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Company Law

Corporate Personality

. “Like any juristic person, a company is legally an entity apart from its members, capable of rights and duties of its own, and endowed with the potential of perpetual succession.” The fundamental attribute of corporate personality from which indeed all the other consequences flow is that the corporation is a legal entity distinct from its members. Hence it is capable of enjoying rights and of being subject to duties which are not the same as those enjoyed or borne by its members Sec. 34 of the companies act describes that from the date of its registration the company shall be a body corporate by the name contained in the memorandum, and it becomes capable of exercising all the functions of an incorporated company. Incorporation providers certain advantages to the business community as compared with all other kinds of business organization.
1. Independent Corporate existence:- The outstanding feature of a company is its independent corporate existence. A partnership has no existence apart from its members. It is nothing but a collection of partners. A company, on the other hand, as is in law a person. It is a distinct legal persona existing independent of its members. By incorporation under the Act, the company is vested with a corporate personality which is distinct from the members compose it.
A well-known illustration of this principle is the case of Saloman V. Saloman & Co. In this case Saloman was a boot & shoe manufacturer. His business was in sound condition and there was a substantial surplus of assets over liabilities. He incorporated a company named, Saloman & Co. Ltd. for the purpose of taking over and carrying on his business. The seven subscribers to the memorandum were Saloman, his wife, his daughter and four sons and they remained the only members of the company. Saloman and two of his sons, constituted the board of directors of the company. The business was transferred to the company for £ 40,000. In payment, Saloman took 20,000 shares of £ 1 each and debentures worth £ 10,000 and created a charge on the company’s assets. One share was given to each remaining member of his family. The company went into liquidation within a year.
On winding up, the assets were of £ 6,000 and Liabilities as – Salmon as debenture holder for £ 10,000 and unsecured creditors for £ 7,000. Thus after paying off the debenture holder nothing would be left for the unsecured creditors.
The unsecured creditors, therefore, contended that, though incorporated under the Act, the company never had an independent existence; it was in fact Saloman under another name; he was the managing directors and other directors being his sons and under his control. His vast preponderance of shares made him absolute master. The business was solely his, conducted solely for and by him and the company was a mere sham and fraud, in effect entirely contrary to the intent and meaning of the Companies Act. But it was held that Saloman & Co. Ltd was a real company fulfilling all the legal requirements. It must be treated as a company, as an entity consisting of certain corporators, but a distinct and independent corporation. Their Lordships of the House of Lords observed:
“When the memorandum is duly signed and registered, though there be only seven shares taken, the subscribers are a body corporate capable forthwith of exercising all the functions of an incorporated company. It is its individuality by issuing the bulk of its capital to one person. The company is at law a different person altogether from the subscribers of the memorandum; and though it may be that after incorporation the business is precisely the same as before, the same persons are managers, and the same hands receive the profits, the company is not in law their agent or trustee. The statute enacts nothing as to the extent or degree of interest which may be held by each of the seven or as to the proportion of interest which may possessed by one or majority of the shareholders over others.
It was also said that ‘the act contemplated that incorporation of seven independent bonafide members, who had a mind and a will of their own, and were not the mere puppets of an individual who, adopting the machinery of an individual who, his old business in the same way as before, when he was a sole trader.’ The words “seven independent bonafide members with a mind and will of their own and not the puppets of an individual” are by construction to be read into the Act.
Kay, L.J., said that ‘the statute were intended to allow seven or more persons bonafide association for the purpose of trade to limit their liabilities under certain condition and to become a corporation, but they were not intended to legalise a pretended association for the purpose of enabling an individual to carry on his own business with limited liability in the name of a joint stock company.
Further it was stated that Act prescribes the essential of the memorandum in the case of a company limited by shares inter-alia, enacts that “no subscriber shall take less than one share”. The first of these enactments does not require that the persons subscribing shall not be related to each other and the second plainly imports that the holding of a single share affords a sufficient qualification for membership.
2. Limited Liability:- The privilege of limiting liability for business debts is one of the principal advantages of doing business under the corporate form of organization”. The company, being a separate person, is the owner of its assets and bound by its liabilities. Members, even as a whole, are neither the owner of the company’s undertaking, nor liable for its debts. Where the subscribers exercise the choice of registering the company with limited liability, the members’ liability becomes limited or restricted to the normal value of the shares taken by them or the amount guaranteed by them. In a partnership, the liability of the partners for the debts of the business is unlimited. They are bound to meet, without any limit, all the business obligations of the firm. The whole fortune of a partner is at stake, as the creditors can levy execution even on his private property.
