Company Law: Introduction and Key Concepts

Introduction

• The concept of 'Company' or 'Corporation' in business is not new; it was discussed in the 4th century BC in the 'Arthashastra'.
• The term 'Company' originates from the Latin words 'Com' (meaning 'coming together') and 'panis' (meaning 'bread'). Originally, it described a group of people sharing a meal.
• Understanding the concept and legal framework of Company Law is crucial for Company Secretaries.
• This lesson provides an overview of the history and development of corporate legislation in India, the distinctive characteristics of a Company, different business structures, and key concepts under the new law.

History and Development of Company Law in India

• Indian Company Law is heavily influenced by English Company Law.
• The first Companies Act in India was enacted in 1850, following the Joint Stock Companies Act, 1844 in England.
• Subsequent acts include the Indian Companies Act, 1866, 1882, 1913, and 1956, each introducing new concepts.
• Before the 1857 amendment, the concept of limited liability did not exist.

The Companies Act, 1956

• Based on the recommendations of the Bhaba Committee.
• The government of independent India formed a committee under H.C. Bhaba in 1950 to revise the Indian Companies Act, 1913.
• The Companies Act, 1956 was introduced based on the committee's recommendations and underwent several amendments.

Major Developments in Company Law in India

• East India Companies: Introduced the company concept in India indirectly through Royal Charter Companies.
• The Companies Act, 1850: Enacted to register joint stock companies, establishing the company as a distinct legal entity.
• The Joint Stock Companies Act, 1857: Introduced the concept of Limited Liability.
• The Companies Act of 1866: Consolidated various laws related to companies.
• The Indian Companies Act, 1882: Limited the liability of members but maintained unlimited liability for directors, registered minutes, formed MoA, and empowered local governments administratively.
• The Companies Act 1913: Introduced the concept of Private Companies, Not-for-Profit Distribution Companies, Annual General Meetings, Statutory Meetings, Extra Ordinary General Meetings, Registration of Mortgages, and Charges.
• The Companies Amendment Act, 1951: Granted substantial powers to the Central Government.
• The Companies Act, 1956: Enacted to consolidate and amend previous laws, effective from April 1, 1956, based on the Bhabha Committee's recommendations. It originally consisted of 658 sections and 15 schedules.
  • Key features: Full and fair disclosure in prospectus, detailed financial information, government intervention and investigation, restrictions on managerial powers, enforcement of duties by company management, and protection of minority shareholders.
  • Objective: to amend and consolidate the law relating to companies, providing the legal framework for corporate entities in India.
• The Companies (Amendment) Act, 1960: Introduced new provisions based on the Shastri Committee's recommendations, focusing on overlooked aspects of company management.
• The Companies (Amendment) Act, 1963: Provided for the appointment of a Companies Tribunal and the Board of Company Law Administration, empowering the Central Government to remove managerial personnel involved in fraud.
• The Companies (Amendment) Act, 1965: Based on the Vivian Bose Commission, this act introduced changes such as clear definitions of main and subsidiary objects in the Memorandum of Association and strengthened provisions for investigating company affairs.
• The Companies (Amendment) Act, 1969: Abolished the institutions of managing agents and secretaries and treasurers, and prohibited contributions by companies to political parties or for political purposes.
• The Companies (Amendment) Act, 1974: Introduced significant changes to incorporate public interest elements in the corporate sector.
• The Companies (Amendment) Act, 1977: Amended sections $58A, 220, 293, 620$ and $634A$ of the 1956 Act.
• The Companies (Amendment) Act, 1985: Permitted Non-Government companies to make political contributions, and amended Sections $529$ and $530$ and introduced a new Section $529A$ to prioritize workers' dues with secured creditors.
• The Companies (Amendment) Act, 1988: Streamlined existing provisions based on the Sachar Committee's recommendations.
  • Changes included aligning the definition of 'Secretary' with the Company Secretaries Act, 1980, introducing the concept of 'company secretary in practice', and establishing an independent Company Law Board.
• The Depositories Act, 1996: Introduced dematerialization of securities, leading to related amendments.
• The Companies (Amendment) Act, 1999: Allowed companies to issue Sweat Equity shares and buy back their own securities. It also established an Investor Education and Protection Fund and the National Advisory Committee on Accounting Standards.
• The Companies (Amendment) Act, 2000: Set minimum paid-up capital requirements for private and public companies, made provisions for deemed public companies inoperative, empowered SEBI regarding securities and dividends, and mandated dematerialized form for IPOs exceeding Rupees ten crores ($10^8$).
• The Companies (Amendment) Act, 2002: Inserted Part IXA relating to Producer Companies and proposed dissolving the Company Law Board.
• The Companies (Amendment) Act, 2006: Introduced electronic filing, Director Identification Number (DIN), and electronic records maintenance.

