reading a case the reader should focus first on the facts of the case and make a self analysis
of the facts. Then he/she should refer the check list prepared earlier for appropriate information relating to law and
practice on the facts. Then the student should prepare a list of arguments for and on behalf of the plaintiff/appellant.
Keeping the arguments for the plaintiff/appellant in view of the reader should try to build up counter arguments on
behalf of the defendant/respondent. These exercise can take days. After these exercises are done one has to prepare
the arguments for or against and then decide on the issues. While deciding it may be necessary often to evolve a
guiding principle which also must be clearly spelt out. Subsequently the reader takes up the decision given in the
case by the judge and compare his/her own exercise with the judgment delivered. A few exercise of this type shall
definitely sharpen the logical ability, the analytical skill and the lawyering competence. Though it is not compulsory,
the reader may send his/ her exercises to the Course Coordinator for evaluation. On receiving such request the
Course Coordinator shall get the exercises evaluated by the experts and send the experts’ comment to the students.
Through these exercises one can build up an effective dialogue with the experts of the Distance Education Department
(DED).
Problems and Responses
After reading the whole module which is divided into several topics and sub-topics the reader has to solve the
problems specified at the end of the module. The module is designed in such a manner that a reader can take about
a week’s time for completing one module in each of the four courses. It is expected that after finishing the module
over a period of a week the student solves these problems from all possible dimensions to the issue. No time limit
is prescribed for solving a problem though it would be ideal if the reader fixes his/her own time limit for solving the
problem - which may be half an hour per problem - and maintain self discipline. While solving the problems the
candidate is advised to use the check list, the notes and the judicial decisions - which he/she has already prepared.
After completing the exercise the student is directed to send the same to Course Coordinator for evaluation. Though
there is no time stipulation for sending these responses a student is required to complete these exercises before he/
she can be given the certificate of completion to appear for final examination.
N.L. Mitra
Course Co-ordinator
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 CORPORATE ACCOUNTS AND AUDIT

TOPICS

1 Concept of Corporate Accounts ................................................................................. 321

2 Corporate Accounts and Boards’ Responsibility ........................................................ 346

3 Dividend .......................................................................................................................... 348

4 Audit and Auditor .......................................................................................................... 350

5 Auditor’s Rights and Duties .......................................................................................... 354

6 Auditor's Liabilities ....................................................................................................... 356

7 Case Law ......................................................................................................................... 361

8 Supplementary Readings ............................................................................................... 365

9 Problems ......................................................................................................................... 366

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1. CONCEPT OF CORPORATE ACCOUNTS
SUB-TOPICS
1.1 Introductory Note
1.2 Books of Accounts
1.3 System of Accounting
1.4 Responsibility for keeping Accounts
1.5 Inspection of Accounts
1.6 Authentication of Accounts
1.7 Submission of Accounts for Audit
1.8 Preparation of Annual Accounts
1.9 Right of Members for the Annual Accounts
1.10 Submission of Annual Accounts to the Shareholders
1.11 Standards of Accounts and Proposed Amendment to the
Law
1.12 Annexures
1.1 INTRODUCTION
A joint stock company by its very nature ensures separation of
management from ownership. The management is vested with
the Directors acting collectively as a Board. The commercial
decisions taken by the Board get reflected in the accounts. An
account is a summary of business transactions and reflects the
result of a business decision. As the Directors of a company act
in their fiduciary capacity to the company, they are enjoined
upon to maintain proper books of accounts of all transactions
and to present the same to the shareholders.
The Directors shall annually present the accounts to the
shareholders in the form of the Balance Sheet and Profit and
Loss Account at the Annual General Meeting.
A Balance Sheet is a statement showing the assets and liabilities
of a company as on a particular date. It enables an assessment
of the credit- worthiness of a company. But it is also a historical
document and shows the value of the assets, liabilities and net
worth on a historical cost basis. Entries in the Balance Sheet
have been held by courts to be an acknowledgement of debt.
A Profit and Loss Account is a statement showing the revenues
earned, expenditure incurred, profits made and appropriated to
payment of a return on the capital called as dividend or
transferred to Reserves.
Since the accounts are the main mode of reporting to the
shareholders, it is essential that they are reliable, credible and
consistent. This can only be done by ensuring that they are
prepared on the basis of generally accepted accounting
principles. These principles should be consistently followed
and should reflect the transactions in their entirety. Certain
fundamental accounting assumptions underlie their preparation
and presentation the assumption of a going concern, that is as
continuing in operation for the forseeable future; consistency,
which leads to reliability and certainty, and accrual by which
costs are matched with revenues.These are to be followed to
give a proper perspective to the accounts.
In order to ensure the reliability and credibility of the accounts
of companies, the company Law provides for the appointment
of an independent person,an outside agency, namely the Auditor,
to verify the accounts and give a report on the same to the
shareholders.
The Auditor is appointed by the shareholders and is responsible
to them. The duties, rights, powers and responsibilities of the
Directors and Auditors have been laid down in the Companies
Act.
1.2 BOOKS OF ACCOUNTS
According to sec. 209(1) of the Companies Act, 1956 every
company shall keep at its Registered Office proper books of
account containing records of:
(a) all sums of money received and expended by the company
and the matters in respect of which the receipts and
expenditure take place (i.e., Cash book including petty Cash
book);
(b) all sales and purchases of goods by the company (ie.,Sales
and Purchase day book);
(c) all assets and liabilities of the company (i.e., ledgers); and
(d) in the case of a company pertaining to any class of
companies engaged in production, processing,
manufacturing or mining activities, such particulars relating
to utilising material or labour or other items of costs as
prescribed, if such class of companies is required by the
Central Government to include such particulars in the books
of accounts (i.e., Cost Accounts, Cost Account Sheets).
Proper books of accounts are necessary to record evidences of
all transactions so that the books of accounts may reflect or
provide a true and fair view of the state of affair of the company.
Further, such books have to be kept on accrual basis and
according to the double entry system of accounting. Such books
are to be kept normally at the registered office of the company.
The books may also be kept at any other place in India as the
Board may decide. This decision of the Board should however
be communicated to the Registrar of companies. In the case of
the winding up of a company, an officer of the company may
be punished in case proper books of accounts have not been
kept. Proper books in such a case means such books as are
necessary to exhibit and explain the transactions and financial
position of the business including books containing day to day
entries in sufficient detail of all cash received and paid. In case
of a trading company proper books means statements of the
annual stock-taking and particulars of all goods sold and
purchased showing the name of the buyer and seller thereof in
sufficient detail so that these persons can be identified. The
books of accounts should be prepared and maintained in indelible
ink. Adequate safeguards have been built into the
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law to prevent abuses, irregularities and mal-practices by the
law insisting on maintaining of proper books of accounts,
making adequate disclosures, a system of audit, establishment
of internal control procedures and prescribing liability and
punishment for transgression of the above. Besides the proper
books of accounts the company is required to keep the following
statutory registers :
(i) Register of investment in order to maintain various
particulars about investments made by the company (refer
to sec. 49 of the Companies Act,1956);
(ii) Register of Members - A register of members of the
company is to record various particulars of its members
(refer to sec. 150 of the Companies Act, 1956);
(iii) Index of Members - Every Public Limited company is
required to keep an index of its members (refer to sec.
151 of the Companies Act, 1956);
(iv) Foreign Register of Members or debenture holders (refer
to secs. 157 & 158 of the Companies Act, 1956);
(v) Register of Charges - A register of charges is to be kept
for recording particulars of all charges (refer to sec. 143
of Companies Act, 1956);
(vi) Register of Contracts - Particulars of all the contracts
entered into by the company and the companies in which
Directors are interested must be kept in a separate register
(refer to sec. 301 of the Companies Act, 1956);
(vii) Register of Directors (refer to sec. 303 of the Companies
Act, 1956);
(viii) Register of Share Holdings of the Directors (refer to sec.
307 of Companies Act, 1956);
(ix) Register of all investments of the company in shares (refer
to sec. 372(6) of the Companies Act, 1956);
(x) Register of Loans (refer to sec. 370(i)(c) of the Companies
Act, 1956); and
(xi) Register of Public Deposits (refer to sec. 58(a) of the
Companies Act, 1956).
1.3 SYSTEM OF ACCOUNTING
Books of accounts are to be kept ;
(a) according to the double- entry system of accounting and
(b) on approval basis (refer to sec. 209 of the Companies Act,
1956)
The principle of the double- entry system of book- keeping is
based upon the philosophy that every transaction has two
impacts inversely affecting two accounts. Keeping the complete
record of these two impacts in two accounts is known as double-
entry. These two impacts in the accounting language is known
as Debit and Credit. Therefore in the double- entry system of
accounting the total debit is always equal to the total credit.
The accrual system is based upon the concept of keeping records
not merely of cash transactions (as is done in the mercantile
system) but also of transactions primarily based upon the
concept of expenses incured, but not paid for and of amounts
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receivable but not received. Therefore these are Credit
transactions.
1.4 RESPONSIBILITY OF KEEPING ACCOUNTS
The following categories of persons are responsible for
maintenance of proper books of account of a company.
1. Where the company has a Managing Director or Manager
such Mangaing Director or Manager and all other officers
and employees and agents.
2. Where the company has neither a Managing Director nor
Manger, every Director of the company.
It should be noted that the Auditors, Legal advisers and Bankers
are excluded from the above list. (refer to sec. 209(6) of the
Companies Act, 1956)
1.5 INSPECTION OF ACCOUNTS
Every Director has a right of inspection of the accounts as also
the Registrar of Companies or such officers of the government
as may be authorised by the central government. However the
shareholder has no such right of inspection. (refer to sec. 209(a)of
the Companies Act,1956)
1.6 Authentication of accounts
The Balance sheet and Profit and Loss Account are prepared
and considered by the Board of Directors before the same is
submitted to the Auditor for his report. The responsibility for
the preparation is that of the Board and not of the Auditor. Every
Balance Sheet and Profit and Loss Account should be
authenticated by the Board. It does not mean that the Board
certifies the accounts to be true, but only that the accounts are
genuine and have been placed before the Board.
The authentication is done by signing the Balance sheet and
Profit and Loss account on behalf of the Board of Directors. In
the case of a company other than a Banking company, the
Manager or Secretary and not less than two Directors of the
company, one of whom shall be a Managing Director if there is
one, should authenticate the accounts. In the case of Banking
company the authentication should be done as provided in the
Banking Regulations Act, 1949. The Balance Sheet and the
Profit and Loss account shall be approved by the Board of
Directors before they are signed as mentioned above.
1.7 SUBMISSION OF ACCOUNTS FOR AUDIT
The authenticated Balance Sheet is then submitted to the Auditor
for discharging his audit function and preparing his report. In
case there is any qualification by the Auditor, an explanation
needs to be given by the Board as an addendum to the Directors’
Report. In practice, the accounts are usually authenticated by
the Board with the same date as the date of the report by the
Auditor.
Where any company has a subsidiary, the holding company’s
Balance sheet shall be attached with the following documents
of its subsidiary:
1. Balance Sheet and Profit and Loss Account of the
subsidiary;
2. Report of the Board of Directors of the subsidiary;
3. Auditors’ report on the subsidiary; and
4. A statement of the holding company’s interest in the
subsidiary.
1.8 PREPARATION OF ANNUAL ACCOUNTS
The Annual Accounts are to be prepared to indicate the profit
and loss of the company in the form specified in Annexure- I
(which relates to Part II of Sch. VI of the Companies Act, 1956).
This Profit and Loss Account is prepared in two parts. The
first part is known as the Trading Account and the latter, the
Profit and Loss Account. Of course a Manufacturing Account
is also prepared. In the Trading Account all direct expenses and
direct receipts are posted to show gross profit. All other revenue
expenses stand reflected in the Profit and Loss Account and a
transfer posting is made of the gross profit as well. That shows
the net profit. The Profit and Loss Account shall give a true
and fair view of the profit or loss of the company for the period
in view.
The balance of all assets and liabilities of the company are then
placed in the Balance Sheet which shall give a true and fair
view of the state of affairs of the company at the end of the
period of report. (refer to sec. 211 of the Companies Act, 1956).
The Balance Sheet is to be prepared in the form given in
Annexure- II (which relates to Part I of Sch. VI of the Companies
Act, 1956)
Every Balance Sheet and every Profit and Loss Account of the
company shall be signed for the Board of Directors of the
company by its Manager or Secretary, if any, and by not less
than two Directors of the company, one of whom shall be the
Managing Director, if any. The Balance Sheet and Profit and
Loss Account shall be approved by the Board of Directors before
they are signed. (refer to sec. 215 of the Companies Act, 1956)
1.9 RIGHT OF MEMBERS TO THE ANNUAL
ACCOUNTS
Every Member is entitled to be given a copy of Balance Sheet,
Profit and Loss Account and all documents required to be
annexed or attached to the Balance Sheet and the same should
be sent to him at least 21 days before the Annual General
Meeting. (refer to sec. 219 of the Companies Act, 1956)
In the case of a listed company, an abridged version of the
account in Form 23B which contains the salient features may
be sent to the members. Even though such an exemption is
granted, a member can ask for and should be provided with a
full set of accounts in case he so demands.
Since the documents of a public company are open to inspection
by the members of the public, a copy of the Balance Sheet and
Profit and Loss Account, the Auditors’ Report, and the Directors’
Report need to be filed in the office of the Registrar
of Companies. In the case of a private company Balance Sheet
and Profit and Loss Account shall be filed separately as the
Profit and Loss Account is not open for inspection by the public.
(refer to sec. 220 of the Companies Act, 1956)
1.10 SUBMISSION OF ANNUAL ACCOUNTS TO
SHAREHOLDERS
For the purpose of presenting the Annual Accounts to the
shareholders, the Board of Directors shall place before them
every year at the Annual General Meeting the Balance Sheet
and Profit and Loss Account. In the case of a company not
carrying on business for profit, an Income and Expenditure
Account shall instead be laid before the company.
It is the task of the Directors to get the Balance Sheet and Profit
and Loss Account prepared and presented to the shareholders
along with the report of the Auditors. But these accounts have
to be considered by the shareholders and approved by them
before they can be deemed final. A dividend recommended by
the Board becomes final, and a debt thereon due, only after the
approval by the shareholders.
The Profit and Loss Account should be annexed to the Balance
Sheet and the Auditor's Report attached thereto. The difference
lies in the fact that the Auditor needs to examine and report on
every document annexed to the Balance Sheet.
The Balance Sheet can be prepared either in the Horizontal form
or the Vertical form. The Balance Sheet and Profit and Loss
Account should give comparative figures for each head of
account for the previous year also. The Balance Sheet is always
prepared as on a particular day whereas the Profit and Loss
Account is prepared for a period or year ending on that date.
All the disclosure requirements of Schedule VI should be strictly
followed as this information is mandatorily to be given.
In case the information required to be given in the Balance Sheet
cannot be conveniently included in the Balance Sheet it can be
furnished in a separate schedule to be annexed to and forming
part of the Balance Sheet.
The Profit and Loss Account should be clearly made out to
disclose the result of the working of the company during that
period. It should disclose every material feature and also
exceptional items. The various items of revenue and expenditure
should be arranged under the most convenient heads. Unlike
the Balance Sheet the format of the Profit and Loss Account
has not been stated in Part II of Schedule VI which only states
the information to be disclosed. Information required to be
disclosed can also be given by way of a note attached thereto.
The Act also provides that in case companies do not disclose
information as required by Schedule VI due to any exemption
granted by the government or are exempted from
disclosure of certain information due to any special Act they
come under, the Balance Sheet shall nevertheless be deemed to
be true and fair. What is true and fair has not been fully defined
in the Act except negatively. The Auditor is also called upon to
report on the true and fair views of the accounts. So we could
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say generally, that the accounts would reflect a true and fair
view and disclose the information mandatorily required to be
disclosed in case they are prepared as per the requirements of
the Act and generally accepted accounting principles.
However in the case of companies which are governed by
separate Acts like the Banking Regulation Act, Insurance Act
or Indian Electricity Act, the format and contents of the Balance
Sheet and Profit and Loss Account are to be as laid down in
these Acts .
1.11 THE COMPANIES BILL, 1993
The Companies Bill, 1993 has been introduced in Parliament in
order to recodify the company Law. Certain changes are
proposed in the Bill as regards Corporate Accounts.
1. The formating of the Balance Sheet and the disclosure
requirements of the Profit and Loss Account have been
revised as stated in Schedule XII. A set of accounting
policies to be followed by companies is set out in Part I of
Schedule XII.(See Annexure III)
2. Accounting standards issued by the Institute of Chartered
Accountants of India are
sought to be given statutory recognition. Uniformity in
accounting policies would now be possible.
1.12 ANNEXURES
ANNEXURE I
(Schedule VI Part II)
REQUIREMENTS AS TO PROFIT AND LOSS
ACCOUNT
1. The provisions of this Part shall apply to the income and
expenditure account referred to in sub-section (2) of section
210 of the Act, in like manner as they apply to a Profit and
Loss Account, but subject to the modification of references
as specified in that sub-section.
2. The Profit and Loss Account
(a) shall be so made out as clearly to disclose the result
of the working of the company during the period
covered by the account ; and
(b) shall disclose every mateiral feature, including credits
or receipts and debits or expenses in respect of non-
recurring transactions or transactions of an exceptional
nature.
3. The Profit and Loss Account shall set out the various items
relating to the income and expenditure of the company
arranged under the most convenient heads ; and in particular,
shall disclose the following information in respect of the
period covered by the account :
(i) (a) The turnover, that is, the aggregate amount for
which sales are effected by the company, giving the
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amount of sales in respect of each class of goods
dealt with by the company, and indicating the
quantities of such sales for each class separately;
(b) Commission paid to sole selling agents within the
meaning of section 294 of the Act;
(c) Commission paid to other selling agents; and
(d) Brokerage and discount on sales, other than the usual
trade discount.
(ii) (a) In the case of manufacturing companies —-
(i) The value of the raw mateirals consumed, giving item-
wise break-up and indicating the quantities thereof.
In this break-up, as far as possible, all important basic
raw materials shall be shown as separate items. The
intermediates or components procured from other
manufacturers may, if their list is too large to be
included in the break-up, be grouped under suitable
headings without mentioning the quantities, provided
all those items which in value individually account
for 10% or more of the total value of the raw material
consumed shall be shown as separate and distinct items
with quantities thereof in the break-up.
(ii) The opening and closing stocks of goods produced,
giving break-up in respect of each class of goods and
indicating the quantities thereof;
(b) In the case of trading companies, the purchases made
and the opening and closing stocks, giving break-up
in respect of each class of goods traded in by the
company and indicating the quantities thereof;
(c) In the case of companies rendering or supplying
services, the gross income derived from services
rendered or supplied;
(d) In the case of a company, which falls under more than
one of the categories mentioned in (a), (b) and (c)
above, it shall be sufficient compliance with the
requirements herein if the total amounts are shown in
respect of the opening and closing stocks, purchases,
sales and consumption of raw material with value and
quantitative break, up and the gross income from
services rendered is shown; and
(e) In the case of other companies, the gross income
derived under different heads.
Note 1 : The quantities of raw materials, purchases, stocks and
the turnover, shall be expressed in quantitative denominations
in which these are normally purchased or sold in the market.
Note 2 : For the purpose of items (ii)(a), (ii)(b) and (ii)(d), the
items for which the company is holding separate industrial
licences, shall be treated as separate classes of goods , but where
a compnay has more than one industrial licence for production
of the same item at different places or for expansion of the
licensed capacity, the item covered by all such licences shall be
treated as one class. In the case of trading companies, the
imported items shall be classified in accordance with the
classification adopted by the Chief Controller of Imports and
Exports in granting the import licences.
Note 3 : In giving the break-up of purchases, stocks and turnover,
items like spare parts and accessories, the list of which is too
large to be included in the break-up, may be grouped under
suitable headings without quantities, provided all those items,
which in value individually account for 10% or more of the
total value of the purchases, stocks, or turnover, as the case may
be, are shown as separate and distinct items with quantities
thereof in the break-up.
(iii) In the case of all concerns having works in progress,the
amounts for which [such works have been completed] at
the commencement and at the end of the accounting period.
(iv) The amount provided for depreciation, renewals or
diminition in value of fixed assets. If such provision is not
made by means of a depreciation charge, the method adopted
for making such provision. If no provision is made for
depreciation, the fact that no provision has been made shall
be stated and the quantum of arrears of depreciation
computed in accordance with section 205(2) of the Act shall
be disclosed by way of a note.
(v) The amount of interest on the company’s debentures and
other fixed loans that is to say, loans for fixed periods, stating
separately the amount of interest, if any (paid or payable)
to the Managing Director,the Managing Agent, the
Secretaries and Treasurers and the manger, if any.
(vi) The amount of charge for Indian income-tax and other Indian
taxation on profits, including, where practicable, with Indian
income-tax any taxation imposed elsewhere to the extent
of the relief, if any, form Indian income tax and
distinguishing, where practicable, between income-tax and
other taxation.
(vii)The amounts reserved for
(a) repayment of share capital ; and
(b) repayment of loans
(viii) (a) The aggregate, if material, of any amounts set aside
or proposed to be set aside, to reserves, but not
including provisions made to meet any speicific
liability, contingency or commitment known to exist
at the date as on which the Balance Sheet is made up.
(b) The aggregate, if material, of any amounts withdrawn
from such reserves.
(ix) (a) The aggregate, if material, of any amounts set aside
to provisions made for meeting specific liabilities,
contingencies or commitements.
(b) The aggregate, if material, of the amounts withdrawn
from such provisions, as no longer required.
(x) Expenditure incurred on each of the following items,
separately for each item :-
(a) Consumption of stores and spare parts;
(b) Power and fuel;
(c) Rent;
(d) Repairs to buildings;
(e) Repairs to machinery;
(f) (1) Salaries, wages and bonus
(2) Contribution to provident and other funds
(3) Workmen and staff welfare expenses to the extent
not adjusted from any previous provision or reserve
Note : Information in respect of this item should also be given
in the Balance Sheet under the relevant provision or reserve
account.
(g) Insurance;
(h) Rates and taxes, excluding taxes on income; and
(i) Miscellaneous expenses.
Provided that any item under which the expenses exceed one
percent of the total revenue of the company or Rs.5,000
whichever is higher shall be shown as a separate and distinct
item against an appropriate account head in the Profit and Loss
Account and shall be combined with any other item to be shown
under miscellaneous expenses.
(xi) (a) The amount of income from investments,
distinguishing between trade investments and other
investments.
(b) Other income by way of interest, specifying the nature
of the income
(c) The amount of income-tax deducted if the gross
income is stated under sub-praragraphs (a) & (b)
above.
(xii) (a) Profits or losses on investments showing distinctly
the extent of the profits or losses earned or incurred
on account of membership of a partnership firm to
the extent not adjusted from any previous provision
or reserve.
Note : Information in respect of this item should also be given
in the Balance Sheet under the relevant provision or reserve
account.
(b) Profits or losses in respect of transactions of a kind,
nor usually undertaken by the company or undertaken
in circumstances of an exceptional or non-recurring
nature, if material in amount.
(c) Miscellaneous income
(xiii)(a) Dividends from subsidiary companies
(b Provisions for losses of subsidiary companies
(xiv)(a) The aggregate amount of the dividends paid, and
proposed, and stating whether such amounts are
subject to deduction of income-tax or not.
(xv)Amount, if material, by which any items shown in the Profit
and Loss Account are affected by any change in the basis
of accounting.
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4. The Profit and Loss Account shall also contain or give by
way of a note detailed information, showing separately the
following payments provided or made during the financial
year to the directors (including Managing Directors) of the
company, the subsidaries of the company and any other
person :
(i) managerial remuneration under section 198 of the Act
paid or payable during the financial year to the
directors (including managing directors the Managing
Agent, Secretaries and Treasurers) or Manager, if any;
(ii) expenses reimbursed to the Managing Agent under
section 354 ;
(iii) commission or other remuneration payable separately
to ta Managing Agent or his associate under sections
356, 357 & 358 ;
(iv) commissin received or receivable under section 359
of the Act by the Managing Agent or his associate as
selling or buying agent of other concerns in respect
of contracts entered into by such concerns with the
company ;
(v) the money value of the contracts for the sale or
purchase of goods and materials or supply of services,
entered into by the company with the Managing Agent
or his associate under section 360 during the financial
year ;
(vi) other allowances and commission including
guaranteee commission (details to be given);
(vii) any other perquisites or benefits in cash or in kind
(stating approximate money value where practicable);
and
(viii) pensions, etc :-
(a) pensions,
(b) gratuities,
(c) payments from provident fund, in excess of
ones own subscriptions and interest
thereon,
(d) compensation for loss of office,
(e) consideration in connection with retirement
from office
4A The Profit and Loss Account shall contain or give by way
of a note a statement showing the computation of net profits
in accordance with section 349 of the Act with relevant
details of the calculation of the commissions payable by
way of percentage of such profits to the directors (including
Managing Directors), (the Managing Agents, Secretaries
and Treasurers) or Manager (if any).
4B The Profit and Loss Account shall further contain or give
by way of a note detailed information in regard to amounts
paid to the Auditor, (whether as fees, expenses or otherwise
for services rendered)
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(a) as Auditor;
(b) as adviser, or in any other capacity, in respect of;
(i) taxation matters ;
(ii) company law matters ;
(iii) management services ; and
(c) in any other manner
4C In the case of manufacturing companies, the Profit and Loss
Account shall also contain, by way of a note in respect of
each class of goods manufactured, detailed quantitative
information in regard to the following namely :-
(a) the licensed capacity (where licence in force) ;
(b) the installed capacity; and
(c) the actual production.
Note 1 : The licensed capacity and installed capacity of the
company as on the last date of the year to which the Profit and
Loss Account relates, shall be mentioned against items (a) and
(b) above, respectively.
Note 2 : Against item (c), the actual production in respect of
the finished products meant for sale shall be mentioned. In cases
where semi-processed products are also sold by the company,
separate details thereof shall be given.
Note 3 : For the purposes of this paragraph, the items for which
the company is holding separate industrial licences shall be
treated as separate classes of goods but where a company has
more than one industrial licence for production of the same item
at different places or for expansion of the licensed capacity, the
item covered by all such licences shall be treated as one class.
4D The Profit and Loss Account shall also contain by way of a
note the following information namely :-
(a) value of imports calculated on C.I.F. basis by way the
company during the financial year in respect of:
(i) raw materials
(ii) components and spare parts
(iii) capital goods ;
(b) expenditure in foreign currency during the financial
year on account of royalty, know-how professional
consultation fees, interest, and other matters;
(c) value of all imported raw materials, spare parts and
components consumed during the financial year and
the value of all indigenous raw materials, spare parts
and components similarly consumed and the
percentage of each to the total consumption;
(d) the amount remitted during the year in foreign
currencies on account of dividends with a specific
mention of the number of non-resident shareholders,
the number of shares held by them on which the
dividends were due and the year to which the
dividends related; and
 (e) earnings in foreign exchange classified under the
following heads, namely:-
(i) export of goods calculated on F.O. B. basis
(ii) royalty, known how professional and consultation
fees
(iii) interest and dividend
(iv) other income, indicating the nature thereof
The Central Government may direct that a company shall not
be obliged to show the amount set aside to provisions other
than those relating to depreciation, renewal or dimunition in
value of assets, if the Central Government is satisfied that the
information should not be disclosed in the public interest and
would prejudice the company, but subject to the condition that
in any heading stating an amount arrived at after taking into
account the amount set aside as such, the provision shall be so
framed or marked as to indicate that fact.
(1) Except in the case of the first Profit and Loss Account laid
before the company after the commencement of the Act,
the corresponding amounts for the immediately preceding
financial year for all items shown in the Profit and Loss
Account shall also be given in the Profit and Loss Account.
(2) The requirement in sub-clause (1) shall, in the case of
companies preparing quarterly or half-yearly accounts,
relate to the Profit and Loss Account for the period which
ended on the corresponding date of the previous year.
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ANNEXURE II
Balance Sheet of ...............................................(Here enter the name of the company)
As at .......................(Here enter the date as at which the balance-sheet is made out).
Instructions in accord
ance with which liabili-
ties should be made out
*Terms of redemption or
conversion (if any) of any
Redeemable Preference Capital
to stated, together with
earliest date of redemption
or conversion.
Particulars of any option on
unissued share capital to be
specified
Particulars of the different
classes of preferences shares
to be given
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SCHEDULE VI
[PART I-FORM OF BALANCE SHEET]
Liabilities
Figures Figures
for the previous for the current
year year
Rs. Rs.
(b) (b)
SHARE CAPITAL :
Authorised .... shares
of Rs .... each. +Issued
(distinguishing between the
various classes of capital and
stating the particulars specified
below, in respect of each class...
shares of Rs.... each. +Subscribed
(distinguishing between the various
classes of capital and stating the
particulars specified below, in
respect of each class), (c)..shares
of Rs ......... each
Rs.... called up ... Of the above
shares,... shares are allotted as
fully paid-up-pursuant to a contract
without payments being received in
cash.
Assets
Figures Figures Instructions in accor
for the previous for the current dance with which
year year assets should be made
out
Rs.
(b) (b)
*FIXED ASSETS : *Under each head the
Distinguishing as far as original cost, and the
possible between expenditure additions thereto and
(a)goodwill, (b)land, (c)buildings, deductions therefrom
(d)lease-holds,(e)railway sidings, during the year, and
(f)plant and machinery, (g)furniture the total depreciation
(h)development of property, (i)patents written off or provi-
trademarks and designs, (j)live-stock ded up to the end of
and (k) Vehicles, etc. the year to be stated.
“Where the original
cost aforesaid and
additions and
deductions thereto,
relate to any fixed
asset which has been
an increase or
reduction in the
liability of the
company, as expressed
in Indian currency, for making payment towards the whole
or a part of the cost of the asset or for repayment of the
whole or a part of monies borrowed by the company from
any person, directly or indirectly, in any foreign currency
specifically for the purpose of acquiring the asset (being in
either case the liability existing immediately before the date
on which the change in the rate of exchange takes effect,
the amount by which increased or reduced be added to, or
as the case may be, deducted from the cost, and the amount
arrived at after such addition or deduction shall be taken to
be the cost of the fixed asset.
Explanation 1:— This paragraph shall apply in relation to
all balance-sheets that may be made out as at the 6th day of
June, 1966, or any day thereafter and where, at the date of
issue of the notification of the Government of India, in the
Ministry of Industrial Development and Company Affairs
(Department of Company Affairs),
 G.S.R.No.129, dated the 3rd day of January, 1968, any
balance-sheet, in relation to which this paragraph applies,
has already been made out and laid before the company in
annual general meeting, the adjustment referred to in this
paragraph may be made in the first balance-sheet made out
after the issue of the said notification.
Explanation 2.-In this paragraph, unless the context otherwise
requires, the expressions “rate of exchange”, “foreign
currency” shall have the meanings respectively assigned to
them under sub-section(1) of section 43-A of the Income-
tax Act, 1961 (43 of 1961), and Explanation 2 and
Explanation 3 of the said sub-section shall as far as may be,
apply in relation to the said paragraph as they apply to the
said sub-section(1)”.
*In every case where the original cost cannot be ascertained
without unreasonable expense or delay, the valuation shown
by the books shall be given. For the purposes of this
paragraph, such valuation shall be the net amount at which
an asset stood in the company’s books at the commencement
of this Act after deduction of the amounts previously provided
or written-off for depreciation or diminution in value, and
where any such asset is sold, the amount of sales proceeds
shall be shown as deduction.

Liabilities Assets

Instructions in accord Figures Figures Figures Figures Instructions in accor-

ance with which liabili- for the previous for the current for the previous for the current dance with which
ties should be made out year year year year assets should be made
out

Rs. Rs. Rs. Rs.

(b) (b)
*Specify the source from Of the above shares
which bonus shares are ....shares are
issued, e.g., capitali- allotted as fully
sation of Profits or paid-up by way of
Reserves or from Share bonus shares
Premium Account.
Less: Calls unpaid :
(i) By Managing Agents or
Secretaries and treasures
and where the Managing Agent
or Secretaries and Treasurerrs
are a firm, by the partners
thereof, and where the
Managing Agent or Secretaries
and treasurers are a private
company, by the Directors or
members of that company.
(ii) By Directors,
(iii) By others.
(b) (b) (b)
Where sums have been
written off on a
reduction of capital or
revaluation of assets,
every balance-sheet,
(after the first
balance-sheet), subsequent
to the reduction or
revaluation shall show the
reduced figures, and with
in place of the original
cost.
Each balance-sheet for the
first five years subsequent
to the date of the reduction,
shall show also the amount
of the reduction made.
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Any capital profit on
reissue of foreited
shares should be trans-
ferred to Capital
Reserve.
*Additions and deduc-
tions since last
balance-sheet to be
shown, under each of
the specified heads.
The word “fund” in
relation to any “Reserve”
should be used only where
such Reserve is specifi-
cally represented by
earmarked investments.
classes of shares and showing also in
Loans from Directors, the
Managing Agents, Secretaries
and Treasurers. Manager should
be shown separately.
Interest accrued and due on
Secured Loans should be
included under the appropriate
sub-heads under the head
“Secured Loans”
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*Add: Forfeited shares
(amount originally
paid-up)
RESERVES AND SURPLUS :
(1) Capital Reserves —
(2) Capital Redemption Reserve. of valuation, for example, cost or market
(3) Share Premium Account (cc). value and distinguishing between —
(4) Other Reserves specifying the
nature of each reserve and the
amount in respect thereof.
Less : Debit balance in Profit &
Loss Account (if any) (h).
(5) Surplus, i.e., balance in
Profit & Loss Account after
providing for proposed alloca-
tions, namely :
Dividend, Bonus or Reserves.
(6) Proposed additions to
Reserves.
(7) Sinking Funds.
Similarly, where sums have been
added by writing up the assets,
every balance-sheet subsequent
to such writing up shall show
the increased figures with the rate
of in the increase in place of the
original cost. Each balance-sheet
for the first five years subsequent
to the date of writing up shall also
show the amount of increase
made.
Explanation —Nothng contained in the preceding two
paragraphs shall apply to any adjustment made in accordance
with the second paragraph’.
INVESTMENTS :
Showing nature of investments and mode *Aggregate amount of
company’s quoted
investments and also
the market value
thereof shall be shown.
Aggregate amount of
company’s unquoted
investments shall
also be shown.
*(1) Investments in Government or Trust
Securities.
*(2) Investments in shares, debentures
or bonds showing separately shares,
fully paid-up and partly paid up and
also distinguishing the different
similar details investments in shares,
debentures or bonds of subsidiary
companies.
*(3) Immovable proparties.

Instructions in accord
ance with which liabili-
ties should be made out
The nature of the security to
be specified in each case.
Where loans have been guaran-
teed by Managing Agents,
Secretaries and Treasurers,
Managers and/or Directors, a
mention thereof shall also be
made and also the aggregate
amount of such laons under
each head. Terms of redemption
or conversion (if any) of
debentures issued to be stated
together with earliest date
redemption or of conversion
Liabilities Assets
Figures Figures Figures Figures Instructions in accor
for the previous for the current for the previous for the current dance with which
year year year year assets should be made
out
Rs. Rs. Rs. Rs.
SECURED LOANS : CURRENT ASSETS, LOANS AND ADVANCES :
*(1) Debentures (A) Current Assets. Mode of valuation of
*(2) Loans and Advances from (1) Interest accrued on Investments stock shall be stated
Banks and the amount in
*(3) Loans and Advances from (2) Stores and Spare Parts respect of raw
subsidiaries (3) Loose Tools materials shall also
*(4) Other Loans and Advances (4) Stock-in-trade be stated separately
(5) Works in Progress where practicable.
(6) Sundry Debtors
(a) Debts outstanding for a period ** Mode of valuation
exceeding six months. of works-in-progress
(b) Other debts shall be stated.
Less : Provision In regard to Sundry
(7-A) Cash balance on hand Debtor particulars to
(7-B) Bank balnces — be given separately of
(a) with Scheduled Banks and (a) debts considered
(b) with others good and in respect of
which the company is
(G.S.R. No.78, dated 4-1-1963) fully secured ; and (b)
debts considered good for which the company holds no
security other than the debtor’s personal security; and
(c) debts considered doubtful or bad.
debts due by Directors or otehr officers of the company
or any of them either severally or jointly with any other
person or debts due by firms or private companies
respectively in which any director is a partner or a
director or a member to be separately stated.
Debts due from other companies under the same
management with in the meaning of sub-section (1-B)
of Section 370 to be disclosed with the names of the
companies.
The maximum amount due by Directors or other officers
of the company at any time during the year to be shown
by way of a note.
The provision to be shown under this head should not
exceed the amount of debts stated to be considered
doubtful or bad and any surplus of such provisions, if
already created, should be shown at every closing under
“Reserves and Surplus” (in the Liabilities side) under s
separate sub-head `Reserve for Doubtful or Bad Debts’.
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 Liabilities Assets

Instructions in accord Figures Figures Figures Figures Instructions in accor

ance with which liabili- for the previous for the current for the previous for the current dance with which
ties should be made out year year year year assets should be made
out
Rs. Rs. Rs. Rs.

Out
Loans from Directors, the In regard to bank balances,
Managing Agents, Secretaries particulars to be given
and Treasurers. Manager should separately on
be shown separately. (a) the balance lying with
Scheduled Banks on
Interest accrued and due on current accounts, call
unsecured Loans should be accounts and deposit
included under the appropriate accounts ;
sub-heads under the head (b) the names of the
“Unsecured Loans” bankers other than
Scheduled Banks
and the balances
lying with each such banker on current accounts, call accounts and deposit accounts and the maximum amount outstanding at any time during
the year from each such banker ; and
(c) the nature of the
interest, if any, of any director or his relative or the Managing Agent, or Secretaries and Treasurers any associate of the latter in each of the
bankers (other than scheduled Banks) referred to in (b) above”.
(G.S.R. No.78 dated 4th Jan 1963).
UNSECURED LOANS
Where loans have been (1) Fixed Deposits
guaranteed by managing (2) Loans and Advances
agents, Secretaries and from subsidiaries.
Treasurers, Managers, (3) Short Term Loans and
and/or Directors, a Advances :
mention thereof shall (a) From Banks,
also be made and also (b) From others.
the aggregate amount of (4) Other Loans and Advances :
such loans under each (a) From Banks
head (b) From others

*See note (d) at foot CURRENT LIABILITIES & PROVISIONS :

of Form. A. Current Liabilities (B) Loans and Advances. The above insturctions
(1) Acceptances (8) Advances and Loans to subsidiaires. regarding “Sundry Deb-
(2) Sundry Creditors. (9) Bils of Exchange tors” apply to “Loans
(3) Subsidiary Companies (10) Advances recoverable in cash or in Advances” also.
(4) Advance payments and kind or for value to be received,
unexpired discounts for the e.g., Rates, Taxes, Insurance, etc
the portion for which value has (11) Balances on current account with
still to be given e.g., in the Managing Agents or Secretaries and
case of the following classes of Treasurers.
companies :

(Newspaper, Fire Insurance, (12) Balances with Customs, Port Trust

Theatres, Clubs, Banking, etc., (where payable on demand)
Steamship Companies, etc.)

(5) Unclaimed Divisdends.

(6) Other Liabilities (if any)
(7) Interest accrued but not on loans.

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 Liabilities Assets

Instructions in accord Figures Figures Figures Figures Instructions in accor

ance with which liabili- for the previous for the current for the previous for the current dance with which
ties should be made out year year year year assets should be made
out

Rs. Rs. Rs. Rs.

B. Provisions :
(8) Provisions for Taxation.
(9) Proposed dividends
(10) For contingencies
(11) For Provident Fund Scheme.
(12) For insurance, pension and similar
staff benefits schemes.

The period for which the (13) Other provisions.

dividends are in arrear or
if there is more than one
class of the dividends on
each such class are in
arrear, shall be stated
The amount shall be stated
before deduction of income
tax, except that in the case
of tax-free dividends for
the amount shall be
shown-free of income-tax
and the fact that it if so
shown shall be stated.
The amount of any guarantee
given by the company on behalf
of Directors or other officers
of the company shall be stated
and where practicable, the
general nature and amount of each
such contingent, liability, if
material, shall also be specified.
A foot-note to the Balance Sheet
may be added to show separately :
(1) Claims against the company not
acknowledged as debts.
(2) Uncalled liability on shares partly
paid
(3) Arrears of fixed cumulative dividends.
(4) Estimated amount of contracts remaining
to be executed on capital account and not
provided for.
(5) Other money for which the company is
contigently liable.
MISCELLANEOUS EXPENDITURE
(to the extent not written off or
or adjusted)
(1) Preliminary expenses.
(2) Expenses including commission
or brokerage on under-writing
or subscription of shares or
debentures.
(3) Discount allowed on the issue
of shares or debentures.
(4) Interest paid out of capital
during construction (also
stating the rate of interest).
(5) Development expenditure noT Show here the debit
adjusted. balance of profit
(6) Other items (specifying nature) & loss account
carried forward
PROFIT AND LOSS ACCOUNT. after deduction of
the uncommitted
reserves, if any.