3. Perpetual succession:- An incorporated company never dies. It is an entity with perpetual succession. Perpetual succession means that the membership of a company may keep changing from time to time, but that does not affect the company’s continuity. The death or insolvency of individual members does not, in any way, affect the corporate existence of the company. For this Gower illustrated that ‘During the war all the members of one private company, while in general meeting, were killed by a bomb. But the company survived; not even a hydrogen bomb could have destroyed it.
4. Separate Property:- A company, being a legal person, is capable of owing, enjoying and disposing of property in its own name. The company becomes the owner of its capital and assets. The shareholders are not the several or joint owners of the company’s property. “The company is the real person in which all its property is vested, and by which it is controlled, managed and disposed of. A member does not even have an insurable interest in the property of the company. In a case a person was the holder of nearly all the shares, except one, of a timber company and was also a substantial creditor. He insured the company’s timber in his own name. The timber having been destroyed by fire, the insurance company was held not liable to him. No shareholder has any right to any item of property owned by the company, for he has no legal or equitable interest therein. But in a Canadian Case it was held that a sole shareholder has insurable interest in the company’s property.
The incorporation helps the property of the company to be clearly distinguished from that of its members. “The property is vested in the company as a body corporate, and no changes of individual memberships affect the title. In a partnership the distinction between the joint property of the firm and the private property of the partners is often not clear.
5. Transferable shares:- When joint stock companies were established the great object was that their shares should be capable of being easily transferred. Accordingly the Companies Act in Section 82 declares that the shares or debentures or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company. Thus incorporation enables a member to sell his shares in the open market and to get back his investment without having to withdraw the money from the company. This provides liquidity to the investor and stability to the company. In a partnership a partner cannot transfer his share in the capital of the firm except with the unanimous consent of all the partners.
6. Capacity to sue and be Sued:- A company, being a body corporate, can sue and be sued in its own name. Criminal complaint can be filed by a company but it must be represented by a natural person. A company has the right to protect its fair name. It can sue for such defamatory remarks against it as are likely to damage its business or property etc
7. Professional Management:- The corporate sector is capable of attracting the growing cadre of professional managers. Their independent functioning as managers is assured because of the fact that there is no one to exercise control over them. Such an atmosphere of independence gives them the opportunity to develop extraordinary managerial capabilities. With the financial backing that companies are able to provide, they are able to develop the business to a considerable extent.
8. Finances:- The company is the only medium of organizing business which is given the privileges of raising capital by public subscription either by way of shares or debentures. Further, public financial institutions lend their resources more willingly to companies than to other forms of business organization. The facility of borrow and giving security by way of a floating charge is also an exclusive privilege of companies.
The advantages of incorporation are by no means inconsiderable and, as compared with them, the disadvantages are, indeed very few. Yet some of them, which are of essence complications arising out of the privilege of trading with limited liability are as follows:
1. Formality and expense:- Disadvantage of incorporation is its expense and formality. Incorporation is a very expensive affair and requires a number of formalities to be complied with. As compared with it, the formation of a partnership is very simple. Again, the administration of a company has to be carried on strictly in accordance with the provisions of the Act.
2. Company is not citizen:- A company, though a legal person, is not a citizen either under the Constitution of India or under the Citizenship Act. A company is, however, a person in the eyes of law and it can claim the protection of such fundamental rights as are guaranteed to all persons whether citizens or not. A company cannot claim the protection of such fundamental rights as are expressly guaranteed to citizens only.
The hardship caused by this pronouncement has, however, been subsequently modified by holding that a citizen shareholder may petition, proceeding on behalf of the company, against violation of his company’s fundamental rights.
3. Loss of Privacy:- A public limited company is required to publish its constitution, capital structure, final accounts, etc. by filing prescribed documents with the registrar or companies. Thus, there is loss of privacy in the case of company.
4. Lifting the Corporate Veil:- ‘Lifting of Corporate Veil’ means the circumstances in which the law disregards the corporate entity and pays regard instead to the economic realties behind the legal façade. In exceptional cases the law either goes behind the corporate personality to the individual members, or ignores the separate personality of each company in favour of the economic entity constituted by a group of associated concerns.
The veil of the incorporation never means that the internal affairs of the company are completely concealed from view. On the contrary, the legislature has always made it an essential condition of the recognition of corporate personality that it should be accompanied by the widest publicity. Third parties dealing with the company will normally have no right of resort against its members but they are entitled to see who these members are, what shares they hold and, in the case of quoted company, the beneficial interest in those shares if substantial.
In Lee V. Lee’s Air Farming Ltd, Lee incorporated a company of which he was the managing director. In that capacity he appointed himself as a pilot of the compay. While on the business of the company he was lost in a flying accident. His widow recovered compensation under the Workmen’s Compensation Act. “In effect the magic of corporate personality enabled him to be master and servant at the same time.
