Why Do We Need Company Law?

When we think of a company, we think of business. Business is nothing but a systemized series of transactions. There needn’t be a specific law that tells people how to get together and carry out transactions. Even if we needed a law to bind us to our word and perform our part of the promise, the law of contracts exists to provide legal backing to our claims and those of the other parties to a transaction.

The law of companies serves a function beyond merely ensuring that contracts are performed, and that people are benefitted from commerce.  But once a company is incorporated, it acquires a number of features that give it a distinct identity.

A company needs people to believe in it by investing in it and by availing of its products or services. Thus, the people’s interests figure largely in the functioning of a company.

To ensure that there are no defaults that may disrupt the smooth functioning of a business enterprise, and to uphold transparency and accountability, we need company laws that provide an outline of the way in which a company must do business and be managed.

 

What Is A Company?

A company is a body or an entity that has a separate legal existence from the members who comprise of it. It is a legal fiction that has been created by the Companies Act, 1956. This independent corporate personality that’s conferred upon a company on its creation is very unique in its features. For instance, a partnership has no existence apart from its members.

There are different people who contribute in various ways to the working of the company.

Who looks out for the company when the directors have not yet been appointed?

Promoters exist to provide the financial and fiduciary aid in the setting up of a company and they are the individuals who constitute the yet unformed company at the time of submitting documents and registration.

The other important parts are played by the directors and shareholders. The board of directors take care of the business and management of the company, and the shareholders help keep the company afloat.  Even the directors are appointed after the formation and registration of the company.

The business is done in the name of the company and all the profits accrue to it, out of which dividends are paid to the shareholders – who are the investors in the company.

 

What Are The Features Of A Company?

When a company is being incorporated, the individual(s) setting up the company, will have an idea of what they want out of the incorporation, and they can choose from choices that vary according to identity, ownership, liability etc.

Perpetual Existence: After a company is set up, it may continue to exist and function until it is wound up or the object for which it was set up is achieved. Therefore, even if all the members currently comprising a company pass away or leave the company, it continues to exist. This is done so that the identity of the company is not limited to its directors or members. The identity of a company remains as long as it continues to conduct business under the same name and terms.

The only way a company will cease to exist is if it is wound up. This shall be dealt with in detail later. Until there is any reason to wind-up, it will continue to run. In fact, even if the company has no funds and is not doing any business for a while, the company continues to exist until an order for winding up has been passed.

 

–> Example: A and B set up a company known as FunFirst, but they have some disputes about the way the company is supposed to work. After the company has been incorporated, but before it begins business, A leaves the company and starts another company called Fundays. B is disillusioned and FunFirst does not start work. Even now, FunFirst is still in existence because it took birth upon its incorporation and has not been put to death as yet.

Capacity to sue and be sued: Deriving from the notion of separate legal identity, it follows that a company has the capacity to sue against a wrongdoer and has the capacity of being sued for civil wrongs.

When there is improper conduct of business by the company, or there is a need to specifically enforce a contract, or for any other civil remedy, the company is a legal entity that may sue and be sued. The company may not be held criminally liable as a criminal act requires mens rea, or a guilty mind, which cannot be proved in the case of a company.

Try being a Judge!

In India, defaming someone by publishing falsehood about them is a crime. If a company broadcasts an advertisement openly mocking a rival product, can the person who commissioned the advertisement be held criminally liable?

Limiting Liability: Business always involves an element of risk; sometimes the risk leads to high returns and sometimes to losses. Monetary liabilities are bound to occur in the course of conduct of any business.

An individual may incur unlimited liability which could ruin a company and defeat the goal of perpetual existence. The law allows a company to put a cap beforehand on the extent to which it will be liable in the event of default. Any liabilities arising out of business conducted in the name of the company, with the sanction of its shareholders, will be limited to the extent specified by the company.

Also, although a company is a legal person, it cannot be held criminally liable because of the absence of the critical concept known as mens rea, or a guilty mind. However, there is a concept known as ‘piercing the corporate veil’ through which the people behind the company, the directors who owe a fiduciary duty to the company may be indicted for criminal offences committed by them in the name of the company.

Corporate Veil: Imagine that all the people working for the company, in the name of the company, are standing under one all-encompassing blanket of identity. Let us call this the corporate veil. To pierce or lift this veil is (usually for the courts) to “see through” the company and let its members directly be liable for (or benefit from) the company’s legal position.