Concept Paper on Company Law, 2004 & J.J. Irani Report

• The government undertook a comprehensive revision of the Companies Act, 1956, to enable companies to achieve global competitiveness.
• A Concept Paper on Company Law was released for public feedback.
• An Expert Committee was formed on December 2, 2004, under Dr. J J Irani, to advise on revisions to the Companies Act, 1956, aiming for a simplified law that addresses national and international changes and adopts best practices.
• The committee submitted its report on May 31, 2005, advocating for flexibility, accountability, and transparency.
• The report recommended flexibility for private and small companies and stricter corporate governance for companies with higher public interest.
• The report sought to shift from a “Government Approval Regime” to a “Shareholder Approval and Disclosure Regime”.

Companies Act, 2013

• Received presidential assent on August 29, 2013.
• Amended multiple times, most recently in 2019.
• Introduced new concepts supporting enhanced disclosure, accountability, and better board governance such as associate company, one person company, small company, dormant company, independent director, women director, resident director, special court, secretarial standards, secretarial audit, class action, registered valuers, rotation of auditors, vigil mechanism, corporate social responsibility, E-voting, etc.
• The Companies Act, 2013 contains Orders, Rules, Notifications and Circulars.
• One should read each section of the Act, with relevant Rule, Notification and Circular.
• The Act is a superior authority in law passed by the Legislature. Notifications and Rules are notified by the Executive under the powers derived from the Act itself.
• The Central Government may amend schedules of the Act using power given under Section 467.
• Schedules must be read with the main Section.
• Where provisions of the Act along with Removal of Difficulties Orders (RoDs), Exemption Notifications and Schedules, deals with the policy framework of the law; rules deals with the procedures.
• Rules cannot change policy framework in any manner an cannot override substantial provision of the Section empowering the Rules.
• Secretarial Standards are standards prepared by Institute of Company Secretaries of India to standardise secretarial practices under the Companies Act and other areas related to Secretarial Practices. By virtue of Explanation to Section 205(1), secretarial standards issued by the Institute of Company Secretaries of India constituted under section 3 of the Company Secretaries Act, 1980 and approved by the Central Government are part of law itself.
• Further Section 118(10) mandates that every company shall observe secretarial standards with respect to general and Board meetings.
• This whole ecosystem is called the Companies Law and should be read collectively and comprehensive.

Meaning and Definition of a Company

• The word 'company' is derived from the Latin words 'Com' (with or together) and 'panis' (bread), referring to an association of people who took meals together.
• A company is a corporate body and a legal person, distinct from its members.
• It is a 'body corporate' because its members are made into one body through incorporation, giving it a legal personality.
• A 'corporation' is a legal person created by a process other than natural birth.
• Companies can be formed under a Special Act of Parliament or under company law.

Legal Sense

• A company is an association of natural and artificial persons, incorporated under the law of a country.
• Section 2(20) of the Companies Act, 2013 defines a company as one incorporated under this Act or any previous company law.
• In common law, a company is a 'legal person' or 'legal entity', separate from its members.
• Lord Justice Lindley defined a company as an association of many persons contributing money or money’s worth to a common stock, employing it in trade or business, and sharing the profit and loss.