General Instructions for preparation of Balance Sheet

(a) The information required to be given under any of the items
or sub-items in this Form, if it cannot be conveniently
included in the Balance Sheet itself, shall be furnished in a
separate Schedule or Schedules to be annexed to and to
form part of the balance-sheet. This is recommended when
items are numerous.
(b) Paise can also be given in addition to rupees, if desired.
(c) In the case of (subsidiary companies) the number of shares
held by the holding company as well as by ultimate holding
company and its subsidiaries must be separately stated.
The auditor is not required to certify the correctness of such
share holdings as certified by the management.
(cc) [The item “Share Premium Account” shall include details
of its utilisation in the manner provided in section 78 in the
year of utilisation].
(d) Short Term Loans will include those which are due for not
more than one year as at the date of the Balance Sheet.
(e) Depreciation written off or provided shall be allocated under
the different heads and deducted in arriving at the value of
Fixed Assets.

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(f) Dividends declared by subsidiary companies after the date
of the Balance Sheet (should not be included) unless they
are in respect of period which closed on or before the date
of the balance-sheet.
(g) Any reference to benefits expected from contracts to the
extent not executed shall not be made in the Balance Sheet
but shall be made in the Board’s report.
(h) The debit balance in the Profit and Loss Account shall be
shown as a deduct on from the uncommitted reserves if any)
(i) As regards Loans and Advances amounts due by the
Managing Agents or Secretaries and Treasurers, either
severally or jointly with any other persons, to be separately
stated : the amounts due from other companies under the
same management within the meaning of sub-section (1-B)
of Section 370. G.S.R. 7 should also be given with the names
of the companies the maximum amount due from every one
of these at any time during the year must be shown.
(j) Particulars of any redeemed debenture which the company
has power to issue should be given.
(k) Where any of the company’s debentures are held by a
nominee or a trustee for the company, the nominal amount
of the debentures and the amount at which they are stated
in the books of the company shall be stated.
(l) A statement of investments (whehter shown under
investments or under “Current Asset” as stock-in-trade)
separately classifying *trade investments and other
investments should be annexed to the Balance Sheet
showing the names of the bodies corporate, indicating
separately the names of the bodies corporate in the same
group (with the name of the Managing Agent or Secretaries
and Treasurers, if any, of every body corporate) in whose
shares or debentures investments have been made (including
all investments whether existing or not, made subsequent
to the date as at which the previous Balance Sheet was made
out) and the nature and extent of the investments so made
in each such body corporate; provided that in the case of an
investment company that is to say, a company whose
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principle business is the acquisition of shares, stock,
debentures or other securities, it shall be sufficient if the
statement shows only the investments existing on the date
as at which the Balance Sheet has been made out; provided
further that it shall not be necessary to give any particulars
in respect of investments made by a managing agency or
Secretaries and Treasurers company in the managed
companies shares or debentures.
(m) If, inthe opinion of the Board, and of (the current assets
loans and advances) have not a vaue on realisation in the
ordinary course of business at least equal to the amount at
which they are stated, the fact that the Board is of that
opinion shall be stated.
(n) Except in the case of the first balance-sheet laid before the
company after the commencement of the Act, the
corresponding amounts for the immediately preceding
financial year for all items shown in the balance-sheet shall
be also given in the Balance Sheet. The requirement in this
behalf shall in the case of companies preparing quarterly or
half-yearly accounts, etc., relate to the Balance Sheet for
the corresponding date in the previous year.
(o) The amounts to be shown under Sundry Debtors shall
include the amounts due in respect of goods sold or services
rendered or in respect of other contractual obligations but
shall not include the amounts which are in the nature of
loans or advances.
(p) Current accounts with Directors, Managing Agents,
Secretaries and Treasurers and Manager whether they are
in credit or debit shall be shown separately.
Substituted by G.S.R. 414, dated 21st March 1961.
Trade Investment means an investment by a company in the
shares or debentures of another company, not being its
subsidiary, for the purpose of promoting the trade or business
of the first company.
 PART II - A VERTICAL FORM OF BALANCE-SHEET

Items Instructions in accordance with

which assets and liabilities
should be made out

FUNDS EMPLOYED
A. Fixed assets 1. Under each head the original cost, and additions thereto and deductions therefrom
I. Tangible assets during the year, and the total depreciation written off or provided up to the
1. Land end of the year shall be stated
2. Buildings
3. Plant and machinery 2. (a) The cost of a fixed asset shall be determined by adding to the purchase price
4. Furniture and Fittings any attributable costs of bringing it to its working condition for its intended
5. Vehicles use.
6. Livestock
7. Others (specify nature) (b) The cost of construction of a fixed asset shall be determined by adding to
II. Intangible Assets the purchase price of the materials and consumables used, the costs incurred
1. Goodwill by the company which are directly attributable to the construction of that asset.
2. Patents, Trade marks, In addition, there may be included in the cost of construction of a fixed asset a
Designs and similar rights reasonable proportion of the costs incurred by the company which are indirectly
3. Others (specify nature) attributable to the construction of that asset, but only to the extent that they
relate to the period of construction.
III. Capital work-in-progress
(c) Financing costs relating to deffered credits or borrowed funds attributable to
construction or acquisition of fixed assets up to the period such assets are ready
to be put to use should also be included in the cost of the asset to which they are
related. The fact of inclusion of interest in determining the cost of the asset to
which they relate and the amount of the interest shall be disclosed in a note to
the Balance Sheet in the year in which it is so included.

3. Where the original cost and the additions thereto and deductions therefrom
relate to any fixed asset which has been acquired from a country outside India,
and in consequence of a change in the rate of exchange at any time after the
acquisition of such asset there has been an increase or reduction in the liability
of the company, as expressed in Indian currency, for making payment towards
the whole or a part of the cost of the asset or for repayment of the whole or a
part of moneys borrowed by the company from any person, directly or indirectly.
In any foreign currency specifically for the purpose of acquiring the asset, the
amount by which the liability is so increased or reduced during the year, shall
be added to, or, as the case may be, deducted from, the cost, and the amount
arrived at after such addition or deduction shall be taken to be the cost of fixed
asset.

Explanations :
(a) ‘Foreign currency’, for the purpose of this Schedule, means any currency other
than the Indian currency.
(b) ‘Rate of exchange’, for the purposes of this Schedule, means the rate quoted by
a bank or other authorised dealer in foreign exchange at which the rupee may
be exchanged for a unit of a foreign currency or a foreign currency may be
exchanged for a unit of the rupee.
4. In every case where the original cost cannot be ascertained without unreasonable
expense or delay, the valuation shown by the books shall be given. For the
purpose of this paragraph, such valuation shall be the net amount at which an
asset stood in the Company’s books at the commencement of this Act after
deduction of the amounts previously provided or written off for depreciation
or diminution in value, and where any such asset is sold, the amount of sale
proceeds shall be shown as deduction.

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 5. Where sums have been written off on a reduction of capital or a revaluation of assets,
every Balance Sheet (after the first Balance Sheet) subsequent to the reduction or
revaluation shall show the reduced figures with the date of the reduction in place of
the original cost. Similarly, where sums have been added by writing up the assets,
every Balance Sheet subsequent to such writing up shall show the increased figures
with the date of the increase in place of the original cost.
6. Each Balance Sheet for the first five years subsequent to the date of the reduction/
increase shall also show the amount of the reduction/increase made.
Explanation : Nothing contained in paragraphs Nos.5 and 6 shall apply to any
adjustment made in accordance with parargraph No.3 above.
7. Depreciation written off or provided shall be allocated under the different asset heads
and deducted in arriving at the value of fixed assets.
8. Provisions of diminution in value shall be made in respect of any fixed asset which
has diminised in value if the reduction in its value is expected to the permanent
(whether its useful life is limited or not) and the amount to be included in respect of
it shall be reduced accordingly.
9. Land or buildings acquired on leasehold basis shall be shown separately under the
respective heads.
10. Goodwill shall be shown only when some consideration in money or money’s worth
has been paid for it and shall be written off over a period which shall not exceed its
useful life.
11. If any of the fixed assets acquired by the company under a finance lease are not
included under the appropriate sub-heads, disclosure shall be made by way of a note
to the balance-sheet of the type of assets (e.g., plant and machinery), the total value
of the assets and the future obligations of the company as per the lease agreement.
12. Capital expenditure on incomplete construction work shall be shown under the heading
“Capital work in Progress”. Advance payments to contracts shall not be classified
under the specific fixed assets but disclosed in the balance-sheet as a separate item.
B. Long term investments

1. Investments in Government or 1. Long term investment for the purpose of this Schedule, means an investment other
Trust Securities than a current investment.
2. Investments in shares,
debentures or bonds ‘Current investment’, for the purposes of this Schedule means an investment that
3. Immovable properties is by its nature readily realisable and is intended to be held for not more than
4. Investment in the capital of one year.
associations of persons 2. Long term investments shall be shown at cost or revalued amounts. The book value
5. Loans to subsidiaries of long term investments shall be reduced to recognise a decline, other than temporary,
6. Others (specify nature) in their value. Such reduction shall be determined and made for each investment
individually.
3. Aggregate amount of Company’s quoted investments and also the market value thereof
shall be shown. Aggregate amount of Company’s unquoted investments shall also
be shown.
‘Quoted investment’, for the purposes of this Schedule, means an investment in respect
of which a quotation or permission to deal on a recognised stock exchange has been
granted, and the expression ‘unquoted investment’ shall be construed accordingly.
4. In the case of subsidiary companies, the number of shares held by the holding company
as well as by the ultimate holding company and its subsidiaries shall be separately
stated. In the latter case, the Auditor shall not be required to certify the correctness
of such shareholdings as certified by the management.
5. A statement of long-term investments shall be annexed to the balance-sheet showing
the names of the bodies corporate (indicating separately the names of the bodies
corporate under the same management) in whose shares or debentures investments
have been made (including all investments, whether existing on the date of the balance-
sheet or not, made subsequent to the date as at which the previous Balance Sheet
was made out) and the nature and extent of the investment so made in each

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 such body corporate ; provided that in the case of an investment company, that is to
say, a company whose principal business is the acquisition of shares, stock, debentures
or other securities, it shall be sufficient if the statement shows only the investments
existing on the date as at which the Balance Sheet has been made out.
6. Loans due from Directors or other officers of the company or any of them either
severally or jointly with any other person or debts due by firms or private companies
respectively in which any director is a partner or a director or a member shall be
separately stated.
7. The maximum amount of loans due to directos or other officers of the company at any
time during the year shall be shown by the way of a note.
8. Loans due from other companies under the same management within the meaning of
subsection (3) of section 387, shall be disclosed separately with the names of the
companies.
9. The nature of security, if any, shall be specified in respect of loans.
10. Provision made for bad and doubtful loans if any, shall be shown under respective
sub-heads.

C. Net current assets

Current assets 1. If the net realisable value of any current asset is lower than
its cost, the amount to be included in respect of that asset
shall be the net realisable value.
I. Investories
1. Raw materials and components
2. Stores, spares loose tools &
other consumables
3. Work-in-process
4. Finished goods
II. Debtors 1. Debts shall not include amounts which are in the nature
of loans or advances.
1. Trade debtors
2. Other debtors
2.‘Trade debtor’, for the purposes of this Schedule, means a person
from whom amounts are due for goods sold or services rendered.
3. Instructions Nos. 6,7,8,9 and 10 regarding ‘Long-term investments’
apply to ‘Debtors’ also.
4. Debts outstanding for more than one year shall be shown separately
under the respective heads.
III. Short term loans and advances 1. ‘Short term loans and advances, for the purposes of this Schedule,
1. To subsidiaries mean deposits and other advances which fall due for payment, in a
2. To such other entities in relatively short period, normally not more than 12 months from the
which the company or any of date on which such loans, deposits or other advances are made.
its subsidiaries is a member 2. Instructions Nos. 6,7,8,9 and 10 regarding ‘Long-term investments’
3. Advances recoverable in cash apply to ‘Short-term Loans and Advances’ also.
or in kind or for value to be
received 3. Current accounts with Directors and Manager shall be shown
4. Others (specify nature) separately.

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IV. Current investments 1. ‘Current investment’, for the purposes of this Schedule, means
1. Investments in shares, an investment that is by its nature readily realisable and is intended
debentures and bonds to be held for not more than one year.
2. Other investments (specify nature)
2. A statement of current investments existing on the date of the balance
sheet shall be annexed to the balance sheet showing the names
of the bodies corporate (indicating separately the names of the
bodies corporate under the same management) in whose shares or
debentures, investments have been made and the nature and extent
of the investment so made in each such body corporate.
V. Bills of exchange In regard to bank balances, particulars
shall be separately given of balances
VI. (a) Cash in hand lying in current accounts, call accounts
(b) Cheques in hand and deposit accounts. The maximum amount
(c) Balance at bank outstanding at any time during the year
from non-scheduled banks shall be separately disclosed.

VII. Other current assets (specify nature) Dividends declared by subsidiary companies after the date of the
balance-sheet shall not be included unless they are in respect of a period
which closed on or before the date of the balance-sheet.

Less current liabilities provisions

and short-term loans and advances
I. Current liabilities
1. Acceptances
2. Sundry creditors
3. Advance payments and unexpired
discounts for the portions for
which value has still to be given
4. Unclaimed dividends
5. Interest accrued but not due on loans
6. Others (specify nature)
II. Provisions ‘Provisions’, for the purposes of
this Schedule, means any amount
1. For taxation written off or retained by way of
2. Proposed dividends providing for depreciation, renewals
3. For Contingencies or diminution in value of assets, or
4. For pension, gratuity and retained by way of providing for any
similar staff benefit schemes known liability the amount of which
5. Others (specify nature) cannot be determined with substantial accuracy.
III. Short-term loans and advances 1. ‘Short-term loans and advances’,
1. From banks and other financial for the purposes of this Schedule,
institutions mean loans, deposits and other advances which fall due for payment
2. From subsidiary companies in a relatively short period, normally not more than 12 months
3. Others (speicfy nature) from the date on which such loans,
deposits or other advances are obtained. 2. Current accounts with Directors and Manager shall be show separately.
3. The nature of security, if any, shall be specified in respect of
short-term loans and advances.
4. Interest accrued and due on short-term loans and advances shall be
included under the appropriate sub- heads under the head “short-term
loansand advances”.

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Net current assets

D. Miscellaneous expenditure to the extent not written

off or adjusted.

1. Preliminary expenses

2. Expenses including commission or brokerage on

underwriting or subscription of shares or debentures

3. Discount allowed on the issues

of shares, debentures and other securites

4. Other items (specify nature)

E. Loss as per the profit and loss The debit balance of the profit account carried forward after
account deduction of the uncommitted reserves, if any, shall be shown here.

FINANCED BY 1. In respect of each class of

A. Shareholders’ funds shares, the number of shares and
I. Share capital the face value per share shall be
1. Authorised capital disclosed in respect of authorised,
subscribed and called-up capital.
2. Subscribed capital
2. The number of shares alloted as
3. Called-up capital fully paid-up pursuit to a contract
without payments being received in
Less : Calls unpaid shall be separately disclosed.
Add : Forfeited shares
3. The number of shares allotted as fully paid-up by way of bonus shares shall be
separately disclosed. Also, the source from which bonus shares are issued, e.g.,
capitalisation of profits or reserves or from share premium account, shall be
specified.
4. Terms of redemption or conversion (if any), of any redeemable preference
capital shall be stated, together with the earliest date of redemption or conversion.
5. Particulars of the different classes of preference shares shall be given.
6. Particulars of any option on unissued share capital shall be specified.
7. Where the company has, by special resolution, determined that any portion of
its share capital which has not already been called up shall not be capable of
being called up, extent in the event and for the purposes of the company being
wound up, the fact shall be suitably disclosed by way of a note to the Balance
Sheet specifying the amount that shall not be so capable of being called up.

II. Reserves and surplus 8. Any profit on reissue of for-

feited shares shall be trans-
1. (a) Capital reserve ferred to the capital reserve.
(b) Capital redemption reserve 1.(i) Unless the context otherwise requires —
(c) Share premium (a) the expression “reserve” shall not include any amount
2. Debenture redemption reserve written off or retained by way of providing for depreciation, renewals
or diminution in value of assets or retained by way of providing for
any known liability ;
3. Other reserves (specify nature) (b) the expression “capital reserve” shall mean a reserve
Less : debit balance in the which is not available for distri-
Profit and Loss Account bution as dividend ;
(if any) and in sub-clause(a) above, the expression “liability” shall
4. Revaluation reserve include all liabilities in respect of expenditure contracted for and
5. Surplus i.e. balance in the all disputed or contingent liabi-
Profit and Loss Account after lity” shall include all liabilities
providing for proposed in respect of expenditure contracted
allocations, e.g., dividend, reserves for and all disputed or contingent liabilities
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 2. Where —
(a) any amount written off or retained by way of providing for depreciation,
renewals or dimunition in value of assets, not being an amount written off in
relation to fixed assets before the commencement of this Act; or (b) any
amount retained by way of providing for any known liability;
is in excess of the amount which in the opinion of the Directors is reasonably
necessary for the purpose, the excess shall be treated for the purposes of this
Schedule as a reserve and not as a provision.
3. Additions and deductions since last balance-sheet shall be shown under each
of the specified heads
4. The word “fund” in relation to any “Reserve” shall be used only where such
“Reserve” is specifically represented by earmarked investments.
5. In respect of share premium, details of its utilisation in the manner provided
in section 101 shall also be given in the year of utilisation.

B. Long term loans 1. ‘Long-term loans”, for the

I. Secured purposes of this Schedule, mean
1. Debentures loans which fall due for payment
2. Loans from financial in a relatively long period,
institutions normally more then 12 months from
3. Loans from banks the date on which they are obtained.
4. Loans from subsidiaries 2. The nature of the security in
5. Others (specify nature) the case of all secured loans,
II. Unsecured whether short-term or long-term,
1. Fixed deposits shall be specified in each case.
2. Loans from subsidiaries “Secured loan”, for the purposes
3. Loans from banks of this Schedule, means a loan
4. Others (specify nature) secured wholly or partly against an asset.
3. Where loans have been guaranted by Directors and/or Manager, a mention
thereof shall be made and the aggregate amount of such loans under each head
shall be shown.
4. Interest accrued and due on long-term loans shall be included under the
appropriate sub-heads under the head “secured loans” or “unsecured loans”.
5. Terms of redemption or conversion (if any) of debentures issued shall be
stated, together with the earliest date of redemption or conversion.
6. Loans from Directors and Manager shall be shown separately.
7. Particulars of any redeemed debentures which the company has power to
issue shall be given.
8. Where any of the Company’s debentures are held by a nominal amount of the
debentures and the amount at which they are stated in the books of the company
shall be stated.
9. The aggregate amount of long-term loan due for repayment within a period of
12 months from the date of the balance-sheet shall be indicated.

Contingent liabilities 1. The period for which the dividends

A foot-note to the Balance Sheet
may be added to show separately
1. Claims against the company
not acknowledged debts
2. Uncalled liability on shares
partly paid
3. Arrears of fixed cumulative
dividends
4. Other moneys for which the
is contigently liable
(specify)
on preference shares are in arrears or if
there is more than one class of shares,
the dividends one each class are in arreas
shall be stated. The amount shall be
stated before deduction of income-tax.
2. The amount of any guarantees given
by the company on behalf of Directors or
other officers of the company on behalf
of Directors or other officers of the
company shall be stated, and where
practicable, the general nature and amount of each such
contingent liability, if material, shall also be specified.

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ANNEXURE III

General instructions and accounting principles according to Companies Bill 1993

1. The company shall be presumed to be carrying on business as an on-going concern. Where there is prima facie evidence to
the contrary, suitable disclosure shall be made.
2. Accounting policies shall be applied consistently from one financial year to the next. Any change in the accounting policies
which has a material effect in the current period or which is reasonably expected to have a material effect in later periods
shall be disclosed. In the case of a change in accounting policies which has a material effect in the current period, such
change shall also be disclosed to the extent ascertainable. Where such extent is not ascertainable, wholly or in part, the fact
shall be indicated.
3. Provision shall be made for all known liabilities and losses even though the amount cannot be determined with certainty and
represents only a best estimate in the light of available information. Revenue shall not be recognised unless (i) it is realised
(either in cash, receivables or other consideration); (ii) no significant uncertainty exists regarding the amount of the
consideration ; and (iii) it is not unreasonable to expect ultimate collection.
4. The accounting treatment and presentation in the Balance-Sheet and Profit and Loss Account of transactions and events
shall be governed by their substance and not merely by the legal form.
5. In determining the accounting treatment and manner of disclosure in the Balance-Sheet and Profit and Loss Account, due
consideration shall be given to the materiality of the relevant items.
6. An inappropriate treatment of an item in the Balance-Sheet or Profit and Loss Account is not rectified either by disclosure
of accounting policies used or by notes thereto.
7. Notes to the Balance-Sheet and the Profit and Loss Account shall contain only the explanatory material pertaining to the
items in the Balance Sheet and the Profit and Loss Account.
8. All significant accounting policies adopted in the preparation and presentation of financial statements shall be disclosed at
one place. Where they are not in conformity with accounting standards, particulars of any material departures from those
standards and the reasons therefore shall be given.
9. The information required to be given under any of the items or sub-items in this Form, if it cannot be conveniently included
in the Balance-Sheet or the Profit and Loss Account itself, as the case may be, can be furnished in a separate Schedule or
Schedules to be annexed to and forming part of the Balance-Sheet or Profit and Loss Account. This is recommended where
items are numerous.
10. The Schedules referred to above, accounting policies and explanatory notes that may be attached shall form an integral part
of the Balance-Sheet.
11. The corresponding amounts for the immediately preceding financial year for all items shown in the Balance-Sheet and
Profit and Loss Account shall also be given in the Balance Sheet or Profit and Loss Account, as the case may be. The
requirement in this behalf shall, in the case of companies preparing quarterly or half-yearly accounts, etc., relate to the
Balance Sheet/Profit and Loss Account for the corresponding date/period in the previous year.
12. Amounts in respect if items representing assets or income shall not be set off against amounts in respect of items representing
liabilities or expenditure, as the case may be, or vice versa.
13. Assets and liabilities shall be adjusted for those events occuring between the end of the financial year of the company to
which the balance-sheet relates and the date on which the Balance-Sheet and Profit and Loss Account are approved by the
Board of Directors which provide additional evidence to assist the estimation of amounts relating to conditions existing at
the date of the Balance-Sheet.
14. The figures in the balance sheet and profit and loss account may be rounded off appropriately, e.g., to the nearest .000 or
.00.
15. A statement of sources and application of funds shall be annexed to the Balance-Sheet. Such a statement shall be prepared
and presented for the period covered by the Profit and Loss Account and for the corresponding previous period. Funds
provided from or used in the operations of a company shall be shown separately in the statement of sources and applications
of funds. Unusual movement of funds, if material, should be separately disclosed. Each company shall adopt the form of
presentation for the statement and changes in financial position which is most informative in the circumstances.

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ANNEXURE IV
SCHEDULE XIV
(See Sections 205 and 350)

RATES OF DEPRECIATION
Nature of Assets Single Shift Double Shift Triple Shift
W.D.V. S.L.M. W.D.V. S.L.M. W.D.V. S.L.M.

1 2 3 4 5 6 7

I. (a) Buildings (other than factory 5 1.63

buildings[NESD] percent percent
(b) Factory Buildings 10 3.34
percent percent
(c) Purely temporary 100 100
erections such as percent percent
wooden structures
II. Plant and Machinery
(i) General rate applicable
to plant and machinery (not
being a ship) for which no
special rate has been
prescribed under below 15 5.15 22.5 8.90 30 11.31
percent percent percent percent percent percent
(ii) Special rates
A. 1. Cinematography films 20 7.07
-Machinery used in percent percent
the production and exhibition of
cinematograph of cinematograph
films [N.E.S.D]
(a) Recording equipment, reproducting
equipment, developing machines.
printing machines, editing machines,
synchronisers and studio lights except
bulbs.
(b) Projecting equipment of film exhibiting
concerns.
2. Cycles [N.E.S.D] 20 7.07
percent percent
3. Electrical Machinery Batteries;
X-Ray and electrotherapeutic
apparatus and accessories thereto
[N.S.E.D.]
4. Juice boiling pans (karhais)[N.E.S.D.]
5. Motor-cars, motor cycles, scooters and
other mopeds [N.E.S.D.]
6. Electrically operated vehicles including
battery powered or fuel call powered
vehicles [N.E.S.D.]
7. Sugarcane crushers (indigenous
kolhus and belans) [N.E.S.D]
8. Glass manufacturing concerns except
direct fire glass melting furnaces
Recuperative and regenerative
glass melting furnaces 20 7.07 30 11.31 40 16.21
percent percent percent percent percent percent
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 1 2 3 4 5 6 7
9. Machinery used in the manufacture
of electronic goods or components.
B.
1. Aeroplanes - Aircraft, aerial photo-
graphic apparatus (N.E.S.D.)
2. Concrete pipes manufacture-Moulds
(N.E.S.D.)
3. Drum container manufacture-Dies
(N.E.S.D.)
4. Earth-moving machinery employed
in heavy construction works.
such as dams, tunnels, canals, etc. 30 11.31
(N.E.S.D.) percent percent
5. Glass manufacturing concerns
except direct fireglass melting
furnaces - Moulds (N.E.S.D.)
6. Moulds in iron foundaries (N.E.S.D.)
7. Mineral oil concerns - Field operations
(above ground) - Portable boilers
drilling tools, wellhead tanks, rigs, etc.
(N.E.S.D.)
8. Mines and quarries - Portable
underground machinery and
earthmoving machinery used in
open cast mining (N.E.S.D.)
9A. Motor tractors, harvesting combines
(N.E.S.D.)
10. Patterns, dies and templets (N.E.S.D.)
11. Ropeway structures - Ropeways.
ropes and trestle sheaves and
connected parts. (N.E.S.D.)
12. Shoes and other leather goods
factories-Wooden lasts used in
the manufacture of shoes 30 11.31 45 18.96 60 29.05
percent percent percent percent percent percent
C.
1. Aeroplanes-Aero-engines (N.E.S.D.)
2. Motor buses, motors, lorries and
motor taxies used in a business
or running them on hire (N.E.S.D.)
3. Rubber and plastic goods factories 40 16.21
Moulds (N.E.S.D.) percent percent
4. Data processing machines including
computers (N.E.S.D.)
5. Gas cylinders including valves
and regulators (N.E.S.D.)
D.
1. Artificial silk manufacturing machinery
wooden parts
2. Cinematograph films - Bulbs of
studio lights
3. Floor mills-Rollers
4. Glass manufacturing concerns-Direct
fire glass melting furnaces
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 1 2 3 4 5 6 7
5. Iron and Steel industries Rolling
mill rolls
6. Match factories-Wooden match
frames
7. Mineral oil concerns (a) Plant used
in field operations (below ground)
Distribution returnable package
(b) Plant used in field operations
(below ground) but not including
assets used in field operations
(distribution)-Kerbside pumps
including underground tanks and
fittings
8. Mines and quarries - (a) Tubs, winding
ropes, haulage ropes and sand stowing
pipes (b) Safety lamps
9. Salt works-Salt pans, reservoirs and
condensers, etc., made of earthy,
sandy or clay material or any other
similar material
10. Sugar works - Rollers
III. Furniture and Fittings -
1. General rates (N.E.S.D.) 10 3.34
percent percent
2. Rate for furniture and fittings used
in hotels, restaurants and boarding
houses; schools, colleges and other
educational institutions, libraries;
welfare centres, meeting halls,
cinema houses; theatres and circuses;
and for furniture and fittings let out
on hire for use on the occassion of
marriages and similar functions 15 5.15
(N.E.S.D.) percent percent
IV. Ships —
1. Ocean-going ships
(i) Fishing vessels 27.05 10
with wooden hull percent percent
(N.E.S.D.)
(ii) Dredgers, tugs, barges, survey
launches and other similar ships
used mainly for dredging purposes 19.8 7
(N.E.S.D.) percent percent
(iii) Other ships (N.E.S.D.) 14.6 5
percent percent
2. Vessels ordinarily operating on
inland waters —
(i) Speed boats (N.E.S.D.) 20 7.07
percent percent
(ii) Other vessels (N.E.S.D.) 10 3.34
percent percent
W.D.V. : Written Down Value
S.L.M. : Straight Line Method.
NOTES
1. "Buildings" include roads, bridges, culverts, wells and tube-wells.
2. "Factory buildings" does not include offices, godowns, offices and bridges, culverts, wells and tube-wells.

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3. "Speed boat" means a motor boat driven by a high speed internal combustion engine capable of propelling the boat at a speed exceeding 24
kilometres per hour in still water and so designed that when running at a speed it will plane, i.e., its bow will rise from the water.
4. Where, during any financial year, any addition has been made to any asset, or where any asset has been sold, discarded, demolished or destroyed,
the depreciation on such assets shall be calculated on a pro rata basis from the date of such addition or, as the case may be, upto the date on which
such asset has been sold, discarded, demolished or destroyed.
5. The following information should also be disclosed in the accounts :
(i) depreciation methods used ; and
(ii) depreciation rates or the useful lives of the assets, if they are different from the principal rates specified in the Schedule.
6. The calculations of the extra depreciation for double shift working and for triple shift working shall be made separately in the proportion which
the number of days for which the concern worked double shift or triple shift, as the case may be, bears to the normal number of working days
during the year. For this purpose, the normal number of working days during the year shall be deemed to be —
(a)in the case of seasonal factory or concern, the number of days on which the factory or concern actually worked during the year or 180 days,
whichever is greater ;
(b) in any other case, the number of days on which the factory or concern actually worked during the year or 240 days,
whichever is greater.
The extra shift depreciation shall not be charged in respect of any item of machinery or plant which has been specifically, exempted by inscription
of the letters “N.E.S.D.” (meaning “No Extra Shift Depreciation”) against it in sub-items above and also in respect of the following items of
machinery and plant to which the general rate of depreciation of 15 per cent applies —
(1) Accounting machines.
(2) Air-conditioning machinery including room air-conditioners
(3) Building contractor’s machinery
(4) Calculating machines.
(5) Electrical machinery-switchgear and instruments, transformers and other stationary plant and wiring and fitting of electric light and
fan installations.
(6) Hydraulic works, pipelines and sluices.
(7) Locomotives, rolling stocks, tramways and railways used by concerns, excluding railway concerns.
(8) Mineral oil concerns - field operations:
(a) Boilers.
(b) Prime movers.
(c) Process plant.
(d) Storage tanks (above ground).
(e) Pipelines (above ground).
(f) Jetties and dry docks.
(9) Mineral Oil concerns - field operations (distribution)- kerbside pumps, including underground tanks and fittings.
(10) Mineral oil concerns - refineries:
(a) Boilers.
(b) Prime movers.
(c) Process plant.
(11) Mines and quarries:
(a) Surface and underground machinery (other than electrical machinery and portable underground machinery).
(b) Head-gears.
(c) Rails.
(d) Boilers.
(e) Shafts and inclines.
(f) Tramways on the surface.
(12) Neo-post franking machines
` (13) Office machinery.
(14) Overhead cables and wires.
(15) Railway sidings.
(16) Refrigeration plant containers, etc. (other than racks).
(17) Ropeway structures :
(a) Trestle and station steel work.
(b) Driving and tension gearing.
(18) Salt works-Reservoirs, condensers, salt pans, delivery channels and piers if constructed of masonry, concrete, cement, asphalt or similar
materials, barges and floating plant, piers, quays and jetties; and pipelines for conveying brine if constructed of masonry, concrete, cement,
asphalt or similar materials.
(19) Surgical instruments.
(20) Tramways electric and tramways run by internal combustion engines—permanent way : cars - car trucks, car bodies, electrical equipment and
motors; tram cars including engines and gears.
(21) Typewriters.
(22) Weighing machines
(23) Wireless apparatus and gear, wireless appliances and accessories.

Notes: Refer to Notes under sections 205 and 350.