Some of the situations in which the corporate veil may be pierced are: (1) Fraud (2) Group of Enterprises (3) Agency (4) Trust (5) Tax

–> Example: A man leaves a company to start his own business, but his contract had mandated that he should not solicit the clients of the company if he leaves. He set up a company in his wife’s name and began to solicit clients. The Court here will elect to pierce the corporate veil to reveal the fraud.

 

–> Example: Under the law, if a person issues a cheque that does not clear due to lack of funds, it is a criminal offence. A director makes a payment with a cheque on behalf of the company, which later bounces. In such an instance, the corporate veil will be pierced and the director will be held personally liable for issuing a bad cheque.

 

–> Example: There exist a group of companies owned by the same set of people. If any accounting discrepancies arise, the Courts may elect to pierce the corporate veil to see the financial accounts of the group of enterprises together, as one.

 

–> Example: To decide whether an entity must be charged liable to pay tax, the Courts may have to lift the veil on the identity and ownership of the company.
Transferable Shares: Anyone who contributes financially towards the working of the company by buying a share of the company owns that much of the company. Every shareholder, is thus a partial owner of a company. In a private company, there cannot be more than 50 shareholders, which is a restriction on the transferability of shares. A public company’s shares, on the other hand, may be traded freely on the stock market. One of the primary attributes of a public company, in fact, is the free transferability of shares.

 

–> Example: When the stock market news says that the shares of ‘A’ company have fallen by ‘x’ points, they mean that the value at which the shares are being traded is lower than the value at which they were first released.
Separate Property: A company is a legal person and may thus own property in its own right. The legal personhood of the company gives it certain inalienable attributes, such as that it can enter into contracts, it has liabilities, it is liable to be taxed etc. This personhood separates the actions of the people acting on the company’s behalf and the liability of the company itself.

–> Example: The director of a company cannot buy land in the name of the company and then build a residential house on that plot.

–> Example: If any company buildings are built over disputed property, the claim must be made against the company and not against the director(s).

 

Private and Public Company: A private company is one where the stakeholders of the company – whoever has a stake in the company – are not members of the general public. They are members to whom shares have been offered, or they may be the promoters or directors of the company.

People who set up private companies do so with the intention of keeping the business decisions and profits within the desired community. As more people begin to contribute towards the company, their stake in the company increases and so do their rights as to the working of the company.

A public company is one where the stakeholders may include members of the public. A company may do this by dividing its capital into many small parts and offering these parts to the public, so that each member of the general public who has an interest in the business and the growth of the company may buy as many of these parts, known as shares, as they want.

There are a few other differences between a private and a public company. In a private company, the minimum number of members required to start a company is 2, whereas for a public company the minimum of 7 members are required to start a company.

There is a restriction on the maximum number of members for a private company, and that is 50, but there exists no such upper limit for a public company.

 

Point of Interest!

A private company may be transformed into a public company, or vice versa, if the necessary amendments are made in all the documents that refer to such status of the company and the Registrar is notified. A public company’s activities are far more regulated than a private company, because of the number of stakeholders.

Registrar of Companies: When a company is set up and commences business, it affects not only the employers and employees within the company, it affects the industry and market as a whole, affects the consumers and the various stakeholders in the company and it also affects the government.

The inter-relationships between these various entities require supervision and regulation. The Registrar’s Office is the place where a company is registered, along with the name and the necessary documents. The documents required to register a company will be discussed soon.

Point of Interest!

National Company Law Tribunal

The Supreme Court recently validated the setting up of an overarching corporate law tribunal that will take up the company law disputes pending with the Company Law Board, the Board for Industrial and Financial Reconstruction and various high courts.

Amendments were made to the Companies Act made in 2002, and paved the way for the establishment of the National Company Law Tribunal (NCLT).

Chapter Two: How does a Company Work?

Incorporation of a Company

For a company to be registered and legally recognized, it needs to be incorporated. A body of individuals or entities may possess all the attributes that indicate the existence and working of a company, but the incorporation of a company gives it the required legal status.

This incorporation is done when a company is registered and the certificate of incorporation is given. The company is registered when it has submitted the Memorandum of Association and the Articles of Association to the Registrar of Companies. These documents give a basic outline of the scope of business of the company, define its objectives, and try to lay down the various roles to be essayed by the different individuals and entities working within the company’s framework.

 

Some of the documents needed for registration are:

1. Memorandum of Association
2. Articles of Association

Memorandum of Association: The memorandum of association is one of the most important documents of a company as it sets out the distinct aspects of the company and provides requisite information about the company to outsiders – such as the name of the company in the name clause; the state in which the registered office is situated, in the registered office clause; the main objective and the other ancillary objects that the company was set up with, in the objects clause; the nature and extent of the company’s liability in the event of default or bankruptcy and the capital clause sets out the total amount of share capital, and provides for the number of shares.