The corporate veil is said to be lifted when the court ignores the company and concerns itself directly with the members of managers. It is impossible to ascertain the factors which operate to break down the corporate insulation. But the following grounds have become well established.
(a) Determination of Character:- Occasionally it becomes necessary to determine the character of a company to see whether it is “enemy”. In such a case, the courts may in their discretion examine the character of persons in real control of the corporate affairs. In Daimler Co. v. Continental Tyre & Rubber Co., a company was incorporated in England for the purpose of selling tyres manufactured in Germany by a German Company. The German company held a bulk of shares in English Company. The holders of the remaining shares except one and all the directors were German, resident in Germany. Thus the real control of the Co. was in German hands. During the First War the English company commenced an action to recover a trade debt. And the question was whether the company had become an enemy company and should, therefore, be barred from maintaining the action.
The House of Lords laid down that the company incorporated in UK is a legal entity, with the status and capacity which the law confers. It is not a natural person with mind or conscience. It can be neither loyal nor disloyal. It can be neither friend nor enemy. But it may assume an enemy character when persons in de facto control of its affairs are residents in any enemy country or, wherever resident, are acting under the control of enemies. Accordingly the company was not allowed to proceed with the action. If the action had been allowed the company would have been used as a machinery by which the purpose of giving money to the enemy would be accomplished.
But where there is no such danger to public interest, the courts may refuse to tear open the corporate veil. In People’s Pleasure Park co. V. Rohleder, certain lands were transferred by one person to another perpetually enjoining the transferee from selling the said property to coloured persons. He transferred the property to a company composed exclusively of negroes. An action was commenced fro annulment of this conveyance on the ground that all the members of the company being negroes, the property had, in breach of the restriction, passed to the hands of coloured persons.
The court, however, rejected this argument and held that members individually or collectively are not the corporation, which “has a distinct existence an existence separate from that of its shareholders. It leads its own life. It stands apart as a separate subject and, in contemplation of law, as a stranger to its own members.
(b) For benefit of revenue:- The court has the power to disregard corporate entity if it is used for tax evasion or to circumvent tax obligation. In Dinshaw Maneckjee Petit, the assessee was a wealthy man enjoying huge dividend and interest income. He formed four private companies and agreed with each to hold a block of investment as an agent for it. Income received was credited in the accounts of the company but the company handed back the amount to him as a pretended loan. This way he divided his income into four parts in a bid to reduce his tax liability.
But it was held that, “the company was formed by the assessee purely and simply as a means of avoiding super-tax and the company was nothing more than the assessee himself. It did no business, but was created simply as a legal entity to ostensibly receive the dividends and interests and to hand them over to the assessee as pretended loans.
Members themselves, are not allowed to claim that they should be regarded as economically identical with the company, particularly when this is not in the interest of revenue. In Bacha F. Guzdar V. CIT, Bombay, Under the Income Tax Act, then in force, agricultural income was exempt from tax. The income of a tea company was exempt up to 60% as agricultural income and 40% was taxed as income from manufacture and sale of tea. The plaintiff was a member of a tea company. She received a certain amount as dividend in respect of shares held by her in the company and claimed that his dividend income should be regarded as agricultural income up to 60%.
But, it was held that although the income in the hands of the company was partly agricultural, yet the same when received by the shareholders as dividend could not be regarded as agricultural income.
Another attempt by the members of company to treat themselves at par with the company was frustrated In CIT V. Associated Clothiers Ltd. In this case the assessee, formed a company holding all its shares. They sold certain premises to the new company. The difference between the selling price and the cost of the property in the hands of the assessee was assessed as their income. The contended that this could not be done as there was no commercial sale, but only a transfer from self to self. The court rejected that and held that it was sale from one entity to another and not a trading with oneself.
(c) Fraud of improper conduct:- The corporate entity is wholly incapable of being strained to an illegal or fraudulent purpose. The court will refuse to uphold the separate existence of the company where it is formed to defeat or circumvent law, to defraud creditors or to avoid legal obligations. One clear illustration is Gilford Motor Co. V. Horne. Here Horne was appointed as a managing director of the plaintiff company on the condition that he shall not at any time while he shall hold the office of a managing director or afterwards, solicit or entice away the customers of the company. His employment was determined under an agreement. Shortly afterwards he opened a business in the name of a company which solicited the plaintiff customers.
It was held that the company was a mere cloak or sham for the purpose of enabling the defendant to commit a breach of his covenant against solicitation. Evidence as to the formation of the company and as to the position of its shareholders and directors leads to that inference. The defendant company was a mere channel used by the defendant for the purpose of enabling him, for his own benefit, to obtain the advantage of the customers of the plaintiff company, and that the defendant company ought to be restrained as well as the defendant.
