The Companies Act, 2013

Weightage: Roughly 12 marks. The characteristics of a company, the grounds for lifting the corporate veil, and the doctrines of constructive notice and indoor management are the reliably examined points.

The company as a person

Section 2(20) of the Companies Act, 2013 defines a company as a company incorporated under this Act or under any previous company law. The definition is circular by design: what makes a company is registration, and everything that distinguishes it flows from that act.

The central consequence is separate legal personality. On incorporation, the company becomes a person in law, distinct from the members who compose it. This was settled in Salomon v Salomon & Co Ltd, where a trader who had incorporated his business and taken debentures over its assets was held entitled to rank as a secured creditor ahead of the company's unsecured creditors, notwithstanding that he held all but six of its shares. The company was not his agent or trustee; it was a different person.

The characteristics follow from that single fact:

Separate legal entity. The company can own property, enter contracts, and sue and be sued in its own name. A member has no insurable interest in the company's property, because it is not his.

Limited liability. A member's liability is limited to the amount unpaid on his shares, or in a company limited by guarantee to the amount he undertook to contribute on winding up. Creditors have recourse to the company's assets and not to the members' personal estates.

Perpetual succession. The company continues irrespective of the death, insolvency or exit of members. Members may come and go; the company remains until wound up in accordance with law.

Separate property. The company's property belongs to it and not to the members, even a member holding virtually all the shares.

Capacity to sue and be sued in its own name.

Transferability of shares. Shares of a public company are freely transferable; a private company restricts transfer by its articles.

Common seal. Historically the company's signature. Under the Act as amended, having a common seal is optional, and where a company does not have one, documents may be signed by two directors, or by a director and the company secretary.

Artificial person, not a citizen. A company is a juristic person but has no citizenship and cannot claim fundamental rights available only to citizens, though it can claim those available to all persons.

Lifting the corporate veil

The separateness of the company from its members is the general rule, but it is not absolute. Where the corporate form is used to defeat the law or to perpetrate a wrong, courts and the legislature will look behind it and treat the company and its members as one. This is called lifting or piercing the corporate veil.

Statutory grounds

The Act itself displaces separateness in defined situations, including:

• Misstatement in a prospectus, where those responsible are personally liable to compensate persons who subscribed on the faith of it, and may face criminal liability for fraud.
• Failure to return application money where the minimum subscription is not received, the directors becoming liable to repay with interest.
• Misdescription of the company's name — an officer who signs a bill of exchange, promissory note, cheque or order for goods on which the company's name is not properly mentioned is personally liable.
• Fraudulent conduct of business in the course of winding up, where persons knowingly party to it may be made personally responsible without limit.
• Liability for ultra vires acts of directors and officers.
• Furnishing false statements in returns, reports or other documents.

Judicial grounds

Courts have lifted the veil where:

• The company is a mere cloak or sham, formed to evade an existing legal obligation. Where a person bound by a restrictive covenant forms a company to do what he personally may not, the company is treated as him.
• Fraud or improper conduct, where the corporate form is being used to perpetrate a fraud.
• Determination of enemy character in wartime, where the nationality of the controllers is examined notwithstanding the company's place of incorporation.
• Evasion of tax or of a statutory obligation.
• The company is acting as the agent of its members, on the facts.
• Protection of public interest or public policy.
• Avoidance of welfare legislation, where a group is structured to defeat employees' rights.

The organising principle is that separate personality is a privilege conferred for legitimate commercial purposes, and it is withdrawn where it is used as an instrument of evasion.

Classification of companies

By incorporation

Chartered companies, created by royal charter — of historical interest only in India. Statutory companies, created by a special Act of Parliament or a State Legislature, such as the Reserve Bank of India. Registered companies, formed and registered under the Companies Act, which is the ordinary case.

By liability

Company limited by shares — the liability of members is limited to the amount unpaid on the shares held.

Company limited by guarantee — the liability of members is limited to the amount they respectively undertake to contribute to the assets of the company in the event of its being wound up. Such a company may or may not have share capital. The form suits clubs, trade associations and non-profit bodies, where no working capital is needed from members but a fund must be available on winding up.

Unlimited company — no limit on members' liability, though members are liable to the company and not directly to its creditors.

By number of members

One Person Company — a company with only one person as a member. Only a natural person who is an Indian citizen may incorporate an OPC, and the memorandum must nominate another person who becomes the member on the subscriber's death or incapacity. An OPC cannot be incorporated as or converted into a section 8 company, and cannot carry on non-banking financial investment activities.