What does a memorandum of association contain?

1. Name Clause
2. Registered Office Clause
3. Objects Clause

The memorandum provides the structure within which the company expects to function. It also lays down some boundaries as to the operation of the company. For instance, the objects clause provides for the main area of business and also ancillary areas, but a company cannot conduct business in any other areas than those specified in that clause.

However, the memorandum is not the only document through which the powers of a company may be ascertained. If the memorandum provides for something that is not legal under the Companies Act, the provision is void.

The last part of the memorandum is the subscription where the subscribers declare that they are intent on forming a company and they agree to take up the shares that have been set against their names.

–> Example: The Companies Act says that a company cannot have any illegal objects for setting up a company. If I set up a company to build warships to overthrow the government, it would be an illegal company.

 

–> Example: Omar sets up a company with the purpose of conducting research into cloning cows to increase dairy productivity. Since cloning is illegal, the company will be illegal.
Articles of Association: The Articles of Association of the company lays down the rules for its administration. All the rules and regulations that outline the relations between the company and its members, among the members themselves are given in the Articles. The However, in case of an inconsistency between the Articles and the Memorandum, the Articles must give way.

–> Example: There is a provision in the Memorandum of Association of a company that violates the Articles of Association of the Company. It is found that the provision also violates the Companies Act.

If the Memorandum violates any provision of the Companies Act, it is void. Therefore, in cases where the Articles of Association conforms with the Companies Act, and the Memorandum is in disagreement with both, the provision of the Companies Act will prevail.

Try being a judge

A director of a company does something that is not authorized by the Articles of Association, but he tells the client that there is no restriction on his doing so. Later, the client finds out that the act had never been authorized by the company. Can the client cannot claim compensation from the company?

Through development of case law in other common law countries and elsewhere in the world, the law of companies comes with a few legal principles that may be used in cases involving companies.

Let us start with the doctrine of Constructive Notice:

Constructive Notice: The memorandum and the articles of association of every company are registered with the Registrar of Companies. It is a public office and all the documents filed with the Registrar therefore become public documents, open and accessible to all the members of the public. A person intending to deal with the company, who wishes to do business with the company can easily access these documents and get to know about the framework within which the company operates and the manner in which business is done. The doctrine of Constructive Notice, in fact, presumes that any person intending to enter into a contract with the company would have read the Memorandum and Articles of the company, and has acted on the basis of that knowledge.

–> Example: An intern at a company enters into a deal with a client by saying that he was authorized to make the deal. The client later finds out that the intern was given no such power or authorization, and so, the deal was never valid. The client cannot take action against the company, because he should have verified beforehand with the Articles of Association of the company.

The filing of these public documents with the Registrar is to be construed as constructive notice for anyone intending to enter into a contract and do business with the company.
Indoor Management: You must have understood that the doctrine of Constructive Notice exists in order to protect the company against the outsider and any needless legal action that may arise in the absence of the doctrine.

The doctrine of Indoor Management says that any person entering into a contract with any member of the company is entitled to presume that the contract is legal and valid. That means that all the rules and regulations relating to the conduct of that business have been complied with and unless there is reason for the outsider to believe otherwise, the contract is legal.
–> Example: Suppose the directors of a company do not have the power or the authority to enter into certain contracts without holding a meeting, the contracting party has a right to presume that the directors have held that meeting and have received the requisite power or the authority to enter into those contracts.

 

Now, we have an idea of some of the legal principles under which a company may operate. Let us move on to the composition of a company. Typically, a company is established by the promoters, managed by the directors and kept afloat by investors. The Companies Act does not contain the word promoters and the role they play is not governed by the Act. Thus, we will move on to understand the directors of a company.
Directors

The directors are the living beings through which the company, an artificial legal entity conducts its business. As you may have learned in contracts, when a person enters into contracts and does business on another person’s behalf, he is called an agent; an agent of the principal. In this case, the company is the principal and the directors are agents of the company. It is an important distinction to realize that the directors are not each other’s agents but the agents of the company.

 

–> Example: Anil, who is the director of ABC & Co., has taken a personal loan and he defaults on the loan. The recovery cannot be made against the other directors of the board ABC & Co.

 

–> Example: Anil, a director on the board of ABC & Co., has taken a loan on behalf of the company and fails to repay it by the maturity date. The creditors may proceed against the other directors of the company.

