MODULE 4 – FORMATION OF A COMPANY

TOPICS TO BE COVERED –

 How A Company is Formed

How A Company is Formed

The same principle of succession theory can be applicable here. It’s a culmination of three steps
process coming together as one. Not all these processes are of legal nature. The registration and
incorporation step are of legal nature.

 FIRST PHASE – PROMOTION

Floating a company prior to the legal process begins, essentially selling an idea in a form.
There are two facets involved. Legal and Financial. Promotion is commercial aspect or
activities carried out prior to the incorporation of a company.

Commercial Steps in Promotion

1. Discovery of An Idea – Creating or selecting the business area where the

company will work.
2. Determination of the Feasibility of the idea – In terms of technological aspect,
economic aspect. These ideas are included in AoA and MoA, therefore a
feasibility check needs to be done before putting them there. Whether a company
has resources, technological resources etc. to work in that field. It will be
economically feasible to work as per the idea in the long-term phase also.
 3. Planning – Drawing a probable roadmap to be shown to the directors and
investors to show them how the company is going to function in future, providing
adequate guidance once it has been incorporated.
4. Financing – Either through investors or through own money of the promoter.
Seed financing or Foundational Finance is the base money which creates the
platform on which the company creates further finances. It is the first capital.
Before creating share capital, some capital is still needed for functioning. Such
money can be from investors or promoters. It is a very important step, since base
capital needs to be shown before incorporation is done, to show it’s not a sham.

Legal Steps in Promotion – Essentially the application procedure, or the registration part when a
company comes into existence. In terms of legal steps, its not very different from registration and
Incorporation under S.3, 4 of the Companies Act. This is given so that any person who has any
semblance of control is left out in the company.

Promoters – S. 2(69) Of the companies Act. It is a wide definition and even if you are not a part
of the company, you can still control it if you satisfy one of the three requisites in the definition
that are

1. A person who has been named as such in a prospectus or is identified by the company in
the annual return in section 92; or
2. A person who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or otherwise; - Here a person is a part of the company.
3. A person who is in agreement with whose advice, directions or instructions the Board of
Directors of the company is accustomed to act. - Here promoter has no role in the company
per se but the directors are accustomed to work with you.

Phase 3 – Commencement of Business

The second phase is for incorporation and registration, which is basically integrated in the first
phase (legal steps) and are taken care by the promoter. Therefore, the steps of promotion
officially end after incorporation, and when the commencement of business starts.
Pre – 2015 – There needs to be a

1. Certificate of incorporation – A company has been subscribed as a separate legal entity.

2. Certificate of commencement – Only after this company becomes fully functional.

After the Amendment to Companies Act, 2015, incorporation rules were amended. The two
steps were combined into one as certificate of incorporation and the business can be started right
away. This was done for Ease of Doing Business.

Pre-Incorporation Contracts

It is divided into two phases-

1. 1. Prior to Specific reliefs Act, 1963 – Incorporation of company is synonymous with

respect to existence, thus before being incorporated, it has no existence of its own.
Incorporation is necessary for making an artificial person a legal person. You need to have a
legal existence. These contracts were allowed, though not popular, why?
- Question of validity of this contract – This was resolved by suggesting this is a
beneficiary contract.
- Question of enforcement of this contract

2. Post Specific Relief Act, 1963 –

Incorporation of a company

Memorandum of Understanding and Articles of Association, two constitutional documents

for Incorporation - Going by the bracket theory, certain restrictions are created right at the
outset of a company, or during the process of incorporation which describes the objectives and
purposes of the company, which are to be followed in later time.

Memorandum
 A document with fundamental and underlying objectives behind the formation of a company.
“Memorandum of a company contains the object for which a company is formed and
additionally the scope for the operations of a company, beyond which a transaction is not to be
allowed”1. It provides for restrictions and obligations beyond which a company can’t function.
It’s a charter of negative and positive rights.

In Achbury railways carriage and Iron Co ltd case – the MoU defines the limitation or the
powers of a company – both negative and positive. Negative rights are given to the state, who
works on behalf of the shareholders, imposing limits and restrictions on the company.

S.2(56) Companies Act, 2013 – Defines MoA

Significance of a MoA

(notes incomplete for two days)

1
Palmer