Nature and Characteristics of a Company

The most striking characteristics of a company are:

• Corporate Personality: A company is a separate legal entity and bears its own name, owns its own assets, and is distinct from its members. A shareholder cannot be held liable for the acts of the company. A shareholder’s ownership is limited to the number of shares they own.

  • Case Example Salomon v. Salomon and Co. Ltd., (1897) A.C. 22
    • Salomon formed a limited company with his family members as shareholders, selling his business to the company.
    • The company later faced difficulties and went into liquidation.
    • The House of Lords ruled that the company is a separate person from its members.
  • Case Example Lee v. Lee’s Air Farming Ltd. (1961) A.C. 12 (P.C.)
    • Lee formed a company for aerial top-dressing and was killed in an air crash while working for the company.
    • The Privy Council held that Lee and his company were distinct legal persons, and his widow was entitled to compensation.
  • Case Example New Horizons Ltd. v. Union of India, (AIR 1994, Delhi 126)
    • The tender of the company, New Horizons Ltd., for publication of telephone directory was not accepted by the Tender Evaluation Committee on the ground that the company had nothing on record to show that it had the technical experience required to be possessed to qualify for tender.

• Company as an Artificial Person: A company is an artificial person created by law and acts through human beings. It can enter into contracts and possess properties in its own name.

  • Case Example Union Bank of India v. Khader International Construction and Other [(2001) 42 CLA 296 SC]
    • The court was deciding whether a company could sue as an indigent person.
    • The Supreme Court held that the word ‘person’ included any company or association of individuals, granting them the right to file a suit as an indigent person.

• Company is not a Citizen: A company is not a citizen under the Citizenship Act, 1955, or the Constitution of India.

  • Case Example R.C. Cooper v. Union of India, AIR 1970 SC 564
    • The Supreme Court held that a shareholder can petition on behalf of the company if their rights are infringed by legislative measures directly affecting the company.
  • Case Example Bennet Coleman Co. v. Union of India, AIR 1973 SC 106
    • The Supreme Court stated that the Fundamental Rights of shareholders are protected when their rights as shareholders are impaired by state action.

• Company has Nationality and Residence: Though not a citizen, a company has nationality, domicile, and residence. A limited company’s domicile is the place of its registration, which it retains throughout its existence.

  • Case Example Tulika v. Parry and Co., (1903) I.L.R. 27 Mad. 315
    • The joint stock company resides where its place of incorporation is, where the meetings of the whole company or those who represent it are held and where its governing body meets in bodily presence for the purposes of the company and exercises the powers conferred upon it by statute and by the Articles of Association.

• Limited Liability: The liability of a member is limited to the unpaid amount on their shares. Members are not liable for the company’s debts.

  • Exceptions to the principle of limited liability
    • When the number of members falls below the statutory minimum.
    • When the company is incorporated as an Unlimited Company.
    • When a company has obtained incorporation by furnishing any false or incorrect information.
    • Where it is proved that a prospectus has been issued with intent to defraud the applicants for the securities of a company or any other person or for any fraudulent purpose
    • Where a company fails to repay the deposit or part thereof or any interest thereon
    • Where the report made by an inspector states that fraud has taken place in a company

• Perpetual Succession: A company continues to exist even with changes in membership, unaffected by the death or departure of any member, except when it is wound up as per law.

• Separate Property: A company can own, enjoy, and dispose of property in its own name, distinct from its members.

  • Case Example Mrs. Bacha F. Guzdar v. The Commissioner of Income Tax, Bombay, A.I.R. 1955 S.C. 74
    • The Supreme Court held that a shareholder does not become the part-owner of the company or its property.

• Transferability of Shares: Shares are movable property and freely transferable, subject to certain conditions.

• Capacity to Sue and Be Sued: A company can sue and be sued in its own name.

• Contractual Rights: A company can enter into contracts for the conduct of the business in its own name.