 

Trustee: A director is also a trustee of the company, as he is responsible for the conduct of business on behalf of the company and uses the company’s property and wealth to conduct that business.
Directors of a company are expected to look after the interests of the company, and to work in the interest of the company. While it is not expected of them to forego their own interests, what is required is a disclosure by the director in relation to the transaction that he has an interest in. There are no regulations cast in stone that lay down the rights and duties of the directors of a company.
Regarding duties, he is required to take care of the Company, nurture it in a sense and help it grow and prosper. And in the proper context, a director’s duties in equity are his duties in law, meaning that anything he may be expected to do as a responsible person with fiduciary duties towards the company, will be the standard he will be evaluated against. While equity is merely a set of principles that are applied instead of strict legal principles, it is necessary in cases such as these. This is so because it is not possible to list out the various responsibilities that may arise in the course of business by the directors.

However, some duties are necessary for the smooth everyday functioning of the company. For instance, a director is expected to attend most of the board meetings and if he fails to attend 3 meetings in a row, he will have automatically vacated his position as director.

He is also required to acknowledge and attest the financial statement of the company that is presented at the annual general meeting.

1. A director need not exhibit more skill than may be reasonably expected from a person of his knowledge and experience.

–> Example: If a director of a company is also qualified as a Chartered Accountant, he is expected to be able to analyse a balance sheet and declare whether the company is making profits or undergoing losses.

–> Example: A director of a company is not required – in terms of skill – to be able to motivate his employees and workers daily to make them work 12 hours every day.

2. A director is not bound to give continuous attention of the affairs of his company, his duties being of a managerial nature, to be performed at periodical Board Meetings. He is not bound to attend all Board meetings, though he ought to attend all such meetings as he is able to.
3. If the director has entrusted someone with a responsibility, in the course of his business – then, in the absence of grounds for suspicion, the director is justified in trusting that person to perform such duties honestly.
4. Though all books of account and other documents of the company are open to inspection by him, he is not bound to examine individual entries in the books.
5. While a director will be liable if he causes loss to the company due to his negligence, he is not expected to take all possible care. His duty to the company extends only to the taking of such care as an ordinary man is expected to take in his own affairs.

–> Example: If a director entrusts his secretary with filing the company’s tax returns, he is required to take only as much care as he would if he had entrusted his secretary with filing his individual tax returns.

6. Directors should ensure that the company’s fund are properly invested and not indulge in dangerous speculation.

This just means that in terms of the investments they make with the company’s money, the directors must exercise caution and act wisely.

7. In discharging their duties, directors must act honestly and must exercise such degree of skill and diligence as would amount to reasonable care which an ordinary man might be expected to take.

 

Shareholders

The next important role in the running of a company is played by the members or the shareholders. Every shareholder is a member of the company. And each share that a member holds represents his ownership of that fraction of the company.

There may be different kinds of shareholders, like, preference shareholders and equity shareholders. Equity shares are also called ordinary shares. It depends on the kind of share you have bought. The kind of share you buy will be based on the difference in features, in rights and liabilities that arise from owning them.

The Stock Market

Companies need capital to do business, to grow and flourish. In a bid to do so, they may decide to raise capital from the public. Ordinary shares are exactly what the name signifies — they are shares that are bought and sold in the stock market.

Preference shares, on the other hand, are a little more special. To understand preference shares, we will have to first understand what dividends are. When you buy shares, you invest in the company. That makes you a shareholder or part-owner in the company.

The good news is that, since you own part of the assets of the company, you are entitled to a share in the profits these assets generate.

If you sell the shares for more money than you bought them for, the profit you make is called capital appreciation.

You could also make money with dividends.

Usually, a company distributes a part of the profit it earns as dividend.

 

–> Example: A company may have earned a profit of Rs. 1 crore in 2003-04. It keeps half that amount within itself. This will be utilised to buy new machinery or more raw material or to reduce its loan with the bank. It distributes the other half as dividend.

 

 

Meetings

Meetings are essential for the proper functioning of the company. Through these periodically scheduled meetings, the investors and the managers of a company can get together and perform the duties required to ensure such proper functioning.
Meetings: A meeting must be periodically called by the company’s directors to review the workings of the company, to announce the financial statement, to appoint directors and auditors, to decide on a future course of action or any of the important functions that a company has to undertake with the approval of the shareholders.

There are different types of meetings that are convened for different purposes. They are:

1. Statutory Meeting
2. Annual General Meeting
3. Extraordinary General Meeting

 

Point to be noted, milord!