Private company — a company which by its articles restricts the right to transfer its shares, limits the number of members to two hundred (excluding present and former employee-members and joint holders counted as one), and prohibits any invitation to the public to subscribe for its securities. Minimum two members and two directors.

Public company — a company which is not a private company, and a private company which is a subsidiary of a public company. Minimum seven members and three directors.

Other classifications

Government company — one in which not less than fifty-one per cent of the paid-up share capital is held by the Central Government, by a State Government or Governments, or partly by each, including a subsidiary of such a company.

Foreign company — a company incorporated outside India which has a place of business in India, whether by itself or through an agent, physically or through electronic mode, and conducts any business activity in India.

Holding and subsidiary companies. A company is a subsidiary of another where that other controls the composition of its board, or exercises or controls more than one-half of the total voting power, either alone or with one or more of its subsidiaries. The other company is the holding company.

Associate company — one in which another company has significant influence, meaning control of at least twenty per cent of the total voting power, or control of or participation in business decisions under an agreement. It includes a joint venture company but excludes a subsidiary.

Small company — a company other than a public company, whose paid-up share capital and turnover do not exceed the limits prescribed under the Act, which the Government has revised from time to time. A holding company, a subsidiary, a section 8 company and a company governed by a special Act are excluded from the definition however small.

Dormant company — a company formed for a future project or to hold an asset or intellectual property, having no significant accounting transaction, which may apply to the Registrar for the status of a dormant company. An inactive company may also obtain the status.

Section 8 company — a company formed with the object of promoting commerce, art, science, sports, education, research, social welfare, religion, charity, protection of the environment or any such object, which intends to apply its profits or other income in promoting those objects and prohibits the payment of any dividend to its members. It is licensed by the Central Government, may be registered as a limited company without using the words "Limited" or "Private Limited" in its name, and enjoys certain exemptions.

Listed company — one whose securities are listed on a recognised stock exchange.

Producer company — a body corporate having objects relating to production, harvesting, procurement, grading, pooling, handling, marketing, selling or export of the primary produce of its members.

Formation of a company

Promoters

Section 2(69) defines a promoter as a person named as such in the prospectus or identified by the company in its annual return; or who has control over the affairs of the company directly or indirectly, whether as shareholder, director or otherwise; or in accordance with whose advice, directions or instructions the board is accustomed to act. A person acting merely in a professional capacity is excluded.

A promoter stands in a fiduciary relationship with the company he is forming. He must not make a secret profit at its expense, and must disclose any interest in transactions with it. He is not an agent or trustee of the company — it does not yet exist — but the fiduciary obligation is imposed nonetheless.

Pre-incorporation contracts cannot be ratified by the company, because ratification requires a principal in existence at the date of the act. The promoter is personally liable, and the company must enter into a fresh contract if it wishes to take the benefit, subject to the provisions of the Specific Relief Act, 1963 permitting enforcement where the contract was warranted by the terms of incorporation and the company has accepted it and communicated that acceptance.

Incorporation

Application is made to the Registrar of Companies with the memorandum and articles, a declaration of compliance, particulars of subscribers and first directors, and the address for correspondence. Directors require a Director Identification Number.

On registration the Registrar issues a certificate of incorporation with a Corporate Identity Number. From the date of incorporation the subscribers, together with such other persons as may from time to time become members, are a body corporate capable of exercising all the functions of an incorporated company.

The memorandum of association

The memorandum is the company's charter. It defines the company's relationship with the outside world and the scope of its powers. Section 4 requires it to state:

Name clause. The name of the company, ending with "Limited" for a public company and "Private Limited" for a private company, subject to exemptions for section 8 companies. The name must not be identical to or too nearly resemble an existing company's name, and must not be undesirable or contain words suggesting government connection without approval.

Registered office clause. The State in which the registered office is to be situated. The registered office fixes jurisdiction and is the address to which communications are sent.

Object clause. The objects for which the company is proposed to be incorporated and any matter considered necessary in furtherance thereof. Under the 2013 Act the older division into main, ancillary and other objects has been dispensed with.

Liability clause. Whether the liability of members is limited or unlimited, and if limited, whether by shares or by guarantee.

Capital clause. The amount of authorised share capital and its division into shares of a fixed amount, with the number each subscriber agrees to take.

Subscription or association clause. The declaration by the subscribers that they wish to be formed into a company and agree to take the shares stated against their names.