• Limitation of Action: A company cannot go beyond the power stated in its Memorandum of Association.

• Separate Management: The company is administered and managed by its managerial personnel.

• Voluntary Association for Profit: A company is a voluntary association for profit, with profits divided among shareholders or saved for future expansion.

• Termination of Existence: A company’s existence is terminated by means of winding up.

Company vs Other Forms of Business

• A limited company has a number of similarities and dissimilarities with other forms of associations.

Distinction between Partnership Firm and Company

Distinction between a Hindu Undivided Family Business and a Company

Distinction between Limited Liability Partnership (LLP) and a Company

• An LLP combines the benefits of limited liability with the flexibility of a partnership.
• LLP is a separate legal entity with perpetual succession.
• Partner's liability is limited to their contribution in the LLP.
• LLP is a hybrid between a company and a partnership.
• The management-ownership divide inherent in a company is not there in a limited liability partnership.
• LLP has more flexibility and has lesser compliance requirements as compared to a company.

Doctrine of Lifting of or Piercing the Corporate Veil

• The separate personality of a company must be used for legitimate business purposes.
• The Court will look behind the corporate entity and take action as though no entity separate from the members existed and make the members or the controlling persons liable for debts and obligations of the company.
• Applicable in cases of fraudulent or dishonest use of the legal entity where entities rely on their corporate personality as a shield to cover wrong doings.
• Shareholders cannot ask for lifting of the veil for their purposes.

Statutory Recognition of Lifting of Corporate Veil

• The Companies Act, 2013 itself contains some provisions [Sections 7(7), 251(1) and 339] which lift the corporate veil to reach the real forces of action.
• Section 7(7) deals with punishment for incorporation of company by furnishing false information; Section 251(1) deals with liability for making fraudulent application for removal of name of company from the register of companies and Section 339 deals with liability for fraudulent conduct of business during the course of winding up.

Lifting of Corporate Veil under Judicial Interpretation

• Ever since the decision in Salomon v. Salomon & Co. Ltd., (1897) A.C. 22, normally Courts are reluctant or at least very cautious to lift the veil of corporate personality to see the real persons behind it.

Circumstances;

(a) Where the corporate veil has been used for commission of fraud or improper conduct

• Case Example Jones v. Lipman, (1962) I. W.L.R. 832
  • A sold and transferred the land to a company which he had incorporated to escape a decree for specific performance in a suit brought by B. The Court held that the company was the creature of A and a mask to avoid recognition and that in the eyes of equity A must complete the contract

(b) Where a corporate facade is really only an agency instrumentality

• Case Example In Re. R.G. Films Ltd. (1953) 1 All E.R. 615
  • Board of Trade refused to register a film as a British film which stated that English company acted merely as the nominee of the American corporation.

(c) Where the conduct conflicts with public policy, courts lifted the corporate veil for protecting the public policy.

• Case Example In Connors Bros. v. Connors (1940) 4 All E.R. 179
  • The principle was applied against the managing director who made use of his position contrary to public policy
• #### (d) In Daimler Co. Ltd. v. Continental Tyre & Rubber Co., (1916) 2 A.C. 307
  • it was held that a company will be regarded as having enemy character, if the persons having de facto control of its affairs are resident in an enemy country or, wherever they may be, are acting under instructions from or on behalf of the enemy.

(e) Where it was found that the sole purpose for which the company was formed was to evade taxes

• Case Example Re. Sir Dinshaw Maneckjee Petit, A.I.R. 1927 Bombay 371
  • The Court decided to disregard the corporate entity as it was being used for tax evasion.
• #### Vodafone case
  • Vodafone International Holdings B.V. v. Union of India & Another [S.L.P. (C) No. 26529 of 2010]
    • The Supreme Court set aside the Bombay High Court’s judgment directing Vodafone International Holdings BV (“Vodafone”), to pay INR 110 billion, as withholding tax in a transaction that took place off-shore.
    • Six factors that may be considered to determine whether the transaction is a bogus is: the concept of participation in investment, the duration of time during which the Holding Structure exists, the period of business operations in India, the generation of taxable revenues in India, the timing of the exit; and the continuity of business on such exit.