Quorum: A requirement of a valid meeting is that there must be a minimum number of members present to pass any resolution. If the minimum requirement is not fulfilled, it will not be a valid meeting.

1. Statutory Meeting: This meeting is so called because it is required by the Company Law statute. It is the first meeting that is held by the company after it is incorporated and must be held any time before 6 months elapse, but after a minimum of 30 days have passed since its incorporation. It is known as a statutory meeting because the statute, the Companies Act, necessitates the holding of such meetings. All the shareholders are required to be present at this meeting. Here they appoint the board of directors, discuss the direction of the company etc.

If a meeting is not held within this period, the directors of the company may be liable to pay a fine. Another possible outcome of this default is that the court can order the winding up of the company.

2. Annual General Meeting: An annual general meeting is a meeting of the shareholders of the company and one such meeting must be held every year. The first of these meetings must be held within 18 months of the incorporation of the company, which is 1.5 years. The company need not have another one for that year and the year after that. Thereafter, one meeting must be held every year and the gap between two meetings should not be more than 15 months.

This is the most important meeting for every shareholder of the company. At this meeting, the members will review the working of the company and discuss the accounts. They will also be able to appoint new directors to take the place of any retiring directors. In this meeting, they also appoint the auditor for the company. All of these decisions are made at the meeting by taking votes and passing resolutions based on those votes. Each shareholder gets one vote for each share he holds. Depending on the nature of the issue to be decided, the members resolve the issue either by ordinary or by special resolution.

There are two types of Resolutions:

1. Ordinary Resolution: Ordinary resolutions are those that are passed by a simple majority, when the total number of people for the motion are greater than the total number of people against the motion.
2. Special Resolution: Special resolutions are required for issues that are more important and therefore need the consent of a greater number of members. 75% of the members present and voting must vote in favour of the issue for it to be resolved.

 

 

Extraordinary General Meeting: Any meeting of a company that is not held as an annual general meeting and does not fall within such a scope is known as an extraordinary general meeting. The board of directors may call such a meeting whenever it thinks fit and any resolution passed at such a meeting is a special resolution. This means any resolution that is passed requires the assent of ¾ of the members present and voting.

Chapter Three: What happens when things go wrong?

Prevention of Oppression and Mismanagement

As in a democracy, where the decisions are made on the basis of number of votes, the decisions of the company usually reflect the voice of the majority. Although this is the intent of setting up the vote system, so that most people are satisfied with the decisions, there is a need to protect the interests of the minority as well.

 

Point to be noted, milord!

There was an English case, Foss v. Harbottle, where the court held that it would not interfere in the management and administration of the company upon a shareholder’s complaint if the directors were acting within the ambit of their powers. This basically upheld the sanctity of the majority rule.

 

The Court also said that in case a detriment is caused to the company, then the proper plaintiff would be the company itself, as it is a legal person with capacity to sue. This was done to prevent undue interference of the courts in the working of the company.

However, the very need for the court’s interference may arise because of improper working of the company by the Management or the majority.

These situations are exceptional and are noted in the Companies Act where the Court must take notice in case the minority speaks up against certain acts by the majority or managerial misconduct. They are:

1. Acts ultra vires the Articles of Association or beyond the scope of the Articles of Association
2. Fraud on Minority
3. Acts requiring Special Majority
4. Wrongdoers in Control
5. Oppression and Mismanagement

 

1. Acts ultra vires the Articles of Association

The Articles of Association, as we know, provides for the internal administration of the company and contains information about the nature and extent of the interrelationship of the various entities within the company.

–> Example: The Articles state that the remuneration of the directors of a company will not exceed a certain amount. But it is found later that they have been taking home salaries greatly exceeding that amount. This would be to an Act ultra vires the Articles of Association.

1. Fraud on Minority

This phrase is generally used to mean ‘a discriminatory action’ by which the majority gets something that the minority is deprived of. The point is, even if the decision taken is that of the majority, but the powers should be exercised in good faith and for the benefit of the company as a whole.

–> Example: In a particular case, the majority shareholders procured a contract in their own names in place of the company’s name. This was seen as a fraudulent action on the minority.

1. Acts requiring Special Majority

We have discussed the distinction between Ordinary and Special Resolutions. There is a reason why certain decisions require a greater number of people within the company to give their assent. If these decisions are taken without the requisite number of votes, it would be an improper resolution.

Therefore, the Courts have made it actionable where Ordinary Resolutions are passed where Special Resolutions are required.

–> Example: If the Board of Directors of a company wish to alter the Memorandum of Association of a company, a Special Resolution will have to be passed at the shareholder’s meeting.