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2. CORPORATE ACCOUNTS AND BOARD’S RESPONSIBILITY
SUB-TOPICS
2.1 Introductory Note
2.2 Responsibility of Directors for Proper Upkeep of Accounts
2.3 Fiduciary Relation
2.4 Directors’ Liabilities
2.1 INTRODUCTORY NOTE
The Board of Directors of a company is in charge of the affairs
of the company. It acts for and on behalf of the company. Lord
Selbourne, L.C. explained the position of Directors thus: "The
Directors are the mere trustees or agents of the company - trustees
of the company’s money and property; agents in the transactions
which they enter into on behalf of the company”. [G.E.Railway
Company v. Turner (1872)LR 8 Ch App 149]. According to
sec. 291 of the Companies Act in India, the Board of Directors
shall be entitled to exercise and draft and prepare, subject to
the provisions of the Companies Act, Memorandum of
Association and Articles of Association of the company.
Every company should preserve the Books of Accounts together
with the relevant vouchers for a period of not less than 8 years
in good order. Directors are liable to be punished in case proper
Books of Accounts are not kept. In the following passages an
attempt is made to explain the responsibilities of the Directors
in so far as keeping of accounts is concerned.
2.2 RESPONSIBILITY OF DIRECTORS FOR PROPER
UPKEEP OF ACCOUNTS
The Managing Director or the Manager and every Director of a
company and every officer or other agent of the company
appointed for that purpose are responsible to keep proper Books
of Accounts according to the provisions laid down in sec. 209
of the Companies Act, 1956. 'Proper Books of Accounts' shall
mean keeping of all those books necessary to give a true and
fair view of the state of affairs of the company including all its
branch offices. Directors are, therefore, liable to be punished
if default is made in keeping proper Books of Accounts.
According to sec. 209(5) such an act is punishable with
imprisonment for a term which may extend to 6 months or with
fine which may extend to Rs.1000 or with both. A person is
liable to be proceeded against in respect of an offence under
sec. 209 for failure to take reasonable efforts to secure
compliance by the company with the requirements of the section.
Of course it has been provided that no person shall be sentenced
to imprisonment except when the offence is committed wilfully.
Directors are also responsible to propose dividends out of the
profits of the company after taking into consideration the detailed
provision laid down in sec. 205 of the Companies Act. Every
Director is responsible, therefore, not only on the
recommendation but also on all consequential steps. For
example, according to sec. 207, every Director is punishable
with simple imprisonment for a term which may extend to 7
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days and shall also be liable to fine if a default is made knowingly
in not posting the dividend warrant within 42 days from the
date of declaration of the dividend. According to sec. 210 the
Board of Directors shall present before the company in a Annual
General Meeting:
(a) A Balance Sheet; and
(b) A Profit and Loss Account for the same period.
A Director who fails to take all reasonable steps to comply with
the provisions of this section shall be punishable with
imprisonment which may extend to six months or with fine up
to Rs.1000 or with both. Of course the imprisonment is not to
be given unless the offence is committed wilfully. The Directors
may take a defence by proving that a competent and reliable
person was put in charge to discharge the duties and
responsibilites. Similar provisions of responsibilites to be
undertaken by the members of the Board of Directors are
provided in sec. 211 which specifies a Balance Sheet and Profit
& Loss Account to be prepared in the forms indicated in Part I
& Sch VI. sec. 212 provides for procuring information from
the subsidiaries and putting it in the Balance Sheet of the holding
company. sec..215 requires authentication of Balance Sheet and
Profit and Loss Account by the Managing Director and another
member of the Board.
Board’s Report : The Balance Sheet must accompany the
report of the Board of Directors which shall inter alia include :
(a) The state of the company’s affairs (The state of affairs of
the company);
(b) The amount if any which the Board proposes to carry to
any reserves ;
(c) The amount if any which the Board recommends to be paid
as a dividend ; and
(d) Material changes affecting the financial position of the
company which occured during that period.
The report also includes all materials relating to the affairs
of company which according to the Board is harmful to the
company and its subsidiaries. It also includes list of employees
drawing more than Rs.36,000 annually and also showing relation
of such an employee with the Director or Manager. All the
annexures to the company’s accounts are not required to be
included in the Board’s report. But the report must give the
fullest information and explanations. (Refer to sec. 217). In all
the above provisions as indicated in secs. 210, 211, 212, 217
and 218 noncomplaince of the duty imposed has been made an
offence punishable with imprisonment and fine. Of course unless
the offence is wilful a person canot be sentenced to
imprisonment. A member of the Board may however take a
defence that a person having special knowledge in accounts had
been appointed to look after the Books of Accounts and system
of accounts.
The Act also imposes certain restrictions on the powers of the
Board of Directors. It provides that the Board of a Public Ltd
company or that of a Private company which is a subsidiary of
a Public Ltd company will not do the following business except
with the consent of the members obtained in the General Meeting
: from statutory liability the Directors as trustees are liable for
(i) Sale, lease or otherwise dispose off the whole or
substantially the whole of the company’s undertaking ;
(ii) Remit or give time for the payment of any debt due by a
Director, except renewal or continuance of an advance made
by a Banking company to its Director in the ordinary course
of business ;
(iii) Invest otherwise than in trust securities, the sale proceeds
resulting from the disposal of the undertaking (refer to
clause(i) above);
(iv) Borrow money exceeding the aggregate of the paid up
capital of the company and its free reserves ; and
(v) Contribute to charitable or other funds not relating to business
of the company or Welfare of its employees, any account which
will in any year not exceed Rs.25,000/- or 5% of the net average
profit during the three preceeding years whichever is greater.
(refer to sec. 293 of the Companies Act, 1956)
2.3 DIRECTORS’ FIDUCIARY RELATIONS
Jessel, M.R. has very appropriately described the role of the
Directors in Re Forest of Dean Coal Company [(1878)10 ch.
D 415]. According to him “they are commercial men managing
a trade concern for the benefit of themselves and of all the share
holders in it. They stand in a fiduciary position towards the
compay in respect of their powers and capital under their
control”. According to Romer, J., “In discharging his duties a
Director must act honestly and must exercise such degrees of
skill and diligence as would amount to the reasonable care which
an ordinary man is expected to take in the circumstances in his
own behalf”. [Re City Equitable Insurance Company (1925)
Ch.407] In other words a Director has to use fair and reasonable
diligences in the management of the company’s affairs and act
honestly. So long as he is fulfilling these conditions he is not
liable for error of judgement. Though he has the right of
inspection of accounts he is not bound to inspect individual
entries. So long as he ensures that maintenance of Books of
Accounts is in the hands of competent persons he can be said to
be not negligent.
According to sec. 71(3) of the Companies Act of 1956 any
Director who knowingly contravenes or wilfully authorises or
permits the contravention of the statutory restrictions with respect
to allotment of shares, remains for two years after the allotment
under a statutory liability to compensate the company for any
loss or damage or costs incurred. In Eastern Shipping
Company v. Bangkee [(1924) AC 177] it was held that apart
breach of their fiduciary duties to their company. The failure of
Directors to act within powers (ultra vires acts) will render them
liable, and thus shall have to indemnify the company for any
loss or damage.
If a Director acts malafide, i.e., acts otherwise than honestly for
the benefit of the company he is bound to compensate the
company. It is on this ground that the Directors are required to
account for and surrender secret profits of the company. The
Director has to exercise the powers for the benefit of the
company. He will be guilty of dereliction of duties, if his
negligence, as such, enable frauds to be committed and losses
are thereby incurred by the company. Improper maintenance of
Books of Accounts, falsification of books or frauds will
obviously make the Director liable for punishment.
2.4 DIRECTORS’ LIABILITES
For several financial and accounting improprieties, the
Companies Act attaches personal liabilities to the Directors.
Some of the accounting improprieties and Directors’ liabilities
thereon have already been stipulated. Some of the financial
improprities and personal liabilities of the Directors are as
follows :
(i) Directors have civil and criminal liability for misstatement
in the prospectus ; (refer to secs. 62 and 63)
(ii) If public deposits are invited without issuing an
advertisement and in violation of the provision of sec. 58A.,
a Director is personally liable. He is even punishable with
imprisonment for a term which may extend to 5 years ;
(iii) A Director is personally liable if the application money is
not returned within 120 days unless the shares are allotted;
(iv) A Director is liable for irregular allotment and his liability
can be unlimited under secs. 322 and 323;
(v) A Director is liable personally for fraudulent trading on
the part of the company in its winding up proceedings ; and
(vi) There are various statutory penalties for non complaince
that can be imposed on a Director. He can be prosecuted
under the Indian Penal Code for offences like fraud, perjury,
misappropriation, embezzlement or conspiracy to default.
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3. DIVIDEND
SUB-TOPICS
3.1 Introductory note
3.2 Legal Position of Corporate Profit and Dividend
3.3 Declaration and Payment of Dividend
3.4 Dividend to be paid out of Reserve
3.5 Issues Relating to Reserves and Funds
3.6 Suggested Changes in Companies Bill 1993
3.7 Annexure
3.1 INTRODUCTORY NOTE
The Profit earned by a company belongs to the company and
not to the shareholders. A member, being a shareholder, has a
right to his share only and has no right on the assets of the
company. Dividend is the payment made to him as return, for
his investment in the share capital. Dividend can only be paid
out of profits and not out of capital.
It is the prerogative of the Board to appropriate the profits of a
company for any year. The appropriation of profits to reserves
and dividends shall be stated in the Directors’ report. Only the
Board has the right to recommend the payment of profits as
dividends to the shareholders. The shareholders cannot enhance
the dividend recommended but can reduce or reject it at the
Annual General Meeting. Hence payment of dividend is subject
to recommendation by the Board and approval of the same by
the shareholders for payment. The dividends once declared to
the shareholders become a debt due.
3.2 LEGAL POSITION OF CORPORATE PROFIT
AND DIVIDEND
Futcher Moulton, L.J., explained Profit In Re Spanish
Prospecting Company Ltd [(1911)1 Ch.D 92] thus : "profits
implies a comparison between state of business at two specific
dates usually separated by an interval of a year. The fundamental
meaning is the amount of gain made by the business during the
year. This can only be ascertained by a comparison of assets at
two dates .....” According to the principle of accounting this
method of finding out profit by comparison of assets in two
dates is not scientific. Profit according to the principle of
accounting over a particular period of time is the surplus of
income over expenditure. In this sense it is nearer to the
dictionary meaning. According to Chambers Dictionary - Profit
is the excess of selling price over the fixed cost. According to
taxing statutes, profit is the excess of revenue income over
revenue expenditure. The double entry system of book keeping
on accrual basis takes into account the accruals and outstandings
while calculating the profit. Accountants are - generally
prudence driven. They provide for doubtfuls while considering
the revenue income or revenue expenditure and recognise income
de Cannon of Certainty.
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Part II of Schedule VI of the Companies Act as reproduced in
the Annexure I prescribes the requirements which the profit and
loss account of a company should follow. Similarly, secs. 29 to
44 of the Income Tax Act, also provides the expenses which
can be deducted to ascertain the Income of a concern. Where
there is a difference in the provision of Income Tax Act and
Companies Act the profit of a company is determined according
to Companies Act for all purposes excepting in the matter of
corporate tax.
It has been already pointed out earlier that the profit of a company
belongs to the company and not to the shareholders. As soon as
dividends are declared at the AGM, a shareholder gets the right
on the profit. Thus profit and dividend are two very inter-linked
concepts.
The expression dividend has two meanings which the Supreme
Court pointed out in CIT v. Girdhari dass & Co Pvt Ltd (AIR
1967 SC 795). To a runing concern it means portion of the
profit of a company which is allocated to the holders. In the
company and in case of a winding up proceeding it means the
division of the realised assets among the creditors and
contributors according to their respective rights. Dividend for
our purpose, in the section means the former, i.e., allocated profit
on a share.
3.3 DECLARATION AND PAYMENT OF DIVIDEND
According to sec. 205 of a Companies Act, a company cannot
declare dividend or pay it for any financial year unless it has
earned profit. The following are the clear provisions regarding
declaration of dividends to the shareholders :
(i) In order to declare dividend the profit must be found after
providing for depreciation as stipulated in Schedule XIV
of the Companies Act. (See Annexure IV) While providing
for the depreciation, unabsorbed depreciation of the
previous years or loss whichever is lower is also required
to be provided for (sec. 205 and sec. 350)
(ii) No dividend shall be payable except in cash. Of course
capitalised profits may be used to issue bonus shares. (sec.
205)
(iii) The dividend when declared becomes a debt due. In order
to ensure that disbursement of the dividend amount is not
delayed by the company, the law provides that in case the
dividend is not paid or claimed within 42 days of the
declaration thereof then within 7 days after the end of the
42 days, the total amount of dividend should be transfered
to a bank account with a scheduled bank.
This bank account cannot be operated except for the
payment of dividend. In case the dividend is not claimed
or paid within 3 years after the transfer, the amount should
be transfered to the general revenue account of the
government. This can be later claimed by the shareholder
by making a claim on the government. (secs. 205A and
205B)
(iv) No dividend shall be paid by a company except to the
registered shareholder of such share or to his order or to his
banker or in case a share warrant has been issued to the
bearer of the share warrant or to his banker. (sec. 206)
(v) Where any instrument of shares has been delivered to any
company for registration but has not yet been registered the
company shall transfer the dividend amount to the special
account mentioned in (iii) above, unless the shareholder in
writing asks the company to pay the amount to the transferee.
(vi) No dividend shall be declared or paid by a company except
after transfer to the reserve of the company such percentage
of profit as stipulated by the Central Government from
time to time, not exceeding, 10%.
3.4 DIVIDEND TO BE PAID OUT OF REVENUE
It has been already stated that a company is not bound to declare
entire profit or any part thereof by way of dividend. Therefore,
the profit may be held in a general reserve. According to sec.
205(2A) a company is not prohibited to voluntarily transfer
higher percentage of profit than the stipulated percentage of
profit that may be prescribed by Central Government to be
transferred to the reserve. The Central government has made
rules for the companies (transfer of profit to reserves) in 1975.
According to rule 2 of the said Rules a company declaring
dividend upto 12.5% has to transfer to the general fund atleast
2.5% of the current profit. If the dividend exceeds 12.5% but
not 15% of the paid up capital the reserves shall not be less than
5% and if exceeds 15% but not 20% the reserve shall be not
less than 7.5%. If the dividend is more than 20% the profit to
be transfered to this reserve shall not be less than 10%. Where
no dividend is declared the amount proposed to be transfered to
its reserves shall be lower than the average amount of dividends
to the shareholders declared by it over the immediately
preceeding 3 years. Of course the company is not prohibited to
voluntarily transfer higher percentage of profit to its reserve.
According to sec. 205A(3) a company not having adequate profit
in a year may propose to declare dividend out of the accumulated
profits earned by the company in the previous years and
transfered to its reserves. The Central government has prepared
rules for this purpose in 1975. According to Rule 2 of the
Companies (declaration of Dividends out of Reserves) Rules
1975 a company not having sufficient profit in year may declare
dividend out of the accumulated profits transfered to its reserves
subject to the following conditions :
(i) The rate of dividend shall not be higher than the average of
the rates of dividend declared in the immediately preceeding
5 years or 10% of its paid up capital, whichever is less;
(ii) The total amount to be declared as dividend shall not exceed
10% of the paid up capital and reserves;
(iii) The amount thus drawn shall first use to set off the losses;
and
(iv) The amount of the reserve shall not fall below 15% of the
paid-up share capital.
3.5 ISSUES RELATING TO RESERVES AND FUNDS
General reserve has not been defined in the Act. A full Bench
of the Madras High Court held that the General Body can only
create general reserve on the advice of the Board of Directors
under sec. 217(1)(6). Institute of Chartered Accountants in
London defined this reserve as “Amount set aside out of profits
and other surplus which are not designed to meet any liability,
contingency, commitment or diminition in value of assets known
to exist as at the date of the Balance Sheet. However, in ITC v.
Century Spining and Manufacturing Co Ltd [(1953) 23
Comp.Cas 462] it was held that mass of undistributed profits
cannot automatically make it a reserve. Reserve may be either
general or special which has to be clearly indicated.
Fund is also not defined in the Companies Act. Fund is created
for specific purpose by transfering a profit to a fund. Such a
specific purpose fund is known as Sinking Fund. Fund is the
capitalised version of profit. As such a general fund can also be
not distributed by way of dividend. Out of the general fund and
reserve, bonus shares can be issued. Sinking Funds like Specific
Funds, Debentures-Redemption Reserve Fund or Depreciation
Fund cannot be used for issue of bonus share until the basic
purpose of the fund is fulfilled.
3.6 SUGGESTED CHANGES IN COMPANIES BILL
1993
1. Companies would henceforth need to inform members about
the dividend remaining unclaimed by them, by way of a
notice to be sent with every notice of an Annual General
Meeting. In case unpaid dividend is not transfered to a
separate bank account, the company would be liable to pay
interest at 18% per annum.
2. Dividends unclaimed and transfered to the General Revenue
account of the Central Government would be credited to an
Investors Protection Fund to be used for purposes to be
notified.
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4. AUDIT AND AUDITOR
SUB-TOPICS
4.1 Introductory note
4.2 Role of Audit
4.3 Principles of Audit
4.4 Relation between Accounting and Auditing
4.5 Different Types of Audit
4.6 Qualification of a company Auditor and Restriction on
the number of Auditors
4.7 Auditor’s Remuneration
4.8 Removal of an Auditor
4.9 Auditor’s Report
4.10 Some Proposed Changes Relating to Audit and Auditor
4.1 INTRODUCTORY NOTE
In a Joint Stock company, the management carries on business
with shareholders funds. There is a separation of power between
management and ownership. The shareholder has no access to
the Books of Accounts which would be maintained by the
Directors. This necessitates the involvement of an independent
person who would report on the accounts of a company to the
shareholders. The Directors have cast upon them a duty of
presenting to the shareholders each year, the Balance Sheet and
Profit and Loss account, and the auditor has the duty of
expressing his opinion on them in the form of a report on the
accounts.
As the law enjoins upon the management to present a true and
fair view of the accounts, the auditor is expected to report
whether the accounts in his opinion are true and fair.
4.2 ROLE OF AUDIT
Audit is concerned with the verification of accounting data and
with determining the accuracy and reliability of accounting
statements and reports. It primarily involves testing the
reliability, competency and adequacy of evidence in support of
all transactions. The main objectives of company audit are to
conduct an independent review of the financial statements and
offer an opinion about their reliability in presenting the
organisation’s financial condition and working results.The main
function of the Auditor is to ascertain whether the financial
statements fairly represent the actual financial position and
working results of an organisation. The management’s
responsibilities include the maintenance of adequate accounting
records and internal controls, the selection and application of
accounting policies and the safeguarding the assets of the entity.
The audit of financial statements does not relieve the
management of its responsibilities.
4.3 PRINCIPLES OF AUDIT
The Institute of Chartered Accountants of India, in its statement
on Standard Auditing Practices, identified the basic principles
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governing an Audit has listed certain principles for independent
audit of financial information. These principles are as follows :
a) Integrity and independence :
The auditor is appointed by the shareholders to carry out certain
duties as laid down by the Companies Act, 1956. This requires
that the auditor be straight forward, honest and sincere in his
approach to his work. He should be free from bias and maintain
an impartial attitude. He should be independent and able to
withstand the pressures of management;
b) Confidentiality :
The auditor is expected to respect the confidentiality of
information that he acquires during the course of his professional
work and unless required by statute or any legal and professional
demands he should not divulge any information;
c) Skills and competence :
The auditor requires certain specialized skills and competence
to undertake an audit. This is ensured through his qualification
which is acquired through a process of education, training and a
qualifying examination.
The Institute also adds to his skill and competence through its
various pronouncements on matters of accounting and auditing
and various guidance notes on ways and means to undertake
audits and to handle the varied situations that arise in an audit;
d) Responsibility :
The auditor is personally responsible for whatever opinion that
he forms and expresses on the financial information made
available to him for audit. However, he can rely on work done
by others provided adequate skill and care is excercised and the
work so done by others has been properly supervised;
e) Accounting systems and internal control :
Though the management is responsible for maintaining adequate
accounting systems incorporating internal controls, the
company’s auditor should assure himself that the system is
adequate and the internal control procedures are in operation
and are commensurate with the size of the company and the
nature of its business;
f) Planning :
Based on the adequancy of internal controls, the auditor can
plan his audit to cover the various facets of the company’s
activities and to establish a certain degree of reliance on the
internal controls; and
g) Evidence and documentation :
Gathering evidence forms an integral part of an audit activity.
Obtaining sufficient evidence enables him to draw reasonable
conclusions and to base his opinion. The evidence so gathered
should be documented. This is the proof of an audit having
been undertaken in accordance with the basic principles and
will help him in case of any legal or professional requirements.
4.4 RELATION BETWEEN ACCOUNTING AND
AUDITING
Auditing is an examination of accounts kept for and on behalf
of an organization with a view to authenticate the periodical
account with the help of Books of Accounts and the original
vouchers and documents. Original vouchers and documents
are known as primary evidences and the records maintained in
the Books of Accounts are secondary evidence of transactions
made by the organisation in course of a period of time. Audit,
therefore, is the last step of function in the chains of accounting
functions. The relation between accounting and auditing,
therefore, is very close. Auditing procedures and principles
and principles of accounting are inter-related and integrated.
Of course without the proper development of accounting
principles, the development of auditing procedures and
principles are not possible. The main purpose of accounting is
to find out the net result of the transactions over a period of
time. The main object of auditing on the other hand is to
authenticate that the result thus found is true and fair. The first
principle of accounting is that the working result of transactions
over a period of time which are revenue in nature determine the
net profit or loss of the concern but transactions which are
concerned with real or personal account determine the assets
and liabilities of the concern at a given point of time. The audit
principle closely follows this basic accounting principle for the
purpose of accurately determining the profit and loss, and assets
and liabilities at a given point of time. This working of the
result and its authentication does in no way indicate the future
course of transactions though there may be a logical expectation.
In this sense this accounting systems is essentially historical in
nature. It has nothing to do with projection, forecasting and
management decisions for futher actions. Of course historical
accounting is used as a data for future indication on the
supposition that the future is modelled in the direction of the
past. So auditing of historical accounting is essentially
authenticating of what has happened through reivewing primary
and secondary evidences.
4.5 DIFFERENT TYPES OF CORPORATE AUDIT
A company has two types of audit viz. (i) Financial Audit and
(ii) Cost Audit. The Financial Audit is done by the company
Auditor appointed under sec.224 and he is required to submit
audit report on the lines laid down in sec. 227 and issued
dividend. According toManufacturing and other Companies
(Audit Report) Order, 1975 the cost audit is to be done by the
Cost Auditor appointed under sec.233 B. The Cost Auditor is
to submit his report to the Central Government with a copy to
the company.
According to sec.209(1)(d), in the case of a company engaged
in production, processing or mixing activities has to keep proper
books of accounts with respect to such particulars relating to
materials or labour or to other items of cost as may be prescribed.
This particular clause has been inserted for the purpose of
determining efficiency through Cost Audit.
Of course there is a provision for a special audit in specified
extraordinary circumstances under sec.233A which can be done
at the behest of Central government by an Auditor appointed
under the section even if the audit has already been done under
sec.221. The coverage of the audit shall extend to other matters
as directed by the government. The report will be submitted to
the government and not to the shareholders.
4.6(A) QUALIFICATIONS OF COMPANY
AUDITORS
Section 226 of the Companies Act, 1956 provides that only a
person who is a member of the Institute of Chartered Accountants
of India, holding a certificate of Practice and who is not in full
time employment can be appointed as the auditor of a company.
Further certain disqualifications exists as to the appointment of
an auditor. He should not form a body corporate, or be an officer
or employee of the company whose accounts are to be audited
or a person who is a partner or in the employment, of an officer
of the company, nor should he be indebted to the company for
more than Rs.1000/- or have guaranteed the repayment of any
such debt. A statutory auditor cannot be appointed as an internal
auditor. Hence the intention of the law is that an auditor should
be a truly independent person who is neither connected with the
company nor with the management.
A professional auditor should be constantly aware of his possible
legal obligations to his clients and third parties, specially in the
context of the increasing expectation of the society from his
profession as is evident from the various amendments to the
Companies Act and other relevant legislations as well as from
various judicial pronouncements in this area.
Knowledge of the Companies Act and its provisions is essential
for a company auditor. Compliance with such provisions is no
doubt the responsibility of the directors and other officers of
the company. However, non compliance of many provisions of
the Act may materially affect the financial statements and validity
of transactions of a company. The auditor should therefore
always keep the provisions of the Companies Act in mind.
The qualification of a Cost Auditor as per sec.233B is that he
shall be a Cost Accountant within the meaning of Cost and Works
Accountants Act, 1959. Of course, Central Government may
by notification empower a Chartered Accountant to function as
a Cost Accountant until such time when sufficient numbers of
Cost Accountants are available. A “special Auditor” appointed
to conduct a special audit is required to be a Chartered
Accountant under the Chartered Accountant Act of 1949. He
may be the company Auditor or any other Chartered Accountant
appointed under sec.233 A.
4.6(B) APPOINTMENT OF AUDITORS
a) Company Auditor :
The first auditor of a company may be appointed by the Board
of Directors within a period of one month from the date of
registration of the company. The term of the first auditor is
only upto the conclusion of the first annual general meeting.
The appointment of the first auditor shall be made by the
company in a general meeting in case the first auditor is not
appointed by the Board.
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The appointment of subsequent auditor must be made at each
annual general meeting and such auditor holds office normally
upto the conclusion of the next annual general meeting. The
shareholders appoint the auditor at the annual general meeting.
In case an auditor is not appointed or reappointed at the annual
general meeting, he would be appointed by the Central
Government.
The Board of Directors are entitled to appoint the auditor in
case a casual vacancy occurs due to any reason other than
resignation. Where an auditor resigns, the vacancy may be filled
only by the company at the annual general meeting.
Where the central or state governments, nationalised banks or
nationalised insurance companies, hold either singly or jointly
25% or more of subscribed capital of a company, the appointment
or reappointment of an auditor shall be made by passing a special
resolution at the annual general meeting. If an auditor is not
appointed or reappointed before the expiry of his term, the
company shall inform the central government within 7 days
thereafter and in such cases, the central government may appoint
auditors to fill the vacancy.
b) Cost Auditor :
A Cost Auditor shall be appointed by the Board of Directors of
a company in accordance with the provisions of sec.224(1)(b)
with the previous approval of the central government. The
company Auditor appointed for financial audit shall not be
appointed or re-appointed for cost audit.
c) Special Auditor :
The central government may at any time direct a special audit
to be conducted either by the same company Auditor or by any
other Chartered Accountant for the purpose of submission of
report to the central government.
4.6(C) RESTRICTIONS ON THE NUMBER OF
AUDIT
A quantitative restriction has been placed on the number of
company audits that can be accepted. The maximum number of
public limited companies of which a person may hold
appointment as auditor is twenty of which not more than ten
may be companies each of which has a paid up share capital of
Rs.25 lakhs or more. Hence, it is necessary to ascertain and
obtain a certificate from the auditor that in case he is appointed
or reappointed, the appointment would be within the limits and
that he has not acquired any disqualification, to avoid an
embarassing situation. The Act also provides that in case a firm
is appointed as Auditors, the quantitative limit would be
applicable taking each partner of a firm separately and where a
partner is common to other firms he shall be counted only once.
4.7 AUDITOR’S REMUNERATION
Where the auditors are appointed by the company, the
remuneration must always be fixed by the company at the general
meeting. The remuneration is fixed by the Board or by the central
government where the appointment is made by the Board or the
government.
It is interesting to note that, in practice, and in most cases the
shareholders while appointing the auditor at the annual general
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meeting authorise the Board of Directors to fix the remuneration
in consultation with the auditors.
The remuneration paid to an auditor by whatever name called
as also the expenses paid to him needs to be specifically disclosed
in full in the profit and loss account. (section 224(8)). This is to
enable the shareholders to have adequate and full information
of the payments so made.
4.8 REMOVAL OF AN AUDITOR
An auditor enjoys certain safeguards as regards his continuance
in office. The previous approval of the central government is
necessary to remove an auditor before the expiry of his term
and that too only at the general meeting. In case a person other
than the retiring auditor is to be appointed at an annual general
meeting, 14 days special notice should be given to the company.
The company shall forthwith send a copy of the special notice
to the retiring auditor. He is entitled to make a written
representation and to have such representation circulated among
members, otherwise he is also entitled to have his representation
read out at the meeting. Further under the Code of Ethics to
which a Chartered Accountant is subject a person so appointed
to fill in the existing office needs to communicate with his
predecessor to find out objections, if any.
An Auditor should not accept any position as auditor previously
held by some other Chartered Accountant under such conditions
as to constitute under cutting of fees.
4.9 AUDITORS REPORT
The auditor is required to make a report on the accounts
examined by him and on the balance sheet and profit and loss
account of the company.
The report must be signed by a qualified auditor practising in
India and not by a firm. If such an auditor is a partner in a firm
of auditors, which has been appointed as the auditor of the
company, he must sign in his individual name as a partner of the
firm. The report must be read out before the company at the
general meeting and also be open to inspsection by any member
of the company.
The auditor’s report consists of two parts namely the affirmative
and the opinionative. In the opinionative part, he has to express
an opinion on certain matters. The affirmative part of the report
consists of :
(i) Whether he has obtained all the information and
explanations which is to the best of his knowledge and belief
were necessary for the purpose of the audit ;
(ii) Whether the report on the accounts of any branch office
audited under section 228 of the Companies Act by a person
other than the company’s auditor has been forwarded to
them a report as required by section 228(3)(C) and how he
has dealt with the same in preparing the auditor's report ;
and
(iii) Whether the company’s Balance Sheet and Profit and Loss
account dealt with by the report are in agreement with the
books of account and return.
The opinionative part of the report consists of :
(i) Whether proper books of account as required by law have
been kept by the company so far as it appears from his
examination of the books and proper returns adequate for
the purpose of the audit have been received from branches
not audited by him ;
(ii) Whether the accounts give the information required by the
Act in a manner so required ; and
(iii) Whether the accounts give a true and fair view, in the case
of the Balance Sheet, of the state of the company’s affair,
and in the case of the profit and loss account, for the year.
The auditor’s report has to be made on the accounts examined
by him, the Balance Sheet and Profit and Loss Account and
every document declared to be a part of or annexed to such
balance sheet. Documents annexed include the list of
investments and particulars required by section 372(9) and any
information given in a schedule where permitted to be so done.
Documents attached to the Balance Sheet are excluded from
the ambit of the report.
Further, under section 227 (IA) the auditor has to make specific
enquiries and report on the matters specified there in only if he
is not satisfied on those matters. The matters are :
(i) 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 not prejudicial
to the interests of the company and its members;
(ii) Whether transactions of the company which are represented
merely by book entries are not prejudicial to the interests
of the company;
(iii) Where the company is not an investment company within
the meaning of section 372, or a banking company, whether
so much of the assets of the company as consists of shares,
debentures and other securities have been sold at a price
less than that at which they were purchased by the company;
(iv) Whether loans and advances made by the company have
been shown as deposits;
(v) Whether personal expenses have been charged to revenue;
and
(vi) Where it is stated in the books and papers of the company
that any shares have been allotted for cash, whether cash
has actually been so received in respect of such allotment
and if no cash has actually been so received, whether the
position as stated in the account books and the Balance Sheet
is correct, regular and not misleading.
In addition, the central government has the power to direct, by a
special or general order that in the case of specified companies,
the auditor’s report shall include a statement, on such matters
as may be specified. The central government has issued in 1975
and amended in 1988 the Manufacturing and other Companies
(Auditor’s Report) Order by which the auditor is to report on
the matters specified therein.
The Auditor’s report can be an unqualified report, a qualified
report, an adverse report, or a disclaimer. An unqualified report
does not state any adverse comments either in the affirmative
part or the opinionative part. Generally an audit report is an
unqualified one, as the management would ensure compliance
with law and with accounting norms.
A qualified report is one which has a reservation attached to it.
Any failure to perform a statutory duty in the manner required
under law cannot be absolved by merely giving a qualification
or a reservation in the report. A qualification is necessary where
disclosure is not made in accounts as per law. However, while
qualifying a report, an auditor should be guided by the concept
of materiality, whether the item to be qualified is so material
that a qualification is required. In extreme cases, a disclaimer
or an adverse report may be required. Where the auditor is
unable to express an opinion due to lack of information, or
otherwise, he would give a disclaimer expressing his inability
to express an opinion. Where, however, the qualification is so
severe so as to affect the true and fair view of the accounts itself,
he would issue an adverse report. The qualification should be
contained in the Auditor’s report proper, and should be self
explanatory. It should be indicated by the correct terminology
with the prefix “subject to”.
A qualification is a serious matter and the law recognizes it and
as such section 217(3) of the Companies Act enjoins the Director
to give the fullest information and explanation on every
qualification in the auditor’s report.
An auditor is for certain purposes of the Act deemed to be an
officer of the company. In the case of winding up of the company
by the court, the auditor can be called by the court for purposes
of examination on oath and for production of any books and
papers in his custody relating to the company. The court may
also publicly examine him as to the conduct of the business of
the company, in case the official liquidator makes a report to
the court that a fraud has been committed.
As an officer he is liable for committing of fraud or for
misfeasance in the case of winding up.
.4.10 SOME PROPOSED CHANGES RELATING TO
AUDIT AND AUDITOR
The Companies Bill 1993
The Companies Bill 1993 has proposed some changeswith
regard to audit and auditor.
They are :
(i) Only qualified Audit reports need to be read out at the annual
general meeting. An unqualified report could be taken as read
with the permission of the members present ;
(ii) A relative of a Director or Manager of a company cannot be
appointed as Auditor; and
(iii) In the Audit report the auditor should also express his
opinion on (a) whether the accounting policies of the company
are in conformity with the accounting standards laid down by
the Institute of Chartered Accountants of India; (b) whether there
have been any deviation from the company’s accounting policies;
(c) Whether the accounting treatment in the financial statements
in respect of any item is inappropriate; and (d) whether it is in
line with substance with the legal form.
The scope of the report has been enlarged and comes closer to
international norms of reporting.
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5. AUDITOR’S RIGHTS AND DUTIES
SUB-TOPICS
5.1 Introductory note
5.2 Independence of an Auditor
5.3 Powers of an Auditor
5.4 Special Right of a company auditor to attend a meeting
5.5 Duties of a company Auditor
5.6 Branch Audit
5.1 INTRODUCTORY NOTE
The role of a company Auditor cannot be exaggerated in the
context of his rights, duties and responsibilities undertaken. Care
in his Professional Ethics of Public Accounting emphasised the
independence of the professional practioners on account of their
responsibilites, moral or legal to the corporation and to the public
in the context to which their relationship may tend to influence
others judgement. The following text explains Auditor's rights
and duties.
5.2 INDEPENDENCE OF AN AUDITOR
A note issued by the Research Committee of the Institute of
Chartered Accountants of India has stated that independence
actually implies that the judgement of a person is not subordinate
to the wishes or directions of another person who might have
engaged him or to his own self-interest.
Independence is a well accepted standard of auditing. The need
for independence has been recognised in the Chartered
Accountants Act wherein provisions have been made to cover
areas or situations where there would be a conflict between
interest and duty and the independence of the auditor could be
affected.
The Companies Act also recognises the independence of
auditors. One specific area where the Act has made itself clear
is with regard to the appointment of internal auditor as the
statutory auditor of the company. The Act specifically states
that an internal auditor cannot be appointed as the statutory
auditor because the internal auditor is appointed by the
management and is in the position of an employee and if he is
appointed as the company’s statutory auditor, it will not be
possible for him to give an independent and objective report as
required under the Act.
Independence does not mean that the auditor should assume an
attitude of hostility and proceed like a prosecutor. It only points
to the need for his functioning in a fair and impartial manner
with a sense of obligation not only to the management and those
immediately concerned or interested in the company’s business
but also to those who would be interested to become
shareholders or creditors. It would be apt in this context to
quote Justice Lopes in the Kingston Cotton Mill Co, case
citation wherein he observed that “The auditor is a watchdog
but not a blood hound. He is justified in believing tried servants
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of the company in whom confidence is placed by the company.
He is entitled to assume that they are honest and to rely upon
their respresentations, provided he takes reasonable care. If
there is anything calculated to excite suspicion, he should probe
it to the bottom, but in the absence of anything of that kind he is
only bound to be reasonably cautious and careful.”
The Companies Act can be read in the context of this observation
in the following circumstances:
Under sec.227(1A), the auditor is under an obligation to make
an inquiry and report only if the provisions of the Act are not
complied with and, under sec. 227(2) and (3), the auditor shall
make a report stating whether, in his opinion and to the best of
his information and according to the explanations given to him,
the said accounts give the information required by the Act in
the manner so required and give a true and fair view with regard
to : (a) in the case of the balance sheet, of the state of affairs of
the company ; and (b) the case of the Profit and Loss account
for the financial year. Here again, the auditor only expresses an
opinion on the truth and fairness of the financial statements and
does not vouch for the correctness of the statements concerned.
These clauses have been provided in the Act basically because
it would be impracticable for an auditor to vouch for the veracity
of each and every transaction and activity of the company and
also because quite a number of the transactions could not be
material enough to be considered for an indepth verification.
An auditor can only approach his work with an inquiring mind
and not with any preconceived notion that there is something
wrong or that there is fraud in the accounts although the tests
that he performs shall runover any fraud.
In the statement on Auditing Practices published by the ICAI, it
was pointed out that it is the directors of the company who are
primarily responsible for the preparation of the annual accounts
and for the information contained therein. The duty of
safeguarding the assets of a company is primarily that of the
management and the auditor is entitled to rely upon the
safeguards and internal controls instituted by the management
although he will, and of course, take into account any
defficiencies he may note therein while drafting his audit
programme.
Based on the above, it can be stated that the auditor cannot be a
bloodhound but only a watch dog. However, this does not
absolve the auditor of his primary duty of reporting to the
members on the accounts examined by him and he should be
careful 'not to certify what he does not believe to be true and
must take reasonable care before he believes that what he certifies
is true’(Lindley L.J.)
5.3 POWERS OF THE AUDITOR
The auditor of a company is empowered to have a free and
complete access at all times to the books, accounts and vouchers
of the company and also to require from the directors and
officers, such information and explanation as may be necessary
for the performance of his duties as an auditor. These powers
enable him to discharge his duties effectively. This power is
important as he can only express an opinion when he has
adequate information at his disposal. The auditor should obtain
all the necessary information and should take into account the
views of directors before he finalises any qualification to the
accounts. His report should be based on the books as he has to
state whether the balance sheet and profit and loss account are
in agreement with the books.
5.4 RIGHT TO ATTEND COMPANY MEETINGS
The auditor is entitled to attend any general meeting of the
company and to receive all notices and other communications
relating to any general meeting which any member of the
company is entitled to receive and to be heard at any general
meeting or any part of the business which concerns him as an
auditor. This right has been given so that the auditor is able to
present his opinions/views to the shareholders if required.
5.5 DUTIES OF THE AUDITOR
In completing his statutory function, the auditor is required to
employ reasonable skill and care as is expected of a person
having specialised knowledge.
The duty of safeguarding the assets of the company, is primarily
that of the management and the auditor is entitled to rely upon
the safeguards and internal control instituted by the management.
He has to take into account any deficiencies he may note therein.
The auditor does not conduct the audit with the objective of
discovering all frauds because in the first place, it would not be
possible to complete the audit within the time limit prescribed
by the law for the presentation of accounts to shareholders.
Further such an examination would require a detailed and minute
examination of all the books, records and other documents of
the company and the cost of doing this would be prohibitive
and disproportionate to the benefits which may be derived by
the shareholders. Finally even if such an examination is
conducted, there will be no assurance that all types of fraud,
omission and forgery etc., would be discovered. The auditor
while conducting the audit bears in mind the possibility of
existence of fraud and irregularities in the accounts of the
company. His duty is to primarily report on the account to the
shareholders.
5.6 BRANCH AUDIT
The accounts of the branch office(s) of every company must be
audited by the company’s auditor, or by a person qualified for
appointment as auditor. However, the compulsory audit of
branch office is exempted in certain cases according to the rules
made in this behalf by the Central Government.
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6. AUDITOR’S LIABILITIES
care and due diligence. Of course a Corporate Auditor in such
SUB-TOPICS
cases is liable under the statute itself.
6.1 Introductory Note
6.2 Auditor’s Liability for Negligence 6.2(A) AUDITORS LIABILITY FOR NEGLIGENCE
6.3 Auditor’s Liability for Misfeasance The question of an auditor’s liability for negligence has been
6.4 Auditor’s Criminal Liability tried more in the English courts rather than in India. This
question can be best illustrated by referring to various judicial
6.5 Auditor’s Liability to Third Parties
decisions. The question basically is one of fact as to whether
6.6 Professional Ethics the Auditor has shown reasonable care in the discharge of his
6.7 Professional Misconduct function. Members of a profession must exercise the standard
of skill which is usual in the profession. The standard is
6.1 INTRODUCTORY NOTE ordinarily that of a skilled man exercising and professing to
have that special skill and one need not possess the highest
An Auditor’s liabilities have different dimensions. As a
expertise or skill at the risk of being found negligent. In a suit
contractual assignment he has some contractual liabilities that
for negligence it would be upto the plaintiff to prove that the
arise from the non-fulfilment of the terms and conditions of the
professional had some duty to him and a breach of such duty
agreement. The Corporate Auditor has a statutory Civil and
has resulted in an injury.
Criminal liability also. The following chart shows Auditor’s
liabilities at a glance. The earliest decision with regard to an Auditor’s liability for
negligence was given In Re London and General Bank [(1895)
Liability of an Auditor 2 ch 673 (No.2)]. In that case Lord Justice Lindley said “An
Auditor’s duty is to ascertain and state the true financial position
of the company at the time of audit. An auditor, however is not
Contractual Liability Statutory bound to do more than exercising reasonable care and skill in
making enquiries and investigation. He is not an insurer, he
Liability does not guarantee that the books do correctly show the true
position of the company’s affairs. If he did, he would be
responsible for error on his part, even if he were himself deceived
Liability arising Liability arising
without any want of reasonable care on his part; he must be
on non-fulfilment on account of breach honest i.e. he must not certify what he does not believe to be
of Conditions true and he must take reasonable care and skill before he believes
that what he certifies is true. What is reasonable care in any
particular case must depend on the cirumstances of that case”.
Civil Liability Criminal This decision then became the precedent in several other cases
and was often cited with approval. In the case of In Re Kingston
Liability Cotton Mill Co. [(1896) 2 ch 279 (No 2)] Lord Justice Lindley
stated that the auditors should not be suspicious but only be
Due to Negligence Due to Misfeasance reasonably careful. Lord Justice Lopes, in the same case stated
: “In determining whether any misfeasance or breach of duty
Besides these liabilities, the Auditor being a member of a has been committed it is essential to consider what the duties of
professional body has a professional liability and accountability an auditor are. It is the duty of an auditor to bring to bear on the
also. He has to follow the code of conduct. In other words if he work he has to perform that skill, care and caution which a
does not follow the code of conduct prescribed by the Institute reasonably competent, careful and cautious auditor would use.
of Chartered Accountants, he is liable for professional What is reasonable skill, care and caution must depend on the
misconduct and has to face this charge before the professional particular circumstances of the case. An auditor is not bound to
body. be a detective or, as was said, to approach his work with suspicion
or with a foregone conclusion that there is something wrong.
6.2 CONTRACUTAL LIABILITY He is a watch dog but not a blood hound. He is justified in
believing true servants of the company in whom confidence is
A Corporate Auditor has a Statutory Standard Form of Contract.
placed by the company. If there is anything calculated to excite
If he fails to perform his contractual obligation he is liable to
suspicion he should probe it to the bottom but in the absence of
his employer, ie., his company. The complicacy arises primarily
anything of that kind, he is only bound to be reasonably cautious
when the Auditor is also required to prepare whole or part of
and careful."
the accounts. In that case his contractual obligation is wider.
Contractual liability arises also on account of lack of proper
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The duties of the auditor must not be rendered too onerous.
Their work is responsible and laborious and the remuneration
moderate .... auditor must not be made laible for not tracing out
ingenious and carefully laid schemes of fraud when there is
nothing to arouse their suspicion.
In the case of London Oil Storage Co., Ltd., v. Seear Hasluck
& Co., ((1904) 31 Acent LRI) Lord Alverstone stated "The
auditor is an officer contemplated by law to protect the interests
of the company and its shareholder as such; he is there having
certain duties prescribed by the Act. The auditor has got to
bring to bear upon those duties reasonable and watchful care,
he has got to discharge those duties remembering that the
company looks to him to protect its interest. He is not, however,
supposed to be a man constantly going about suspecting other
people of doing wrong.”
In the case of City Equitable Fire Insurance Co., Ltd., [(1925)
1 ch 407], Sir Pollock M.R. wrote that it is the duty of the court
to endeavour to ascertain what was the problem presented to
the auditor, and what was the knowledge available to him at the
time to audit. It is not fair to consider the case with hindsight
and hold that the auditors were negligent in discharging their
duties. The court must bear in mind the facts available at the
time of alleged negligence by the auditor, and it is not fair to
determine the fact of negligence by taking into consideration
what has come to light after true scrutiny carried out in the special
audit.
However the legal standards of reasonable care have been
critically examined in recent times more particularly in the
decision of the House of Lords reported in Fomento Sterling
Area Ltd., v. Selsdon Fountain Pen Co Ltd ((1958) 1 WLR
45), in which Lord Denning said “What is the proper function
of an auditor ? It is said that he is bound to verify the sum, the
arithmetical calculations, by reference to the books and all
necessary vouching material and oral explanations;..... I think
this is too narrow a view. His vital task is to take care to see
that errors are not made, be they errors of computation, or errors
of omission or commission or down right untruth. I would not
have it thought that the Kingston Mill’s case ((1896) 2 ch 279)
relieved an auditor of his responsibility of making a proper check.
It is part of his duty to use reasonable care to see that none have
been omitted which ought to be included. If he cannot
be sure, of his own knowledge he can take the advice of a lawyer
...........”
The reasonable care and skill expected of an auditor would
obvioulsy become more stringent with the passage of time.
Justice Pendse in Tri sure India Ltd., v. A.F. Ferguson & Co.,
and others (company case volume 6 (1981) Bomb 548), said
“The auditor is required to employ reasonable skill and care,
but he is not required to begin with suspicion and to proceed in
the manner of trying to detect a fraud or a lie unless some
information has reached which excites suspicion or ought to
excite suspicion in a professional man of reasonable competence.
An auditor’s duty is to see what the state of company affairs
actually is, whether it is reflected truly in the accounts of the
company, upon which the Balance Sheet and Profit and Loss
accounts are based, but he is not required to perform the function
of a detective. What is reasonable care and skill must depend
upon the circumstances of each case. Where there is nothing to
excite suspicion and there is an atmosphere of complete
confidence based on the record of continued success in financial
matters, less care and less severity of scrutiny may be considered
reasonable. Whereas, reasonable care and skill may be regarded
as not exercised when in spite of the presence of unusual features
in the accounts or other prima facie reason for believing that the
affairs of the company may not be in order, the examination is
perfunctory and not sufficiently detailed.”
6.3 AUDITOR’S LIABILITY FOR MISFEASANCE
Auditor has civil liability for misfeasance. Several sections of
the Companies Act attach such liability on the Auditor. As for
example secs. 57, 58, 59, 62(3), 62(4), 70(5), 233, 477, 488,
543, 545, 621, 625, 633 provide civil liability on an Auditor.
These relate to :
(i) Providing for expert opinion relating to prospectus or
statement in lieu of prospectus ;
(ii) Submission of an Auditor’s report not in confirmity with
secs. 227 and 229 of the Act ;
(iii) Court’s power of summoning in the event of liquidation for
public examination; and
(iv) Assessment of damages for misfeasance or breach of trust.
6.4 CRIMINAL LIABILITY
Under sec.197 of the Indian Penal Code (IPC) whosoever issues
or signs any certificate required by law to be given or signed or
relating to any fact which such certificate by law is admissible
by evidence, knowing or believing that such certificate is false
in any material point shall be punishable in the same manner as
if he gives a false evidence. So if a company Auditor knowingly
issues or signs an Audit report which is false in any material
points he is punishable for the offence under sec.197 of IPC.
Besides, the company Law has criminalized the following acts:
(i) When false statements are made by the Auditor either in
Profit and Loss Account, Balance Sheet or any other
document;
(ii) When any voucher or document is destroyed intentionally
by the Auditor; and
(iii) When any voucher or document is mutilated with the object
to deceive the others.
The Companies Act provides in particular, for example the
following criminal liabilities of a Corporate Auditor :
(i) Authorising the issue of properties with a false statement
knowingly or intentionally made, the offence being
punishable with imprisonment upto 2 years or fine upto
Rs.5000/- or with both (s.63(1)) ;
(ii) Knowingly or recklessly certifying a false, deceptive or
misleading statement, promise or forecast which is
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 punishable with imprisonment upto 5 years or fine upto
Rs.10,000/- or with both; [s.68]
(iii) Certifying a false particular in the report, or certificate, or
balance sheet or prospectus, punishable with imprisonment
for a term upto 2 years and also fine (s.628) ; and
(iv) Intentional destruction, alteration or falsification of any
books of accounts, papers or securities, punishable with
imprisonment upto 7 years and also fine (s.539).
6.5 LIABILITY OF THIRD PARTIES
The annual account of a company as certified by the Auditor is
the standard disclosure required from the company under the
corpoate law. The position of the Auditor vis-a-vis the company
is based upon the contract between the parties but at the same
time it is statutorily regulated also. More and more people are
putting reliance on Auditor’s report and take the position of the
company as certified by the Auditor. It is true that an Auditor
doesn’t have any privity with the third party but his status of
independant profession and his specialised knowledge makes
him a trusthworthy person to the outside world. As such
investors, creditors, bankers, tax authorities and all other parties
having any relation with the company take a decision on the
basis of Auditor’s certificate. An author takes the analogy of a
physician's relation with the clients with the Auditor’s position
in so far as relation between him and third parties are concerned
based on his certificate. (Basu Dr. B.K., An Insight to Auditing
(1982), Books Syndicate Pvt. Ltd, p. 9.42). The physician is
primarily responsible to his client and secondarily to other
members of the family for the injury arising from the negligence
of his duty of care and issue of certificate.
Auditors’ position is perhaps more intricate than a physician. It
is for this reason that the issue gets its importance in many
litigations in several countries. The age old principle in the law
of Tort as enunciated in 1893 in Le livre & Dennes v. Gould
[(1922) IK.B. 688] is that the “question of liability for negligence
cannot arise at all until it is established that the man who has
been negligent owe some duty to the person who seeks to make
him liable for his negligence". In 1889 it was held in Deery v.
Peek [(1889) 14 App. Cas 337] that to make an Auditor liable
to third parties the following four grounds must be satisfied:
(a) the statement made by the Auditor was untrue in fact ;
(b) the Auditor making it knew that it is untrue or he was ...
negligent to find out the truth ;
(c) the statement was made with an intent that the identified
third party should act on it with sound belief ; and
(d) the identified third party suffered loss by placing reliance
on it.
Following these two cases for long it was argued that Auditors
are not liable for the certificate in the absence of fraud. In fact
in a dissenting judgement Lord Denning first tried to make a
very big shift from this proposition in Candler v. Crane
Christmans & Co [(1951) 2KB 164] as he observed that the
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circumstances in which the duty to use care in making a statement
can exist apart from a contract. According to him (i)... those
persons, such as accountants, surveyors, valuers and analysts,
whose profession and occupation is to examine books and
accounts and other things and to make reports on which other
people, other than their clients rely in the ordinary course of
business. Their duty is not merely a duty to use care in their
reports; and (ii) They also owe the duty to any third person to
whom they know their employer is going to show the accounts
so as to induce them to invest money ....
In Hadley Byrne & Co Ltd v. Haller & Partners Ltd
[(1964)AC 465] Lord Morris observed that “It should now be
settled that if someone possessed of a special skill undertaken,
quite irrespective of contracts, to apply that skill for the
assistance of another person who relies on such skill, duty of
care will arise .... Furthermore if, in a sphere in which a person
is so placed that others could reasonably rely on his judgement
or his skill or on his ability to make careful enquiry, a person
takes it on himself to give information or advice to, allows his
information or advice to be passed on to another person who, as
he knows or should know, will place reliance on it, then a duty
of care will arise”.
In India the issue came before the court in CIT v. GM Dandekar
[(1952) 22 Comp.Cas 256] where the issue was brought by the
Income Tax officer holding the Auditor for negligence and
therefore liable to compensate. The court held that the Auditor
did not owe a duty of care to third parties. This decision is
perhaps against the strong arguments of making an Auditor
responsible for his functions.
The Institute of Chartered Accountancts in England and Wales
has advised its members to use a disclaimer in the certificate
restricting their responsibilites. For example, the certificate is
prepared for the private use of the company and no
responsibilities to any third party is accepted.
Guide to Companies Act, 1988
According to Ramaiya "an Auditor also owes a legal
responsibility to third parties who might have been misled by
his audit certificate and acted in reliance thereof. Under sec.28
of the Securities Exchange Act of USA, an Auditor is made
liable to third parties not only for fruad but also for negligent
misrepresentation even if it be innocent. In State Strict Trust
Co. v. Ernest [(15 N & 41)] it was held that “ A representation
certified as true to the knowledge of an accountant where there
is knowledge or a reckless mistatement or an opinion based on
grounds so flimsy as to lead to the conclusion that there was no
genuine belief to its truth, are all sufficient upon which to base
liability. A refusal to see the obvious, a failure to investigate
the doubtful, if sufficiently gross, may furnish evidence leading
to an inference of fraud so as to impose liability for losses
suffered by those who rely on the balance sheet. In Utra Meyers
Corporation v. Touche [(225 N.Y. 170)] the Court had to give
a caution by holding that it would be quite wrong to expose the
Auditor to all possible and potential liabilities “in an
indeterminate account for our indefinite time to an indeterminate
class.”
It is therefore necessary to have a balanced approach towards
Auditor’s liability towards the third party. It would be wrong to
make the institution fail under heavy responsibilities.
Standard Auditing Practices (Mandatory)
Standards on Auditing are now issued by professional bodies
(most of whom are members of the International Federation of
Accountants which issues through its International Auditing
Practices, Standards on Auditing Practice) on various aspects
of Audit with a view to furnish a theoretical consistency as a
basis for Audit which is rooted in practice. The Institute of
Chartered Accountants has made the following Auditing
Practices, which it has issued, as mandatory :-
Statement on Standard Auditing Practices
a) SAP-1 Basic Principles Governing an audit.
b) SAP-2 Objective & Scope of Audit of Final Statement.
c) SAP-3 Documentation.
d) SAP-4 Fraud and Error.
e) SAP-5 Audit Evidence.
f) SAP-6 Study and Evaluation of Accounting System.
g) SAP-7 Relying on work of Internal Auditor.
h) SAP-8 Audit planning.
6.6 PROFESSIONAL ETHICS
John L. Carey [Professional Ethics of certified Public
Accountants, American Institute of Accountants, (1956), p.3]
defines professional ethics as voluntary assumption of the
obligation of self discipline above and beyond the requirement
of law. Every profession builds up a code of professional conduct
which its members undertake to observe.
According to Carey no self-respecting professional man will
reverse or modify his professional judgement to satisfy a client
or anyone else. If the clients do not agree with the advice he
may atleast regret it, but his ethical standards would never
condone any change in his opinion to retain his client or to secure
his fee. The code of professional conduct is based upon the
principle of morality and ethics. It distinguishes the professional
men from others and ensures public confidence. Though the
corporate law does not prescribe a clear code of conduct for the
auditors, the corporate auditors are covered by the code of
conduct legislated by the Institute of Chartered Accountants of
India. The code of conduct prepared by the Institute of Chartered
Accountants of India suggested that for the success of the
profession, it is essential that it should be able to command the
respect and confidence of the general public because quite often
a professional man is placed in a position varrying his ablities
to acquire knowledge of the affairs of his client. A client, before
engaging the services of a professional man, require to be assured
: (i) that he has the required competency; and (ii) that he is a
man of character and integrity. For this reason, the Institute has
made a code of professsional conduct which is euphemistically
called professional ethics based on moral principles and quality
of practice.
6.7 PROFESSIONAL MISCONDUCT
The code of conduct has been negatively identified as
professional misconduct. The definition of professional
misconduct is given in sec. 22 of Chartered Accountants Act of
1949 as “deemed to include any act or omission specified in
any of the schedules but nothing in the section shall be construed
to limit or abridge in any way the power conferred or duty cast
on the council under sub-sec(1) of sec.21 to enquire into the
conduct of any member of the Institute under any other
circumstances”. Thus the definition is inclusive and therefore
not exhaustive. The Council of the Institute has been given the
power to enquire into the other misconduct. The Chartered
Accountants Act of 1949 has two schedules. The first schedule
contains those misconducts which are to be dealt with by the
council on the report of the disciplinary committee. The first
schedule contains three parts :
First Part :
A Chartered Accountant shall face the charge of professional
misconduct if:
(i) he allows any person to practice in his name as a chartered
accountant unless such person is also a chartered accountant
in practice and he is in partnership with or is employed by
himself;
(ii) if he pays or allows or agrees to pay or allow directly or
indirectly any share, commission or brokerage in the fees
or profits of his professional business to any person other
than a member of the institute or a partner or a retired partner
or the legal representative of a diseased partner;
(iii) he accepts or agrees to accept any part of the profits of the
professional work of a lawyer, auctioner, broker or other
agent who is not a member of the institute;
(iv) he enters into a partnership with any person other than a
chartered accountant;
(v) he secures, either through the services of a person not
qualified to be his partner or by means which are not opened
to a chartered accountant any professional business;
(vi) he solicits clients or professional work either directly or
indirectly by circular, advertisement, personal
communication or by interview or by any other means;
(vii)he advertises his professional attainments or services or uses
his designation or expression other than chartered
accountants, on professional documents like visiting cards
etc., unless it be a degree of any university;
(viii)he accepts a position as auditor previously held by another
chartered accountant without first communicating with him
in writing;
(ix) he accepts an appointment as Auditor of a company without
ascertaining it whether the requirements of secs.224 & 225
of the Companies Act, 1956 have been complied with ;
(x) he charges fees based on percentage of profit of clients
unless permitted under any of the regulations made under
the Chartered Accountant Act, 1949;
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(xi)he engages in any other business or occupation unless
permitted by the council;
(xii)he accepts a position as Auditor previously held by some
other Chartered Accoutant by under-cutting the fees ; and
(xiii)he allows a person not being a Chartered Accountant and a
partner to sign on his behalf or behalf of his firm any
financial statement.
Second Part:
The second type of misconduct is mentioned in part II of first
schedule which can be said to be committed if a Chartered
Accountant:
(i) pays or allows or agrees to pay any share in the emoluments
undertaken by him;
(ii) accepts or agrees to accept any part of fees, any profit or
gain from a lawyer, chartered accountant, or broker by way
of commission or gratification ; and
(iii) discloses confidential information of the client without the
client’s permission.
Third Part:
The misconduct under part III of the first schedule is committed
if a Chartered Accountant:
(i) includes in any statement return or a form to be submitted
to the council any particulars knowing them to be false;
(ii) style himself as a Fellow without being a Fellow; and
(iii) does not comply with the requirements asked for by the
council or of its committee
Misconduct under Part I is meant for chartered accountants in
practice where as under part II those are meant for Chartered
Accountantants not in practice. Misconduct under part III are
applicable to both whether in practice or not.
The misconduct mentioned in schedule II are to be decided by
the High Court. This schedule has two parts.
First Part:
Misconducts contained in this part are committed:
(i) if the Chartered Accountant discloses the information
acquired in the course of his professional engagement to
anyone without the consent of the client;
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(ii) if he certifies a report of an examination of financial
statement without personally examining the same or by a
partner or an employee of his firm;
(iii) if he permits his name or name of his firm to be used in
connection with an estimate of earnings contingent upon
future transactions as if he is vouching the accuracy of the
forecast;
(iv) if he expresses opinion on a financial statement of any
business in which he, his firm or a partner of his firm is
involved without disclosing the same;
(v) if he fails to disclose material fact known to him though the
disclosure is necessary to make in the financial statement
to make it not misleading;
(vi) if he fails to report a material misstatement known to him in
his professional capacity;
(vii) if he is grossly negligent in the conduct of his
professional duties;
(viii) if he fails to obtain sufficient information to warrant
expression of an opinion or his exceptions are suffienctly
material to negate the expression of an opinion;
(xi) if he fails to invite attention to any material departure from
the generally accepted procedure of audit; and
(x) if he fails to keep money of his client in a separate banking
account or to use such money for purposes for which they
are intenteded.
Second Part :
Misconduct under Part II are the following :
(i) if a Chartered Accountant contravenes any of the provisions
of the Chartered Accountants Act of 1949 or the regulations
made thereunder; and
(ii) if he is guilty of such other act or omission as may be
specified by the council.
It may be noted that misconducts under Part I are for the
Chartered Accountants in practice whereas misconducts under
Part II are meant for all chartered accountants whether in practice
or not.
7. CASE LAW
Wilde & Ors v. Cape & Dalgleish [(1897) Acct L.R. 81]
The plaintiff M/s Wilde Butchell & Butchell a firm of solicitors
claimed damages from the defendant Mr. Dalgleish who used
to carry on the profession of accounting and auditing the title
Cape, Dalgleish & Co., for negligence and breach of duty in
auditing the Books of Accounts. The Auditor did not examine
the pass books and failed to discover some of the fraudulent
transactions made by the plaintiff’s cashier who defrauded a
sum of £ 1756 s4 pI. It was held by Lord Russell that the Auditor
was liable for losses occasioned by his not fulfilling the contract
with due care.
Arantage v. Brewer & Knott [(1932)77 Acct L.R. 28]
The plaintiff filed a suit against his Chartered Acountant firm
M/s Brewer & Knott, for negligence claiming a compensation
of £ 1400 for not being able to detect defalcation of the said
amount. The Auditor could not detect the duplicate entries and
manipulations in the Wage Sheets. They had also accepted
unstamped receipts, i.e., invoices and vouchers. The defalcation
was made through duplicate entries and manipulation in the
Wage Sheets. Some of the expenditures were shown in
unstamped receipts. In defence the Auditor argued that their
responsibility under the contract was to balance the books and
prepare the final accounts for Income Tax purposes. So though
they have certified the accounts they are not required to go for
the audit work. Talbot, J in his judgement remarked that an
Auditor was required to be suspicious and he had to examine
the Books of Accounts diligently before giving the certificate,
even if it is for Income Tax purposes. Therefore, he was found
guilty of negligence and was asked to pay a compensation of
£ 1259 to the plaintiff.
Pendlebury’s Ltd v. Allis Green & Co [(1936)80 The Acct
LR 39]
The company brought an action against the Auditor of the
company claiming damages for alleged negligence and breach
of duties. It was alleged by the plaintiffs that a sum of £ 1552
was lost by them on account of negligence by the Auditor
because of :
(a) failure to properly add the total of the Cash receipt book ;
(b) failure to check and/or reconcile the daily Cash receipt book
with the general cash book;
(c) failure to check the counter foil Cash slips against the daily
Cash receipt book;
(d) failure to count at one audit the cash in hand at or about the
date of making up the books;
(e) failure to compare cash & cheque receipts as shown in the
Cash receipt book with the entries in the general Cash Book;
(f) failure to check the addition of the Wage book and to vouch
the Wage book with the general Cash book ; and
(g) failure to take any proper checks to vouch the accuracy of
the recorded cash sales.
The Auditor brought to the notice of the Directors that there
was no proper internal check with regard to the cash receipts. It
was argued on behalf of the Auditor that the Auditor was not
the accountant and therefore, not responsible for accounting
lapses. It was further argued that the Auditor was not negligent
because they had no knowledge in particular of the existence of
the cash receipt book and also they had no means of knowing,
at any time, the existence of such book. Similarly, they did not
also know the existence of the Wage book and the plaintiff had
not lost the alleged money at all. The plaintiff company was
composed of three shareholders all of whom happened to be the
sole Directors and sole Debenture-holders. In this case Swif,
J., found the Auditor not negligent because on several ocassions
the Auditors brought to the notice of the Directors the absence
of internal checks on cash receipts. While delivering his
judgment Swif.J., distinguished the position of an Auditor in a
company of three shareholders all of whom were Directors and
a company with many shareholders, say six or seven hundred.
According to him “the position of an Auditor must be different
when his duty is to vouch the information which he gives to a
large body of shareholders, as against his position when he is
criticising the affairs of the company confined to three men who
alone are interested in the company and who hold its very primary
interest. In case of the company with a large body of
shareholders, he has the responsibility of watching the Directors
in order that those outside people may be properly informed,
for they rely upon him to keep watch on their behalf; but where
the interests of a small company are confined to a very few
persons, and there are no outside people because all the interests
in the company are held by the Directors themselves, if the
Auditor has infact, reported to the Directors, what more could
he be expected to do?”
In Re The Kingston Cotton Mills Co Ltd [(1896)1 Ch.6]
The facts of the case were that the company went into liquidation
after 15 years from the date of the commencement in 1879. A
action for misfeasance was taken by the liquidator against the
Auditor of the company to recover the amounts for dividends
which, it was alleged, were paid by the company out of inflated
profits arising from more valuation of closing stock and non-
allowance for depriciation on the value of the site machinery.
The Auditor relied upon the stock sheet prepared by the manager
who for number of years deliberately exaggerated the quantities
of cotton and Yarn in the stock of the company and thus over-
valued the stock with the motive of getting higher commission
on the inflated profit. The Manager used to give every year a
certificate verifying the value of the stock. The Auditor used to
accept the certificate and indicate in the report that the stock
was as per the manager’s certificate. This was an appeal against
the decision of Williams.J. asking the Auditor to pay to the
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liquidator a sum of money equal to the amount of dividend
improperly declared and paid out of assets of the company.
Lord Lopes, J. accepting the appeal held that “It is the duty of
an Auditor or bring to bear on the work he has to perform, that
skill, care and caution which a reasonably competent, careful
and cautious Auditor would use. What is reasonable skill, care
and caution must depend on the particular circumstances of each
case. An Auditor is not bound to be a detective, or as was said,
to approach his work with suspicion or with forgone conclusion
that there is something wrong. He is a watch-dog, but not a
blood-hound. He is justified in believing tried servants of the
company in whom confidence is placed by the company. He is
entitled to assume that they are honest and to rely upon their
representation, provided he takes reasonable care. If there is
anything calculated to excite suspicion he should probe into the
bottom, but in the absence of anything of that kind, he is only
bound to be reasonably cautious and careful”. [Critically review
the case in the light of the present legal position]
In Re London General Bank Ltd[(1895)2Ch.166]
This is an appeal made by one of the Auditors of a company, Mr
Theobalt, against the judgment of William.J. holding Mr.
Theobalt and all other Directors of the company jointly and
severally liable to pay a sum of £ 14,433 with interest being the
amount of dividend declared and paid for two consecutive years.
The audit report certified by Mr. Theobalt stated inter-alia that
"the value of assets as shown by the Balance Sheet is depended
upon realisation. On this point we have reported specifically to
the Board.” In a separate report to the Directors the Auditor
suggested that “In view of the present financial state of the
company no dividend should be paid at the present moment.”
Disregarding this separate report of the Auditor to the Directors,
the Directors declared dividend out of unrealised profits.
The Auditor’s serious doubt about the realisation of part of book
debts was also brought to the notice of Directors.
While delivering the judgment Lord Lindley,J. held that “It is
no part of a Auditor’s duty to give advice either to Directors or
to Shareholders as to what they ought to do. An Auditor has
nothing to do with prudence or imprudence of making loans
with or without security ... He is not an insurer, he does not
guarantee that the books do correctly show the true position of
the company’s affairs .... He must be honest ....ie., he must not
certify what he does not believe it to be true, and he must take
reasonable care and skill before he believes that what he certifies
is true. ..... An Auditor who gives shareholders means of
information instead of information in respect of a company’s
financial position, does so at his peril, and runs the very serious
risk of being held, liable judicially for failure to discharge his
duties. The duty of an Auditor is to convey information, not to
arise inquiry .....”.
Therefore, it was held that the Auditor did not perform his duty
properly and was guilty of negligence.
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In Re City Equitable Fire Insurance Co. Ltd [(1925)68, The
Acct L.R.53]
The liquidator of a company brought an action against the
Directors and Auditors of the company. The Directors were
charged under fraud and the Auditors for misfeasance of
negligence for failure to verify the securities of the company.
The company under consideration carried re-insurance business.
Mr.Beran, the Chairman of the company, was also a senior
partner in Ellis & Co, the company’s stock brokers. The Auditors
audited the Balance Sheet of the company for three consecutive
years ending February 1919, 1920 and 1921. The Auditor did
not verify the company’s securities kept in the custody of Ellis
& Co. The following were the charges for negligence and breach
of duties:
(i) that in the Balance Sheet the debts due to the company from
Ellis & Co and Mr.Mansell, the general Manager of the
company, were misdescribed as “loans at call or short
notice” and the part of Ellis & Co’s debt was shown under
the heading “Cash at bank and in hand”;
(ii) that the sum of money due from Ellis & Co, was, in fact,
larger, at the date of each Balance Sheet, than was included;
and
(iii) that the Auditors failed to detect and report to the
shareholders that a large number of company’s Securities
kept in the custody of Ellis & Co for long was in fact pledged
by the firm to some of its customers.
In the Trial Court, Romer,J., acquitting the Auditors on all the
charges remarked, “that it is no part of the duty of the Auditor
to bring to the notice of the Directors and shareholders as to the
misdescription of the debt ... that any such misdescription does
not, in any way, involve damage to the company. Moreover there
was nothing to raise in the Auditors’ mind any doubt as to
goodness of the debt.”
While dismissing the appeal Lord Warrington,J. M.R., remarked
that “this case is important in the sense that it has arisen in the
course of liquidation of a notable insurance company with many
and considerable liabilities. The company was at one time
prosperous, and in short time it was brought to a tragic end by
the fraud of the Chairman .... It is true that if you take the three
Balance Sheets together and cast them in the form of a chart
you can see that an increasing amount of window dressing was
going on, and on the chart you will find that there is a rise of
figures which are manipulated for the purpose of window
dressing .... No such chart was available to Mr.Lepine and we
have to take the books singly which were before him ....”
[N.B. Make a critique on the decision looking to Indian legal
position in view of the following questions:
(a) Should the Auditor of the company take a Certificate from
the brokers that securities were in custody of them without
physical verification?
(b) Can the Auditor be excused on the ground of misdescription
of an asset which has not been disclosed?
(c) What is the Auditor’s liability for not being able to
understand and report the window dressing in the Balance
Sheet?]
S. Ganesan v. A.K. Joscesyne [(1957)27 Comp.Cas 114]
A shareholder of Deccan Sugar Co. Ltd addressed a complaint
to the Institute of Chartered Accountants against the Auditor of
the company. The Shareholder's plea was that in the relevant
Profit and Loss Account of the company the amount shown as
paid to the Managing Agent for the remuneration included only
the sum paid to him on a monthly basis and the sum due to him
as a percentage of profit. According to the agreement between
him and the company he was also entitled to a commission on
sales which amounted to Rs.35,400/-. But the item was not
shown as the item of expenditure in Profit and Loss Account
either separately or by including it in the selling expenses. The
selling commission paid to the managing agents was deducted
out of the gross receipts and the net amount so arrived at was
only shown as part of the gross profit.
The contract with the managing agents stipulated as follows:
“by way of remuneration for their services,
(i) an allowance of Rs. 5000/- per month; and
(ii) a commission of 10% on the annual accounts of the
company .... commission ... on account of sales of
the company’s products elsewhere than in Madras city
at or through their branches or their agencies."
The charges against the company were :
(i) The auditors failed to report to the shareholders the
misstatement in the Profit and Loss Account;
(ii) The Auditors failed to disclose the total of the amounts
paid to the managing agents;
(iii) The Auditor misled the shareholders by not reporting
to them the non-disclosure of the total remuneration
of the managing agents; and
(iv) The Auditor was negligent and had the desire to
accomodate the managing agents to conceal the
payment of the commission.
The fourth charge was subsequently withdrawn. It was held
that the professional misconduct on the part of a person
exercising one of the technical professions cannot fairly or
reasonably be found, merely on the finding of a mere non-
performance of a duty or some default in performing it. The
test must always be whether in addition to the failure to do the
duty, partial or entire, which had happened, there had also been
failure to act honestly and reasonably. In this case though it
was found that the Auditor did not act with reasonable care but
the judge was unable to hold the Auditor liable for gross
negligence because he was charged under the item (q) of the
Schedule I of the Chartered Accountants Act of 1949. Since the
charge of acting with a desire to accomodate the managing
agent was withdrawn, the Court could not go into the question
though the disciplinary committee found the Auditor offending
against clauses (o) and (p) of the Schedule, as well.
Caparo Industries Ltd., v. Dickman & Others [(1990) BBC
164]
Affirming the decision of the Court of Appeal, reported at (1989)
5 BCC 823, it was held that auditors owe a duty of care to existing
members of the company but not to potential investors in the
company. They owe a duty of care to the members because
they are under a statutory obligation to report to them and
because the members have a corresponding statutory entitlement
to receive their reports. Auditors of a public company’s accounts
owe no duty of care to members of the public at large who rely
upon the accounts in deciding to buy shares in the company.
Al. Saudi Banque v. Clark [(1989) 5 BCC 823]
Approved by the House of Lords in Caparo Industries case . the
question for decision was whether, in examining the accounts
of a company and reporting thereon to its members, the
company’s auditors owe a duty of care to lending banks, whether
known and existing or unknown and potential creditors of the
company, which they know or ought to foresee may rely on those
accounts and their reports when considering whether to continue,
renew or increase existing facilities or to grant new facilities to
the company. Millet, J. held that the auditors did make their
reports to the plaintiff banks or to the company with the intention
or in the knowledge that they would be supplied to the banks.
The banks had no close or direct relationship with the auditors,
the element of proximity was lacking, and no duty of care was
owed to them.
James McNaughton Paper Group Ltd., v. Hicks Anderson
& Co., [(1190) BCC 891 (CA)]
The Court of Appeal applied the Caparo principle and held that
the existence of a duty of care had not been made out. One of
the three learned judges said:
“At the time of the hearing before His Honour Judge Lipfriend
the hearing by the House of Lords of the appeal in Caparo
Industries Ltd. v. Dickman [ (1990) BCC 164] had not taken
place and the speeches had not been delivered, let alone reported.
If the judge had the advantage of reading the speeches of the
Law Lords in the case, I think it is highly improbable that he
would have reached the conclusion that a duty of care extended
on the facts of the present case. The case decided that in general
there was no reason in policy or principle why the auditors of a
company should be deemed to have a special relationship (giving
rise to a duty of care) with non-shareholders contemplating
investment in the company in reliance of the published accounts.
It also decided that such a duty of care did not even extend to
the shareholders in the company when they relied on the
accounts, not so as to exercise their class rights in general
meeting, but to make decisions as to future investment in the
company.”
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Lloyd Cheyham & Co., [(1987) BCLC 303]
This case proceeded on a different track, in that the court held
that the auditors did owe the plaintiffs a duty of care as the
defendants (auditors) knew that the accounts were going to be
relied on by the plaintiffs; however, on the facts there had been
no breach of that duty. This was a case of take over which was
based on the company’s audited accounts which the auditors of
the company knew.
Al-Nakib Investments (Jersey) Ltd., v. Longcoff [(1990) BCC
517 (Ch D)]
On the question whether auditors owe a duty of care to an
investor who purchases a company’s shares in the market but
bases his purchases on a prospectus which had been issued
earlier, the court held that the defendant did because there was
not the necessary proximity, in that the prospectus having been
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addressed to the first plaintiff for a particular purpose,
considering the rights issue, was used by the plaintiffs for another
purpose namely buying shares in the market.
Morgan Crucible Co., Ltd. v. Hill Samuel & C., Ltd., [(1990)
BCC 686]
The takeover bidder lost the claim for damages, inter alia, against
the auditors alleging that certain pre-bid financial statements
and a profit forecast were misleading. Dismissing the plaintiff’s
claim, the court held that the purpose of the documents was to
advise the shareholders as to whether or not to accept the bid
and there was nothing to suggest that they were meant for the
guidance of the bidder and no justification for extending a duty
of care to a person relying on them for another purpose. The
fact that in a contested bid, the interest of the bidder and of the
shareholders were in conflict was a strong reason for denying a
duty of care.
8. SUPPLEMENTARY READINGS
1. Companies Act, 1956, secs. 205-208; 209-223; 224-233B, Schedule VI; XIV.
2. A. Ramaiya, Guide to the Companies Act, Wadhwa and company, Nagpur, (respective sections and Schedules as mentioned
in the text)
3. N.D. Kapoor, Company Law, Sultan Chand & Co.
4. Publication of the Institute of Chartered Accountants of India.
5. Kamal Gupta, Contemporary Auditing, Tata McGraw-Hill Publishing Co Ltd, (Ch.13,14)
6. S.V. Ghatalia (ed), Spicer and Pegler’s Practical Auditing, Allied Publishers Pvt. Ltd (Ch.XIII)
(a) Compendium of Guidance notes
(b) Compendium of Opinion
(c) Accounting and Auditing Standards
(d) Standard Auditing Practices
(e) Code of Conduct
(f) Professional Ethics
7. S.M. Shah, Lectures on Company Law, Tripathi (Ch.XIV)