(f) Avoidance of welfare legislation is as common as avoidance of taxation

• Case Example The Workmen Employed in Associated Rubber Industries Limited, Bhavnagar v. The Associated Rubber Industries Ltd., Bhavnagar and another, A.I.R. 1986 SC 1.
  • amount of dividends received by the new company should, therefore, be taken into account in assessing the gross profit of the principal company.

(g) Another instance of corporate veil arrived at by the Court arose in Kapila Hingorani v. State of Bihar

• Kapila Hingorani v. State of Bihar, 2003(4) Scale 712
  • the State may not be liable in relation to the day-to-day functioning of the PSUs but its liability would arise on its failure to perform the constitutional duties and the functions of these undertakings.

(h) Where it is found that a company has abused its corporate personality for an unjust and inequitable purpose

• the court would not hesitate to lift the corporate veil.

Lifting the Corporate Veil of Small Scale Industry

• it was permissible to lift the veil of the company to see whether it was the subsidiary of another company and, therefore, not entitled to the proposed exemptions.

Use of Corporate Veil for Hiding Criminal Activities

• the Court could lift the corporate veil and treat the assets of the company as the realisable property of the shareholder.

Applicability of Companies Act, 2013 and Key Concepts

(A) Applicability

• According to section 1 of the Companies Act, 2013, the Act extends to whole of India and applies to:
  • Companies incorporated under this Act or previous company law.
  • Insurance companies (except if inconsistent with the Insurance Act, 1938, or the IRDA Act, 1999).
  • Banking companies (except if inconsistent with the Banking Regulation Act, 1949).
  • Companies engaged in electricity generation or supply (except if inconsistent with the Electricity Act, 2003).
  • Any other company governed by a special Act (except if inconsistent with that Act).
  • Any body corporate incorporated by an Act, as specified by the Central Government.
• Companies Act, 2013 is not applicable to unincorporated companies. By virture of section 464 of the Companies Act, 2013, no association or partnership consisting of more than such number of persons as may be prescribed * shall be formed for the purpose of carrying on any business that has for its object the acquisition of gain by the association or partnership or by the individual members thereof, unless it is registered as a company under this Act or is formed under any other law for the time being in force. Rule 10 of Companies( Miscellaneous) Rules, 2014 prescribes 50 persons in this regard. The maximum number of persons which may be prescribed under this section shall not exceed 100.
• Section 464 of the Act does not apply to the case of a Hindu undivided family carrying on any business whatever may be the number of its members.
• However, this section is also not applicable to an association or partnership, if it is formed by professionals who are governed by special Acts.

B. Key Concepts

• The 2013 Act has introduced several new concepts and has also tried to streamline many of the requirements by introducing new definitions.

1. Companies

1.1 One-person company: The 2013 Act introduces a new type

• apart from forming a public or private limited company, the Act enables the formation of a new entity a ‘one-person company’ (OPC). An OPC means a company with only one person as its member (section 3(1)).

1.2. Private company

• The 2013 Act introduces a change in the definition for a private company, inter- alia, the new requirement increases the limit of the number of members from 50 to 200. [section 2(68).

1.3. Small company: A small company has been defined as a company, other than a public company.

• i) paid-up share capital of which does not exceed fifty lakh rupees or such higher amount as may be prescribed which shall not be more than ten crore rupees; and
• ii) turnover of which as per profit and loss account for the immediately preceding financial year does not exceed two crore rupees or such higher amount as may be prescribed which shall not be more than one hundred crore rupees

1.4 Dormant company

• A company formed and registered under this 2013 for a future project or to hold an asset or intellectual property and has no significant accounting transaction such a company or an inactive company may make an application to the Registrarfor obtaining the status of a dormant company.(Section 455)

1.5 Nidhi company

• Nidhi Company means a company which has been incorporated as a Nidhi with the object of cultivating the habit of thrift and savings amongst its members, receiving deposits from, and lending to, its members only, for their mutual benefit, and which complies with such rules as are prescribed by the Central Government for regulation of such class of companies. (section 406)

2. Roles and responsibilities

2.1 Officer

• The definition of officer has been extended to include promoters and key managerial personnel (section 2(59)).