In Workmen V. Associated Rubber Industry Ltd., a company created a subsidiary and transferred its investment holdings to it in a bid to reduce its liability to pay bonus to its workers, the Supreme Court brused aside the separate existence of the subsidiary company. It is the duty of the court, in every case where ingenuity is expended to avid taxing and welfare legislation, to get behind the smokescreen and discover the true state of affairs.
A new company is created, wholly owned by the principal company, with no assets of its own except those transferred to it by the principal company, with no business or income of its own except receiving dividends from shares transferred to it by the principal company and serving no purpose whatsoever except to reduce the gross profits and of the principal company. These facts speak for themselves. There cannot be direct evidence that the second company was formed as a device to reduce the gross profits of the principal company for whatever purpose. An obvious purpose that it served and which stares one in the face is to reduce the amount to be paid by way of bonus to workman. This finding was further supported by the fact that the subsidiary was subsequently would up and amalgamated into the holding company.
(d) Government Companies:- A company may sometimes be regarded as an agent or trustee of its members or of another company and may, therefore, be deemed to have lost its individuality in favour of its principal. In India this question has frequently arisen in connection with Government Companies. A large number of private companies for commercial purposes have been registered under the companies Act with the President and a few other officers as the shareholders. The obvious advantage of forming a Government company is that it gives the activities of the State “a little of the freedom which was enjoyed by private corporation and the Government escaped the rules and principles which hampered action when it was done by Government department instead of a Government corporation. In order to assure the freedom the Supreme Court has reiterated in a number of cases that a Government company is not a department or an extension of the State. It is not an agent of the State. Accordingly its employees are not civil servants and prerogative writs cannot issue against it.
In England it was held by the Court in a case that transport services provided by a company all of whose shares were owned by the Transport commission were services provided by the commission or by any person acting as agent for the Commission. A Government Company will be regarded as an agent of the State only when it is performing in substance governmental or sovereign and not merely commercial functions.
In Som Prakash Rekhi V. UOI, that the company in question arose out of the acquisition and vesting in the Central Government of the assets and business of Burmah Shell. The employee who had certain rights as to provident fund, etc., against the former company, claimed them against the Government by means of a writ. His claim was resisted on the grounds that the undertaking had been vested in a company registered under the companies Act and the question of a writ against private company could not arise. Krishna Iyer J brushed aside this contention. He laid emphasis upon the fact that the whole undertaking has been vested in the Central Government and, therefore, it became a State undertaking. The learned judge also stressed the fact that the law should not go by the fact whether the company is registered under the Companies Act or otherwise, but by the nature of the functions that the unit was performing. Here the statement of reasons stated that the company was being acquired in public interest and thus the new company was created to perform a function of public nature. The court noted the fact that the reason why the State chose to function through companies was not to frustrate employees, but to assure commercial flexibility and freedom from departmental rigidity, slow motion procedures and hierarchy of officers.
In Smith, Stone & Knight Ltd. V. Birmingham Corpn,, a company acquired a partnership concern, registered it as a company, and then continued to carry it on as a subsidiary company. The parent company held all the shares except a few, treated the subsidiary’s profits as its own, appointed managers and exercised effectual and constant control. When the business of the subsidiary was acquired by the defendant corporation the court allowed the parent company, brushing aside the legal distinction between the two companies, to claim compensation in respect of removal and disturbance. The subsidiary company was not operative on its own behalf, but on behalf of the parent company. It was noted as rule that it is well settled that the mere fact that a man holds all the shares in a company does not make the business carried on by the company his business. It is also well settled that there may be such an arrangement between the shareholders and a company as will constitute the company the shareholders agent for the purpose of carrying on the business and make it the business of the shareholders.
In F.G. (Films) Ltd., an American company produced a film called ‘Monsoon’ in India technically in the name of a company incorporated in England. The English Company had a capital of £ 100 in £1 shares, 90 of which were held by an American Director. The production was financed by the American Company. IN these circumstances the Board of Trade refused to register it as a British film and their decision was upheld by the court. It would be a mere travesty of the facts to say or to believe that this insignificant company undertook the arrangements for the making of the film. They acted, in so far as they acted at all in the matter, merely as the nominee of, and agent for the American company.
(e) Group Enterprises:- Consideration of the cases in which the courts have treated a company as the agent of its controlling shareholders suggests that they are more ready to do so where the shares are held by another company. In other words, they are coming to recognise the essential unity of a group enterprise rather than the separate legal entity of each company within the group.