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9. PROBLEMS
Solve the following problems and send the answers to the
Course Coordinator
1. Mr. Dasgupta FCA was appointed as an Auditor by Aryan
Bank Ltd to audit for the years 1990, 1991, 1992. The
Bank subsequently went into liquidation. The Audit report
had been in the usual form with some special notes contained
therein. The Auditor did not personally verify the cash in
hand. One of the audit reports contained some information
of omission, e.g., in the 1991 audit report it was mentioned
on the remark that “all the loans and overdrafts of branches
are shown in the Balance Sheet as fully secured." But a
note was specified in the description of the asset 'Loan or
Overdraft’ specifying that “these have been granted to eight
parties against the fixed deposit receipts of debtors.” The
Auditor did not enquire about the identity of these debtors.
A few criminal proceedings have been brought against the
Managing Director and other Directors for falsification of
the Books of Accounts of the Bank. Mr. Dasgupta was
produced as one of the prosecution witnesses where he
observed against some of the enquires on those audit reports
that he had doubts about some of the loans and overdrafts.
He did not examine the identity of the parties to whom the
loans were granted and he did not know that some of those
parties were non-existent. Due to the enormity of cash in
hand as shown, he did not verify the same.
The Deputy Secretary of the Department of Economic
Affairs, Government of India filed a formal complaint to
the Institute of Chartered Accountant of India against the
Auditor. The disciplinary committee examined the whole
affair and found that:
(i) the Auditor failed to verify the cash in hand ;
(ii) though according to him some loans and overdrafts were
doubtful about recovery, he did not specifically mention
then ; and
(iii) he did not examine the identity of the parties to whom loans
were granted and adequacies of the security there on.
The Institute referred the matter to the High Court. Give
your decision as the Presiding Judge.
2. Mrs. Singhania, the proprietor of B.B. Woollen Mills leased
out the mill to J.K. Woollen Manufacturers which was
originally a partnership concern but subsequently converted
into a Private Limited Company. The terms and conditions
of the lease included that Mrs.Singhania was to get a 57.2%
of the net profit which the lease would earn subject to the
minimum rent of Rs.25,000/- per annum. The Books of
Accounts of the company were audited by M/s P.L. Tandon.
Mrs. Singhania filed an application to the High Court against
the Chartered Accountant Firm, and the Auditor of the
company alleging negligence on account of the following:
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(i) Payment of higher salary to the Manager :
A Manager with no technical qualification was appointed
and he had some relation with one of the Directors. A very
high salary of Rs.1,00,000/- per month was given to him
and the Auditor did not give any comment on it;
(ii) Payment of exessive remuneration to Directors :
The Directors both of whom were the only members of the
Private Ltd Co fixed very high sitting charges, allowances
and entertainment expenses;
(iii) Gratuity was paid to the widow of the deceased Accounts
officer of the company and the gratuity amount as fixed by
the Board of Directors was Rs.5,00,000/-; and
(iv) A contribution of Rs.5,00,000/- was made by the company
to Mahatma Gandhi Memorial Fund.
According to Mrs. Singhania, the Auditor was negligent in not
pointing out these excessive expenditure so as to find out
real profit of the company in which case her lease rent would
have been much higher. Prepare a list of arguments for
defending the case.
3. What do you mean by window dressing ? Critically examine
the liability of an Auditor for failure to discover the window
dressing.
4. Mr. Banerjee audited the Books of Accounts of Arthur &
Green Ltd from 1980 to 1990. Over the period worthless
debt to the value of Rs. 1,90,000/- accumulated. Some of
the debts had been outstanding for a number of years and a
big proportion was actually statute barred and therefore
should have been regarded as irrecoverable. The Auditor
accepted the figures supplied by the Managing Director and
the Board as to the amounts to be written-off for bad and
doubtful debts each year. The Managing Director had
explained his reason for allowing the old debts to remain
on the books by saying that in money-lending business it
did not matter how old the debts were, because people would
come back and pay in order to be able to obtain further
advances. In 1990 the company went into liquidation and
the liquidator proceeded against the Auditors and Board of
Directors on the ground of breach of duty and misfeasance.
Decide, Give reasons and cite the precedent if any
5. Royal Mail Co Ltd which was a non-banking financial
institution created a huge secret reserve during the seventies.
But during the eighties it started incurring actual trading
loss. But their published accounts used to show regularly
considerable profits available for dividends. This position
was largely brought about by a credit given in the Profit
and Loss Account showing ‘taxation reserves earlier created
no longer required’. A shareholder wanted to challenge
the decision of the Board in recommending the dividend in
1985. You are required to prepare a list of arguments on
behalf of the shareholder. [ Refer to Rex v. Lelson &
 Moreland [(1931) Acct P.109] or as reproduced in Spicer
& Pegler’s Practical Auditing, edited by S.V. Ghatalia,
Allied Publishers Pvt Ltd.]
6. The Registrar of Companies made an inquiry about the
affairs of Rural Bank of India Ltd and found the following,
based upon which he made a complaint against the Auditor
of the company that the Auditor was guilty of professional
misconduct :
(i) The actual cash in hand was far short of the amount stated
in the Balance Sheet. The Auditor admitted in the inquiry
that even though he certified that the cash and securities
have been verified by him he did not in fact do so. He
stated that he verified the cash in hand on several dates, he
visited the bank for audit, in each of the years, but those
dates were later than the dates of the Balance Sheet
concerned. He admitted that he had not verified the
intermediate transaction between the dates of the Balance
Sheets and the dates on which he actually checked the cash;
(ii) The money received from applicants for shares were not
deposited and kept in a Scheduled Bank. The Auditor failed
to report this to the shareholders. This was admitted before
the Court in a case filed against the company on the
contravention of relevant provisions of the Companies Act.
Of course the Managing Director explained that the
Scheduled Bank was hundred miles away and that it could
[Note: Please specify your name, ID number and address while sending answer papers].
be reached only by bus and that within a week the certificate
to commence business would be obtained; and
(iii) Imaginary deposits were created in the Books of Best
Security Trust Ltd, one of the shareholders, for the
purchase of shares of the bank though the Managing Director
admitted that cash was not actually received from the share
applicants. It was also not disputed that the bank had on
several occassions debited to the accounts of certain
persons’ loans which were bogus. The Auditor failed to
make proper enquiries regarding the financial position of
Best Security Trust Ltd with a view to satisfy himself as
to its capacity for making large investments and verifying
whether the fixed deposit receipts of the company held as
security of the bank were worth their face value and were
sufficient to cover their loans.
(a) Do you think that the Auditor is guilty of professional
misconduct?
(b) If so, explain why?
(c) What appropriate punishment may be imposed upon
the Auditor for such professional misconduct ?
(d) Is the Auditor also negligent ?
(e) Who deals with the question of such professional
misconduct?
[Refer to In Re. P.M. Hedge [(1954)24 Comp.Cas 453]
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 Master in Business Laws

Corporate Law

Course No: III

Module No: IX

Winding up and Alternative Devices

Distance Education Department

National Law School of India University

(Sponsored by the Bar Council of India and Established
by Karnataka Act 22 of 1986)
Nagarbhavi, Bangalore - 560 072
Phone: 23211010 Fax: 23217858
E-mail: mbl@nls.ac.in

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Materials prepared by:
Ms. Sudha Peri
Prof. N.L. Mitra
Materials checked by:
Ms. Archana Kaul
Materials edited by:
Prof. T. Devidas

© National Law School of India University

Published by:
Distance Education Department
National Law School of India University,
Post Bag No: 7201
Nagarbhavi, Bangalore, 560 072.

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 INSTRUCTIONS
You must have by now understood in detail various stages in corporate character and management.
At every stage you have to refer to the bare statute, i.e.. the Companies Act, 1956 amended up-to-
date. The Act has been amended several dozens times. So you must have purchased the latest form
of the Act. It is always advisable to keep the text of the Act by the side when you read a module on
Company law. Though it is true that the text of the Act is complicated but if you try to read the
same with the help of the reading materials you will be able to understand it properly. In case you
have any difficulty kindly write to us immediately so that we can solve your problem.
This module refers to winding up. One of the present day observation of multinational firm is that
'exit' is a very difficult, time-consuming and costly affair in this country. 'Going in' and 'going out'
both are difficult processes. Any empirical study will show you that winding up procedure of a
company goes on for over 8 to 10 years. As such, cost involved in the procedure of winding up is
really enormous. Besides, though under the Corporate law a company may go for voluntary winding
up simply by a special resolution, labour law poses certain obstacles. All these problems are
discussed with reference to judicial interpretation. What you have to do is to read the module with
a critical mind. Do please keep the Bare Act always with you while reading this module.
'Liquidator' is an office specially designed to see the Company finally wound up and dissolved.
But in India we do not have any specialised agency discharging this function. Lawyers operate
as this functionary even when they do not have any formal training and competence. So try to
understand the responsibility of this office and the special professional skills that are needed for
the job. An Official Liquidator is the Officer appointed by the High Court who may be appointed
by the Company as its liquidator, as well. In compulsory winding up by the Court, the Court
appoints Official Liquidator for the job. You have to understand clearly his rights and duties.
Carefully go through the module and refer to us if you have any questions.

N. L. Mitra
Course Co-ordinator

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 Winding up and Alternative Devices

TOPICS

1. Introduction .................................................................................................................... 372

2. Winding Up by Court ................................................................................................... 374

3. Voluntary Winding Up ................................................................................................... 385

4. Winding Up and the Supervision of the Court ........................................................... 390

5. Some other Forms of Winding up ................................................................................. 391

6. Conduct of Winding up .................................................................................................. 394

7. Liquidators ..................................................................................................................... 399

8. Conclusion ....................................................................................................................... 402

9 Sick Industrial companies (Special Provision) Act 1985 ............................................. 405

10. Case Law ......................................................................................................................... 408

11. Problems ......................................................................................................................... 411

12. Supplimentary Readings ............................................................................................... 412

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1. INTRODUCTION
Article 19(1)(g) of the Constitution embodies the right of
a person to carry on any business of his choice in the
following words:
“All citizens shall have the right to practice any profession,
or to carry on any occupation, trade or business.”
Naturally enough a right which has been given to a citizen
is also available to a group of citizens coming together
with an intention of doing business either in the form of
a partnership or a Company. This right to carry on business
incorporates within it the ‘right not to carry on a business’
i.e., just as a person cannot be prevented from carrying
on business so also he cannot be compelled to do a
business. An important question which arises in this regard
is that, if a businessman wants to close his business does
he have the right to do so? In normal circumstances,
there is no problem especially when the business in question
is a ‘family concern`. The trouble arises when the business
in question is a large one - say an industry or a Company
employing a number of people. In such situations, closure
of business may adversely affect the interests of the
employees who depend on the Company for their
livelihood. Or it may adversly affect the society in general
by shrinking the market. So does it mean that owners/
managers of a large business concern should be prohibited/
prevented from closing their business ? If yes, then would
it not be infringing the guarantee given to them under
Article 19(1)(g) that they have the right not to do business
if they so chose ? A very difficult question to answer
certainly, and one where you cannot have an absolutely
black and white answer. One has to take into consideration
the various interests involved, balance them with the
surrounding circumstances, see which option would serve
the best interest of all concerned and then arrive at a
conclusion.
Some of these questions were raised and answered by the
Supreme Court in Excel Wear v. Union of India [AIR
1979 SC 25]. Excel Wear, a registered partnership firm
had a garments factory in Bombay employing about 400
people. After 1974, the relations between the management
and the employees started becoming extremely strained,
resulting in labour trouble of unprecedented nature,
compounded by the fact that the factory was running at
a loss. In 1977, finding it impossible to carry on the
business Excel Wear decided to go in for ‘closure’ of
business and served a notice to the Maharashtra
Government seeking its permission for closure. The said
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permission was refused. Excel Wear approached the
Supreme Court by an appeal against the State Government
order. Two very important questions amongst others raised
for consideration were: Is the right to close down a
business a fundamental right? And secondly, can there
be a reasonable restriction upon the fundamental right to
close down a business? These questions were respectively
answered by the Supreme Court in the following words:
“It is not quite correct to say that a right to close down
a business can be equated or placed at par or as high
as the right not to carry on business at all. The extreme
proposition urged on behalf of the employers by equating
the two rights and placing them at par is not quite apposite
and sound. Equally so, or rather more emphatically, we
do reject the extreme contention put forward on behalf
of the Labour Unions that right to close down a business
is not an integral part of the right to carry on business,
but is a right appurtenant to the ownership of property
or that it is not a fundamental right at all. It is wrong
to say that an employer has no right to close down
a business once he starts it. If he has, it cannot but
be a fundamental right embedded in the right to carry
on any business guaranteed under Article 19(1)(g) of
the Constitution.” It further said: “we now proceed to
examine whether the restriction imposed under the
impugned law are reasonable within the meaning of Article
19(6). This is undoubtedly on the footing, as held by
us above, that the right to close down a business is an
integral part of the right to carry on business. But as
no right is absolute in its scope, so is the nature of this
right. It can certainly be restricted, regulated or controlled
by law in the interest of general public.”
This view point of the Supreme Court has been consistently
followed through the years in a number of cases. Thus,
a Company which starts business can also go out of it,
the only problem being that just as a Company cannot
be born automatically i.e., without effort, it cannot go out
of business easily. Just as certain technicalities have to
be followed for incorporation, so also for closure a
procedure has to be followed. The closure procedure of
a Company is known as winding up and this procedure
may sometimes take as long as thirty to forty years. Its
only at the end of the process that the Company can finally
down its shutters and stand dissolved.
The following flow chart shows the various ways in which a
Company may reach its end.
 END OF A COMPANY

By Winding up By Dissolution
(S 425)

Under Compulsory Voluntary Applicable only to

Supervision
of the Court
(S 522)

By Court Defunct Unregistered

(Sec.433) Companies Companies
Members Creditors
(S 490-498) (S 500-509)

Special Non-delivery Non-commencement Reduction Commercial Just and

resolution of statutory of business of members insolvency equitable
passed report

In the following pages we will deal with each of these modes in
detail.
At this stage it is perhaps necessary to understand the concept
of 'winding up'. Though in corporate law 'winding up' has a very
significant place, the term is not defined in the law. An author
has defined winding up as "a means by which the dissolution of
a Company is brought about and its assets are realised and
applied in payment of its debts, and after satisfaction of the
debts, the balance, if any, is paid back to the members in
proportion to the contribution made by them to the capital of
the Company" (Ramaiya, p. 2338). Winding up is therefore a
procedure through which the Company can be brought to an
end. Liquidation is also a procedure through which the Company
comes to an end. In liquidation procedure all assets, tangible
and intangible are sold for cash (liquidated) and the liabilities
and claims are also settled in cash. Thus liquidation is included
in a winding up procedure. But winding up is a bigger concept
than liquidation. In winding up the Company may continue to
function in the sense that (1) the Company may enter into fresh
contracts in order to perform old contracts; (2) it may fulfill the
obligations arising from old contracts; (3) gradually set out assets
and inventories (4) gradually pay off the debts on the basis of
priorities and (5) settle the accounts of the shareholders if some
surplus is available. Once all these functions are done, the
Company comes to an end. So winding up, liquidation and
dissolution are all related concepts.