–> Example: If the Board of Directors of a company wish to appoint an additional member to the Board, an Ordinary Resolution will have to be passed at the shareholder’s meeting.

1. Wrongdoers in Control

If an obvious wrong has been done to the company by the majority shareholders, then the minority or even a single shareholder can sue on behalf of the company for the obvious violations of fiduciary duty.

–> Example: if the majority sells the company’s assets to some of their own members at a loss to the company, then they are committing an obvious wrong to which the minority has no solution except to sue on behalf of the company.

1. Oppression and Mismanagement

Although the general rule exists to uphold the sanctity of the majority powers, there need to be some safeguard provisions in place that protect the interests of the investors and also the public interest.

A shareholder entrusts his money to the company and is entitled to fair dealings and fair play from the other members of the company. If he does not receive the fairness he is entitled to, he may make an application for oppression by the majority.

The Companies Act itself, in Section 399 provides for a remedy to the shareholders in case of oppression by the majority or any instances of mismanagement affecting the company.

It must be noted that under this section, the Company itself cannot apply for any relief. It has to be a case of oppression within the company adversely affecting minority shareholder interest.

The section provides that a particular proportion of the member strength must make the application to the Company Law Board, but the Central Government may, on application, allow any member or members to sue if ‘it is just and equitable to do so.’

The conditions under which relief will be given to the complainant shareholder are:

• The company’s affairs are being conducted in a manner,
• Prejudicial to public interest or oppressive to any member or members,
• Which would make it just and equitable to wind up the company,
• But winding up would unfairly prejudice such member or members.

Thus, a combination of these conditions must exist which would make it justifiable for the Company Law Board to provide relief under this section.

Mismanagement: For a petition of mismanagement to succeed, the shareholders must apply to the Company Law Board and show that the company’s affairs are being conducted by the directors in a manner which runs against the company’s interest.

The Company Law Board has wide powers to provide relief under this section, and upon scrutiny may provide for:

• Regulation of the company’s affairs in future
• Purchase of shares or interest of any member(s) by other member(s).
• Termination or setting aside of any agreement between members of the company.
• Termination or setting aside of any agreement between the company and a third party (with due notice and consent).
• Any other matter for which it is just and equitable to do so.

 

Winding Up

We had earlier mentioned that companies have perpetual existence. But this runs counter to our knowledge of many companies that have ‘gone bust’ or ‘wound up’ or become ‘sick’. So there are certain situations when a company will cease to exist. This can happen due to many reasons. These reasons are well laid out in the Companies Act.

The process through which the company may be wound up, and the manner in which its rights and liabilities should be taken care of, are also provided for in the Act.

 

Point to be noted, milord!

The term ‘winding-up’ bears a similar meaning of ‘liquidation’. It generally means that all the assets of the company would be realized (sold off and converted to cash) through a legal process in order to repay its debts. Winding-up brings a company to an end.

 

Compulsory Winding Up – Winding up a Registered Company

The Companies Act provides for two modes of winding up a registered company.

Grounds for Compulsory Winding Up or Winding up by the Tribunal

• If the company has, by a Special Resolution, resolved that the company be wound up by the Tribunal.
• If the company makes defaults, such as
• In delivering the statutory report to the Registrar or in holding the statutory meeting. The Tribunal may, instead of winding up, order the holding of statutory meeting or the delivery of statutory report.
• Failing to commence its business within one year of its incorporation, or suspends its business for a whole year. The Tribunal’s power in this situation is discretionary.
• The company being unable to pay its debts, resulting in insolvency.
• If the company has defaulted in any other way or has acted against the State in any manner.

The petition for winding up to the Tribunal may be made by:

• The company, in case of passing a special resolution for winding up.
• A creditor, in case of a company’s inability to pay debts.
• A contributory or contributories, in case of a failure to hold a statutory meeting or to file a statutory report or in case of reduction of members below the statutory minimum.
• The Registrar, on any ground provided prior approval of the Central Government has been obtained.
• A person authorised by the Central Government.
• The Central or State Government, if the company has acted against the sovereignty, integrity or security of India or against public order, decency, morality, etc.

 

Voluntary Winding Up

If a company has been set up for a specific purpose or a fixed duration and that is provided for in the Articles of Association of the company, then, when the purpose is achieved or the duration is up, the company may be wound up by passing an ordinary resolution at a meeting.

(i) Members’ voluntary winding up: A company may pass a special resolution providing that a company be wound up voluntarily. A declaration must be made by the directors that the company is solvent. If such a declaration is not made, it becomes a creditor’s voluntary winding up.