In Holdsworth & co. V. Caddies., Caddie had been appointed managing director of the parent company upon the terms that he should perform the duties and exercise the power in relation to the business of the company and its subsidiary companies which may from time to time be assigned to or vested in him by the board of directors of the company. After disagreement between him and the board he was directed to confine his attention to one of the subsidiaries only. This was held not to be a breach of contract by the company, notwithstanding that it prevented him from working for the company employing him. The argument that the subsidiary companies were separate legal entities each under the control of its own board of directors was described as too technical since an agreement must be construed in the light of the facts and realities of the situation which were that the parent company had full control of the internal management of its subsidiaries.
(f) Quasi-Criminal cases: In quasi criminal case, court seeks to dealt with the substance of a transaction rather than with the legal form in which it may be clothed. This is best illustrated by Trebanog Club case, it was held that members club did not require a licence to sell liquor to club members. The test was held to be the actual nature of the club, not the legal framework.
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Points of Difference between Company and Partnership-
1. Limited Liability:
2. Perpetual succession;
3. separate property
4. transferable shares
5. capacity to sue or be sued
6. professional management
7. no. of members
8. finance
9. formation
10. Registration
11. Legal Status
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Memorandum of Association

An important step in the formation of a company is to prepare a document called the memorandum of association. It contains the fundamental clauses which have often been described as the conditions of the company’s incorporation:
1. Name Clause:- The first clause of the memorandum is required to state the name of the proposed company. A company, being a legal person, must have a name to establish its identity. “The name of a corporation is the symbol of its personal existence.
There are certain legal requirements which are required to be observed while framing this clause. According to this the name of the company should not be identical with or should not too nearly resemble, the name of another registered company, for such a name may be declared undesirable by the Central government. Moreover, the other company can also apply for an injunction to restrain the newcomer from having an identical name.
The name must not suggest connection with an unlawful activity or be offensive in form. Two women forming a company for their personalized services were not allowed the name “Prostitutes Ltd.”
Further, whatever the name of the company, if the liability of the members is limited, the last word of the name must be “Limited”, and in the case of a private company “Private Limited”.
A company may change its name by passing a special resolution and with the approval of the Central Government signified in writing. But if a company has been registered with a name which subsequently appears to be undesirable or resembling the name of another company, it may change its name by passing an ordinary resolution and with the approval of the Central Government.
2. Registered Office Clause:- The second clause of the memorandum must specify the State in which the registered office of the company is to be situate.
Within thirty days of incorporation or commencement of business, whichever is earlier, the exact place where the registered office is to be located must be decided and notice of the situation given to the Registrar who is to record the same. All communication to the company must be addressed to its registered office.
Change of Registered Office Situation:
A company can shift its registered office from one place to another within the same city, town or village. But if it is proposed to carry the registered office from one city to another within the same State, a special resolution to that effect must be passed. A notice of any such change must be given to the Registrar within thirty days of the change. If the shifting of the registered office has the effect of taking the office from the jurisdiction of one Registrar of Companies to that of another within the same State, permission of the Regional Director must be taken.
Shifting of the registered office from one State to another is a much more complicate affair, as it involves alteration of the memorandum itself. The alteration of the memorandum for this purpose is subject to the provisions of Section 17 which requires, in the first place, a special resolution of the company and, in the second, confirmation by the Central Government. The Central Government can confirm the alteration only if the shifting of the registered office from one State to another is necessary for any of the purposes detailed in Section 17(1). When this condition is fulfilled, the second stage is reached namely, to consider the objections of a “person or class of persons whose interest will, in the opinion of the Central Government, be affected by the alteration”. In Orient Paper Mills Ltd. V. State, the Orissa High Court, shifting of the registered offices of certain companies to places outside Orissa was opposed by the State on Several Grounds, including the loss of revenue and employment opportunities. The Court declined confirmation in both cases. Based his decision on the grounds that in Federal Constitution every State has got the right to protect its revenue and, therefore, the interest of the State must be taken into account and are of considerable importance in confirming inter-State change of registered office.
In Mackinnon Mackenzie & Co., the Calcutta High Court, a company desired to shift its registered office from the State of West Bengal to Bombay. The company’s petition was resisted by State on the ground of loss of revenue. The Court refused to sustain the contention of the State and allowed the transfer. The court said that there is no statutory right of the State, as State, to intervene in an application made under Section 17 for alteration of the place of the registered office of a company. To hold that the possibility of the loss of revenue is not only relevant, but of persuasive force in regard to the change is to rob the company of the statutory power conferred on it by Section 17. The question of loss of revenue to one State would have to be considered in the total conspectus of revenue for the Republic of India and no parochial considerations should be allowed to turn the scale in regard to change of registered office from one State to another within India.