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2. COMPULSORY WINDING UP BY COURT
Sub Topics
2.1. Introduction
2.2. Grounds for winding up
2.3. Petitioners for winding up
2.4. Procedure for winding up
2.5. Consequences of a winding up order
2.6. Dissolution of Company
2.7. Conclusion
2.1 INTRODUCTION
As seen earlier, winding up is the process by which the
dissolution of a Company is brought about, its assets realized
and applied in satisfaction of its debts, and any balance amount
remaining after such satisfaction is paid to the members in
proportion to their holding in the Company. The winding up by
Courts may be either compulsory [i.e., when the Company is
woundup whether the management/members want it or not] or
voluntary [i.e., on request of the members/creditors of the
Company] Sec.433 of the Companies Act, deals with the
compulsory winding up of a Company by the Court, and states
that :
S.433 Circumstances in which Company may be wound up
by Court - A Company may be wound up by Court-
(a) If the Company has, by special resolution, resolved that the
Company may be wound up by the Court;
(b) If a default is made in delivering the statutory report to the
Registrar or in holding the statutory meeting ;
(c) If the Company does not commence its business within a
year from its incorporation, or suspends its business for a
whole year ;
(d) If the number of members is reduced, in the case of a public
Company, below seven, and in case of a private Company,
below two;
(e) If the Company is unable to pay its debts;
(f) If the Court is of the opinion that it is just and equitable that
the Company should be wound up.
We would now deal with each of these grounds in detail.
2.2 GROUNDS FOR WINDING UP
Sec.433 itself mentions six grounds on which the Court may
wind up a Company. These grounds are as follows :
1. Special Resolution
A Company may by special resolution [i.e., a resolution
supported by a three fourth majority of shareholders present
and entitled to vote at the meeting] resolve or decide to be
wound up by the Court. The Court is, not however, bound to
order the winding up, merely because the Company so resolves.
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The power of the Court under this section is purely discretionary,
and, the Court may not exercise its power if in its opinion, the
winding up would be opposed to the public or Company’s
interest. This ground for winding up is seldom availed of,
because when the Company itself wants to be wound up it would
go in for voluntary winding up.
2. Default in holding statutory meeting
Every Company limited by shares or having a share capital is
required under Sec.165(1), to hold a general meeting of the
members of the Company, called as “statutory meeting”, within
a period of not less than one month, but not more than six months
from the date at which the Company is entitled to commence
business. In order to hold this `statutory meeting’, a minimum
of twenty one day’s notice must be given to the members, and,
the Board of Directors are also required to forward to them a
report called as “statutory report”, setting out the particulars
specified in Sec. 165(3) and certified as being `correct’ by not
less than two directors of the Company (one of them being the
managing director where such an office exists). The Auditors
of the Company are also required to certify those portions of
the report which deal with the accounts. Explaining the
significance of “statutory report” and “statutory meeting” Palmer
observes [Palmer, pp. 455-456]:
‘The obvious purpose of a statutory meeting with its preliminary
reports is to put the shareholders of the Company in possession
of all the important facts relating to the new Company, what
shares have been taken up, what money received, what contracts
entered into, what sums spent on preliminary expenses, etc.
Furnished with these particulars the shareholders are to have an
opportunity of meeting and discussing the whole situation, the
management methods and prospects of the Company.’
The Board has to file a copy of this report with the Registrar.
Keeping in mind the importance of both the ‘statutory report
and meeting’, failure to submit the report or hold the meeting
has been made one of the grounds for winding up by the Court,
though in practice it is very rarely used.
3. Non commencement of business
Sec. 149 of the Act provides that, where a Company having a
share capital has issued a prospectus inviting the public to
subscribe for its shares it shall not commence any business or
exercise any borrowing powers, unless (a) shares held subject
to the payment of the whole amount thereof in cash have been
allotted to an amount not less in the whole than the minimum
subscription; (b) every Director of the Company has paid to
the Company, on each of the shares taken or contracted to be
taken by him and for which he is liable to pay in cash, a
proportion equal to the proportion payable on application and
allotment on the shares offered for public subscription; (c) no
money is, or may become liable to be repaid to applicants for
any shares or debentures which have been offered for public
subscription by reason of any failure to apply for, or to obtain
permission for the shares or debentures to be dealt in on any
recognized stock exchange, and (d) there has been filed with
the Registrar a duly verified declaration by one of the Directors
or the Secretary in the prescribed form, that the above clauses
have been complied with.
On the filing of the declaration, the Registrar issues a certificate
of ‘commencement of business’, and this certificate shall be
conclusive evidence that the Company is so entitled to
commence business from the date mentioned in the certificate
[Sec.149(3)]. This provision does not apply to private companies
which do not invite public to subscribe for its shares.
If a Company does not commence business within a year from
its incorporation or has suspended business for a whole year, it
may be ordered by the Court to be woundup, if the Court is of
the opinion that, there is a fair indication that there is no intention
on the part of the Company to commence or resume business.
If the suspension or non commencement is satisfactorily
accounted for and appears to be due to temporary causes, the
Court may refuse to issue an order of winding up. For example,
in Murlidhar v. Bengal Steamship Co. [AIR 1920 Cal. 722],
a Company employed a steamer and two flats for the purposes
of its business. The flats were acquired by the Government
during the first world war and the Company was not able to
replace them immediately in view of rise in prices. This resulted
in suspension of business for more than a year. In a petition for
winding up the Company, the Court held that, “the suspension
of business for a whole year is sufficiently accounted for and
does not furnish an indication that there is no intention to carry
on the business”. The petition was accordingly dismissed. In
Registrar of Companies v. Bihar Wire & Wire Products [45
Comp.cas 194], the position has been summarized as follows :
(1) The mere fact that business has not been commend within a
year or that business has been suspended for a whole year
or more, by itself is not a ground for a Court to order winding
up, although they give the jurisdiction to the Court to do so;
(2) It has to be found out whether the non-commencement or
suspension of business was for some good reason accounted
for;
(3) The mere fact of non-commencement or suspension of
business is no evidence which indicates that the Company
has no intention of carrying on business or is not likely to
do so;
(4) The decisive question is whether there is a reasonable hope
of the Company commencing or resuming business and
doing it at a profit, and whether the substratum of the
Company has disappeared [Ramaiya, p.2353].
4. Reduction of members
If the number of members within a Company is reduced below
the required ‘statutory minimum’ i.e., below two members in
case of private company and seven members in case of a public
Company, the Court may order the Company to be wound up.
This ground is meant as a protection to the members of the
Company whose membership has fallen below the statutory
minimum from incurring a personal liability, which they would
otherwise incur under Sec. 45.
5. Inability to pay debts
This is the most common ground for winding up. A Company
is liable to be wound up when it is unable to pay its debts.
“Debts” means `debt absolutely due’ - that is, debts for which a
debtor could go to Court and demand payment, or per
Lindley,L.J., “.....a debt is a sum of money which is now payable
or will become payable in the future by reason of present
obligation [Webb v. Stenton, (1883)11 QBD 518 CA]. In
Registrar of Companies v. Kavita Benefit Pvt.Ltd. [48
Comp.Cas.231] Mehta J., held that, `in order to bring the case
within clause (e) the Court must be satisfied, in the first instance,
that there are in fact, debts in the sense that there is a liability of
the Company in presenti’. The Court also rejected as too broad
a submission the contention that the liabilities which may
crystallize in future would also be relevant for the purpose of
determining whether the Company is unable to pay its debts.
The word debt cannot be extended to include unliquidated
damages or an unidentified sum incapable of ascertainment
immediately; it must be a definite and ascertained sum. Evidence
of inability to pay debts is given by serving notice under sec.
434, and, on non payment, after expiry of 3 weeks a presumption
of inability to pay debts arises and the Company is deemed by
law, to be unable to pay its debts. Where a debt is not disputed
it is futile for the Company to say, “we are able to pay our debts
but we do not choose to pay this particular debt.” The Court
will not listen to such a defence (Sen, p.247).
Section 434 enacts that a Company shall be deemed to be unable
to pay its debts-
(1) (a) if a creditor, by assignment or otherwise, to whom the
Company is indebted in a sum exceeding five hundred
rupees then due, has served on the Company by
causing it to be delivered at its registered office, by
registered post or otherwise, a demand under his hand
requiring the Company to pay the sum so due and the
Company has for three weeks there after neglected to
pay the sum, or to secure or compound for it to the
reasonable satisfaction of the creditor;
(b) if execution or other process issued on a decree or
order of any Court in favour of a creditor of a
Company is returned unsatisfied in whole or in part;
or
(c) if it is proved to the satisfaction of the Court that the
Company is unable to pay its debts, and, in
determining whether a Company is unable to pay its
debts, the Court shall take into account the contingent
and prospective liabilities of the Company.
(2) The demand referred to in clause (a) of sub-section
(1) shall be deemed to have been duly given under
the hand of the creditor if it is signed by any agent or
legal adviser duly authorized on his behalf, or in the
case of a firm, if it is signed by any such agent or
legal adviser or by any member of the firm.
We will now take each of these clauses of Sub-sec(1).
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(a) Statutory notice
Firstly, if a creditor to whom the Company owes a sum exceeding
Rs.500, serves a notice on the Company demanding payment,
and the Company neglects to pay or otherwise satisfy him then,
such a creditor can approach the Court for an order of winding
up. The debt must be really due and presently payable. If there
is a bonafide and reasonable dispute as to a substantial part of
the debt on which the petition is based, winding up will be
refused, because, “when a debtor Company believes even
wrongly that it is justified in law to refuse to pay, such a refusal
cannot be regarded as neglect to pay “[British India Banking
Corpn. v. Sylhet Commercial Bank, AIR 1949 Ass. 45]”.
Where the object of a petition to wind up a Company is to bring
pressure upon the Company in order to make it pay the petitioner
cheaply and expeditiously, when the Company desires to dispute
the debt in the civil Court, the petition is an abuse of the process
of the Court and is liable to be dismissed” [P.Satyarazu v.
Guntur Cotton Jute and Paper Mills, AIR 1925 Mad. 199].
Thus, in re British India General Insurance Co. [AIR 1971
Bom. 102], an insured cricket match had to be abondoned on
account of rains. The insurance Company appointed a surveyor
to determine whether this type of loss was covered by the terms
of the policy. It was held that, it could not be said that the
Company had neglected to pay. But, where the dispute is not
real but is imaginary, and has been put forward by the Company
as a cloak to hide its inability to pay its debts, the application
for winding up would be allowed. Thus, in Vanaspati Industries
Ltd. v. Firm Prabhu Dayal [AIR 1950 EP 142], the petitioner
claimed to be a creditor of the defendant Company. The
Company never disputed that the amount claimed was wrong.
They only said that they had some kind of a counter claim, which
the Court found to be of a highly nebulous character. All they
said was that the accounts required scrutiny, and that the
petitioner was not presently entitled to the sum claimed, but the
why was not clearly stated. The Court, therefore held that, there
was no bonafide dispute with regard to the sum due.
The effect of a notice under section 434 is to raise a presumption
under the statute as to the inability of the Company to pay the
debt and its consequent insolvency, rendering the Company
liable to the extreme penalty of losing its very existence and
being compulsorily wound up by the Court. The statutory notice,
therefore, has to be construed strictly and it must comply with
all the requirements of the statute in totality. Thus, if the amount
due is incorrectly stated in the notice, the petition would fail
[Ofu Lynx Ltd. v. Simon Carves India Ltd., (1971) 41 Comp.
Cas, 174] Even after the requirements of the notice are complied
with, the power of the Court to order winding up is discretionary.
In the words of Ray,J. in M.Gordhandas & Co. v. Madhu
Woolen Industries (P) Ltd. [AIR 1971 SC 2600]: “The wishes
of the creditor will be tested on the ground whether the case of
the persons opposing the winding up is reasonable; secondly,
whether there are matters which should be inquired into and
investigated if a winding up order is made. It is also well settled
that a winding up order is made on a creditor’s petition if it
would not benefit him or the Company’s creditors generally”.
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This right of the creditor is not an individual right, but a
‘representative right’ as one of a class. If majority of the creditors
of like degree, take a different view, the Court, in the absence at
all events of special circumstances making an order “just and
equitable”, gives effect to such right as the majority desire to
exercise.
(b) Decreed debt
Secondly, a Company is deemed as being unable to pay its debts
if execution or other process issued on a decree or order of any
Court in favour of a creditor of the Company is returned,
unsatisfied in whole or in part. Then, such a creditor can file a
petition for winding up. It is not necessary for the decree-holder
to proceed under this provision, but may serve a statutory
demand under sec. 434(1)(a). There is no mutually exclusive
dichotomy between clauses (a) and (b).
A decree is a nullity if it has been passed without jurisdiction,
or obtained by fraud or collusion, or is tainted with illegality, or
offends a public statute. A consent decree also stands on the
same footing as a decree on contract, and if the contract is
founded on the incapacity of the party to the contract, the decree
may be set aside on the same grounds as the contract. Once the
decree is found to be a nullity, no plea of waiver, estoppel or
acquiescence avails the decree holder, nor it is necessary to file
a suit to impeach such a decree and the decree can be attacked
in collateral proceedings in which reliance is placed on such a
decree. If the decree is impeached on any of these grounds, the
Company will not fall within the mischief of this presumption.
But the dispute must be a bonafide dispute, i.e., it is not enough
that the Company has filed a suit for declaration that the decree
was obtained by fraud and is a nullity [Goyle, p.17]. For
example, in re Steel Equipment & Construction Co. [(1968)38
Comp. Cas 82 Cal.], a Company having been sued on a debt,
agreed to a consent decree but failed to satisfy it. In a winding
up petition presented on that ground, the Company claimed that
the debt comprised in the decree was ultra vires and had already
filed a suit to set aside the decree. The Calcutta High Court
held that, “the petition shall be adjourned till the disposal of the
suit”.
(c) Commercial insolvency
Lastly, if it is proved to the Court that the Company is unable to
pay its debts, it may order the Company to be wound up. of a
winding up under this ground, it should be shown that the
Company is “plainly and commercially insolvent that is to say,
that its assets are such and the existing liabilities are such as to
make it reasonably certain to make the Court fully satisfied that
the e existing and probable assets would be insufficient to meet
the existing liabilities” [per Sir William Jones V.C. in re Europe
Iife Insurance Society, 1869, 9 Equity, 122]. What has to be
ascertained is not whether, the assets of the Company converted
into cash would be sufficient to discharge the liabilities of the
Company, but whether, in a commercial sense the Company is
solvent, i.e., a perusal of the balance sheet of the Company must
show that its assets are sufficient to meet its liabilities. Thus, in
Sree Shanmugar Mills v. Dharmaraj Nadar [AIR 1970 Mad.
203], a Company resisted a winding up petition on the ground
that while its liabilities amounted to only Rs. 8,72,414 its assets
were of the value of Rs.10,79,130. It was found that these assets
included building and machinery, excluding which any a sum of
Rs.3,00,000 would be available to discharge the debts. The
Court held that, “the value of such assets without which the
Company could not carry on its business, should not be taken
into account. The proper test is whether in a commercial sense
the existing liability would be paid by it while it continued to
carry on as a Company. However, the Company is entitled to
regard its uncalled capital as money available for the discharge
of its debts”. Moreover, “where at the relevant time there is
reasonable hope of tiding over the difficulty and emerging into
a region in which the Company might be reasonably expected
to carry on at a profit”, it may not be ordered to be wound up on
this ground[Sudhiya v. Bihar National Insurance Co., AIR
1941 Pat 603]. Even where assets are less than liabilities, it
does not necessarily follow that the Company is insolvent. For
example, in Registrar of Companies v. Janta Lucky Scheme
& Investment Co. [(1973) 43 Comp. Cas. 314 (P&H)], the
Company was not only able to, but also met its claims as and
when they arose; winding up was not allowed although its assets
were only worth Rs.6 lakhs and its liabilities amounted to Rs.8.5
lakhs. The Court may further refuse to order winding up if it
feels that such an order would be against public interest. Thus,
in Bhalchandra Dharmajee Makaji v. Alcock, Ashdown &
Co. ltd. [(1972)42 Comp. cas 190 (Bom.)], a Company’s
business came to a standstill owing to paucity of working capital.
The Court explained the extent to which public interest has
entered into the management of companies, and, thought it
improper to destroy a Company which had worked for nearly
87 years and had acquired experience and expertise in the
manufacture of structurals, boat building and ship repairing, and
held that the best order to make is to appoint a Special Officer
to collect, realize, preserve and maintain the assets of the
Company and also to make the necessary investigations.
Section 434 thus splits the concept of inability to pay debts under
three sub-headings. But this does not mean that these clauses
are mutually exclusive. Thus, even if a creditor has obtained a
decree, he can claim winding up under any of the other grounds
and he need not confine himself to the category of decree holders
only [Seethai Mills Ltd. v. M. Perumalsamy, (1980)50 Comp.
Cas. 422 (Mad.)].
6. Just and equitable
The last ground on which the Court can order the winding up of
a Company is when, “the Court is of opinion that it is just and
equitable that the Company should be wound up”. This gives
the Court wide discretionary power to order winding up
whenever it appears to be desirable, after giving due weightage
to the interests of the Company, its employees, creditors,
shareholders and the general public. “Though the Court is not
bound to construe this clause ejusdem generis as only covering
grounds of a like nature with those specified in clauses 1 to 5,
yet it will require grounds of a like magnitude before acting
under the clause” [Cowasjee v. Nath Singh Oil Co.Ltd., (1921)
59 IC 524]. “For a long period ejusdem generis dominated the
interpretation of the just and equitable provision. But the rule
has been entirely abandoned and the words are to be treated as
conferring a discretionary power which is of the widest character
and the Courts are left to workout for themselves the principles
on which such orders should be granted”. [B.H.McPherson,
(1964) 27 MLR 288]. There must be a really valid ground for
ordering a winding up on this ground, and the Court may refuse
to give such an order if, in its opinion some other suitable remedy
or relief is available. It is neither desirable nor possible to
categorize grounds which would render it just and equitable to
wind up a Company, but the circumstances in which the Courts
have in the past dissolved companies on this ground can be
resolved broadly into the following categories:
(i) Deadlock
Whenever there is a ‘deadlock’ in the management of the
Company, it may be just and equitable to order winding up.
‘Deadlock’ occurs when the management is divided into two
groups, having two different and opposite directions, and with
no chance of a compromise between them. In such situations,
since neither group is willing to retreat from the stand they have
taken, work comes to a standstill. For example, if group A wants
to take up option ‘X’ and group B wants option ‘Y’ and neither
group wants to compromise, neither ‘X’ nor ‘Y’option can be
taken up. The work would come to a standstill. Thus, in In re
Yenidje Tobacco Co. Ltd. [(1916)2 Ch. 426], W and R who
traded separately as cigarette manufacturers, agreed to
amalgamate their business and formed a private limited
Company of which they were the shareholders and the only
directors. They had equal voting rights, and therefore, the
Articles provided that any dispute would be resolved by
arbitration. When a dispute arose, W & R did go in for arbitration
and got an award, but later one of them dissented from the award.
Both then became so hostile, that neither of them would speak
to the other except through the Secretary. Thus, there was a
complete deadlock and consequently the Company was ordered
to be wound up although its business was flourishing.
The Courts, in general do not insist on a paralyzing deadlock
before ordering winding up. As ‘Lord Shaw of Dunfermline
observed in Loch v. John Blackwood Ltd. [(1924) AC 783]:
“a justifiable lack of confidence resting on a lack of probity in
the conduct of a Company’s affairs is sufficient to found a
winding up order”. But this clause should not be invoked in a
case where the only difficulty is the difference of view between
the majority of the directorate and those representing the
minority. Thus in Veeramachineni Seethiah v. Venkatsubbaih
[AIR 1949 Mad. 675], the Madras High Court observed, “where
nine or ten directors belonging to different communities
unanimously and socially take one view as against the minority
of three holding the other view and the Company has been
earning profits and has accumulated a good will, the mere
incompatibility of good relations between the rival factions in
the directorate is not sufficient for ordering winding up.
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“Similarly, in re Hind Overseas Ltd. [(1968)2 Comp. LJ 95],
Ray.J, observed, “winding up cannot be ordered on the grounds
of friction and disputes between directors; the scramble for
power is at the bottom of it all.”
(ii) Loss of substratum
The Court may pass a winding up order if it is satisfied that the
objective or purpose for which the Company was formed has
substantially ceased to exist, even if a large majority of
shareholders wish to continue with the business. In considering
whether the substratum has gone or not, the Court should have
due regard to the interest of the shareholders as well as of
creditors. Even if the main object has failed, but there are other
objects which would permit the Company to carry on its business
activities, even though the same may be of lesser volume or
importance, it should be allowed to continue, on the ground
that the majority shareholders are the best judges to decide how
to run the Company under these circumstances. Whether the
Company’s substratum has gone or not would primarily depend
on the true construction of the ‘object clause’ of the
Memorandum of the Company. The word ‘substratum’ was
chosen for a special purpose - so as to signify the ‘foundation of
the Company: Once that is removed, the whole edifice or
superstructure standing on it must crumble down with no
question of possibility of repair work, i.e., it is a situation of
‘total destruction’. In other words, in such cases, no further
business can be undertaken under the Memorandum and
everything comes to a standstill [For example refer to, In re
German Dates Coffee Co., [(1882)20 Ch.D.169]. Mere
depreciation in the assets of the Company, or temporary difficulty
in carrying out the business, which does not knock out the
Company’s bottom should not be permitted to become a ground
for winding up. For example, in re Eastern telegraph Co.
Ltd. [(1947)2 All ER 104], the Company was incorporated in
1872, and in 1929 its issued capital was £ 7 million divided into
£ 2 million in preference stock and £ 5 million in ordinary stock.
The Company was formed for the purpose of acquiring
undertakings, telegraph lines, property of four companies,
establishment of telegraph stations, amalgamating with and
sharing in the business or undertakings of any other telegraph
Company or companies. On 30th December, 1929, Imperial &
International Communications Ltd. bought the whole of the
physical assets of the Company for shares in the Imperial. In
1946, on coming into force of the ‘Cable & Wireless Act’,the
Treasury acquired the holding of Wireless & Cable Ltd. While
the assessment and payment of compensation for the compulsory
transfer was pending, some preference stock holders filed a
petition on the ground that the Company had ceased to carry on
its business for more than a year and that the substratum of the
Company had gone. Dismissing the petition the petition, the
Court held that, ‘it is true that the Company has been expropriated
on terms of receiving compensation by a supervening Act of
the legislature. That was an event to which the Company
had necessarily to bow. It had no option but to comply with
the terms of the Act. But the proper people to look after
that matter are the directors of the Company, and it
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would be quite wrong at this juncture to make a compulsory
order which would have the effect of removing them from office
and which would bring in a Liquidator who, capable and expert
as he might be, would not have the same knowledge as the
Directors have...... there was no suggestion that the Directors
would adventure the money of the Company on some object
which was not contemplated when the Company was formed.
There was no confiscation of the property of the Company either,
and it would be to the detriment of the Company if the winding
up order was made.’
Some of the conditions which may amount to loss of substratum
of the Company are, (a) the subject mater of the Company is
gone; (b) the object for which it was incorporated has
substantially failed; (c) it is impossible to carry on the business
except at a loss; (d) the existing and probable assets are
insufficient to meet its existing liability; (e) suspension or non
commencement of business for a whole year, etc.
(iii) Impossibility of carrying on business at a profit
It is considered just and equitable to wind up a Company when
it cannot carry on business except at a loss i.e., when there is no
hope of achieving the object of trading at a profit. Thus, in Davis
& Co. Ltd. v. Brunswick (Australia) Ltd. [(1936) 1 A11 ER
299 PC] the Directors of a subsidiary Company were the holders
of all the preference shares in the Company and has also been
guaranteed payment of interest for two years after the allotment
of shares and also full payment of the value of the shares in the
event of its giving in liquidation within two years. The Company
however started incurring losses due to general depression. On
the petition of the Directors for winding up, the Court held - “it
is well settled that this clause is not confined to clauses in which
there are grounds analogous to those mentioned in the other
parts of the section : Lock v. John Blackwood Ltd. [(1924)
AC 783 PC]. Nor, on the other hand, can any general rule be
laid down as to the nature of the circumstances which have to
be borne in mind in considering whether the case comes within
the phrase. Where there is no question of deadlock, or of
shareholders who have the voting power using that power for
their own commercial interests outside the Company in disregard
of the interests of the minority, or any question involved of the
improper management of the Company by the Directors who
are in control, and the problem involved is of the nature of a
business problem. The decisive question must be the question
whether at the dater of presentation of the winding up petition
there was any reasonable hope that the object of trading at a
profit with a view to which the Company was formed could be
attained”.
“The fact that the Company has made losses over a number of
years is by itself insufficient to show that it will never be able to
achieve its object of trading at a profit. The principle laid down
by Lord Cairns. In re Suburban Hotel Co [(1867) LR 2 Ch.
App. 737] that it is not permissible to argue from the mere fact
that a Company has consistently made losses in the past, that it
has no reasonable prospects of earning profits in the future, has
been repeatedly affirmed and the decision itself has been taken
to have established that a Company “has lost, is losing and will
continue to lose” does not of itself justify a winding up order, at
least when the capital has not been exhausted. It is not the
business of the Court to manage the affairs of a Company (per
Scrutton LJ in Shuttelworth v. Cox Brothers & Co. (Maiden
head) [(1927) 2KB 9], and the winding up process of the Court,
cannot be used and ought not to be used, as the means of evoking
a decision as to the probable success or non-success of a
Company as a commercial speculation”.
(iv) Fraud
It is just and equitable to wind up a Company if it has been
conceived and brought forth in fraud or for illegal purposes.
Thus in, re Thomas Edward Brismead & Sons [(1897)1 Ch.
45,406 (CAT], T.E.B. and his sons were relatives of, and has
been employed by, persons who carried on the business of piano
manufacturers under the name of S.B. & Sons. They left J.B. &
Sons and formed a Company called T.E.B. & Sons. Ltd. for
carrying on a similar business. A prospectus was issued which
stated that the price paid for the business was £ 76,650, when it
was really only £ 1000 in cash together with £ 5000 in shares in
the Company. Money was subscribed by the public and most of
this money found its way into the hands of the persons who
were the real, though not the ostensible, promoters. J.B.& Sons
obtained an injunction restraining the Company from using the
name ‘Brinsonead’. It was found that the Company T.E.B. &
Sons. Ltd. was formed to filch as much trade as possible from
J.B. & Sons. Numerous actions were brought against the
Company for fraud in the prospectus. It was held that the
Company should be wound up.
(v) Oppression of minority
It would also be just and equitable to wind up a Company where
the principal shareholders have adopted an aggressive or
oppressive or squeezing policy towards the minority. In R.
Sabhapaty Rao v. Sabapathi Press Ltd. [AIR 1925 Mad. 489],
the Directors of a Company were able to exercise a dominating
influence on the management of the Company and the Managing
Director was able to outvote the minority of the shareholders
and retain the profits of the business between members of the
family and there were several complaints that the share holders
did not receive a copy of the balance sheet, nor was the auditor’s
report read at the general meeting, dividends were not regularly
paid and the rate was diminishing, that constituted sufficient
ground for winding up.
(vi) Incorporated or Quasi-Partnership
Generally speaking, there is little in common between the giant
corporation and the one-man Company. To apply the same legal
principles to such different organisation might result in
inconvenience and injustice to avoid which the Act treats them
differently in several respects. But even in matters in which the
Act treats them alike, the Courts usually make a distinction.
One such matter is the interpretation of the just and equitable’
clause in reference to the winding up of small private companies.
The rule of law applied in such cases is one laid down by Lord
Wilberforce in Ebrahimi v. Wastbourne Galleries Ltd. [(1972)
2 A11 ER 492], briefly known as the Ebrahimi Principle and
states as follows:
“The words (just and equitable) are a recognition of the fact
that a limited Company is more than a mere judicial entity, with
a personality in law of its own; that there is room in Company
law for recognition of the fact that behind it, or amongst, it
there are individuals, with rights, expectations, obligations inter
se which are not necessarily submerged in the Company
structure. That structure is defined by the Companies Act and
by the Articles of Association by which shareholders agree to
be bound. In most companies and in most contexts, this definition
is sufficient and exhaustive equally so whether the Company is
large or small. The just and equitable provision does not entitle
one party to disregard the obligation he assumes by entering a
Company, nor the Court to dispense him from it. It does, as
equity always does, enable the Court to subject the exercise of
legal rights to equitable considerations, that is, of a personal
character arising between one individual and another, which may
make it unjust, or inequitable, to insist on legal rights, or to
exercise them in a particular way.
“It would be impossible, and wholly undesirable, to define
the circumstance of in which these considerations my arise.
Certainly the fact that a Company is a small one, or a private
Company, is not enough. There are very many of these where
the association is a purely commercial one, of which it can safely
be said that the basis of association is adequately and
exhaustively laid down in the articles. The superimposition of
equitable considerations require something more, which
typically may include one, or probably more, of following
elements; (i) an association formed or continued on the basis of
a personal relationship, involving mutual confidence this element
will often be found where a pre-existing partnership has been
converted into a limited Company; (ii) an agreement, or
understanding, that all, or some (for there may be ‘sleeping’
members), of the shareholders shall participate in the conduct
of the business; (iii) restriction on the transfer of the members’
interest in the Company-so that if confidence is lost, or one
member is removed from management, he cannot take out his
estate and go elsewhere.
“It is these, and analogous, factors which may bring into
play the just and equitable clause, and they do so directly, through
the force of the words themselves. To refer, as so many of the
cases do, to “quasi-partnerships” or “in substance partnerships”
may be convenient but may also be confusing. It may be
convenient because it is the law of partnership which has
developed the conceptions of probity, good faith and mutual
confidence, and the remedies where these are absent, which
become relevant once such factors are found to exist: the words
“just and equitable” sum these up in the law of partnership itself.
And in many, but not necessarily all, cases there has been a pre-
existing partnership the obligations of which it is reasonable to
suppose continue to underlie the new Company structure. But
the expressions may be confusing if they obscure, or deny, the
fact that the parties (possibly former partners) are now co-
members in a Company, who have accepted in law, new
obligation. A Company, however small, however domestic, is a
Company, not a partnership or even a quasipartnership and it is
through the just and equitable clause that obligations, common
to partnership relations, may come in”.
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But this principle has to be read in the light of what has been
said by the Supreme Court in the case of Hind Overseas Ltd.
v. Raghunath Prasad Jhunjhunwalla where the Court
observed : “It is now well settled that the sixth clause, namely,
“the just and equitable” is not to be read as being ejusdem generis
with the proceeding clauses. While the five earlier clauses
prescribe definite conditions to be fulfilled for the one or the
other to be attracted in a given case, the just and equitable clause
leaves the entire matter to the wide and wise judicial discretion
of the Court. The only limitations are the force and content of
the words themselves, “just and equitable”. Since , however,
the matter cannot be left so uncertain and indefinite, the Courts
in England for long have developed a rule derived from the
history and extent of the equity jurisdiction itself and also born
out of the recognition of equitable considerations generally. This
is particularly so, as 23 (6) of the English Partnership Act 1890
also contains, inter alia, and analogous provision for the
dissolution of partnership by the Court. Section 44(g) of the
Indian Partnership Act also contains the words “just and
equitable”.
“But S 433(f) has to be read S 433(2). Under the latter provision,
where the petition is presented on the ground that it is just and
equitable that the Company should be wound up, the Court may
refuse to make an order of winding up, if it is of opinion that
some other remedy is available to the petitioners and that they
are acting unreasonably in seeking to have the Company wound
up instead of pursuing that other remedy.
“Again under S 397 and 398 there are preventive provisions in
the Act as a safeguard against oppression and mismanagement.
These provisions also indicate that relief under S 433 (f) based
on the just and equitable clause is in the nature of a last resort
when other remedies are not efficacious enough to protect the
general interests of the Company.
2.3 PETITIONERS FOR WINDING UP
As per the requirements of Sec. 439 for purposes of winding up
by Court, a petition has to be filed. A petition may be filed by
any of the following persons:
a. Company
A petition for winding up may be presented by the Company on
any of the grounds u/s 433, and especially when the Company
is being wound up because of a special resolution passed by the
Company. The petition must be presented by the Company itself
and not the Managing Director or Chairman etc. For example,
in re Patiala Banaspati Co. [AIR 1953 Pepsu 195], and
application for winding up was made by the Managing Director
of the Company. Rejecting the petition, the Court said, the
petition by the Company must have behind it the decision of the
general meeting. The Managing Director or directors cannot
constitute the Company for the purpose.
b. Creditors
The word creditor includes a secured creditor, debenture holder
and a trustee for debenture holders, and winding up is equally
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good whether it is obtained by a secured creditor or an unsecured
one. But whether it is obtained by a secured creditor or an
unsecured one. But where the petition is brought about by a
contingent or prospective creditor, it can be admitted only with
the leave of the Court; which is not generally granted unless the
Court is satisfied that there is a prima facie case for winding up
of the Company and reasonable security for costs has also been
given. Some times a creditors petition is opposed by other
creditors. In such cases, the Court may ascertain the wishes of
the majority of the creditors, though their opinion wont be really
binding on the Court. The decision ultimately depends upon the
state of the Company. If the Company is commercially insolvent
and the object of trading at a profit cannot be attained, winding
up order would follow as a matter of course (ex debitio justitiae).
A creditor may present a petition, while he is pursuing his
ordinary remedy of a suit for the enforcement of his claim. The
Court may order a stay of his suit but cannot disqualify a
creditor’s petition on that ground; what is required under this
section is that the creditors claim be enforceable at the time of
the petition - even if it becomes unenforceable by the time of
the order, such unenforceability shall have no effect.
c. Contributory
On the commencement of the winding up of a Company, its
shareholders are called contributories. Any contributory or
contributories may present a petition for winding up, especially
if the petition is on the ground of ‘reduction of members’. But
for a petition on any other ground, the requisite qualification is,
that the shares in respect of which the petitioner is a contributory
are either originally allotted to him or he has been their registered
holder for at least 6 months during the eighteen months
immediately before the commencement of the winding up, or
the shares have devolved on him through the death of a former
holder. In England, a general rule which is followed in case of
fully paid up shares is that, ‘where a fully paid up shareholder
petitions for compulsory winding up he must show, on the face
of his petition, a prima facie probability that there will be assets
available for distribution amongst the shareholders’.
Though previously the Courts in India followed the same
principle, Sec. 439 (3) now clearly lays down that, “a
contributory shall be entitled to present a petition for winding
up, notwithstanding that he may be the holder of fully paid up
shares or that the Company may have no assets left for
distribution among the shareholders after the satisfaction of its
liabilities." Hence, the present position in India is that, though
want of assets may be an element in determining whether the
petition is bonafide, it would not be a relevant consideration for
determining whether winding up should be ordered or not.
d. Registrar
The Registrar of Companies is entitled to present a petition for
winding up on all grounds u/s. 433 except where a special
resolution passed by the Company is required, after obtaining a
sanction from the Central Government for the presentation of
petition for winding up. Such sanction shall not be granted by
the government unless the Company has been accorded an
opportunity of being heard and to make any representation in
that regard.
e. Central Government
The Companies Act authorises the Central Government to
present a petition for winding up in certain situations. For
example, Sec. 243 enables the government to present a petition
for winding up, if it appears from the reports of the inspectors
investigating the affairs of the Company under Sec. 235 that the
business of the Company has been conducted for fraudulent or
unlawful purposes as explained in sub-clauses (i) and (ii) of
clauses (b) of Sec. 237. The Government may authorise any
person to act on its behalf for this purpose.
f. All or any of them
It is not necessary that a petition for winding up u/Sec. 439
must be presented by one of the categories mentioned above.
All or any of them together may present a combined petition on
the grounds mentioned in the section.
Can workers make a petition for hearing either asking for or
contesting winding up? This is contested in some cases following
Excel Wear (citation given earlier). In Bombay Metropolitan
Co Ltd. V. Employers of BTC [(1991) 71 Comp. Cas. 473]
the Court held that there was no conflict between the provision
of the Industrial Disputes Act 1947 and the Companies Act,
1956. According to the Court prior permission of the state
government under Sec. 250 of the ID Act is required for closing
down an industrial unit. It contemplates continuation of the
Company. But when the Company goes into winding up or a
winding up order commences, it is itself a notice of discharge
on the officers and employees of the Company. Sec. 250 of the
ID Act is not attracted here. Even if the liquidator favours
continuation of the corporate activities for the benefit of the
winding up, Sec. 250 of the ID Act is not attracted. In Excel
Wear the petition challenging the winding up was given a
hearing. As such, it may be noted here that though the list of
petitioners does not indicate the workers, Indian Courts do not
deny them hearing.
2.4 PROCEDURE OF WINDING UP
After hearing a petition for winding up the Court may dismiss
it, adjourn it, pass an interim order or make an order for winding
up. This order may take effect either immediately or after a lapse
of certain period, say six months. Commencement of winding
up is not from the date of the order, but is deemed to be from the
time of presentation of the petition itself. But, where the winding
up order is in response to a Special Resolution of the Company,
the commencement of winding up is deemed to be from the
date of passing of resolution.
Application: As mentioned earlier, an application for winding
up shall be in the form of petition u/sec. 439, in Form 45, 46 or
47 as the case maybe, with required variations and shall be
submitted in duplicate. The Registrar of he Court shall note on
the petition the date of its presentation (r. 95). Where the petition
is presented by a contributory, he should state whether he satisfies
the conditions in cl. (a) or (b) of Sec. 4439(4); and when the
petition is presented by the Registrar or a person authorised by
the Central Government, he must annex to the petition the order
of sanction or authorisation. Where the Company is being wound
up voluntarily or subject to the supervision of the Court, the
petition should state the fact that the voluntary winding up or
winding up under supervision of Court cannot be continued with
due regard to the interests of the creditors or contributories or
both. The petition should then conclude with a prayer. It should
also append a note to the effect that the petition is intended to
be served on such and such person to be specified.
Notice: Since the Company is invariably the respondent in a
winding up petition, compliance with Rule 28 is mandatory. If
default is made in complying, the Judge may either dismiss the
petition or give such other directions as he thinks fit. Rule 28
provides that : (i) where a petition is presented against a
Company, it shall be accompanied by a notice for service on the
Company and an envelope addressed to the Company at its
registered office or principal place of business and sufficiently
stamped for being sent by registered post for acknowledgment.
The Registrar of the Court shall immediately on its admission
of the petition send the notice together with the copy of the
petition to the Company by registered post. (2) Every petition
and, save as otherwise provided by these rules or by an order of
the Court, every application, shall, unless presented by the
Company, be served on the Company at its registered office, or,
if there is no registered office, at its principal or last known
principal place of business by leaving a copy thereof with an
officer or employee of the Company, and in case no such person
is available, in such manner, as the Judge or Registrar of the
Court may direct, or, by sending a copy thereof by prepaid
registered post addressed to the Company at its registered office,
or, if there is no registered office, at its principal or last known
principal place of business, or to such person and at such address
as the Judge or Registrar of the Court may direct.
Where the Company is being wound up, the petition or
application shall also be served on the Liquidator, if any,
appointed for the purpose of winding up of the Company.
Verification: The petition should be signed by a proper person,
but in case it is not properly signed it is a mere irregularity and
can be cured at any time. It should also be certified by an affidavit
of the petitioner, and if there are more than one petitioner, by an
affidavit of atleast one of the petitioners The affidavit should be
in the proforma given in Form No.3 (Rule 21), and should be
filed along with the petition. The rule relating to certification is
to be strictly complied with, and if it is not done, then the Courts
will not give leave to re-verify the petition.
Advertisement: Once the petition is filed, it is posted before
the judge in chambers for admission and fixing of date, and also
for directions as to the advertisement to be published and the
persons, if any, on whom the petition copy is to be served. But,
the judge may, if he thinks fit, direct that notice be given to the
Company before advertising the petition (Rule 96) Under
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Rule 24 (2), a winding up petition cannot be placed for hearing
unless it is advertised, but it is not necessary that the moment a
petition is admitted it should be advertised The Supreme Court
has said that when a petition is field the Court may (i) issue
notice to the Company to show cause why the petition should
not be admitted, (ii) admit the petition and fix a date for hearing
and issue a notice to the Company for giving directions about
the advertisement of the petition, or (ii) admit the petition, fix
the date of hearing of the petition and order that the petition be
advertised and direct that the petition be served upon persons
specified in he order.
In answer to a notice to show cause as to why a petition for
winding up be not admitted, the Company may sow cause and
contend that the filing of the petition amounts to an abuse of the
process of the Court There is however no prescribed form for
notice, nor is there s right in a Company to be issued a notice
before the petition is admitted or before the Court fixes the date
for hearing.
Withdrawal : Once the winding up petition is filed, it cannot
be withdrawn without leave of the Court, and if the petition has
been advertised in accordance with the 99, the application for
leave to withdraw shall not be heard at any time before the date
fixed in he advertisement for hearing of petition. A winding up
petition differs from an ordinary civil suit because the petitioner
has to show a preponderance of justice and equity in favour of
winding up. This can be generally done by evidence given
through affidavits on broad questions rather than by weighing
in golden scales the evidence on both sides.
Hearing: According to Sec. 443(i) , on hearing a winding up
petition, the Court may - (a) dismiss it with or without costs; or
(b) adjourn the hearing conditionally or unconditionally; or (c)
make any interim order that it thinks fit, or (d) made an order
for winding up the Company with or without costs, or make any
order that it thinks fit, provided that the Court shall not refuse to
make a winding up order on the ground only that the assets of
the Company have been mortgaged to an amount equal to or in
excess of those assets, or that the Company has no assets.
Winding up of a Company being of utmost importance involving
grave consequences, expedition in the winding up process is
the hall-mark of an efficient winding up. The application for
winding up should be considered at the earliest. As far as
possible, the Court should, either make an order to find up the
Company, or dismiss the petition for, if the petition is adjourned,
and a winding up order is ultimately made, the order would date
back to the presentation of the petition and avoid or imperil
anything done by the Company in the meantime [Central Bank
of India v. Mikenzies Ltd., 47 Comp. Cas 306]. Despite such
observations made by the Courts over the years, in practice it is
seen that, from the date of presentation of petition to the final
order takes any where between 20 and 30 years.
Provisional Liquidator: After the presentation of the winding
up petition and before the making of a winding up order, the
Court may appoint a provisional Liquidator to take charge of
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the Company. But before finalising such order, the Court must
give a notice to the Company and also give it a reasonable
opportunity to make its representation, unless in the special
circumstances the Court decides to dispense with this provision.
If a winding up order is made, the Provisional Liquidator
becomes the Official Liquidator. Unfortunately, the Act itself
does not provide any set criteria for the appointment of a
Provisional Liquidator. In re London, Hemburg and
Continental Exchange Bank, Emmersons case [(1886) 2 LR
Eq 231], Lord Romily said, “It is perhaps convenient that I
should state what my practice is with reference to the
appointment of Provisional Liquidators, where there is no
opposition to winding up, I appoint a provisional Liquidator as
a mater of course on the presentation of the petition. But where
thee is an opposition to it, I never do, because I might paralyse
all the affairs of the Company, and afterwards refuse to make
the winding up order at all. But when the directors themselves
apply, or do not oppose the winding up, then I appoint the
Provisional Liquidator.”
The present position appears to be, that though the Court can
appoint a Provisional Liquidator when the company is obviously
insolvent or its assets are in jeopardy; this is not the extent of its
power. Sec. 450 is framed in general terms and confers on the
Court a discretionary power to be exercised in a proper judicial
manner, since exercise of this power may have serious
consequences for the Company. Particularly, when the petition
is presented by a nominee of the Central Government on grounds
that it is expedient in the public interest that the Company should
be wound up, the public interest must be given full weight, though
that fact by itself is not conclusive enough for the appointment
of the Provisional Liquidator.
Stay of proceedings: On commencement of winding up, any
suit or proceeding pending against the Company, may be
‘stayed’ on a an application made by a creditor or a contributory
of the Company under Sec. 441(2). If the suit or proceeding is
pending in any other Court, he may apply to the Court having
jurisdiction to wind up the Company to restrain further
proceedings in the suit/proceeding under Sec. 442. In Official
Liquidator v. Dharti Dhan Pvt. Ltd. [47 Comp. Cas. 420]
the Supreme Court has held, “The clear object of the section is
that claims in suits and proceedings pending elsewhere, which
have a bearing on Company liabilities, may be stayed only until
the winding up order is made, because after the winding up
order has been passed, Sec. 46 begins to operate so as to
automatically transfer, with certain exceptions, proceedings
against the Company being wound up to the Court exercising
the jurisdiction to wind up.... Section 442 and 446 of the Act
have to be read together. It is only where the object of the two
sections, when read together, is served by a stay order that the
stay order can be justified. That order is to expeditiously decide
and dispose of pending claims in the course of winding up
proceedings. A stay is not to be granted if the object of applying
for it appears to be... merely to delay adjudication on a claim,
and thereby to defeat justice. In other words, a stay under S.
442 cannot be made mechanically, or, as a matter of course, on
showing fulfilment of some fixed and prescribed conditions. It
can only be made judicially upon an examination of the totality
of the facts which vary from case to case. It follows that the
order to be passed must be discretionary and the power to pass
it must, therefore, be directory and not mandatory”.
After a winding up order is made or a Provisional Liquidator is
appointed, no suit or other legal proceedings shall be
commenced, or if pending at the date of winding up order,
shall be proceeded with against the Company except [Sec.
446(01)]. This section does not extend to actions or proceedings
which have been commenced abroad, but where the plaintiff is
within the jurisdiction of the Court, it may exercise its equitable
jurisdiction to restrain him from pro secuting the proceedings.
Statement of affairs: Once a winding up order is made, a
statement of the affairs of the Company made in the prescribed
format is to be submitted to the official Liquidator who should
at his earliest and not later than 6 months from the date of order
or such extended period as the Court may allow, submit a
preliminary report to the Court, under Sec. 455 (a) as to the
amount of capital issued, subscribed, and paid up, and the
estimated amount of assets and liabilities, giving separately,
particulars of (1) cash and negotiable securities, (ii) debts due
from contributorirs, (ii) debts due to the Company and securities,
if any, available in that respect, (iv) movable and immovable
properties belonging to the Company; and (v) unpaid calls; (b)
if the Company has failed, as to the causes of failure; and (c)
whether, in his opinion, further inquiry is desirable as to any
matter relating to promotion, formation, or failure of the
Company, or the conduct of the business.
Committee of Inspection: The Court also if it deems fit, direct
that a ‘Committee of Inspection’ be appointed to act with the
Liquidator. Such a Committee shall not consist of more than 12
members who shall be from amongst the creditors, or the
contributories or their attorneys and in such proportions as may
be agreed upon or as the Court determines [Sec. 465(1)]. The
Committee shall have the right to inspect the accounts of the
Liquidator. But neither the Liquidator nor any member of the
Committee have the right to purchase any part of the Company’s
assets except by leave of the Court, and if any such purchase is
made it shall be set aside. So also, no member can derive any
profit from any transaction relating to the winding up of the
Company, or receive out of its assets any payment for
administration of assets, or goods supplied to the Court and if
he does so receive then he is liable to restore it. These rules are
based on equity, because a Liquidator or a committee member
is in a fiduciary position’ in relation to the Company and so
they cannot make a secret profit out of its assets.
Settlement of list of contributories : Under Sec. 467(1) soon
after the making of a winding up order, the Court shall settle a
list of contributories, and distinguish between persons who are
contributories in their own right and those who are contributories
as being representative of or liable for, the debts of others. But
where there is no need to make calls, the Court may dispense
with the list. According to Sec. 428, a contributory is a person
who is liable to contribute to the assets of the Company in the
event of its being wound up and includes the holder of fully
paid up shares. Though apparently the expression “any person
liable to contribute to the assets of the Company in the event of
its being wound up’’ is wide enough to include persons other
than members, it is now well settled that a contributory refers to
a member, either past or present, or his legal representative, a
Director or Manager with unlimited liability.
Liability of a present member is limited to the amount of money
remaining unpaid against the shares allotted to him; or to the
extent of amount guaranteed by him. If a contributory dies before
or after he has been placed on the list, then his legal representative
shall be liable. If he makes a default, then proceedings will be
undertaken for administering the estate of such deceased
member, compelling the estate to make the payment. If a member
is adjudged insolvent, whether before or after his name has been
placed on the list, his assignees in insolvency shall represent his
for all purposes of winding up, and shall also be contributories
for the purposes of this Act. A past member’s liability to
contribute is similar to that of a present member but he cannot
be made liable: (i) if he had ceased to be member I year upward
before commencement of winding up; (ii) in respect of any debt
or liability of the Company after he ceased to be a member; (iii)
unless it appears to the Court that the present members are unable
to satisfy the contributions required to be made by them.
Private and Public examination: Sec. 477 gives the Court the
power to summon before it (a) any officer of the Company or
person, (i) known or suspected to have in his possession any
property, books, or papers of the Company, (ii) or known or
suspected to be indebted to the Company, or (b) any person
whom the Court thinks is capable of giving information about
some aspect of the Company affairs, for the purpose of
examination on oath or interrogation as also to require him to
produce any books etc. relating to the company in his custody.
Sec. 478 provides that when an order for winding up has been
made, and the Official Liquidator gives a report that in his
opinion a fraud has been committed by any person either in
promotion or formation of the Company or since its promotion,
direct such a person to appear before the Court on the appointed
day and publicly examine him in this regard. The Official
Liquidator is to take part in this examination and may employ
such legal assistance as needed or allowed by the Court. A
creditor or contributory may also take part in the examination
either personally or though his attorney. In order to invoke this
jurisdiction, it is necessary that the allegations must be made
specifically, unless it is averred that several persons acted with
a common object and intention.
In Official Liquidator v. Haridas Mundhra [41 Comp. Cas.
70], the Court observed: “A public examination,” says the
judgement, “is a roving enquiry to discover facts in regard to
the fraud alleged in the promotion or formation or dealings of
the business of the Company or in regard to the conduct and
dealings of the officers who are so examined . Those facts may
or may not be covered by the misfeasance summons but a certain
amount of overlapping between the facts elicited in the course
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of public examination and the facts relied upon for the purpose
of misfeasance summons u/s 543 is inevitable. The phrase
“fishing inquiry”, generally speaking, has, no doubt, an
obnoxious connotation in law. It is, however, perfectly a proper
term to apply to a public examination, so long as the public
examination is not being used for a purpose collateral to s. 478."
“Section 478(5) provides that the person whose is being
examined ‘shall answer such questions as the Court may put, or
allow to be put, to him’. These words are of the widest amplitude
and the only limitation on the Court’s power is that it has to
exercise its discretion judicially and not arbitrarily or
capriciously. In exercising those powers, all that the Court would
require to consider would, therefore, be whether the questions
put, or allowed to be put, are such as will subserve the purposes
of s. 478 and not a purpose collateral to it. The legislature has
advisedly conferred these wide powers because the very nature
of liquidation proceedings would require incriminating questions
to be put and answered without any reservation in regard to
their future use in proceedings, civil or criminal. In view of this
it has also to be held that provisions of Sec. 478(5) override the
provisions of s. 132 of the Evidence Act. Moreover, the omission
of the words ‘in civil proceeding’ in s 196 (7) of the Indian
Companies Act 1913 from s 478(8) clearly shows that the use
of answers given by the delinquent officer in the course of public
examination is permissible against him not only in civil
proceedings but also in criminal proceedings”.
2.5 CONSEQUENCES OF WINDING UP ORDER
A winding up order results in the following consequences, viz.,
1) The Court has to send an intimation of the winding up to
both the Official Liquidator and the Registrar. It is also the
duty of the petitioner and the Company to file with the
Registrar a certified copy of the order within 30 days who
is then required to make minutes of the order in his book
relating to the order and notify in the Official Gazette that
such an order has been made.
(2) A winding up order is deemed to be a notice of discharge to
the officers and employees of the Company, except when
the business of the Company is continued.
(3) The order operates in favour of all the creditors and all the
contributories of the Company.
(4) On the making of the order, the Official Liquidator, by virtue
of his office, becomes the Liquidator of the Company.
(5) Lastly, after the order, no suit or proceedings can be
proceeded with or commenced, against the Company except
by leave of Court.
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2.6 DISSOLUTION OF THE COMPANY
Section 481 of the Act provides that when the affairs of the
Company have been completely wound up or when, the
Liquidator is unable to proceed any further with the winding up
due to lack of funds, or if the Court feels that it is just and
equitable to do so, the Court shall make an order that the
Company be dissolved from the date of the order. Within 30
days of passing such an order for dissolution, a copy of the
order is to be filed with the Registrar.
After dissolution, the Company ceases to exist and the Liquidator
cannot represent a non-existing Company. He also becomes a
‘functus officio’. But the dissolution does not absolve the
Liquidator of his liability if he has committed a breach of duty
to any creditor by distributing assets of the Company without
complying with the requirements of the Act. A judgement
obtained against a dissolved Company is invalid as being
infructous. So also, on dissolution, the surplus assets of the
Company go to the Government as escheat, and the shareholders
or creditors of the Company cannot maintain an action for
recovery of such assets.
Winding up of the Company is deemed to be concluded on the
date on which the order dissolving the Company is reported to
the Registrar by the Liquidator.
2.7 CONCLUSION
Section 433 confers the right on various parties to approach the
Court for a winding up order on any of the grounds thereunder.
The jurisdiction to wind up a Company lies with the High Court
of the State where the registered office of the Company is
situated. Despite the fact that any person can approach the Court
for the order, the power of the Court to pass an order of winding
up is discretionary, and an order is passed only if the Court after
taking all the circumstances into account decides that an order
of winding up would be in the best interests of the Company,
members and the general public. In Bombay Metropolitan
Transport Corpn. Ltd. v. Employees of BMTXC (CIDCO)
[(1987) 3 Comp. LJ 21 Bom] it was held that the public interest
will matter deciding whether to order the winding up of a
Government Company. The fact that a special resolution has
been passed by the shareholders is only one factor and it cannot
overrule the discretion of the Court in the mater.’ Here, the
creditors were not pressing for payment, nor was there any
evidence that the Company could not be carried on except at a
loss. The application of the Company for closure under the
Industrial Disputes Act had been rejected for the same reasons.
The Company was providing public utility services and this fact
was given due importance. The Court observed that a special
legislation, such as the Industrial Disputes Act, must prevail
over general legislation like the Companies Act and dismissed
the petition for winding up.
3. VOLUNTARY WINDING UP
SUB-TOPICS
3.1. Introduction
3.2. Preliminaries to winding up
3.3. Members’ voluntary winding up
3.4. Creditors voluntary winding up
3.5. Provisions applicable to every voluntary winding up
3.6. Conclusion
3.1 INTRODUCTION
It is not necessary that a creditor or member or the Registrar
should go in for the winding up. As seen in Sec. 433, the
Company itself may voluntarily go in for winding up. When
the Company wants to wind itself up it can to do only after the
passing of a resolution as shown below.
Company’s Voluntary Winding Up
Ordinary Resolution Special Resolution
For any other reason
When duration for When an event
its existence comes specified in the Articles for
to an end dissolution of Company occurs.
An ordinary resolution means one passed by a simple majority
of the persons present and voting. A Company may pass and
ordinary resolution for winding up in two situations- (a) if the
Company was formed for a fixed time period, say for 5 years,
then at the efflux of the period, and (b) if the Articles of the
Company specify an event, say for example earning Rs. 20 lakhs
as profits for 3 consecutive years’, on the happening of which
the Company would go in for dissolution, then the Company
may pass an ordinary resolution for dissolution on the happening
of this event, But it is only in rare cases that a Company would
make such a provision in its Articles. Further, merely because
an ordinary resolution to wind up has been passed by a Company
does not mean that the Courts should wind up the Company-
but the resolution is a relevant factor which the Courts do take
into consideration.
As seen in the earlier chapter, a Company may pass a special
resolution for winding up of the Company in all other situation,
not covered above. It is neither necessary to assign any reason
for passing such a resolution nor is one normally given. The
only requirement for a valid resolution is that it should comply
with the requirements mentioned under Ss. 171-173 and 189
(2). Generally speaking, the Court does not interfere if the
resolution of the Company is valid. The voluntary winding up