An OPC's memorandum must additionally contain the nomination clause naming the person who becomes the member on the subscriber's death or incapacity.

The doctrine of ultra vires

An act beyond the objects stated in the memorandum is ultra vires the company and is void. It cannot be ratified even by the unanimous consent of all the members, because the memorandum defines the limits of the company's capacity and the members cannot confer a capacity the constitution withholds.

The consequences: the company can neither sue nor be sued on an ultra vires contract; the directors who authorised it are personally liable to the company; property acquired under an ultra vires transaction can nonetheless be retained by the company and protected; and money lent under an ultra vires borrowing may be recovered by the lender through tracing or subrogation where it has been used to pay lawful debts of the company.

Distinguish an act ultra vires the company, which is void and incurable, from an act ultra vires the directors but intra vires the company, which the members may ratify, and from an act ultra vires the articles but intra vires the memorandum, which may be cured by altering the articles.

The articles of association

The articles contain the regulations for the internal management of the company — the rules governing shares, calls, transfers, meetings, directors, dividends, accounts and the seal.

The relationship between the two documents is worth stating precisely. The memorandum is the dominant instrument: it defines the company's relations with the outside world and the scope of its powers, while the articles govern internal management and are subordinate to it. Articles inconsistent with the memorandum are void to the extent of the inconsistency. The memorandum can be altered only in the specified manner and, for some clauses, with the approval of the Tribunal or the Central Government; articles may be altered by special resolution.

Under section 10, the memorandum and articles, when registered, bind the company and its members to the same extent as if they had been signed by the company and by each member, and contained covenants to observe all their provisions. The contract so created binds the company to its members and members to the company and to each other in their capacity as members — but it does not bind the company to an outsider, and a member cannot enforce a right conferred on him in a capacity other than that of member.

Constructive notice and indoor management

These two doctrines govern how outsiders dealing with a company are treated, and they pull in opposite directions.

Constructive notice

The memorandum and articles are public documents filed with the Registrar and open to inspection. Every person dealing with the company is therefore deemed to have read them and to have understood their contents properly, whether or not he has in fact done so.

The consequence is that a person who deals with a company in a manner inconsistent with those documents cannot complain. If the articles provide that the company may borrow only up to a stated limit, a lender who advances more is deemed to know of the restriction.

The doctrine of indoor management

Constructive notice alone would make dealing with companies impossibly hazardous, because an outsider could verify the public documents but could never verify whether the company's internal procedures had actually been followed.

The rule in Royal British Bank v Turquand answers this. A person dealing with a company in good faith is entitled to assume that the internal proceedings of the company have been regularly carried out. He must read the public documents; he need not, and cannot, inquire into the indoor management.

So where the articles authorise the directors to borrow on the passing of a resolution, a lender may assume the resolution was passed. The doctrine protects outsiders against irregularities they had no means of discovering.

The exceptions

The protection is lost in these situations:

• Knowledge of the irregularity. A person who actually knows the internal procedure was not followed cannot rely on the doctrine.
• Suspicion of irregularity. Where the circumstances are suspicious and would put a reasonable person on inquiry, failure to inquire forfeits the protection.
• Forgery. A forged document is a nullity, and the doctrine does not validate it — the company is not bound at all.
• Acts outside apparent authority. Where an officer acts beyond the authority his position would ordinarily carry, the outsider cannot assume authority he had no basis to expect.
• No knowledge of the articles. A person who has not read the articles and does not rely on them cannot claim protection derived from what they permitted.
• Acts void ab initio, such as those ultra vires the company.

The relationship between the two doctrines is the point to state in an answer: constructive notice protects the company against outsiders, and indoor management protects outsiders against the company. Together they draw a line at the door of the registered office — what is on the public file is the outsider's responsibility, and what happens inside is the company's.

How this chapter is examined

Practical problems typically ask whether the corporate veil should be lifted where a company has been formed to evade an obligation; whether a company is bound by a contract made by directors who exceeded an internal limit, testing indoor management and its exceptions; and whether an act beyond the objects can be ratified, testing ultra vires.

Descriptive questions ask for the characteristics of a company, the classification of companies, the contents of the memorandum, and the distinction between memorandum and articles or between a private and a public company. State the consequence in each case — that an ultra vires act cannot be ratified even unanimously, that a company limited by guarantee calls on members only on winding up, that a section 8 company cannot pay dividends — because the consequence is what shows the classification has been understood rather than listed.