A liquidator is appointed to go over the statement of assets and liabilities of the company to dispose of the company’s liabilities and to sell the assets. The Company is bound to have a number of outstanding debts and liabilities accrued over the course of business. Here, the liquidator will rank the various claims by various parties against the company, and shall enlist the parties who must be repaid on priority followed by the others.

When the affairs of the company are finally wound up, the liquidator makes an account of the winding up and calls a general meeting of the company.

(ii) Creditors’ winding up: The Company will call a meeting of the creditors and a liquidator is appointed by nomination of the members and creditors.

The liquidator has wide powers in tying up the affairs of the company:

1. The power of settling the list of contributories: A contributory is anyone who is liable to contribute to the assets of the company in case of winding up, and includes shareholders with fully paid up shares.
2. The power of making calls: The liquidator can make calls for payment on unpaid shares held by shareholders.
3. The power of calling general meetings: The liquidator needs to keep the members of the Company informed and abreast of the different actions he has undertaken in the course of winding up.

The Act also provides for cases where the liquidator defaults in his duties. The nature of his liability arises out of his position as an agent of the company. He is not a trustee for the shareholders or the creditors. He must act in the best interest of the company.

 

Exercises

1. Principle: A director’s duty is not legally defined, but is equitably definable. It is to be deduced from the circumstances surrounding the alleged default committed by the director.

On the eve of the annual meeting of the company’s shareholders, a director received a tip-off from his auditor that something seemed to be amiss with the accounts. He brushed off the comment and asked the auditor to prepare the account statement without any errors. Later, it was found that fraud had been committed with the company’s assets, and the director was held guilty of negligence although he had not been responsible for the fraud. Is the punishment too harsh?

(a) The punishment is not harsh because the director has to tell the truth to the shareholders who deserve to have the business conducted in a fair and just manner.

(b) The punishment is harsh because the director was not the person involved in the fraud, and he was not even aware of how exactly the accounts had been misrepresented.

(c) The punishment is not harsh because the director’s duty is to ensure that the account statement is right and free from any errors before its presentation at the AGM, and he did not undertake due diligence to ensure that.

(d) The punishment is harsh because the director is not responsible to the shareholders, but he is responsible to the company.

Ans: (c)

While it may be true that the director is not responsible to the shareholders, the investments of the shareholders are an integral part of the company, to which the director is responsible. It was the director’s duty to ensure that the accounts were proper, and he did not do so.

2. Principle 1: When a company is wound up, the liabilities of the creditors are first paid off, followed by preference shareholders. Equity shareholders receive their money, if any, only in the end.

Principle 2: The liability of the directors of a public limited company is limited unless provided for in the memorandum of association.

During the winding up of a public limited company, it was found that 2 of the directors were actually wealthy individuals with a lot of personal wealth. As the company’s liabilities were being paid off, a class of shareholders realised that they would not be paid anything. They sued the directors and asked them to pay off the company’s liabilities with their personal wealth. Is this a valid litigation?

(a) No, it is not as there was nothing provided as to the unlimited liability of the directors in the memorandum of association. Therefore, the directors’ liability was up to their investment in the company.

(b) Yes, it is a valid litigation as the limited liability of the company is as for the liability of the shareholders and not the liability of the directors. The directors’ liability is always unlimited.

(c) No, the litigation is not valid as the shareholders should proceed against the company, and demand that the directors pay up the company’s liability.

(d) Yes, the litigation is valid as the shareholders have a right to recover their investment in the company.

Ans: (a)

3. Principle 1: If a meeting does not possess the quorum required to conduct it, the meeting must be adjourned.

Principle 2: In a meeting that had been previously adjourned on grounds of lack of quorum, and still lacks in requisite number of members for a proper quorum when they reconvene, the quorum will be the number of members present.

At a shareholders meeting where the proper quorum was not present, the agenda was to pass a resolution on the winding up of the company. The issues were presented, the vote was taken but not counted and then the meeting was adjourned; when they reconvened, the proper quorum was present, and the vote was counted to wind up the company. Is it a valid resolution?

(a) It is a valid resolution as it was passed when there was a proper quorum present.

(b) It is not a valid resolution because the first meeting was invalid. Any resolution passed during an invalid meeting is invalid.

(c) It is a valid resolution as the proper quorum had been present at the second meeting.

(d) None of the above

Ans: (b)

The first meeting had not been adjourned, as per the law, at the lack of a quorum. Thus, the first meeting was invalid. Whether there were enough members in the second meeting or not, the resolution would be invalid.