itself may be either the members voluntary winding up or the
creditors voluntary winding up - depending on whether the
Directors make a declaration of solvency at the time of passing
the resolution for winding up. As we have already dealt with
winding up under a special resolution we would now deal with
winding up in other situations.
3.2 PRELIMINARIES TO WINDING UP
‘Victory in battle may depend as much upon thoughtful planning
as upon skill and bravery in the field’. So also the Liquidator’s
capacity to produce the base outcome for creditors, shareholders,
employees and others may be substantially determined by the
conduct of the pre-winding up procedure. In extreme cases the
future of an industry or the well-being of a whole community
may be at stake. Important decisions may have to be made well
before the appointment of a Liquidator and prior to consultation
with creditors at a time when the Company is still under the
control of its Directors who may, at this stage, be under such
pressures that they are emotionally unable to make objective
decisions [Grier, p.5]. It is advisable, therefore, that Directors
faced with the possibility of liquidation, should not only consult
an expert for professional advice, but should also take certain
preliminary steps to facilitate the eventual take over by the
Liquidator. Some of these steps may be as follows:
1. The Decision to liquidate
Liquidation may take place for reasons other than insolvency,
for example, (a) upon completion of a project for which the
Company was formed; (b) upon elapse of the time period for
which the Company was formed; (c) in order to resolve a dispute
between shareholders; (d) upon sale of business etc. In all these
cases, if the directors can swear a declaration of solvency
(discussed below), the liquidation may proceed as a members
voluntary winding up.
In cases where the Company is declared insolvent, the decision
to wind up is usually taken out of the hands of the Directors, as
the decision to liquidate is not made till there is no other
alternative left, Many insolvencies could be avoided by sound
management and paying proper attention to early warning
signals. In cases where the decision to liquidate is not left so as
to become inevitable, Directors may have to consider the
possibility to liquidate in the following circumstances:
(a) Company though yet solvent is suffering constant losses;
(b) Where the Company is faced with sudden and unavoidable
crisis which may in all probability have adverse
repercussions, for example, loss of key personnel, or
technological change making the product obsolete, etc.;
(c) lack of adequate finance;
(d) inability to meet its liability as and when they arise;
(e) where liabilities exceed assets, etc.
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Even at the last state, the Company should consider whether
there are other viable alternatives to winding up, for example
reconstruction and / or amalgamation, and arrangement can be
arrived at with the creditors having a vested interest in seeing
the Company survive not only for recovery of debt but also to
preserve a customer. The management should try to take all steps
to rescue the Company, before giving in to the ultimate decision
to wind up. Once this end decision is reached, then the Directors
should take care to see to the preservation of business run by
the Company as distinct from the Company itself. In a number
of cases, the Liquidators managed to sell off a lot of projects as
going concerns, which later on thrived and prospered, thus not
only achieving the best realisation for creditors, but also
benefiting the community. This area of pre-liquidation planning
requires particular care and systematic planning in order to
provide the best results.
2. Declaration of solvency
In case of solvent companies, before members voluntary
liquidation takes place, a 'declaration of solvency’ must be
completed, sworn and filed in accordance with Sec. 488, which
provides that, (i) such a declaration has to be made by a majority
of the Directors at a Board meeting and verified by an affidavit
declaring that they have made a full inquiry into the affairs of
the Company and have formed an opinion that the Company
has no debts or that it will be able to pay its debts in full within
3 years from commencement of winding up; (2) the declaration
to be effective must be made within 5 weeks immediately before
the date of the resolution and delivered to the Registrar for
registration before that date; (3) the declaration should be
accompanied by a copy of the auditor’s report on profit and
loss accounts and balance sheet of the Company prepared upto
the date of the declaration and should also carry a statement of
Company’s assets and liabilities upto that date; or a punishment
of imprisonment of 6 months and or fine of Rs.5000/- attaches
to the Directors making this declaration without having any
reasonable basis to do so. If the Company fails to pay off its
debts within the specified period then it will be presumed that
reasonable grounds for making the declaration did not exist,
and, in such cases the Liquidator should call forth a meeting of
the creditors, as the winding up then has to proceed as creditor’s
voluntary winding up.
3. Notice to creditors
In case of insolvent companies, following the decision to
liquidate, the Directors are required to send a notice to the
creditors. The normal rules relating to notice are to be followed.
A statement of the affairs of the Company are to be put before
the creditors and thereafter, the winding up proceeds as if it is a
creditors’ voluntary winding up.
3.3 MEMBERS’ VOLUNTARY WINDING UP
After making the declaration of solvency, the Company must
hold a general meeting and pass the requisite resolution for
winding up. A notice of the resolution must be given in the
Official Gazette and also in some newspapers circulating in the
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district where the registered office of the Company is situated
within 14 days of the passing of the resolution [Sec. 485(1)].
Non compliance with this requirement entails a fine of Rs.50/-
per day of default. If at that meeting a Liquidator has also been
appointed, then he is also deemed to be an officer of the Company
and is liable to be fined. Failure to advertise in the newspapers
is a curable irregularity. The winding up is deemed to commence
from the time of passing of the resolution. It is important to note
that commencement is with reference to time and not the date.
After commencement of the winding up, the Company ceases
to carry on its business, except to the extent necessary for the
beneficial winding up of the Company. The Company however
continues to retain its corporate status and power till it is finally
dissolved.
Appointment of Liquidator: In the meeting where the
resolution is passed, or in a separate meeting of the shareholders,
one or more Liquidators are appointed and their remuneration
fixed. The remuneration so fixed cannot be increased under any
circumstances whatsoever, with or without the sanction of the
Court [Sec. 490 (2)]. Within 10 days of appointment, the
Company should give a notice to the Registrar [Sec. 493], and
if a vacancy occurs, the Company may appoint another
Liquidator in a general meeting and re-notify the Registrar again
within 10 days [Sec.492]. The Liquidator has also to inform the
Registrar of his appointment within thirty days and publish the
fact in the Official Gazette. A Liquidator cannot take charge till
his remuneration is fixed by the Company. On appointment of
the Liquidator, all the powers of the Board of Directors shall
come to an end, except when the Company or the Liquidator
gives them sanction to continue. Though the Director loses most
of the powers, he does not cease to be a Director [In re Windsor
Steam Coal Co. [1929]1 Ch. 151].
Reconstruction in winding up: Sec. 494 provides that, where
the Company in liquidation proposes to sell its business or
property to another Company, the Liquidator may, with the
sanction of a special resolution of the Company, received as
consideration for the transfer, shares or other like interest in the
transferee Company for distribution among members of the
transferor Company, or enter into any other arrangement whereby
the members of the Company participate in the profits of the
transferee Company or receive any other benefit there from
either in lieu of receiving cash, shares, policies or other like
interests or in addition to them [Sec.494(1)]. The resolution so
authorising the Liquidator, may be passed any time before or
concurrently with a resolution for voluntary winding up or for
appointing Liquidators and will not be invalid by reason only
that it was so passed. Such a sale/arrangement shall be binding
on the members of the Company, but if any member, who has
not voted in favour of the solution expresses his dissent from it
in writing addressed to the Liquidator and leaves a copy of the
same at the Company’s registered office within 7 days after the
passing of the resolution, he may require the Liquidator either
to abstain from carrying the resolution into effect, or to purchase
his interest at a price to be determined by agreement or by
arbitration. If, however, the Liquidator elects to purchase the
member’s interest, he shall pay the purchase money before the
Company is dissolved.
Sec. 494 is applicable to purely voluntary winding up and where
it is not so, it is not necessary to pass a special resolution. In the
latter case, the dissenting shareholder also does not have a right.
Sale under this section is also binding on the creditors. The assets
that can be disposed of are those which exist at the time of
liquidation and not the assets which come to the Company by
subsequent calls. So also, no disposition of assets will be valid
if it imposes a condition precedent on any shareholder to pay
premium on the shares of the transferee Company, though the
agreement many provide for partly paid up shares in lieu of
fully paid up shares. The sale/transfer contemplated under
Sec.494 is to an existing Company and not to a person about to
form a Company. It is also permissible to adopt a scheme
providing for compensation to the Directors for loss of office.
Further, though the scheme may provide for allotment of partly
paid up shares, it is not open to the transferor Company to
stipulate that if the members do not subscribe to the shares of
the transferee Company, their shares would be sold and applied
in payment of debts and liabilities of the Company in relief of
the obligations of the transferee Company; nor can they make a
call on the shares of the transferee Company. No scheme under
this section can override the rights of the shareholders.
Duty to call creditor’s meeting: Sec. 495(1) provides that, if
a Company has not been able to, or, in the opinion of the
Liquidator will not be able to, pay its debts in full within the
period stated in the declaration of solvency, he should
immediately summon a meeting of the creditors and lay before
them a statement of the assets and liabilities of the Company,
and, thereafter the winding up shall proceed in the manner of a
creditor’s voluntary winding up.
Where the liquidation continues for more than a year the
Liquidator has to call a general meeting of the Company at the
end of first year and at the end of each subsequent year, within
3 months from the end of each year or such longer period as the
Central Government may allow [Sec. 496(1)]. He is required to
lay before the meeting an account of his acts and the progress of
the winding up during the year.
Final meeting and dissolution: Sec. 497 marks the final stage
in winding up. It provides that as soon as the affairs of the
Company are fully wound up, the Liquidator shall, (a) make up
an account of the winding up, showing how the winding up has
been conducted and the Company property disposed of, and (b)
call a general meeting of the Company for the purpose of laying
the account before it and explaining it.
The words “as soon as the affairs of the Company are fully wound
up” do not import a condition precedent to dissolution and it
cannot be contended that if outstanding claims remain, the affairs
cannot be said to have been wound up. What the phrase signifies
is, as far as the Liquidator can wind them up’ or in the words of
Pennyquick J. in re Cornish Manures Ltd [(1967)2 All ER
875]. “it is atleast sufficient that they (the affairs of the Company)
should have been fully wound up so far as the Liquidator is
aware”.
The meeting is to be called by advertisement specifying the time,
place and object of the meeting and published atleast a month
before the meeting in the Official Gazette alongwith some other
newspapers circulating in the district where the registered office
is situated. Failure to call the meeting is punishable with a fine
which may extend to Rs.500/-.
After holding the meeting, the Liquidator is required to send a
copy of the account to both the Registrar and the Official
Liquidator, and, also make a return to each of them of the holding
of the meeting and the date of holding it. If there is no quorum
at the meeting, then the Liquidator is to make a return that, a
meeting was called but no quorum was present. Any creditor or
contributory may inspect any of the statements filed u/Sec. 497
and also make copies of them on payment of token fees.
On receipt of the account and return, the Registrar is required to
immediately register them. So also, the Official Liquidator is
required to make a scrutiny of the books and papers of the
Company, and for this purpose may ask for the cooperation of
both the Liquidator and the past and present officials of the
Company. If after scrutinizing the books, he comes to the
conclusion that the affairs of the Company have not been
conducted in a manner prejudicial to the interests of either its
members or the public, then from the date of the submission of
the report to the Court, the Company shall be deemed to be
dissolved [Sec. 497 (6)]. This date thus determines the ‘termius
a quo’ for the dissolution of a Company. But if the Official
Liquidator makes a report that the affairs of the Company have
been conducted in a manner prejudicial to either the members
or the public or both, the Court shall direct the Official Liquidator
to make further investigations of the affairs of the Company,
and for this purpose the Official Liquidator is invested with the
necessary powers u/Sec. 497 (6-A). After completing his
investigation, the official Liquidator shall again submit a report,
on receipt of which, the Court may either declare that the
Company shall stand dissolved from the date specified in the
order, or make such other order as it deems fit [sec. 497 (6-B)].
3.4 CREDITORS VOLUNTARY WINDING UP
As mentioned earlier, the test for distinguishing between
member’s voluntary winding up and creditor voluntary winding
up is 'whether a declaration of solvency has been made’. If it
has been made it is a member’s voluntary winding up, if it is not
made then it is a creditor’s winding up, even if the Company be
solvent and in such situations the provisions under Ss. 500-509
becomes applicable. The procedure to be followed in such cases
is:
1. Creditor’s Meeting: In this form of winding up, the Company
must call a meeting of the creditors either on the same day on
which it has called a general meeting of its members or the very
next day. Notices of this meeting must be sent to the creditors
simultaneously with notices of the meeting of members and
should also be advertised at least once in the Official Gazette
and once in two newspapers circulating in the district where the
registered office/principal place of business is situated. In
G.R. Deo v. F. Karim [16 Comp. Cas 104], it was held that
since the creditors cannot influence the right of the Company
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to voluntarily wind up, omission to convene creditors’ meeting
is only an irregularity and can be cured, and not an illegality
which vitiates the resolution for winding up the Company.
The Board of Directors are to lay in the creditors’ meeting, a
complete and comprehensive statement relating to the
Company’s affairs, along with a list of the creditors of the
Company and the amount of their claim against the Company.
One of the Directors is appointed u/Sec. 500(3) to preside over
this meeting and he shall be duty bound to do so. Failure to
comply with this provision will render both the Company and
the Directors liable to a fine extending upto Rs. 1000/- but merely
because a fine has been imposed will not make the proceedings
of the meeting invalid. Rules relating to holding of creditor’s
meeting are the same as in case of meeting held under a
compulsory winding up order. Thus, all resolutions must be
passed by a majority in value and number, and if they are passed
by a majority in value only they are invalid. All valid resolutions
passed at the meeting must be notified to the Registrar within
10 days of their passage, and any default in the this regard is
punishable with a fine of Rs.50/- per day of default. In case a
Liquidator has also been appointed, he would be deemed to be
an officer of the Company for this purpose and would also be
held liable.
2. Committee of Inspection : The creditors have been given
an additional right under Sec. 503, to appoint a Committee of
Inspection, consisting of not more than 5 members. But once
the creditors appoint such a committee, then, the members also
get a right to appoint not more that 5 members to the committee.
If the creditors object to any one or all of the members the
nominees appointed by members to act as such the matter
becomes subject to the direction of the Court, and the Court
may, in such situations also appoint some other persons to act
as members.
The following rules shall apply to the Committee:
i) The Liquidator or any member of the Committee may call
a meeting of the Committee;
ii) The Committee shall meet at such times as may be appointed
from time to time;
iii) One third of the number of members subject to a minimum
of two shall form the quorum.
iv) The Committee may act by majority.
v) A member may resign from the Committee by submitting a
notice to the Liquidator.
vi) Continuing members shall continue the formalities of the
Committee not with standing vacancy provided there are at
least two members.
vii) Committee has the right of inspection of the books of
accounts maintained by the Liquidator [Rule 14 of the
Companies (Central Government ) General Rules and Forms
1956]
3. Appointment of Liquidator: It is permissible for both the
creditors and the members to appoint their own Liquidators but
in case they appoint different persons, then, as per provisions
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of Sec. 502(2) the creditors’ appointment would prevail. In such
cases a Director or member or even a creditor may apply to the
Court for an order that the member’s appointee be allowed to
act as the Liquidator either on his own or jointly with the
creditor’s nominee. Application can also be made for an official
Liquidator to act as the Liquidator of the Company. The words
‘appoint’ and ‘nominate’ are synonymous for the purposes of
Sec. 502(2).
The remuneration of the Liquidator (s) is to be fixed either by
the creditors or the committee; and this remuneration cannot be
increased under any circumstance. On appointment of
Liquidator, all the functions of the board cease, except so far as
sanctioned by the committee or the creditors in their general
meeting. In case of vacancy in the office of the Liquidator, the
creditors may fill it up in a general meeting but not if the original
Liquidator had been appointed by the Court, in which case only
the Court can fill up the vacancy. Sec. 507 makes the provision
of Sec. 494 applicable to creditors winding up also with the
modification that the Liquidator shall not exercise his powers
except with the sanction of either the Court or the committee.
4. Meeting and Dissolution : In case the winding up continues
for more tan a year, the Liquidator is required to call a meeting
of the creditors., at the end of the first year and end of the each
subsequent year, and lay before them a comprehensive statement
in the prescribed format, containing detailed particulars in
respect to the proceedings and the position of the winding up. A
copy of the statement along with an affidavit - verification is to
be filed with the Registrar also.
As soon as the affairs of the Company are finally wound up, the
Liquidator must make an account of the winding up, showing
how it has been conducted and the property of the Company
disposed of, and call a general meeting of the Company and the
creditors to lay these matters before them.
The final meeting must be called by means of advertisement in
the Official Gazette, published atleast a month in advance of
the meeting, and also in some newspaper circulating in the
relevant district. Failure to call a meeting is punishable with a
fine which may extend to Rs. 500/-. The quorum for the meeting
is two.
A copy of the accounts and return of holding the meeting is to
be sent to both the Registrar and the Official Liquidator, within
one week of the meeting (if the meetings are held on different
days then within a week of the later meeting). Failure to comply
with this provision will make him liable to a fine of Rs. 500/-
per day of default. On receiving the statement and the return the
Registrar shall immediately register them.
Just as in case of members’ voluntary winding up, the Official
Liquidator would scrutinize the books of accounts etc., and if
he is of the opinion that the affairs of the Company have not
been carried out in a manner prejudicial to its members, or public,
he shall give a report stating that fact, and, the Company shall
stand dissolved from the date of submission of such report. In
case the report is adverse, he may be required by the Court to
submit a second report, and the Court may either dissolve
the Company on receipt of a second report or make any other
suitable order. But winding up shall not be deemed to have been
concluded unless compliance had been made with rule 284 (b)
which states as follows:
In case of the Company wound-up voluntarily, or under the
supervision of the Court, at the date of dissolution of the
Company, unless at such date any funds or assets of the Company
remain unclaimed or undistributed in the hands or under the
control of the Liquidator, or any person who has acted as the
Liquidator, in which case the winding up shall not be deemed to
be concluded until such funds or assets have either been
distributed or paid into the Companies Liquidation Account in
the Reserve Bank of India.
3.5 PROVISIONS APPLICABLE TO EVERY
VOLUNTARY WINDING UP
Though the Act has classified the voluntary winding up under
two categories - members’ voluntary winding up and creditors’
voluntary winding up - both following slightly different
procedures, there are certain provisions given under Ss. 510-
521 which are common to both these kinds of winding up. These
basically deal with the position and functions of a Liquidator.
These provisions can be studied under the following headings:
a) Statement of affairs : Under Sec. 511-A , a statement of
affairs of the Company is to be submitted to the Liquidator.
This statement is to be verified by the Directors, Managers,
Secretary, or other chief officers of the Company.
The statement should contain :
(i) assets of the Company, showing separately the cash in hand,
at bank and negotiable securities;
(ii) the debts and liabilities of the Company;
iii) names and addresses of the Company’s creditors, indicating
the amount of secured or unsecured debts;
(iv) the debts due to the Company and the names and addresses
of the debtors and the amounts likely to be realised from
them; and
(v) such other information as may be required.
b) Powers of the Liquidator : These will be dealt with in a
later chapter.
3.6 CONCLUSION
A voluntary winding up does not put an end to the corporate
existence of the Company. The Company continues to exist till
it is dissolved. The powers of the Directors continue to the extent
allowed by the Liquidator. A voluntary winding up, in contrast
to a compulsory winding up by Court, does not operate as a stay
of any existing proceedings or prevent the institution of any
new proceeding. The Liquidator in these cases is treated as an
agent of the Company, performing his duties in accordance with
the provisions of the Act. Further, the passing of a resolution
for voluntary winding up does not act as a notice of discharge to
the employees of the Company, unlike the position in compulsory
winding up.
As per Sec. 512(1) (a) the Liquidator may, with the sanction of
the Company, or creditors or Committee of Inspection, carry on
the business of the Company so far as may be necessary for
beneficial winding up. Where he carries on business, he can do
all things reasonably necessary for carrying it on, and accordingly
he can buy and sell and make contracts and draw, accept and
endorse bills of exchange. All debts and liabilities incurred in
the course of carrying on the business being in the nature of
salvage, will rank for payment in priority to the general debts
and liabilities of the Company. He is not personally liable on
the contracts he makes, provided that he acts in the name of the
Company, and discloses the fact of its being in liquidation, in
all transactions. [Ramaiya, p. 1261].
A Liquidator’s powers come to an end with the dissolution and
he has no power for instance, to endorse pronotes payable to
the Company’s order after dissolution of the Company. He
becomes ‘functus officio’ on the dissolution and any subsequent
exercise of power by him will be void. But, dissolution does
not always relieve a Liquidator from responsibility for non
performance of his duty. If he had been negligent, he would be
liable in damages to the creditors or contributories affected
thereby. So also, if he has left some debt of which he had notice,
unpaid, he may be made personally liable for his neglect and
default.
Since a voluntary winding up of the Company is undertaken
usually when the Company is still solvent, the role of the
Liquidator assumes even greater importance, as it is in his power
to see that the business of the Company is continued in such a
manner and the property of the Company so disposed off, as to
result in maximum benefit to all parties concerned. It is for this
reason, that, though the duties, rights and powers of a Liquidator
are mentioned in the Act itself, they are couched in such wide
terms that a vast amount of discretion is vested in him so as to
leave him free to function an a manner he deems suitable to
achieve his goals.
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4. WINDING UP UNDER THE SUPERVISION OF THE COURT
SUB-TOPICS
4.1 Power to order winding up
4.2 Effect
4.1 POWER TO ORDER WINDING UP
According to Sec. 522 after a company passed a resolution for
voluntary winding up, the Court may make an order for voluntary
winding up to proceed but under the supervision of the Court.
In making such an order the Court will have regard to the
opinions and prayers of the creditors and contributors as proved
to it with sufficient evidence. One has to distinguish 'compulsory
winding up by the Courts' and 'winding up under the supervision
of the Court.' In compulsory winding up by the Court, the Court
gives an order to the Company to go for compulsory winding
up in stipulated situations and on fulfillment of certain
conditions. Under Sec. 433 a power is given to the Court to
pass an order of winding up in appropriate cases. The effect of
the order of winding up is to put the Company in the hand of the
Official Liquidator for completing the process of winding up.
But an order of winding up under the supervision of the Court is
essentially a voluntary winding up. The Court is only competent
to direct the winding up proceedings to be done under the
supervision of the Court in order to protect any special interest
in question. As for example, in Re Baranards Banking Co
[(1866) 14 WR 722] the Court was of opinion that a proper
investigation into the affairs of the Company was necessary and
the assets happened to be large. So the Court gave an order for
winding up under the supervision of the Court. In such a case
the Liquidators appointed by the members or creditors or both,
continue to take winding up proceedings and open to the
direction and supervision of the Court. According to S 440 when
a Company is already in a voluntary winding up under the
supervision of the Court, the official Liquidator or anyone who
can apply for compulsory winding up may apply to the Court
for an order of the Court for compulsory winding up., If such an
order is given the Official Liquidator takes over the winding up
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process from the Liquidator appointed by the members and or
creditors.
Of course the Court may give order for winding up under its
supervision and appoint additional Liquidator in addition to those
appointed by the members and creditors or may remove the
liquidator appointed by the members/creditors and appoint
another Liquidator or may appoint Official Liquidator as the
Liquidator of the Company. Where an order has been made for
winding up under the supervision of the Court which was later
on replaced by another order for compulsory winding up by the
Court, the Court may direct the Liquidators already appointed
to act as provisional or permanent Liquidator in addition to and
subjects to the Control of the Official Liquidator [S. 527]
4.2 EFFECT OF THE ORDER
One of the advantages of winding up under the supervision of
the Court is that the Liquidator is allowed to continue to have
same powers and functions, as a voluntary Liquidator has, subject
to restrictions imposed by the Court if any. Courts can also
exercise same powers as its can do in case of compulsory winding
up. Thus the order is quite flexible based upon the needs of the
Company. Sec. 526 provides the following as the effects of the
order:
(a) voluntary Liquidator may continue having same powers and
functions, unless altered directly by the order of the Court,
(b) the Court will have full authority to make calls or to enforce
calls made by the Liquidator;
(c) the Court is empowered to exercise all powers as its may
do in a compulsory winding up;
(d) the Court can direct any act or thing to be done to and in
favour of the Liquidator; and
(e) the petition is to be deemed to be a petition for winding up
by the Court [Sec. 523].
5. OTHER TYPES OF WINDING UPS
SUB TOPICS
5.1. Introduction
5.2. Defunct Companies
5.3. Unregistered Companies
5.4. Foreign Companies
5.1. INTRODUCTION
Though in general when we talk of winding up, the immediate
picture which rises in front of our eyes is that of winding up of
existing and operational companies either compulsorily by the
Courts or voluntarily by the members or creditors. But in
practice there are certain other winding ups - for example,
winding up of a defunct Company which technically speaking
is not a winding up since it is more in the nature of a dissolution
of a Company which is not functioning, or the winding up of an
unregistered Company etc. These operations although not
prominent are important enough in their own way. We will now
be looking into these forms of winding up briefly.
5.2. DEFUNCT COMPANIES
A defunct Company means a Company which is not carrying on
any business or which is not in operation. Now the very purpose
of forming a Company is carrying on business, whether the
business be of a commercial nature of not. When a Company
after incorporation does not do any business, there is no reason
for its continued existence. It may be said to have never come
into existence as far as the commercial world is concerned or to
have stopped existing in the eyes of the world, and in such
situations there can be no good reason to allow its ‘paper
existence` in the Registrar’s office. Section 560 of the Act has
been incorporated for this reason and briefly states that:
(a) The Registrar shall send a preliminary notice to such a
defunct Company inquiring whether the Company is still in
operation or not.
(b) If he does not receive any response within a month of sending
the letter, then within 14 days of the expiry of the month he
shall send a registered letter, reminding the Company of
the first letter and informing them that if they do not respond
within a month, he would publish a notice in the Official
Gazette with a view to striking off the Company from his
register.
(c) If the Company does not respond even to the registered
letter or informs him that it is not carrying on any business,
then the Registrar may publish a notice in the Official
Gazette and send a registered notice to the Company stating
that, at the end of a 3 month period (from the date of notice)
he would strike off the name of the company from his
register, unless and until the company is able to convince
him as to why it should not be dissolved.
(d) When the name is actually struck off, the fact has to be
notified in the Official Gazette; and the Company then stands
dissolved.
(e) The same procedure is to be followed where the company is
being wound up and the Registrar has reasonable cause to
believe that no Liquidator is acting or that the affairs of the
company have been completely wound up, but returns have
not been filed.
(f) The liability of every Director, Managing Agent or other
officer and of every member shall continue and may be
enforced as if the Company had not been dissolved. This
raises an important question as to the extent of liability.
Does it mean that the management or the members shall
remain indefinitely liable? This question was answered in
the negative in Sri Krishna Dhoot v. Kamlapurkar [(1965)
1 Comp LJ 233}. Here, the plaintiff who had deposited
certain notes with the Hyderabad Bullion Exchange Ltd.,
as membership security, instituted a suit against the
Company, its Directors and members of its sub-committee
for the recovery of the value of the notes when the Company
had become defunct and was dissolved by the Registrar by
removing it from the register. The Directors and other
officers were however held not liable as there would have
been no claim against them prior to the dissolution of the
Company. As for the liability of the Company, the Court
held that a suit against a Company which is struck off the
register and therefore stands dissolved is not maintainable.
Explaining the scope of this section it was held, “This only
means that the existing liability of any Director or member
prior to the dissolution of the Company will continue in
spite of the dissolution. If the Directors are not personally
liable for the plaintiff’s claim prior to the dissolution of the
Company, they will not be liable after dissolution.”
Restoration: Section 560(6) provides that if any member or
creditor feels aggrieved he may, within 20 years, move the Court.
If the Court feels that the Company was actually carrying on
business or it was just and reasonable to do so, it may order the
Registrar to restore the name of the Company. Thus, in Bhogilal
v. Registrar of Joint Stock Companies (AIR 1954 MB 70), a
creditor of a defunct Company filed a petition for restoration of
its name. The petitioner alleged that he had obtained a decree
against the Company a day before the publication of the
notification. The Directors of the Company on being asked by
the Registrar misinformed him that the Company was not in
operation. It was also found that the entire share capital was
sufficient to satisfy the decree. Holding that it was just and
equitable to restore the name of the Company to the register,
the Court observed: “No steps were taken to discharge the
liability which the Company owned to the petitioner. The effect
of the order of removal would be to make it difficult for the
petitioner to obtain the fruits of his decree. Had the Registrar
known that the Company was actually defending a suit, it is
extremely unlikely that he would have ordered the name of the
Company to be removed from the register.” The provisions
relating to restoration “seems primarily intended for companies
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which were active at the moment of their mortal wound re Test
Holdings [(1969) 3 All ER 517],.”
Restoration operates retrospectively. Thus, in re Boxco Ltd.
[(1970) 2 All ER 183], a Company in ignorance of the fact that
it has been struck off the register, created a legal charge on two
of its properties. On an application by the Company the Court
restored it to the register and gave it a retrospective effect so as
to validate the charges and their registration. In Pazhaniappa
Chettiar v. South Indian Planting etc., Co. [AIR 1953 TC
161], the effect of registration was thus stated, ‘It is clear from
the section that on the restoration of a Company back to the
register after its being struck off the consequence is as though it
had never been struck off the register. The Company will be
deemed to have had its existence all through. Another
consequence is that the rights of all parties would be as though
there had been no cessation or interruption in the existence of
the Company on account of the striking off and subsequent
restoration.’
Winding Up: Section 560(5) also preserves the power of the
Court to wind up a Company, once its name has been struck off
the register, the reason being that striking off is different from
winding up. In winding up the assets of the Company are
liquidated and applied in discharge of the liabilities of the
Company. “But, if the name of the Company is struck off the
register, its undisposed property is not appropriated towards its
liabilities. It vests in the Crown as bona vacantia” [Y.R.Bhide
v. I.T.O. (1974) 44 Comp. Cas. 293].
5.3 UNREGISTERED COMPANIES
Section 582 of the Act defines an unregistered Company and
includes any partnership, association or Company consisting of
more than 7 members at the time when a petition for its winding
up is presented, but does not include a railway Company
incorporated under some Indian law or the Act of Indian or
United Kingdom Parliament, or a Company registered under
the Companies Act either (the current Act or the previous Acts)
excluding a Company whose registered office was in Burma,
Aden or Pakistan immediately before the separation of those
countries from India. Section 583(3) specifies that an
unregistered Company cannot be wound up except by Court.
This section however cannot override the provisions of any other
contemporary enactments providing for any partnership,
association or Company winding up or winding up under the
Companies Act of 1913 or other earlier Acts (Sec. 590). The
question which now arises is, whether an unregistered Company
is the same as an illegal association under Sec. 11 ? If the answer
to this question is ‘yes’ then we arrive at a contradiction, because
we have seen earlier that an illegal association cannot go in for
winding up because the Courts do not entertain any suits by or
against such associations. In Raghubar Dayal v.
Sarrafa Chambers (24 Comp Cas 388), it was specifically
stated that “before any Company can be wound up it must not
have been formed contrary to the provisions of Section 11 of
the Companies Act, 1956.` Thus an unregistered Company is
one which suffers from technical irregularity which in certain
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situations is overlooked by the Courts, but is not tainted with
illegality as the associations falling under Sec. 11 are
An unregistered Company may be wound up under the following
circumstances:
1) if the Company is dissolved or has ceased to carry on
business or is carrying on business only for the purposes of
winding up of its affairs;
2) if the Company is unable to pay its debts i.e., it is
commercially insolvent (the phrases have the same meaning
as under Sec. 433); and
3) if the Court is of the opinion that it is just and equitable that
the Company should be wound up [(Sec. 583(4) and (5)].
For the purpose of winding up, an unregistered Company shall
be deemed to be registered in the State in which its principal
place of business is situated and if it has principal place of
business in more than one State, then in the State where
proceedings for winding up are instituted. The purpose of
ascertaining the principal place of business is to see which Court
will have jurisdiction over the winding up. The jurisdiction is
however discretionary. An unregistered Company may be wound
up in the same manner as a registered Company (subject to some
exceptions and additions), and so all the provisions which apply
to a compulsory winding up by Court also apply to the winding
up of unregistered companies.
In the event of winding up of an unregistered Company, every
person who is liable to pay or contribute to the payment of (a)
any debt or liability of the Company; (b) any sum for the
adjustment of the rights of the members among themselves; or
(c) the costs, charges and expenses of winding up of the
Company, shall be deemed to be a contributory of the
Company[Sec. 85(1)]. In case any such contributory dies or is
declared insolvent, then the relevant provisions of the Act
relating to the legal representatives or assignees of such
contributories become applicable.
Once an order of winding up has been made, no suit or other
legal proceeding shall be proceeded with or commenced against
any contributory of the Company in respect of any debt of the
Company except by leave of the Court and on such terms only
as the Court may impose, and the Court shall have the same
powers as under Sec. 442.
If an unregistered Company has no power to sue and be sued in
a common name, or if for any reason it appears expedient to do
so, the Court may by an order direct that all or any part of the
property movable or immovable (including actionable claims)
belonging to the Company shall vest in the Official Liquidator.
On the passing of such an order, the Official Liquidator may,
after giving such indemnity the Court may direct, bring or defend
in his official name any suit or legal proceeding relating to that
property or which it is necessary to bring or defend for the
purpose of effective winding up of the Company and recovering
its property [Sections 588(1) and (2)].
Section 589 of the Act makes it clear that the provisions of Part
X with respect to unregistered companies shall be in addition
to, and not in derogation of, any provisions contained in the
Companies Act with respect to the winding up of companies by
the Court; and the Official Liquidator has the same powers, rights
and duties as he would have had if the Company was a registered
one; except that an unregistered Company shall not except in
the event of its being wound up be deemed to be a Company
under this Act and even then only to the extent provided for
under Part X of the Act.
5.4 FOREIGN COMPANIES
As seen earlier, a foreign Company is one which has been
incorporated outside India but have established a place of
business in India. When such a Company wants to go in for
winding up while still solvent, the laws of the country where it
has been incorporated would apply, and the Indian Courts will
not have any jurisdiction to supervise or order the winding up
of such a solvent foreign Company.
The position is different when it comes to a non-functioning
Indian branch of a foreign Company, i.e., a branch which has
ceased to do business. Section 584 of the Act, states that, such
a branch can be wound up under Part X of the Act as if it was an
unregistered Company, despite the fact that the parent body has
been dissolved or has otherwise ceased to exist in accordance
with the laws of the country of incorporation. The important
point to be noted is that such a winding up can only be through
the Court.
The wordings of the section make it clear that a foreign Company
may be wound up here irrespective of the fact that it may already
have been dissolved with the parent Company, and the proof of
such dissolution is to be disregarded. For a winding up order
under this section to be justified it is sufficient to show two
things: (a) the existence of some valuable asset of the Company;
and (b) the presence of some creditor either an Indian or a
foreigner whose debt has not been satisfied. It is totally
unnecessary to further show that this Company had an established
place of business in India at some point of time [Re Azoff Don
Commercial Bank, (1954) 1 All ER 947]. After the winding
up is over and the creditors paid off, the surplus assets are dealt
with in accordance with the provisions of the Indian Act,
irrespective of any provisions in this regard for the parent
Company or the foreign company. The assets should be
distributed among the shareholders in pari passu in the same
proportion as their share holding has to the total paid up capital
[In re Banquedes Marchands de Moscou (Koupetschesky),
(1957) 3 All ER 182(ChD)].
‘Ceasing to carry on business in India’ is the sine qua non for
the application of this section, as only in such situations can it
be said that the substratum of the Company has gone. Similar
result can be achieved if the Company is carrying on an ultravires
business, and in either case the Company can be wound up under
the ‘just and equitable` clause [Rajan Nagindas Doshi v. British
Burma Petroleum Co. Ltd., (1972) 42 Comp Cas 197 (Bom)].
Remittance Abroad of Winding up Proceeds
Applications for remittance of winding up proceeds abroad will
be entertained by Reserve Bank of India only after the winding
up has been completed and the actual net remittable surplus
established. Applications should be made on Form A2 supported
by following particulars/documents:
a) Number and date of Reserve Bank’s approval for
establishing the branch/office in India.
b) Number and date of Reserve Bank’s approval for sale of
immovable properties, if any, held by the branch/office.
c) Auditor’s certificate containing the following.
1) Manner in which remittable amount has been arrived
at, duly supported by a statement of all assets and
liabilities of the applicant, the manner of disposal of
assets, name/s, and addresse/s of the purchaser/s,
Reserve Bank’s approval number/s and date/s under
Section 31 of FERA, 1973 for disposal of immovable
properties, etc;
2) Confirmation that all liabilities in India including
arrears of gratuity, employee benefits, etc., in respect
of the applicant have either been fully met or
adequately provided for; and
3) Confirmation that no income accruing from sources
outside India (including proceeds of exports) has
remained unrepatriated to India.
d) NOC or Tax Clearance Certificate from Indian Income Tax
authorities for the remittance of net surplus.
e) Confirmation from applicants that no legal proceedings in
Indian Courts or enquiries from Enforcement Directorate
are pending against them and that after remittance of the
net surplus, no further remittance facilities will be asked
for [R.B.I. Exchange Control Manual, 1993, para 11C-5].
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6. CONDUCT OF WINDING UP
SUB TOPICS
6.1. Liability of the contributories
6.2. Payment of liabilities by the Liquidator
6.3. Adoidance of certain transfers
6.4. Proceedings against delinquent officers
6.1 LIABILITY
Every winding up, whether it be by the Court or a voluntary
winding up, is conducted in accordance with set rules and pattern.
One of the first act undertaken in a winding up is the appointment
of a Liquidator, who takes under his charge all of the Company’s
assets and manages the affairs of the Company in a manner which
would prove to be the most beneficial to the interests of the
creditors, shareholders and the Company itself. Since a
Liquidator is required to take into his charge the assets of the
Company, he has the right to apply to the Court, for recovery of
any property of the Company in possession of some person.
One of the most important assets of the Company is the ‘uncalled
capital` of the Company, because as Sec. 36(2) specifies, “all
money payable by any member to the Company...shall be a debt
due from him to the Company.” If some amount remains unpaid
on the shares of a member, the Liquidator has the power to make
a call on those shares. For this purpose a Liquidator has to
draw up a ‘list of contributories`. A contributory is defined
under Sec. 428 as “a contributory means a person liable to
contribute to the assets of a Company in the event of winding
up and includes the holders of any shares which are fully paid
up.” Of these contributories the Liquidator has to make two
lists: List A of the present members and List B of the past
members.
Liability of Contributors under List A (Section 429)
List A is drawn up on the basis of the names appearing in the
“Register of Members”, at the time when winding up
commenced. If a person knowingly allows his name to appear
on the register, he is later estopped from denying his liability as
a member, i.e., he will not be allowed to say that though his
name appears on the register he is not in reality a member. This
is because, a member’s liability during winding up does not
arise ex contractu [i.e., by virtue of a contract] but is ex lege
[i.e., by virtue of his name appearing on the register]. This
situation would be different if there was a total absence of
contract initially, for example, if shares are allotted to a person
without his applying for them. In such a situation, the Liquidator
cannot place his name on the list of contributories
[H.H.Manabendra Shah v. Official Liquidator, (1977) 47
Comp Cas 356(Del)].
Though a member may own the Company some money on the
face value of his shares, he cannot be forced to pay anything
until and unless there is a Court order to that effect and the
Liquidator serves a call notice on the member in accordance
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with the order [In re Sonardih Coal Co. Ltd., AIR 1930 All
617]. Such an order will be passed by the Court only if it is
assured that the financial situation of the Company is so bad,
that unless such a call is made, the liabilities of the Company
cannot be discharged [Section 470]. The Liquidator can make
a call on the shares without sanction of the court in case of a
voluntary winding up.
Once a valid call by the Liquidator is made, the contributories
liability becomes a statutory debt, i.e., a new liability to pay the
unpaid balance commences. In Pokhar Mal v. Flour and Oil
Mills Co. Ltd. [AIR 1934 Lah 1015], it was held, “It is settled
in a long course of decisions that the members of a Company in
liquidation are liable in respect of unpaid calls even though the
calls were made by the Company before it went into liquidation
and the suit of the Company for its realization had become barred
by time. The principle of these decisions is that Sec. 429 creates
a new liability on the shareholders in respect of such calls, which
is distinct from and independent of the rights which the Company
had against them before the winding up.” Certain other points
to be noted in regard with liability of present members, are:
a) If the list does not include a person’s name, he may give
notice to the Liquidator to make good the default. If the
Liquidator fails to act within 14 days, necessary directions
under Section 556 can be issued by the Court.
b) If a contributory dies either before or during winding up
proceedings, then his liability automatically passes on to
his legal representatives (Section 430).
c) If a contributory is adjudged insolvent, his assignee in
insolvency proceedings takes his place [Section 431].
d) If the contributory is a Company which is itself in the process
of being wound up, the Liquidator of this Company will be
the contributory on behalf of the Company.
Liability of Past Members [Section 426]
Under certain specified circumstances even the past members
may also be held liable as contributories, in accordance with
the qualifications and conditions laid down in Section 426, viz:
i) If a past member has ceased to be a member for more than
a year before the commencement of winding up, then he
cannot be made liable.
ii) The liability of a past member is limited to only those debts
which were incurred by the Company during the period
when he was a member, i.e., he cannot be made liable for
any debts incurred by the Company after he ceased to be a
member.
iii) A past member’s liability to contribute does not arise unless
in the opinion of the Court, the present members cannot
satisfy in full the Company’s liabilities, i.e., the liability of
the past members is only secondary, the primary liability
being that of the present members.
iv) A person whose shares have been forfeited is also liable as
a past member if the liquidation of the Company commences
within .
Officers with Unlimited Liability [Section 427]
Even if a Company is limited, Section 322 provides for an
unlimited liability of any of its Directors or Manager, if a specific
provision to this effect is made in the Memorandum. In winding
up proceedings such members are not only liable as an ordinary
shareholder, but are also required to make additional contribution
as if they are members of an unlimited Company. The unlimited
liability attaches to both present and past officers but in case of
past officers the qualifications under Section 426 would apply.
6.2 PAYMENT OF LIABILITIES BY LIQUIDATOR
Once the Liquidator makes a call, collects the unpaid call money,
converts the assets into cash, determines the value of total
available assets and the extent of the Company’s debts, his
primary duty then becomes the paying off of the liabilities of
the Company. Any person having a claim against the Company
has the right to claim it from the Liquidator. A secured creditor
need not go through the usual channels for claiming his debt
since he has the right to realize his security in settlement of his
claim, but he is required to compensate the Liquidator for
expenses incurred by him in preserving the security from being
realized by other creditors. But he has been given an option of
relinquishing his security and proving his claim like the other
unsecured creditors. Previously under this scheme, a secured
creditor could override the claims of all other creditors, including
the legitimate claims of the workmen. But since the Amendment
Act of 1985, which amended Sec. 529, workers’ claims are now
equated with those of the secured creditors, by providing that
the security of every creditor shall be subject to a pari passu
charge in favour of the workmen, i.e., whenever a secured
creditor wants to enforce his security, the Liquidator shall have
the power to represent the workmen in order to enforce the
presumed charge in their favour. Further, Sec. 529-A was also
added which provides for payment of the workmen’s dues in
priority of all other dues, and if the available assets are not
sufficient to pay off all the liabilities in full, then the payment
shall abate in equal proportion. Sec. 530 which provides for
‘preferential payments’ has also been made subordinate to the
provisions of Sec. 529-A. Once the Liquidator settles the list of
claimants [i.e., persons whom the Company ows money], he is
required to start making payments to them out of the available
assets in his hand.
Preferential Payments [Section 530]
The first payments to be made are called “preferential payments”.
They have to be paid in priority to all other debts. Such payments
are listed below:
1. All revenues, taxes, cesses and rates due to the Central or a
State Government or to a local authority. The amount should
have become due and payable within twelve months before
the winding up.
2. All wages or salary of any employee, in respect of services
rendered to the Company and due for a period of four months
only within twelve months before the winding up
and any compensation payable to any workman under
Chapter V-A of the Industrial Disputes Act, 1947. The
amount is not to exceed one thousand rupees in the case of
any one claimant.
3. All secured holiday remuneration becoming payable to any
employee on the termination of his employment before, or
by the effect of the winding up.
4. All amount due in respect of contributions payable during
the twelve months before the winding up under the
Employees’ State Insurance Act, 1948 or any other law.
5. All amounts due in respect of any compensation or liability
for compensation under the Workmen’s Compensation Act,
1923 in respect of death or disablement of any employee of
the Company.
6. All sums due to any employee from a provident fund, a
pension fund, a gratuity fund or any other fund for the
welfare of the employees, maintained by the Company.
7. The expenses of any investigation held in pursuance of Section
235 or 237 in so far as they are payable by the Company.
After retaining sums necessary for meeting the costs and
expenses of winding up, the above debts have to be discharged
forthwith so far as assets are sufficient to meet them. Where the
Liquidator carries on business for beneficial winding up, the
taxes that become due on the profits are expenses of winding
up. The fee payable to a chartered accountant for preparing the
statement of affairs is also an expense of winding up. The
preferential claims rank equally among themselves and have to
be paid in full. But when the assets are insufficient to meet
them, they shall abate in equal proportion. By virtue of the
provision in Section 178 of the Income Tax Act, 1961, Income
Tax authorities have been claiming preference over other
preferential payments. But the Courts have always held that
there is nothing in the Income Tax Act which interferes with or
abrogates the provisions for priority of debts laid down in Section
530(1)(a) of the Companies Act.[Avtar Singh, Company
Law,IX Edn., Eastern Book Co., Lucknow, Pp.506-508].
Insolvency Laws and Preferential Payments
If a Company is being wound up on grounds of insolvency,
Section 529 providing for application of insolvency laws to the
payment of debts of the insolvent Company becomes applicable.
Section 46 of the Provincial Insolvency Act, 1920 provides that,
if there have been mutual dealings between the debtor and the
insolvent (creditor), only that amount which remains after giving
a set-off can be recovered from the debtor. For example, A has
borrowed Rs.5000/- from B and B also has borrowed Rs.3000/
- from A. If B is declared insolvent, then his assignee can claim
only Rs.2000/- [the amount remaining after deducting Rs.3000/
- from money owed by A] from A. This right of set-off is also
available to insolvent companies regardless of the provisions of
Sec.530. In Official Liquidator v. Laxmikutty [(1981)3 SCC
32], this apparent conflict between Sections 529 and 530 was
attempted to be resolved by Bhagwati,J., in the following
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words. ‘It is true that Section 530 provides for preferential
payments, but the provision cannot in any way detract from full
effect being given to Section 529 and in fact the only way in
which these two sections can be reconciled is by reading them
together so as to provide that whenever any creditor seeks to
prove his debt, the rule enacted in Section 46 of the Provincial
Insolvency Act would apply and only that amount which is
ultimately found due from him at the foot of the account in
respect of mutual dealings should be recoverable from him and
not that the amount recoverable from him should be recovered
fully while the amount due to him should rank in payment after
the preferential payments. We find that the same view has been
taken by the English Courts on the interpretation of the
corresponding provisions of the English Companies Act, 1948,
and since our Companies Act is modelled largely on the English
Companies Act, we do not see any reason why we should take a
different view, particularly when that view appears fair and just.
Finally, if any surplus amount is left it is utilized in paying back
the shareholders in accordance with their rights, with the
‘preference shareholders’ being paid off first wherever the
articles provide that the preference shareholders would be
entitled to their arrears of dividends whether earned, declared
or not, in the event of winding up. Such a provision would
entitle them to claim arrears even if the Company had neither
commenced business nor earned any profits [Globe Motors
Ltd. v. Globe United Engg. and Foundry Co. Ltd., (1975)45
Comp Cas 429 (Del)]. This dividend which is paid to the
members is not construed as their income but deemed to be a
refund of capital, even in cases where the dividend includes
profits earned by the Liquidator [cases where he carries on the
Company business for a more beneficial winding up]. If
dividends remain unclaimed by either the creditors or
contributories for a period of 6 months, they should be deposited
in the R.B.I., from where they can be claimed by any person
after obtaining a Court order. If the dividends remain unclaimed
for a period of 15 years they merge in the general revenue of the
Central Government, but the amount remains available for
payment of liabilities which have been subsequently confirmed,
for example, - income tax dues. Before such merging, the
deposits being to the contributions cannot be claimed back by
the Liquidator or the Company revived under a scheme of
compromise.
6.3 AVOIDANCE OF CERTAIN TRANSFERS
Fraudulent Preference
Under the insolvency laws we have a concept of ‘fraudulent
transfers’ which implies that a transfer or conveyance made by
a debtor in favour of some particular creditor with an intention
of either giving a preferential treatment to that creditor or of
defrauding the other creditors, then, such a transfer would be
void, if made within 3 months of an insolvency petition being
presented against him, and he is adjudged an insolvent. This
concept of ‘fraudulent transfers` has been borrowed by the
Company law also under Section 531 and states that, any
transaction with a creditor entered into by a Company in
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preference of other creditors, within six months prior to the date
of commencement of winding up is deemed to be a fraudulent
preference of its creditors and is accordingly invalid.
But if a Company makes payment to a creditor who is
pressurizing the Company with a threat of a suit and attachment
of property, then such a payment can not be called ‘fraudulent`
provided the debt was really due. Thus in Official Liquidator
v. Venkatratnam [(1966)1 Comp LJ 243 (Andh)], one of the
creditors of a Motor Transport Co., sued the Company for debt
and attachment of its buses before delivery of judgement. A
compromise decree was passed by the Court, under which three
of the Company buses were given to the creditor. A few days
later this Company went into liquidation. The Liquidator
claimed the buses back on the ground that it was a fraudulent
preference of creditors and hence the transfer was invalid.
Rejecting the claim, the Court said: “If a debtor prefers one
creditor to another on account of pressure that is put upon him,
the payment cannot be regarded as a fraudulent
preference...Persons in charge of the management thought that
it is profitable to discharge the debts by allotting some of the
buses to the creditors.”
Ultimately whether a transaction is fraudulent or not, depends
entirely on the ‘intention of the debtor` and nothing else. Further,
under Sec. 532, a transfer or assignment by a Company of all its
properties to a trust/trustee for the benefit of all its creditors
shall also be void.
Voluntary Transfer
Under Sec. 531-A, a transfer of property whether movable or
immovable or any delivery of goods, by the Company within a
one year period prior to the presentation of a winding up petition,
is void as against the Liquidator, unless and until the following
conditions are satisfied:
a) the transfer/delivery was made in the usual course of
Company business; and
b) the transfer was in favour of a purchaser or encumberancer
in good faith and for real and valuable consideration.
Transfer of Shares
When a Company is undergoing voluntary winding up, any
transfer of shares or change in the status of member after
commencement of such proceedings is void, unless a prior
permission of the Liquidator is taken [Sec. 536]. The same
position prevails in case of winding up by Court or under
supervision of Court, with the difference that such transfer is
valid if permission of Court had been taken either before or
after the transfer is made. In respect of attachments executions
etc., the Liquidator has been given a free hand in deciding what
is just, fair or reasonable in all such cases of transfer (either of
shares or property etc.), attachment, distress of property or
execution put in force without leave of Court, after
commencement of winding up. Such transfers can be avoided
[Sec. 537]. The effect of this section was seen in Rajratna
Naranbhai Mills v. New Quality Bobbin Works [(1973)43
Comp Cas 131 (Guj)]. Here, a suit for recovery of debt was
filed against the Company by a creditor and he also got some
shares of the Company attached on the same day. A while later,
a winding up petition was presented against the Company. After
this, but before passing of a final order, a consent decree was
passed in execution of which these attached shares were sold
off, and later the winding up order was passed, and the Liquidator
sought an order declaring the sale of shares as void and the
consequential relief of recovery of the sale proceeds. Under
Sec. 537(1) any attachment or sale of a Company property
without sanction of Court after commencement of winding up
is void, and under Sec. 441(2), the commencement of winding
up is from the time of presentation of petition. In view of these
provisions, the Court had no option apart from declaring the
sale void (as it had taken place after commencement of winding
up) and that the Liquidator was entitled to the sale proceeds.
Onerous Property
Under Sec. 535, a Liquidator of a Company has the power to
abandon any onerous or burdened property belonging to the
Company. Some instances of onerous property are:
a) A land burdened with restrictive covenants;
b) Shares or stocks in companies;
c) A property not having a ready market as it requires its
possessor to either perform certain acts or pay some money;
and
d) Unprofitable contracts.
Before disclaiming such property the Liquidator has to seek
prior permission of the Court. The Court is reposed with the
duty to help the Liquidator in this regard, if it feels that such an
act would be in the best interests of the creditors and shareholders
of the Company. The procedure to be followed for disclaimer
is as follows:
1. the Liquidator should make a written application for
disclaiming the property, within 12 months of winding up
commencement. If necessary, the Court may extend this
period;
2. in case the Liquidator comes to know of the existence of
some onerous property only after a month of
commencement, then the 12 month period will start from
the time he first comes to know of the existence of such
property;
SR. Sec. GROUND OF OFFENCE
No No.
a. 538 Non-disclosure of relevant information to
the Liquidator to deliver property or books
etc., in his custody; concealment of
Company property of value of Rs.100/- or
more; fraudulent removal of property;
material omission in statement given to the
3. disclaimer of property only determines the rights interests
and duties of the Company with respect to the property,
i.e., it releases it from all liability towards the property. But
the rights and liabilities of a third party regarding such a
property remain unaffected. Hence, the Court may ask the
Liquidator to give a notice to all such persons who have an
interest in the property.
4. Occasionally such an interested party may ask the Liquidator
to decide whether he intended to disclaim the property or
not. In such cases, the Liquidator is required to make clear
his intention within 28 days, and, if he does not do so then
he cannot disclaim the property. When the property in
question is a ‘contract` and the Liquidator has not disclaimed
it then he would be deemed to have adopted it [Sec. 535(4)].
6.4 PROCEEDINGS AGAINST DELINQUENT
OFFICERS
Once a Company goes in for winding up, the Liquidator takes
into his charge all the books and papers of the Company. While
going through these books, or during the course of his
investigation he may come across information about the
underhand dealings of some of the officers. These dealings
may be either in their self interest or they in connivance with
the company defrauding the creditors either in general or at
least some of the creditors by giving a preferential treatment to
one or more creditors [i.e., fraudulent preference]. When the
Liquidator comes across these instances he has been given the
power under various sections of the Act to prosecute these
defaulting/delinquent officers and in some instances he can also
make them pay back to the company the amount which the
Company has lost due to their default (be it intentional or
unintentional i.e., through negligence). The basic objective of
these provisions seem to be that, the Directors and other officers
of the Company are owe a fiduciary duty towards the Company
and hence should be held liable when they fail in their duty by
not acting in the best interests of the Company, creditors and
shareholders. Since a Liquidator, on his appointment, takes the
overall charge of the Company, he is automatically put in a
fiduciary position and so is duty bound to prosecute such officers.
The various sections under which a Liquidator may approach
the Court seeking to prosecute the officers are listed below with
a very brief description of the offence involved and the
prescribed punishment.
PUNISHMENT
FINE IMPRISONMENT
at the between 2 to
discretion 5 years.
of Court
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 Liquidator; failure to inform Liquidator
of false claims against the Company made
within his knowledge; prevention of pro-
duction of books of account etc; con-
cealment, mutilation or destruction of
Company books or papers; etc.
b. 539 Falsification, destruction, mutilation at discretion up to 7 yrs.
etc., of books/paper with intent to of Court
defraud.
c. 540 Fraud by officers, in inducing person to at discretion up to 2 yrs.
give credit to Co., or fraudulent trans- of Court
fer by him; or hiding/removal of Co.
assets with intent to defraud creditors.
d. 541 Non-maintenance of proper accounts upto 1 yr.
throughout 2 years period prior to
winding up.
e. 542 Fraudulent conduct of business with an Personal
intent to defraud creditors or for other Liability
fraudulent purpose. for such
debts
f. 543 Same as under Section 542 or briefly ''
for misfeasance.
g. 630 Wrongful withholding of Company upto 1000/- If he defaults
property or wrongful refusal to deliver it. upto 2 yrs.