2.2 Key managerial personnel

• The term ‘key managerial personnel’ has been defined in the Act which means
• (i) the Chief Executive Officer or the managing director or the manager;
• (ii) the company secretary;
• (iii) the whole-time director;
• (iv) the Chief Financial Officer;
• (v) such other officer, not more than one level below the directors who is in whole-time employment designated as key managerial personnel by the Board;
• and (vi) such other officer as may be prescribed (section 2(51)). The role and liability have been defined at various places under the Act.

2.3 Promoter

• The term ‘promoter’ means a person
• (a) who has been named as such in a prospectus or is identified by the company in the annual return; or
• (b) who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
• (c) in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act: Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional capacity.(section 2(69))

2.4 Independent Director

• The term ‘Independent Director’ has been defined in the Act, along with several new requirements relating to their appointment, role and responsibilities. Further some of these requirements are not in line with the corresponding requirements under the equity listing agreement (section 2(47), 149(5)).

3. Audit and auditors

3.1 Mandatory auditor rotation and joint auditors

• The Act mandates the rotation of auditors after the specified time period. (Section 139).

3.2. Secretarial audit

• The Act mandates Secretarial Audit for the following:
• (a) Listed companies;
• (b) every public company having a paid-up share capital of fifty crore rupees or more;
• (c) every public company having a turnover of two hundred fifty crore rupees or more;
• (d) every company having outstanding loans or borrowings from banks or public financial institutions of one hundred crore rupees or more.
• The Secretarial Audit Report is required to be annexed to the Board’s Report (Section 204)

3.3 Secretarial Standards

• The Act requires every company to observe secretarial standards specified by the Institute of Company Secretaries of India with respect to general and board meetings [Section 118 (10)].

4. Corporate Social Responsibility

• The Act introduces the culture of corporate social responsibility (CSR) in Indian corporates by requiring companies to formulate a corporate social responsibility policy and at least incur a given minimum expenditure on social activities.

5. Class Action Suits

• The Act introduces a new concept of class action suits which can be initiated by shareholders against the company and auditors.

FORMATION AND INCORPORATION OF COMPANIES

• Section 3(1) states that a company may be formed for any lawful purpose by:
  • (a) seven or more persons, where the company to be formed is to be a public company
  • (b) two or more persons, where the company to be formed is to be a private company; or
  • (c) one person, where the company to be formed is to One Person Company that is to say, a private company by subscribing their names or his name to a memorandum and complying with the requirements of this Act in respect of registration.

A company formed under Section 3(1) may be either

• (a) a company limited by shares; or
• (b) a company limited by guarantee; or
• (c) an unlimited company.
• Section 7(1) of the Act provides for the detailed procedure for incorporation of company. (Note: For details on Types of Companies and Formation of Companies - you may refer Paper 3 of Module 1 i.e. “Setting up of Business Entities and Closure”)

IMPORTANT DEFINITIONS

• Section 2 of Companies Act, 2013 contains definitions
• Clause (20) “Company” means a company incorporated under this Act or under any previous company law.
• Clause (21) “Company Limited by Guarantee” means a company having the liability of its members limited by the memorandum to such amount as the members may respectively undertake to contribute to the assets of the company in the event of its being wound up.
• Clause (22) “Company Limited by Shares” means a company having the liability of its members limited by the memorandum to the amount, if any, unpaid on the shares respectively held by them.
• restricts the right to transfer its shares:
• (i) except in case of One Person Company, limits the number of its members to two hundred