4. Principle: The rule in Foss v. Harbottle was that the Court would not interfere in the management and administration of the company upon a shareholder’s complaint if the directors were acting within the ambit of their powers. There are certain exceptions to this rule.

In which of the following situations can a shareholder have a right against the company for mismanagement?

(a) When a director commits fraud

(b) When the company undergoes losses

(c) When the directors exceed their appointed term

(d) When there is a violation of the Memorandum of Association or the Articles of Association.

Ans: (c) & (d). When the director commits fraud, the company (which is a legal person having capacity to sue) is the proper applicant. Simply because the company undergoes losses – which is part of the business cycle – there cannot be a motion for mismanagement.

5. Principle: Anything provided in the Memorandum of Association or the Articles of Association that violates the provisions of the Companies Act, or the Companies Rules, will be void.

The Memorandum of Association of Vidya Inc., stated that the matters of shareholding would be as per what was laid down in the Articles of Association. The Articles gave wide powers to the directors to have controlling interest without equivalent shareholding. This was not valid under the Companies Act. What would you as a shareholder do?

(a) Sue the company for fraudulent activities.

(b) Approach the court for relief under writ of quo warranto.

(c) Notify the Registrar of Companies and have the relevant clauses amended.

(d) Call a shareholders’ meeting and discuss ways to usurp the directors’ powers.

Ans: (c)

No fraudulent activities were being perpetrated in the name of the company. The court could not be approached under a writ petition of quo warranto because the company was not an agency of the State. Option (d) is clearly wrong on the face of it.

Logical Reasoning

1. Follow the logical progression and solve:

• Preference shares resemble bonds in that they are fixed income instruments with assured returns and have a fixed value.
• All shares that are not preference shares are equity shares.

Therefore, anything that is not an equity share is a bond.

Is the above syllogism valid?

In the following 3 questions, there will be an assertion and a reason provided. You have to decide whether the assertion is right, and then decide whether the reason provided for it is valid.

2. Assertion: A shareholders’ meeting must be held annually to discuss the business of the company.

Reasoning: Many provisions of the Companies Act do not apply to private companies.

(a) Both assertion and reason are right, but the assertion is not an effect of the reason.

(b) The assertion is not valid, but the reason provided is a valid statement.

(c) The assertion and reason are both false and invalid.

(d) The assertion and reason are both right, and the assertion is a natural consequence of the reason.

Ans: (a)

The fact that provisions of the Companies Act do not apply to private companies has very little to do with the necessity of holding an annual shareholders’ meeting.

3. Assertion: Promoters are not members of the company.

Reasoning: Promoters do not necessarily subscribe to the memorandum and become shareholders.

(a) Both assertion and reason are right, but the assertion is not an effect of the reason.

(b) The assertion is not valid, but the reason provided is a valid statement.

(c) The assertion and reason are both false and invalid.

(d) The assertion and reason are both right, and the assertion is a natural consequence of the reason.

Ans: (b)

The assertion is flawed because there are certain situations where promoters are members of the company and certain situations when they are not. It is determined by whether they have a shareholding in the company or not. The Reasoning is a valid statement. Thus, the answer is (b).

Solve:

4. If in winding up a company, ordinary shareholders have been paid & preference shareholders have been paid,

• Is it possible that the creditors have been paid?
• Is it necessary that the creditors would have been paid at this stage?

Ans: (ii)

The creditors receive first priority of payment upon liquidation of the company’s assets in the process of winding up.

5. The doctrine of indoor management states that a third party may presume that the business being conducted on behalf of the company is legitimate, authorised and valid as far as the documents and authorisations etc. are concerned.

There are two aspects to a transaction, substantive and procedural. The third party may get to know the substantive aspects, but may not know whether the procedure has been followed or not.

(a) A customer bought some bonds, or secured debt instruments from a company’s directors. The director had the authorisation to sell these bonds only after a resolution had been passed by the shareholders. It was found later that the resolution had not been passed.

(b) Company A was lending money to Company B, and the companies had 2 directors in common. It was found that the lending of money from Company A could be done only after the Company had resolved to do so in a meeting, but that resolution had not been taken. The shareholders of Company B are enraged with the actions of its directors.

(c) The accountant of a company signed certain documents of a transaction that company to a third party although he was not authorised to do so. The company later contended, when the third party tried to get returns from the company that he should have taken due care to ensure that the accountant did indeed have the authority.

In which of the above situations will the doctrine of indoor management be a valid defence for the third party?

Ans: (a) and (b)