Apart from the Liquidator applying to the Court for permission
to prosecute, the Court may itself direct the Liquidator to
prosecute personally or refer the matter to the Registrar, if during
the course of compulsory winding up or winding up under
supervision of Court, the Court becomes aware that any past or
present officer of the Court has been guilty of some offence
against the Company [Sec. 545]. When the matter is referred to
the Registrar he may further refer it to the Central Government
for investigation if necessary; but where he does not see the
case as one where he ought to prosecute then he could inform
the Liquidator accordingly, who would then with sanction of
the Court undertake the proceedings himself.

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7. LIQUIDATOR
SUB TOPICS
7.1 Definitions
7.2 Appointments - General principles
7.3 Powers & Functions and duties
7.4 Responsibility for dissolution
7.1 DEFINITIONS
Liquidator - A Liquidator is a person appointed to take charge
of the assets of the Company, once it goes into winding up. He
may be any person chosen by the members/creditors (depending
on what kind of winding up proceeding it is).
Official Liquidator - He is a Liquidator who is permanently
attached to a High Court, and is an officer of the Court appointed
by the Central Government. An Official Liquidator, is appointed
as a Liquidator of the Company in all cases of winding up by
Court.
Official Assignee - He is also an officer of the Court who takes
charge of the assets of the company in case of the winding up
due to insolvency of the Company. He performs the same kind
of functions as an official Liquidator does.
The basic difference between an official Liquidator and a
Liquidator is that the former is an officer of Court who takes
charge in cases of winding up by Court, whereas the latter is an
ordinary person (i.e., one who is not an officer as above) who is
appointed by either the members/creditors, when the Company
goes in for voluntary winding up. A Liquidator is appointed in
all cases of winding up whether due to commercial insolvency
or otherwise, but an Assignee is appointed only in cases of
winding up due to insolvency of the Company.
7.2 APPOINTMENTS
As mentioned earlier, an Official Liquidator is appointed by
the Central Government, whereas the Liquidators in other cases
are appointed wither by the members or the creditors. The terms
and conditions of service and remuneration etc. is fixed by the
appointing authority. Sec. 502 gives certain rules regarding the
appointment of a Liquidator in case of creditors voluntary
winding up viz:
a) If the Company and the creditors appoint different persons
to act as Liquidator, then the choice of the creditors will
prevail.
b) If the Company is aggrieved with the creditor's choice of
the Liquidator, then an application can be made to the Court
within 7 days of such appointment by any Director, member
or even creditor.
c) Such an application can be validly made only if there has
been a prior meeting of the creditors as envisaged u/sec.
500, wherein the decision to appoint a Liquidator has been
taken.
d) If the creditors fail to appoint a Liquidator, then the one
appointed by the Company shall take charge.
e) If the Company fails to appoint a Liquidator, then the one
appointed by the creditors shall take charge.
The Companies (Court) Rules, 1959 [the Rules] also mentions
the rules relating to the appointment, etc. of the Liquidators as
given below:
R. 106. Appointment of Provisional Liquidator (1) After the
admission of a petition for the winding up of a Company by or
of the Company, and upon proof by affidavit of sufficient ground
for the appointment of a Provisional Liquidator, the Court, if it
thinks fit, and upon such terms as in the opinion of the Court
shall be just and necessary, may appoint the Official Liquidator
to be Provisional Liquidator of the Company pending final order
on the winding - up petition. Where the Company is not the
applicant, notice of the application for appointment of
Provisional Liquidator shall be given to the Company unless
the Court, for special reasons to be recorded (in writing),
dispenses with the notice.
(2) The order appointing the Provisional Liquidator shall set
out the restrictions and limitations, if any, on his powers imposed
by the Court. The order shall be in Form 49, with such variations
as may be necessary.
R. 315 Notice of appointment of Liquidator - The notice of
his appointment which every Liquidator is required to publish
in the official gazette under section 516, shall be in Form N.
151 and the notice of the appointment to be delivered to the
Registrar of companies shall be in Form No. 152.
R. 317. Security by Liquidator appointed by Court. (1)
Unless otherwise ordered, every Liquidator appointed by the
Court in a voluntary winding up, other than the official Liquidator
shall, before entering upon his duties as a Liquidator, furnish
security in such sum and in such manner as the Court may direct,
for the due discharge of his duties as a Liquidator. The cost of
furnishing the required security, including any premiums which
he may pay to a Guarantee Society, shall be borne by the
Liquidator personally, and shall not be charged against the assets
of the Company as an expense incurred in the winding up.
(2) If it shall appear at any time to the Court that the security
furnished by the Liquidator is inadequate, the Court may require
the Liquidator to furnish additional security. Where the security
required is excessive, the Liquidator may apply to the Court for
reducing the amount of security, and the Court may make such
order thereon as it thinks fit.
7.3 POWERS AND FUNCTIONS
A Liquidator is by way of being an agent of the Company,
whereas an Official Liquidator is not an agent of the Company
but is an officer of the Court. But when it comes to their powers
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or functions there is no difference between them, i.e., the mode
of appointment makes no difference to the duties which a
Liquidator performs of the powers which he yields. His powers
and duties are briefly discussed below.
Powers
A Liquidator replaces the Board of Directors and hence exercises
the same powers which the Board had, for example,
a) control over the assets of the Company - though he cannot
deal with them arbitrarily;
b) enter into contracts on behalf of the Company, if he decides
to continue with the Company business;
c) take legal action on behalf of the Company;
d) make calls for any unpaid amount on the shares;
e) press for repayment of any debts owned to the Company;
f) ask for the return of Company property in possession of
any director or member;
g) sign cheques etc. on behalf of the Company;
h) make a list of contrubutoirs, and creditors of the Company,
decide on the extent of their claims and settle them; and
i) such other powers necessary for the beneficial conduct of
winding up. Most of these powers are given under sec. 457
of the Act, and they can be exercised with or without sanction
of the Court depending on the nature of the power;
Functions
a) to take into their custody the property of the Company;
b) to maintain proper accounts and have them regularly
audited;
c) to make reasonable enquiries into any debts or claims made
by a member/creditor before allowing them;
d) to ascertain the debts or claims owned to the Company and
take steps to realize them;
e) if he decides to continue with the business of the Company
then to conduct it in a reasonable and prudent manner to
serve the best interests of the parties concerned;
f) to make a report to the Court within 6 months of the order
in cases of winding up by Court;
g) to ascertain whether any fraud has been committed by any
officer of the Company and to make such a report to the
Court;
h) in case of members voluntary winding up if the debts have
not been paid off within prescribed period he is required to
call a meeting of the creditors and lay before them a
statement of assets and liabilities of the Company; and
i) if the winding up continues for more than a year he is
required to call a general meeting at the end of first year
and of each succeeding year, to inform the meeting of the
progress made and of the assets and liabilities of the
Company;
j) in case where a Committee of Inspection is to be appointed,
he is required to call a meeting of the committee within 2
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months convene a meeting of the creditors to decide on the
committee, and within 14 days of this meeting call a meeting
of the members to inform them of the result of creditor's
meetings who can accept the suggestions or reject it. If the
members reject the Committee, he shall apply to the Courts
for directions.
k) On completion of the winding up process, he shall make
final accounts of the conduct of winding up and call a general
meeting to place before it this account, etc.
l) The Liquidator is in a fiduciary position in relation to the
Company and is required to act keeping the best interests
of the Company in mind primarily and to see that interests
of creditors, members etc. do not suffer unduly due to his
acts.
7.4 ON DISSOLUTION
A Liquidator is appointed for the purpose of winding up the
affairs of the Company - i.e., the ultimate intention is that he
would dissolve the Company and end its existence. For this
purpose, he is required to take charge of the Company, settle
claims and debts, wind up the affairs etc. and finally when all
such acts have been done which he is required to do for a
successful winding up, he can then go ahead with the dissolution
of the Company. Sec 497 of the Act provides for the final meeting
and dissolution of the Company as follows:
S. 497. Final meeting and dissolution. (1) Subject to the
provisions of section 498, as soon as the affairs of the Company
are fully wound up, the Liquidator shall-
(a) make up an account of the winding up, showing how
the winding up has been conducted and the property
of the Company has been disposed of; and
(b) call a general meeting of the Company for the purpose
of laying the account before it, and giving any
explanation thereof.
(2) The meeting shall be called by advertisement
(a) specifying the time, place and object of the meeting;
and
(b) published not less than one month before the meeting
in the Official Gazette, and also in some newspaper
circulating in the district where the registered office
of the Company is situate.
(3) Within one week after the meeting, the Liquidator shall
send to the Registrar and the Official Liquidator a copy
each of the account and shall make a return to each of them
of the holding of the meeting and of the date thereof.
If the copy is not so sent or the return is not so made, the
Liquidator shall be punishable with fine which may extend
to fifty rupees for every day during which the default
continues.
(4) If a quorum is not present at the meeting aforesaid, the
Liquidator shall, in lieu of the return referred to in sub-
section (3), make a return that the meeting was duly called
and that no quorum was present thereat.
 Upon such a return being made within one week after the
date fixed for the meeting, the provisions of sub-section (3)
as to the making of the return shall be deemed to have been
complied with.
(5) The Registrar, on receiving the account and either the return
mentioned in sub-section (3) or the return mentioned in sub-
section (4), shall forthwith register them.
(6) The Official Liquidator, on receiving the account and either
the return mentioned in sub-section (3) or the return
mentioned in sub-section (4), shall, as soon as may be, make,
and the Liquidator and all officers, past facilities to make, a
scrutiny of the books and papers of the Company and if on
such scrutiny the Official Liquidator makes a report to the
Court that the affairs of the Company have not been
conducted in a manner prejudicial to the interests of its
members or to public interest, then, from the date of the
submission of the report to the Court the Company shall be
deemed to be dissolved.
(6-A). If on such scrutiny the Official Liquidator makes a report
to the Court that the affairs of the Company have been
conducted in a manner prejudicial as aforesaid, the Court
shall by order direct the Official Liquidator to make a further
investigation of the affairs of the Company and for that
purpose shall invest him with all such powers as the Court
may deem it.
(6-B) On the receipt of the report of the Official Liquidator
on such further investigation the Court may either make an
order that the Company shall stand dissolved with effect
from the date to be specified by the Court therein or make
such other order as the circumstances of the case brought
out in the report permit].
(7) If the Liquidator fails to call a general meeting of the
Company as required by this section, he shall be punishable
with fine which may extend to five hundred rupees.
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8. CONCLUSION
In the preceding chapters we have seen as to how the existence
of a Company can be brought to an end, by following a well
defined procedure. A question may very well arise - why should
the closure of a Company or industry involve such a lot of
technical detail ? In order to answer the question one has to
remember certain basic facts. There are three interest groups
which are majorly affected by the closure of a Company, namely,
the creditors, the shareholders and the employees especially the
workmen. Of these, the first two groups have invested in the
Company in the form of ‘capital` which leaves behind extremely
visual signs, i.e., when a person gives credit to the Company he
is usually given a visual acknowledgment of the debt, in the
form of an IOU, share certificate, promissory note, security
etc. Hence their position is comparatively safer as they can
satisfy their claims from the assets of the Company.
But when it comes to the ‘workmen' of the Company it is an
entirely different story. Their investment in the Company is in
the form of ‘labour` which though instrumental in the progress
the Company is neither identifiable nor ascertainable, i.e., one
cannot say that workman A has been instrumental for .01% of
Company profits and workman B for 5%. Their’s is a collective
investment lost in anonymity, with no visual signs of individual
identity. Thus, though in the words of Gower, “the lot of the
creditors of a limited Company is not a particularly happy one;
it would be unhappier still if the Company could escape liability
by denying the authority of the officials to act on its behalf”
(Gower, p.153 referring to doctrine of “indoor management”]
It is really the lot of the workmen which is an unhappy one
sandwiched as they are between the shareholders and the
creditors and falling in neither category. If a Company could be
brought to an end without any restrictions, then their lot would
be unhappier still with none to heed to their grievances. Atleast
with a settled winding up procedure they are assured that `their
livelihood cannot be taken away from them without they being
given a chance to be heard. In National Textile Workers Union
v.Ramkrishna [(1983)1 SCC 228], the Supreme Court held that,
the workers had a right to be heard in all winding up proceedings,
so that their view point can be conveyed to the Court and their
interests safeguarded. This is one of the basic reasons why the
Courts have been given a discretionary power to order winding
up i.e., even in cases where a special resolution has been passed
by the Company to go in for winding up, the Court does not
have to pass a winding up order. It may refuse to pass such
an order if it feels that it would be against public interest to pass
such an order.
Winding up vis-a-vis Exit Policy
India being a welfare state, the Government has always tried to
look at the various problems connected with winding up,
closures, sick industries etc. from a view point more sympathetic
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to the workmen. The sickness syndrome is something to be
kept in check, corrected and cured by using appropriate measures
(official winding up being the last resort to be used). The
legislature and judiciary have always tried to see that when an
industry/Company makes an ‘EXIT’, it does not leave the
workmen high & dry. Sufficient provisions are made both in
the Companies Act and the Industrial Disputes Act, 1947, to
this end.
We have already seen in the preceding chapters how the Court
and the Liquidators treat the claims of the workmen on part
with those of secured creditors, and as to how workmen have to
be given a chance to be heard in every winding up proceedings.
We would now try to see the relevant provisions in the I.D. Act
relating to ‘EXIT’.
Chapter V-A of the Act relating to lay off and retrenchment of
workmen was introduced as early as 1953. In 1957 closure
compensation was provided for and in 1971 limitations on
compensation payment was removed. Then in 1976, Chapter
V-B was introduced which provided for prior permission of the
Central /State Government before going in for lay-off,
retrenchment or closure. This chapter was later amended after
the striking down of sec.25-O by the Supreme Court in Excel
Wear v. Union of India.
Apart from these provisions which provided for benefit to the
workmen either on their exit from the industry via retrenchment
etc. or on the exit of the industry itself via. closure, the
government has introduced many other schemes. For example,
a soft loan scheme for modernizing 5 select industries was
provided in 1976, in 1977 a scheme for merger of sick units
with healthy ones was introduced with a view to revive the sick
units, etc. These were schemes to prevent units from closing
down.
Since the introduction of the New Economic Policy, Dr.
Manmohan Singh has been talking of introducing a new “Exit
Policy”- to facilitate structural readjustment in our economy in
accordance with the IMF & World Bank directions, so that
production units of both private and public sector may avail of
the same. On the basis of the statements issued by the Finance
Minister and World Bank, it was found that, for the first time
since 1947, this proposed `Exit Policy’ would lead us from a
policy of restraint on sickness and closure to facilitation of the
same in the interest of structural adjustment. This shift in policy
would have an effect on the entire economy and especially on
the workers of organized sector and the effect would not
necessarily be positive. This fear led to an all India strike on
29-11-91. The main point to be remembered is that thought
there have been frequent talks and statements on the new Exit
Policy and its resultant consequences, the policy has neither
been formulated nor legislated upon. So we have to contend
with the exit provisions given in chapter V-A & V B of the I.D.
Act. Some of these provisions in V-A are briefly discussed
below :
1. 50% wages prescribed as layoff compensation.
2. Layoff continued for 45 days could be converted into
retrenchment, and the worker would be paid a retrenchment
compensation @ 15 days wages for every completed year
of service.
3. The principle of ‘last come first go’ to apply in case of
retrenchment of workers.
4. If the industry was in need of additional labour later, then
these retrenched workers had to be given a priority based
on their seniority.
5. Advance notice of 60 days to the State Government was to
be given in case of closure.
6. Prior notice/payment in lien of notice also had to be
complied with in case of retrenchment.
7. Compensation to a maximum of 3 months wages was to be
given when the closure was for reasons beyond control of
the employer. This limit was removed in 1971, and a full
compensation on quantum fixed for retrenchment was made
payable even for closures.
8. During emergency, the most stringent restriction was
imposed in the form of Ch. V-B, providing for prior
permission of the government before resorting to either lay-
off, retrenchment or closure, by all industries employing
more than 100 workmen.
Naturally enough, these restrictions did not find favour with the
employers and they challenged the constitutional validity of
section 25-O in Excel Wears case, The Supreme Court struck
down this section in 1978. As a consequence the most stringent
of the restrictions imposed on the ‘employer’s right to closure`
was held to be unconstitutional thereby giving a free reign to
the employers to close down an industry on their own volition
i.e., there was no necessity to seek any permission from anyone,
and they could do it by paying a nominal compensation of 15
days of wages for every completed year of service. Thus, by its
decision the Supreme Court reduced a stringent exit policy
into a liberal exit policy.
This state of affairs did not continue for long. Section 25-O was
amended in 1982 incorporating within it many of the SCs
observations in Excel Wear. The present exit-policy as
contained in Sections 25-M, 25-N and 25-O is quite
comprehensively drafted and the interests of the workmen are
adequately safeguarded.
Is there a conflict between Companies Act and I.D.Act ?
Section 2(j) of I.D.Act, 1947, defines industry as: “industry”
means any business, trade, undertaking, manufacture or calling
of employers and includes any calling, service, employment,
handicraft, or industrial occupation or avocation of workmen.
This definition is wide enough to cover a “Company”, since a
Company has not been specifically defined in the Companies
Act except for saying that a Company is one incorporated under
the Act. Thus, a Company doing business falls under the
definition of an ‘industry` under Section 2(j). The question that
arises is does a Company also have to follow the stringent
provisions laid down in Chapter V-A, V-B and V-C of the
I.D.Act, while going in for winding up ?
To answer this question we must try to analyze the basic scheme
and objectives of both the I.D.Act and the Companies Act
generally and Sections 25-M, 25-R and 25-O of the I.D. Act in
particular. Though originally this enactment was framed with a
limited purpose of serving as a dispute settlement machinery, it
has to be remembered that it is the most important legislation
governing the relationship between the constantly growing
capital and labour in the country, and hence this Act is subjected
to continuous pressure if it has to adapt to the ever changing
socio-economic needs. Chapter V-A, V-B were introduced to
deal with the entire gamut of questions pertaining to ‘job losses`,
and to as far as possible regulate job losses. Section 25-O helps
in continuing the employer-employee relation till the question
of whether the industry should be continued or wound up is
finally decided. If a particular unit is found viable, then it may
be revived under the same owner by giving it a ‘money infusion`
or it may be handed over to some other entrepreneur or workers
cooperative etc. It is only when the Board for Industrial and
Financial Reconstruction (BIFR) comes to a conclusion that the
unit in question is not viable, then winding up proceedings can
be undertaken to bring an end to the industry’s existence.
Thus, in effect, the Companies Act brings a business to existence,
whereas the I.D.Act helps to regulate the relationship between
the Company (employer) and its employees. The Companies
Act itself provides for claims of workmen to be satisfied in
priority to other claims, the I.D.Act simply specifies the claims
which a worker has if he is laid-off, retrenched or when the
industry closes down. The Companies Act lays down the general
provisions which are added to and clarified by the specific
provisions in the I.D.Act. The Companies Act is a general Act
which has to submit to the I.D.Act which is a special effect. In
effect there is no conflict between the provisions of the
Companies Act and the Exit provisions in the I.D. Act as one
merely supplements the other.
The following flow-chart depicts some of the major causes for
industrial sickness.
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 INDUSTRIAL SICKNESS