In Minerva Mills V. Govt. of Maharashtra, the registered office of the company was situated at Bombay. The company in its general meeting passed a special resolution for alteration of its memorandum of Association. The resolution provided that the registered office of the company would be situated in the State of Mysore. Company’s mils were already in Mysore and the resolution stated that the shifting would be helpful in carrying on company’s activities more economically and efficiently. The company filed a petition for the confirmation of the court under Section 17(2) of the Companies Act.
The Court rejected the contention of the State of Maharashtra that the resolution passed by the company was four year old and that the shareholders ho passed the resolution as well the circumstances then previling had changed. The Court held that where strong ground exist for sanctioning the transferof registered office from one State to another the mere fact that some of the shareholders may be different from the shareholders who passed the special resolution cannot be ground for refusing the confirmation of alteration of memorandum of association. On the facts of the case the Court found strong grounds for sanctioning change of the registered office from the State of Maharashtra to the State of Mysore.
The Court also rejected the second contention of the State that it was not in the interest of the company or of the State to sanction the special resolution. The court held the shareholders are the best judges of what is good for the company and the State cannot assume to itself the role of a guardian of their interest, or interfere in the management of the business of the company which is a matter entirely for the company itself.
The State’s contention that the transfer of registered office would affect adversely the general economy of the State was also rejected by the Court. The court observed that vague considerations of the impact of transfer on the general economy of the State are no ground for rejecting the confirmation of the transfer of the registered office from one State to another.
The Court confirmed the transfer of the registered Office of the company but subject to the condition that the company furnished to the State a bank guarantee claimed as arrears of sales tax by the State.
In Rank Film Distributors of India Ltd. V. Registrar of Companies, West Bengal, the company passed the resolution for transfer of its registered office from the State of West Bengal to the State of Maharastra. The company pleaded that its head office had already been transferred to Bombay, that the registered offices of most foreign film companies were situated in Bombay, that there was better scope of expansion of the company’s business and that it was in the interest of shareholder that the registered office of the company should be moved to Bombay. Company applied for the confirmation of the Court.
Court rejected the contention of the State that sufficient cause had not been shown for the transfer of registered office to the State of Maharashtra. It held that the test to be applied was whether at the time when the resolution were passed, the shareholders had, by domestic deliberation, for any of the reasons specified in S. 17, decided in favour of the transfer of the registered office. Court laid down that it was for the members of the company and not for the State to decide whether the registered office of the company should be transferred from one State to another in the interest of the company. To permit the State to contend that the proposed transfer would not enable the company to carry on its business more efficiency or economically would be to enable the State to have a voice in an aspect of the management of the affairs of the company which is not warranted by the Statute.
The Court took the view that the principles laid down for the guidance of the court in dealing with application for confirmation of reduction of capital should be applied for confirmation of alteration of the memorandum of a company.
Dealing with the question of notice to the State the Court stated that though S. 17(4) specially required notice to the Registrar, no specific provision had been made for notice to the State.
The Court also rejected the State’s contention that transfer of the registered office of the company would adversely affect the economy of the State, that there shall be loss of revenue to the State, and that the opportunities of employment would be lessened. It stated that “a broader perspective” must be taken into account in so far as the loss of one State would be balanced by gain to another, and after all, “the country was one and indivisible.
The alteration of Memorandum of Association of the company was confirmed.
Before confirming the alteration, the Central Government must satisfy itself that sufficient notice has been given to every debenture holder or person or class of persons whose interests are likely to be affected. In reference to creditors, the Government has to feel satisfied that those who have raised objections, their interests have been safeguarded either by paying them out or securing their payment. The Government has also to see that a notice has been served on the Registrar of Companies to enable him to state his objections, if any.
3. Objects and Powers Clause:- In the third clause, the memorandum must state the objects for which the proposed company is to be established. The objects clause must be divided into three sub-clauses, namely:
(i) Main Objects:- This sub-clause has to state the main objects to be pursued by the company on its incorporation and objects incidental or ancillary to the attainment of the main objects.
(ii) Other Objects:- This sub-clause must state other objects which are not included in the above clause.
(iii) States to which objects extend:- In the case of non-trading companies, whose objects are not confined to one State, this sub-clause has to mention the States to whose territories the objects extend.
Choice of objects lies with the subscribers to the memorandum and their freedom in this respect is almost unrestricted. The only obvious restriction are that the objects should not go against the law of the land and the provisions of the Companies Act.