Natural Causes Man made or Induced Causes

Winding up may be
the only feasible
solution

Mismanagement Labour Problems Government Time and cost

Usually due to Policies over run in new units.
Union rivalry

Deliberate Due to negligence or Failure to move Diversion of

incompetance with times working capital
(especially true for expansion etc
for textile industry

Delay in Power Cuts & power Sudden changes Failure to provide

providing failure in import-export infrastructure in
material, policies rural areas.
subsidies etc.

Heavy dependance Delay by govt. in granting Faculty appraised

on loans high interst licenses & permits, by financial
paid power etc., delay in agencies
commencement of
production

The BIFR cannot help an industry which has become sick due
to natural causes; for example, those arising due to acute
competition, market recession or product having absolutely no
market etc., which may be common to an industry as a whole in
a market economy. The BIFR can play an effective role only in
situations where the sickness is induced/manmade i.e., either
because of mismanagement or due to governmental policies or
neglect. We would now briefly study the Constitution and
working of BIFR.

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9. SICK INDUSTRIAL COMPANIES (SPECIAL PROVISION) ACT, 1985
The preamble of this Act states as follows:
“An Act to make in the public interest, special provisions with a
view to securing the timely detection of sick and potentially
sick companies owing industrial undertakings, the speedy
determination by a board of experts of the preventive,
ameliorative, remedial and other measures which need to be
taken with respect to such companies and the expectations
enforcement of the measures so determined and for matters
connected therewith or incidental thereto.”
This clearly shows that this Act was passed to provide an
alternative to companies contemplating winding up, by providing
for a preventive mechanism to check the deterioration which
might have set it either due to lack of funds, labour problems or
some technical problems, the intention of the Act being to
prevent closure of industries as far as practicable and of nurturing
sick industries back to health. Despite having such laudable
objectives the Act itself is pretty short and consists of only 41
sections, which provide for the constitution and working of the
Board for Industrial and Financial Regulation or BIFR.
When one looks at things at the macro level, then one would be
perfectly justified in saying that industrial sickness is a logical
consequence of modern industrial civilization. Industrial
revolution and development can be achieved only by constant
revising and revolution of technology, by introducing new
processes and products. This inevitably leads to old technologies
and products becoming obsolete. It is a fundamental law of
nature that the old order is replaced by new - it is neither possible
nor advisable to change or prevent this law. But at the micro
level i.e., at the level of individual industries, it is essential to
make an attempt to cure their sickness and to rehabilitate them.
India has one of the largest unemployment rate, which has been
steadily rising since independence. It is therefore essential to
try and prevent loss of employment wherever possible, by
reviving of industry and resorting to liquidation only in extreme
cases. And this is where BIFR plays a major role.
Section 4 provides for the constitution of BIFR by the Central
Government, consisting of a minimum of 3 and maximum of 15
members one of whom shall be the Chairman. The basic
qualification for being appointed as BIFR member is that the
concerned person should not have any financial or other interest
which might adversely affect his working. His tenure is for 5
years, but he is eligible for re-appointment, provided he has not
attained the age of 65 years [section 6, which also deals with
some other terms and conditions].
A member may either resign from his service by writing to the
Central Government or he may be removed from service on any
of the grounds given under section 7, viz:
a) he has been adjudged insolvent; or
b) he has been convicted of an offence involving moral
turpitude; or
c) he has physically/mentally become incapable of acting as a
member; or
d) he has acquired some conflicting interest which adversely
effect his functions as a member; or
e) he so abuses his position that it is inadvisable to continue
him, in view of public interest.
Despite such specific grounds being given, a member can be
removed only on an order passed by the Supreme Court, which
investigates the case thoroughly on a reference made to it by the
Central Government before passing the order. This ensures that
members can discharge their functions relieved from the threat
of arbitrary removal at the pleasure of the Government. Section
9 also ensures this free working of members by providing that
their salaries etc., should be paid from the ‘Consolidated Fund
of India’, and further proviso to section 6(7) states that this salary
etc., cannot be varied to the disadvantage of the member after
his appointment.
The BIFR in a quasi-judicial body and under Section 14, the
proceedings before the Act are judicial proceedings. The
moment an industry suffers accumulated losses either equal to
or exceeding the net worth of the Company and this cash loss is
experienced for two consecutive years, then the Company is
deemed “sick” under section 3(1)(o) of the Act. Such a Company
is required to make a reference to the BIFR within sixty days
from date of audit. The report is to be filed in a prescribed
proforma (the format of which is given in the annexure of the
Act) and consists of about 58 entries or questions dealing with
various aspects of the industry to be answered. This wealth of
information itself provides sufficient material for the BIFR to
atleast arrive at a preliminary conclusion regarding the industry’s
sickness or otherwise.
Once it reaches the conclusion that the industry is sick, then the
BIFR begins an investigation into the viability of the industry
i.e., it tries to find out if by adoption of some scheme the sickness
can be checked and cured. This viability study is done by inviting
rehabilitation schemes prepared either by the promoters
themselves or by some other new entrepreneurs or even by the
workers cooperative.
The scheme so submitted is then subjected to intense scrutiny
by experts in operating agency on BIFR orders. This operating
agency is usually a Financial Institution having the necessarily
skill and expertise. Once the agency submits a report its
recommendations are taken account of, and after giving a fair
hearing, the BIFR may adopt the ‘sanctioned scheme` which
may to be successful involve the assistance and cooperation of
the Government, management, workers, financial institutions,
banks etc. The assistance may take various shapes and forms,
for example, it may be in the form of financial assistance,
technical/managerial assistance, negotiation and counsels of the
management and workers etc. The basic intention of adopting
the new scheme being to remove the ‘causative factor of the
sickness` and to nurse the industry back to health.
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If after investigation the BIFR finds that the industrial unit is
non-viable i.e., no scheme can either prevent or cure the wide
spread rot in the industry, then, the BIFR may pass an order for
winding up and inform the High Court having jurisdiction over
the Company accordingly. Once such a recommendation is made
the winding up will proceed as per the procedure prescribed in
the Companies Act and provisions under Sections 25-M, 25-R
and 25-O of the I.D.Act.
Concluding Remarks
The need for a new Act on the lines of SICA was felt, because
the I.D.Act with its pre-constitutional framework was unable to
cope up with the varied new problems arising with modernization
and rapid industrialisation, resulting in problems like excess
labour, rationalization and retrenchment. Even this was being
coped with, but then a trend started where healthy industries
were made sick and then closed, or there were closures for no
identifiable reasons, or industries started being closed merely
to make money, i.e., there was an unhealthy trend of ‘closure’,
which consequently resulted in high rate of job loss, and
unemployment problems increased. The I.D.Act and the
Companies Act were unable to cope with this trend, especially
since they had not expertise to test the viability of a unit. A
need was strongly felt to counter this lacuna and this resulted in
the passing of SICA, 1986 and formation of BIFR under it which
has been given sufficient powers to check this trend.
In an excellent article by M.S.Narayanan [1994, EPW, p.362]
he has tried to analyze the functioning of the BIFR upto the end
of 1993 beginning from its inception in mid-1987, with special
emphasis on 472 cases (of which he has made indepth analysis)
disposed of by the BIFR upto end of 1991. Some of the statistics
he has given are reproduced below:
Number of references received upto 31.7.1993 1,897
Number of references rejected as incomplete 512
Number of references dismissed under
sec. 17(1) as non-maintainable 268
Number of references in which order passed
under sec.17(2) 119
Number of references in which schemes were
sanctioned under Section 18(4) 295
Number of companies wound-up under Section 20(1) 225
Number of draft schemes circulated 41
Notice to show cause why Company should not
be wound up 66
Number of cases where scheme under section 17(2) or 18(4)
had failed and fresh schemes were under consideration 35
Balance of cases were under various steps
of consideration. 336
Despite the formulation of BIFR as an autonomous body, it
performs its functions under a lot of constraints, the major one
being that a BIFR directive is persuasive rather than mandatory
especially as regards to the government, banks or other financial
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institutions. Thus, it can only persuade them or to convince
them but cannot force them to act in accordance with its wishes.
Though the R.B.I. has issued set guidelines to the banks to be
followed in respect of sick industries, and the BIFR proposals
till now have been well within these guidelines, the banks have
not been taking prompt action on them. The State Governments
have not lagged behind in their apathy. Most of these
governments have issued policy packages for sick industries,
but are able to find innumerable delays in implementing them.
The next hurdle to be crossed by it is the delay by the ‘operating
agency` in the preparation and submission of a report, which
may be caused either by the non-cooperation of the management
of the concerned agency or the apathy and ennui of the agency
officials themselves. This problem is now practically under
control because of the time limit of 90 days set by the BIFR for
the agency to submit its report.
Further, the maximum number of members constituting the
Board is 15. These members function by forming benches, of
which four are presently working. The vacancies in the
membership have not been filled up. With the number of
industries making references steadily rising and even the public
sector units coming under the purview of SICA it is essential
for a mere efficient working of BIFR that its strength should be
increased with immediate effect.
The constraints mentioned above are not the only ones hampering
the efficient working of BIFR, but they definitely are the major
ones. Does it mean that these constraints cannot be removed? -
Certainly not. What is required is for the BIFR to be armed
with more teeth - either by making its orders mandatory (which
might not be very advisable) or giving it the power to impose
sanctions whenever it feels that the delay in adopting or
implementing its proposal/scheme is unreasonable. Some other
suggestions which might prove helpful in this regard are:
a] The approval by the Bank/State government to any scheme
proposed by BIFR should be automatically given provided
such scheme falls within the set of guidelines given by either
the R.B.I. or the concerned State government.
b] In case, the said scheme does not come within the guidelines,
then a fixed time limit of about 90 days should be given
within which the bank etc., has to record its objections etc.,
to the said scheme. If the objections are not filed within
this prescribed period then the scheme should be deemed
to have been adopted.
c] The BIFR is a public office and its members public officials.
The BIFR directives should be given ‘force of law` so that
any public servant (ex: a government officer) who does not
comply with the directives for no valid reason becomes
personally liable and punishable under Section 166 I.P.C.
which states as follows:
“Whoever, being a public servant, knowingly disobeys any
direction. If the law as to the way in which he is to conduct
himself as such public servant, intending to cause, or knowing
it likely that he will, by such disobedience, cause injury to any
person, shall be punished with simple imprisonment for a term
which may extend to one year, or with fine, or ‘with both`.”
The same personal liability should be affixed to the BIFR
personnel if they fail in performance of their duty.
d] Though under Section 19(3) a sanctioned scheme is binding
on all parties who have given their consent to it, parties
usually refuse to go ahead with their commitment. The
remedy for such situations is provided under the Act itself
under Section 33. What is needed is that BIFR should
employ people well versed in law so that they can
‘prosecute’ such parties. Such an action would prove a
deterrent to others not having an intention to fulfill their
commitments.
Merely because BIFR is working under so many constraints
does not mean that another superior body should be constituted
to either supervise the BIFR working or implement its schemes.
What is needed is a bit more power given to BIFR and a bit
more cooperation from the concerned agencies. The basic
objective of SICA is not the mere constitution of BIFR but it is
to see that neither do industries have to wind up merely due to
lack of funds, technological inputs etc., nor do the workers suffer
unduly in the eventuality of a winding up taking place. If this
objective is not aimed for then what we would end up with is a
parody of exit policy where in the colourful words of Narayanan,
‘the management will exit with the funds and workers will exit
without their dues’.
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10. CASE LAW
A. Shanmugham v. Official Liquidator [(1992) 75 Comp
Cas (Mad)1811]
Madras Pen and Ink Factory was ordered to be woundup in
1978 on the grounds that it was unable to pay its debts. An
Official Liquidator was appointed, who drew up a list of
creditors, after adjudicating upon claims lodged with him. They
covered claims of ex-workmen of the Company including
‘closure compensation’ under section 25-FFF of I.D.Act, 1947.
The proviso to this section states that if the undertaking is closed
down on account of unavoidable circumstances beyond the
control of the employer the compensation payable to the
workman shall not exceed his average pay for 3 months. The
issue in consideration was whether the present undertaking was
closed down on account of unavoidable circumstances beyond
the control of the employer. Held that the Company was ordered
to be wound up pursuant to a petition for winding up filed by a
creditor. Hence, the root cause for closure was undischarged
debts of the Company which is due to the financial difficulties
of the Company. Explanation to the proviso to Section 25-
FFF(1) of the I.D.Act specifically provides that closure of an
undertaking due to financial strain etc., shall not be deemed to
be due to unavoidable circumstances beyond control of
employer...The petitioner/workmen are entitled to closure
compensation @ 15 days pay for every year’s continuous service,
as prescribed under the first part of Section 25-FFF(1) of I.D.Act.
They are further entitled to an interest @ 12% p.a. Thus, the
Court held, “(1) the workmen become secured creditors by
operation of law from the date of winding up order, (ii) the
workmen have a pari passu charge over the security which is
held by the secured creditor under the contract, and (iii) the cut-
off date for arriving at the ratio at which the sale proceeds should
be divided on pari passu basis under Section 529 of Companies
Act, 1956, should be the date of the winding up order and not
the date of sale. The workmen are entitled to claim interest
from the date of winding up order till the date of realization of
security.
Trilok Chand Jain v. Swastika Strips Pvt. Ltd. [(1992)75
Comp Cas 275 (P & H)]
The respondent Company entered into partnership with a firm
S, which was later dissolved. On dissolution of S, its assets and
liabilities were taken by the Company. At the time of the firm's
dissolution, its goodwill value was shown as Rs.1 crore. The
accounts of the petitioners (who were S’s partners) showed
certain amounts to their credit as their share of goodwill. On
the ground that the Company had failed to pay the said amount
the petitioners sought the winding up of the Company. The
Company contested on the grounds that, (a) the capital in the
accounts of the erstwhile partners of the firm S would be payable
at the time of final dissolution of the firm S, and (b) it was with
the intention of setting off the huge losses of the firm S that its
goodwill was shown at the inflated figure of Rs.1 crore.
Dismissing the petition for winding up it was held “prima facie
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it could not be said that an admitted debt was due from the
Company. The claim to a share in an imaginary figure
representing goodwill was not sufficient to wind up a running
Company. The very fact that the petitioners had sought
dissolution of the firm led to the inference that there was no
admitted debt yet. No relationship of debtor and creditor could
come into existence without the final dissolution of the firm S
and finalization of accounts fixing the rights and liabilities of
each partner. Moreover, the petitioners as partners of the
erstwhile firm S, were jointly and severally liable to the firm’s
secured creditors, and were entitled only to their share in the
assets of the firm remaining after the creditors were paid. It
would not be just to wind up a Company solely on the ground
that some amount had been shown to be due to the petitioners
on the basis of some self-assessed goodwill, that some money
fell to the share of the petitioners even without meeting the
liabilities of the firm towards secured creditors. There was no
evidence to show this incapability of the Company to pay its
debt. Winding up cannot be ordered solely on the creditors
claim; it is the liability of the Company to pay which is the
primary consideration.”
Shree Chamundi Mopeds Ltd. v. Church of South India
Trust Association [(1992) 75 Comp. Cas. 440 (S.C)]
The appellant Company had taken on rent premises belonging
to the respondent, who filed a petition in the Karnataka High
Court for winding up of the appellant Company under Section
433(e) for failure by the Company to pay its rental dues. While
the petition was pending, the Company filed a reference to the
BIFR under Section 15(1) of SICA, in which the Board passed
an order expressing its opinion that the Company should be
wound up. An appeal by the Company against this order was
dismissed by the Appellate Authority for Industrial and Financial
Reconstruction. The Company filed a writ in Delhi High Court
against the Appellate Authority’s orders which was admitted,
and an interim stay order was passed. After dismissal of the
appeal by the Appellate Authority, winding up petition was taken
up for consideration and allowed by a single judge, and
Company’s appeal against this order was dismissed by a Division
Bench. The respondent had also filed a petition under Section
21(1) of Karnataka Rent Control Act, 1961, for eviction of the
Company, while the reference to BIFR was pending and the
trial judge allowed the eviction petition. In an appeal filed before
the Supreme Court, the issues raised were: (a) whether, after
Delhi High Court ordered stay of operation of the order of
Appellate Authority, proceedings under SICA could be said to
be pending so as to bar proceedings in Karnataka High Court
on the winding up petition; and (b) whether proceedings
instituted by a landlord for eviction of a tenant which is a sick
industrial Company are suspended by virtue of Section 22(1) of
SICA, 1985, which is applicable in respect of an industrial
Company, where: (i) an inquiry under Section 16 is pending; or
(ii) a scheme referred to in section 17 is under preparation or
consideration; or (iii) a sanctioned scheme is under
implementation; or (iv) where an appeal under section 25 relating
to industrial Company is pending. In the instant case it could
not be said that any proceedings under the Act were pending
before the Board or Appellate Authority...Section 22(1) could
not be invoked and there was no impediment to the High Court’s
dealing with the winding up petition filed by the respondents.
Further, the proceedings which are automatically suspended
under Section 22(1) of the Act are proceedings (i) for winding
up of the industrial Company; (ii) for execution, distress or the
like against the properties of the sick industry; and (iii) for
appointment of a receiver. Proceedings for eviction instituted
by a landlord against a tenant who happens to be a sick industrial
company cannot be regarded is falling in this category, and the
eviction order was not passed in contravention of Section 22(1)
of SICA, 1985.
Upper India Couper Paper Mills Co. Ltd., v. Appellate
Authority for Industrial and Financial Reconstruction
[(1992) 75 Comp. Cas. 653 (Delhi)]
The petitioner was declared a sick industrial Company under
Section 3(1)(o) of SICA, 1985. An operating agency was
appointed. The petitioner submitted a proposal for scheme of
rehabilitation, by sale of all its assets and establishment of a
new plant at a different place. The operating agency denied
that such a proposal had been made. BIFR recommended that
the petitioner be wound up. On appeal, the Appellate Authority
dismissed the appeal in limine on the ground that the
establishment of an entirely new plant of at far off place did not
amount to rehabilitation and was not covered under the Act.
The Company filed a writ against the dismissal. Held, that the
Board having determined that provisions of Section 17(1) were
not applicable and that no scheme under sections 17(3) and (18)
could be prepared, came t the conclusion that, under Section 20
of the said Act, a report should be submitted to the High Court
for the winding up of the Company. The Appellate Authority
purported to interpret section 18(1)(a) and came to the
conclusion that establishment of a new plant at a far off place
did not amount to rehabilitation and was not covered under the
Act, overlooking the fact, that section 18 did not apply here.
The provisions of Section 18 would have been relevant only if
a proposal had been submitted by the operating agency appointed
under Section 17(3). No proposal being submitted, the
interpretation of scope and effect of Section 18 could not arise.
The Appellate Authority did not apply its mind to the question
whether a scheme should have been formulated by the operating
agency. The Appellate Authority would have to see whether a
proper workable scheme under Sections 17(3) and 18 could be
formulated but if it came to the conclusion that this was not
possible, then the only alternative left was to uphold the finding
of the Board that the Company should be wound up.
S.Sundaresan v. Plasto-O-Fibre Industries Pvt. Ltd.,
[(1993)76 Comp. Cas. 38 (Mad)]
The respondent, a private limited Company was incorporated
for the manufacture of fibre glass reinforced plastic light fittings,
on the understanding that the petitioner, his relatives and friends
would hold approximately 50% of the shareholding and the
remaining 50% to be held by the Managing Director P V and
his group, and that the petitioner would be made a working
director on a salary. The petitioner filed a petition in the High
Court for winding up under Section 433(7) on the grounds that
(a) the substratum of the Company was lost and there was no
hope of revival of the respondent Company; (b) there was
complete deadlock in the Company on account of lack of probity
in the management of the Company and there was no hope or
possibility of smooth and efficient continuance of the Company
as a commercial concern; (c) the Company was really in the
nature of a partnership and the circumstances would justify the
dissolution of a firm; (d) there was no alternative remedy except
to wind up the Company; (e) the majority of the creditors and
shareholders of the Company supported the winding up. The
petitioner alleged that he had been made a Director only 3 years
after the Company was incorporated, and had not received any
salary yet, that he was kept out of the affairs of the Company,
and was unjustly removed from directorship and that there were
several irregularities in the Company’s bank dealings. Held
that (i) on a perusal of various documents, it was evident that
the subtratum of the Company had disappeared because the
object for which the Company was incorporated had completely
failed and the respondent Company had not been able to
manufacture and sell such products on a commercial basis. It
had also not paid any interest to the financial institutions, and
the activities of the Company had virtually come to a standstill
and in the present state of affairs, there was no hope of the
respondent Co. becoming a viable unit. (ii) The manner in which
the petitioner had been excluded from the affairs of the Company
and removed as Director, failure to pay his salary etc., showed
complete lack of probity in company management. Further, as
no attempt had been made after removal of petitioner to revive
the Company the Company was table to be wound up on this
ground also. (iii) Where a private limited company in the nature
of partnership is formed on the basis of an understanding that a
certain person would act as a Director, his expulsion from office
would be a ground for winding up. Principles of partnership
applied to the case and the Company was liable to be wound up.
Bellary Spinning and Weaving Co. Ltd., v. Syndicate Bank
[(1993)76 Comp. Cas. 426 (Kar)]
The petitioner Company was registered as a public limited
Company. It commenced business in 1962 and had never
declared any dividend. For commencement of business it availed
of a loan of Rs.36,24,000 from the respondent bank. Till the
date of presentation of winding up petition by the bank, the
Company owed more than Rs.2 crores to the bank the non-
payment of which had led the bank to file the petition. During
the course of hearing, the workers of the Company got
themselves impleaded and raised the objection that as the
industry was being run under the provisions of SICA it was not
open to the Company Court to order winding up. This contention
was rejected by the Company judge, who came to the conclusion
that winding up was the only alternative left
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open for the Company. The Company appealed against this
order of winding up.
It was held that: (i) section 15(1) of SICA, makes it mandatory
for the Board of Directors of a sick industrial Company to make
a reference to the BIFR within 60 days of the end of financial
year in which the Company becomes sick. The Board of
Directors had not made such a reference nor was there any
explanation of their failure to do so. They could not now insist
that the bank should have made a reference under section 15(2)
of SICA and so exhausted its remedy before BIFR, before
seeking winding up, when under section 15(2) the discretion of
doing so was left to the bank. Since the Board of Directors of
the Company had not acted under section 15(1) of SICA, the
provisions of the Act did not apply to the Company nor to the
winding up proceedings in question. (ii) that, when the Company
was neither in a position to discharge its debts or to generate
funds,nor had it placed any scheme before the Court for
improvement of its industry, the only course open was to order
winding up. No purpose would be served, in the absence of any
viable scheme, to allow the Company to exist, which would
only result in increasing its liabilities. The winding up order
would not therefore be set aside.
Faizabad Distilleries Pvt. Ltd. v. Salim Tailor [(1993) 73
Comp. Cas. 127 (All)]
The case arose out of an application by the official Liquidator
of the petitioner Company, to the Company Court for: (1) rent
due from respondent for a period of 10 months alongwith interest
thereon and (2) eviction of the respondent from property owed
by the Company. The Liquidator had sent registered notices to
the respondent asking him to pay the dues, but the letter came
back with a postal remark ‘dukan band rahiti hai,` before the
filing of this application. A copy of this Court application was
also sent to Salim but was sent back to the High Court showing
an endorsement that it was refused. The Court in these
circumstances held, “The aforesaid Salim is probably under the
impression that there will be separate proceedings by the
Liquidator to engage him in litigation on his home ground. What
the opposite party forgets is that upon a winding up order being
passed under section 446 of the Companies Act no suit or legal
proceedings can be filed or be pending on the date of winding
up order nor can be proceeded with against the Company except
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by leave of Court and subject to such terms as the Court may
impose. Further, notwithstanding anything under any other law
for the time being in force, if a proceeding is to be initiated by
or against the Company, it doesn’t preclude the High Court from
initiating proceedings straightway as if they were proceedings
of the Court of appropriate jurisdiction. The legislative intent
for this purpose is clear that there can be no impediment in the
way of the Liquidator getting involved in unnecessary litigation
as there is public accountability after a winding up order has
been passed. ....Tenants of companies under winding up
proceedings, cannot stretch the winding up proceedings to suit
their personal interest. They have to wind-up also, alongwith
the winding up of the Company. The tenant thus was held a
defaulter for not paying the rents to the official Liquidator and a
trespasser rendering him liable for eviction alongwith rent due
and interest and damage till the date of possession was delivered
to the Liquidator.
Daulat Makanmal Luthria v. Solitaire Hotels Pvt. Ltd.
[(1993) 76 Comp. Cas. 215 (Bom)]
The appellant filed a petition for winding up of the respondent
co., making allegations inter alia, of lack of probity on the part
of the respondents in relation to the functioning of the Company
siphoning off of the funds of the Company to private coffers,
omission to account for money actually received, manoeuvring
of transfers of certain shares and manipulations of entries in the
minutes and other books maintained by the Company. This
petition was dismissed by a single judge who recorded several
findings of facts adverse to the appellant. The appellant filed
an appeal. Dismissing the appeal, the High Court held, “A
winding up has to be resorted to only when other means of
healing an ailing Company are of absolutely no avail. Remedies
are provided by the statute for matters concerning the
management and running of a Company. The extreme and
irretrievable step of winding up must be resorted to only in very
compelling circumstances.
The Company being at the threshold of commencement of
commercial operations, and public financial institutions having
got involved in the working of the Company by giving sizable
financial support, it would be against the interests of all including
the appellant to halt the activities of the Company at a crucial
stage and to dismantle the entire corporate achievement. The
appeal was dismissed.
11. PROBLEMS
1. BIFR passed an order declaring industry ‘A’ as a sick
industry under section 3(i)(o) of SICA, and appointed X
and Y corporation as operating agency for revival of the
industry. The operating agency submitted a report to the
BIFR that a scheme of revival under section 17 of the Act
was under preparation. In the meanwhile, demand notices
for sales tax dues of the Company were served on the
Company, warning that in default of payment coercive
processes of recovery would be adopted, and garnishee
notices under section 23(1) of the M.P.General Sales Tax
Act, 1958 were served on various banks prohibiting them
from making any payments to the Company. Discuss
whether such notices are barred by virtue of Section 22(1)
of SICA. [(1993) 77 Comp Cas 381 (MP)]
2. Misfeasance proceedings were initiated against a Director
of the Company under section 543 of Companies Act. The
concerned Director died at an early stage of the misfeasance
proceedings. The Liquidator wants to proceed against the
legal representatives of the Director on the same charges
decide. [(1993) 77Comp Cas 6 (Kar)]
3. The Liquidator of a Company in voluntary winding up did
not decide or determine the claims of a creditor for 10 years
prejudicially affecting the creditors rights. The creditors
want to have the Liquidator removed and a new one
appointed. Decide whether the Court has the power to
remove a Liquidator on this ground alone. [(1993) 77 Comp
Cas 128 (P&H)]
4. The R.B.I. files an application in the Court for the winding
up of a Company incorporated outside India, but which had
carried on a substantial part of its business in India until
suspension of its business. The Company claims that the
Indian Courts have no jurisdiction to order winding up of a
foreign Company. Decide. [(1993) 78 Comp Cas 207
(Bom)]
5. A winding up order was made against a Company in
December 1978 and 1st June 1982 the Liquidator filed an
application ordering ‘X’ to pay a sum of Rs.3 lakhs owed
by him to the Company and for which he had acknowledged
his liability in April 1977. The winding up petition was
presented on 1.5.1978. The debtor claims that the debt due
is time barred and hence was unenforceable. Decide. [
(1984) 56 Comp Cas 441 (Kar)]
6. A Company was incorporated with the main object of setting
up a cement factory for which purpose it leased a limestone
[Note: Please specify your name, ID number and address while sending answer papers].
quarry from the Government. Despite best efforts of the
Company, finances were not available and a resolution for
voluntary winding up was passed. The office furniture was
sold off and the creditors were paid off, but the formalities
for dissolution of the Company were not completed. The
shareholders filed a petition in the Court for a stay of the
voluntary winding up, and for reviving of the Company on
the grounds that the limestone quarry lease had great
potential and production of increased quantity of cement
was in national interest. Discuss whether such a petition is
maintainable. [1984) 56 Comp. Cas 360]
7. A pledge of the Company machinery was made in favour
of person who was not creditor of the Company. Later a
winding up order was passed against the Company. The
Liquidator claims that the said pledge is invalid on grounds
of ‘fraudulent preference to creditors’. The pledgee resists
the claim. Decide. [(1984) 56 Comp Cas 435 (Kar)]
8. A creditor of a Company obtained a decree against the
Company for a sum of Rs.50,000/- owed to him by the
Company. Instead of applying for execution of the decree,
he applied for winding up of the Company. The Company
resisted the petition on the grounds that the assets of the
Company were much more than the liabilities of the
Company, and hence the petition for winding up was per so
not maintainable. Decide. [(1991) 72 Comp Cas 165
(Gauhati)]
9. A Company was ordered to be wound up by the Court. The
official Liquidator sold the assets and invested the amount
he received in a bank, where it continued to earn interest.
There was no other evidence of any business being carried
out. The Liquidator wants to claim the expenses incurred
by him by way of salaries, legal fees etc., as ‘business
expenditure’. Discuss whether such a claim is maintainable.
[(1991) 72 Comp Cas 740 (SC)]
10. ‘X’ deposited certain notes with Hyderabad Bullion
Exchange Ltd., as membership security. The Company
became defunct and was dissolved by the Registrar by
removing it from the register ‘X’ filed a suit against the
Company, its directors and members of its sub-committee
for the recovery of the value of the notes. Discuss the
liability of the Company, the directors and members of the
Company. [(1965) 1 Comp LJ 233]
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12. SUPPLEMENTARY READING

1. Avtar Singh, Company Law, 1989, Eastern Book Company, Lucknow.

2. Chakraborti, A.M., Taxman’s Company Law, Volume 2, 1994, Taxman Allied Services (P) Ltd., New Delhi.
3. Goyle, L.C., Law and Practice of Company Winding up, 1987, Eastern Law House Pvt. Ltd., Calcutta.
4. Gurbir Singh, [1992], “Another victim of a spreading sickness”, Economic and Political Weekly, December 5: 2630-49 &
50.
5. Gurbir Singh, [1992], “The Murphy Story,” Economic and Political Weekly, August 15: 1724-33.
6. Grier, J.S. and Floyd, R.E., Voluntary Liquidation and Receivership: A Practical Guide, 1985, Ozez Longman Publishing
Ltd., London.
7. Narayanan, M.S., [1994], “Industrial Sickness, Review of BIFRs Role,” Economic and Political Weekly, February 12: 362-
7.
8. Ramaiya, A., Guide to the Companies Act 1, Part 2, 1995, Wadhwa and Company, Nagpur.
9. Tulpule, B., [1994], “Industrial Sickness and Corporate Restructuring,” Economic and Political Weekly, April 9:833-15.

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