The ownership of the corporate capital is vested in the company itself. But in reality that capital has been contributed by the shareholders and is held by the company as though in trust for them. Such fund must obviously be dedicated to some defined objects so that the contributors may know the purpose to which it can be lawfully applied. The statement of objects, therefore, gives a very important protection to the shareholders by ensuring that the funds raised for one undertaking are not going to be risked in another
The object clause, in the second place, affords a certain degree of protection to the creditors also. The creditors of a company trust the corporation and not the shareholders and they have to seek their repayment only out of the company’s assets. The fact that the corporate capital cannot be spend on any project not directly within the terms of the company’s objects gives the creditors a feeling of security. Public financial institutions providing loans to companies have to object-wise because they have their own list of priorities. The object clause is their only guidance in this respect.
Thirdly, by confining the corporate activities within a defined field, the statement of objects serves the public interest also. It prevents diversification of a company’s activities in direction not closely connected with the business for which the company may have been initially established.
Alteration of objects:
Section 17 allows alteration of objects within defined limits. “The intention of the Legislature is to prevent too easy an alteration of the condition contained in the memorandum.” The exercise of the power is, therefore fenced by safeguard which are calculated to protect the interests of creditors and of shareholders. The limits imposed upon the power of alteration are of two kinds, namely, substantive and procedural. The former defines the physical limits of alteration and the latter the procedure by which it can be effected.
1. Substantive Limits:- Section 17 provides that a company may change its objects only in so far as the alteration is necessary for any of the following pruposes:
(a) To enable the company to carry on its business more economically or more efficiently.
(b) To enable the company to attain its main purpose by new or improved means:- This clause is intended to enable companies to take advantage of new scientific discoveries. With the objects remaining the same, only the means of carrying them out are permitted to be changed under this clause.
(c) To enlarge or change the local area of the company’s operation:- This is to enable companies to carry their trades to new quaraters of the globe.
(d) To carry on some business which under existing circumstances may conveniently or advantageously be combined with the business of the company:- This is the only clause which allows a company to undertake any new business having no relation to its existing business except that it must be such as can conveniently or advantageously be combined with the companies existing business. What new business can be so combined must be determined by the persons engaged in the business. Thus a tyre company was allowed to undertake the general business of bankers and financiers. The new business must not, of course, be inconsistent with the existing business.
(e) To restrict or abandon any of the object specified in the memorandum.
(f) To sell or dispose of the whole, or any part of the undertaking, of the company.
(g) To amalgamate with any other company or body of persons.

2. Procedure of alteration:-
Since the amendment of S. 17 of the Act by the Companies Act the prescribed procedure for the altering objects is only the requirement of a special resolution and its filing with the Registrar. The requirement of seeking confirmation of the Company Law Board has been dispensed with. The alteration of objects has become an internal matter. No outside confirmation is necessary. The only restraint now is that the special resolution of the company should be within the scope of the permissible range of alteration as outlined in S. 17(1). The matter being wholly internal, only the shareholders can object to any change which is extraneous to the company and its members. This contract operates within the framework of the Companies Act.
The Company Law Board had the discretion to refuse to confirm the alteration or the confirm it either wholly or in part or subject to such conditions as may be deemed fit.
Registration of alteration:
In the case of alteration of objects, a copy of the resolution should be filed with the Registrar of Companies within one month from the date of the resolution. In the case of inter-State shifting of the registered office a certified copy of the Central Government’s order and a printed copy of the altered memorandum must be filed with the Registrar within three months of the order. The documents have to be filed with the Registrar of the Place from where the office is to be shifted and also with the Registrar of place at which the new office is to be established.
Within one month the Registrar will certify the registration. Alteration takes effect when it is so registered.
4. Liability Clause:- The fourth clause has to state the nature of liability that the members incur. If the company is to be incorporated with the limited liability, the clause must state that “the liability of the members shall be limited by shares”. This means that no member can be called upon to pay anything more than the nominal value of the shares held by him, or so much thereof as remains unpaid; and if his shares be fully paid up his liability is nil. If it is proposed to register the company limited by guarantee, this clause will state the amount which every member undertakes to contribute to the assets of the company in the event of its winding up.
5. Capital Clause:- The last clause states the amount of the nominal capital of the company and the number and value of the shares into which it is divided. A public company must have a minimum paid up capital of five lakh rupees or such higher amount as may be prescribed. A private company is required to have a minimum paid up capital of 1 lakh rupees or such higher amount as may be prescribed by its articles.
Subscription:
The memorandum concludes with the subscribers’ declaration. The subscribers declare: “We, the several persons whose names and addresses are subscribed, are desirous of being formed into a company, in pursuance of this memorandum of association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names.” The memorandum has to be subscribed by at least seven persons in the case of a public company and by at least two in the case of a private company. Each subscriber must sign the document and must write opposite his name the number of shares he takes. But no subscriber shall take less than one share. After incorporation no subscriber can withdraw his name on any ground whatsoever.









Doctrine of Ultra Vires

A company which owes its incorporation to statutory authority cannot effectively do anything beyond the powers expressly or impliedly conferred upon it by its statute or memorandum of association even if agreed by all the members. The purpose of these restriction is two fold. First, to protect investors in the company so that they may know the objects in which their money is to be employed; and secondly, to protect creditors by ensuring that the company’s funds, to which they must look for payment, are not dissipated in unauthorized activities.
It ensured that an investor in a gold mining company did not find himself holding shares in a fried-fish shop, and it gave those who allowed credit to a limited company some assurance that its assets would not be dissipated in unauthorized enterprises.
It is the function of the memorandum “to delimit and identify and objects in such plain and unambiguous manner as that the reader can identify the field of industry within which the corporate activities are to be confined. An action outside the memorandum is ultra vires the company. Its application to such companies was first demonstrated by the House of Lords in Ashbury Railway Carriage and Iron co. Ltd. V. Riche. The memorandum of association of a company thus defined its objects; lend on hire, railway carriage and wagons and all kinds of ailway plants, etc. to carry on the business of mechanical engineers and general contractors.” The company entered into a contract with Riche, a firm of railway contractors, to finance the construction of a railway line in Belgium. The company, however, repudiated the contract as one ultra vires. And Riche, brought an action for damages for breach of contract. His contentions were that the contract in question came well within the powers of the company, and, secondly, that the contract was ratified by a majority of the shareholders.
But the House of Lords held that the contract was ultra vires and, therefore, null and void. The subscribers are to state the objects for which the proposed company is to be established and then the company comes into existence for those objects and those only. Such a statement of objects has a two-fold operation. It states affirmatively the ambit and extent of powers of the company and it states negatively that nothing shall be done beyond that ambit, and that no attempt shall be made to use the corporate life for any other purpose than that which is so specified. The terms “general contractors” must be taken to indicate the mechanical engineers. If the term “general contractors” is not so interpreted, it would authorised the making of contracts of any and every description, such as, for instance, of fire and marine insurance and the memorandum in place of specifying the particular kind of business, would virtually point to the carrying on of the business of any kind whatsoever and would, therefore, be altogether unmeaning. Hence the contract was entirely beyond the objects in the memorandum of association. If the company could not make it, much less could be ratified. If every shareholder of the company had been in the room and had said: “that is a contract which we desire to make, which we authorize the directors to make” the case would not have stood in any different position from that in which it stands now. The shareholders would thereby, by unanimous consent, have been attempting to do the very thing which by the Act of Parliament, they were prohibited from doing.
In Attorney_General V. Great Eastern Railway Co. the House of Lords, observed that the doctrine of ultra vires, as it was explained in the Ashbury case, should be maintained. But it ought to be reasonably and not unreasonably understood and applied and that whatever may be fairly regarded as incidental to the objects authorised ought not to be held as ultra vires, unless it is expressly prohibited.
Thus a company may do an act which is : (a) necessary for, or (b) incidental to, the attainment of its objects, or (c) which is otherwise authorised by the Act. Thus a railway company, having authority to keep steam vessels for the purpose of a ferry, may use them for excursion trips to the sea when they are otherwise unemployed. Again a railway company whose railroad is carried over arches may convert the arches into shops, otherwise “it might as reasonably be contended that a railway company are not entitled to sell the hay which grows on their banks so as to make something out of it.”
Power to carry out an object, undoubtedly includes power to carry out what is incidental or conducive to the attainment of the objects, for such extension merely permits something to be done which is connected with the objects to be attained as being naturally conductive thereto.
Acts incidental to or naturally conductive to the main object are those which have reasonably proximate connection with the object, and some indirect or remote benefit which the Company may obtain and by doing an act not otherwise within the object clause, will not be permitted by the extension.
In India the origin of doctrine dates back to 1866 when the Bombay High Court applied it to a joint stock company and held on the facts of the case before it that “the purchase by the directors of a company, on behalf of the company, of shares in other joint stock companies, unless expressly authorised in memorandum is ultra vires.
The doctrine has been affirmed by the Supreme Court in its decision in A Lakshmanaswami Mudaliar V. LIC. The directors of a company were authorised “to make payments towards any charitable or any benevolent object, or for any general public, general or useful object”. In accordance with a shareholders’ resolution the directors paid two lakh rupees to a trust formed for the purpose of promoting technical and business knowledge.
The payment was held to be ultra vires. The court said that the directors could not spend the company’s money on any charitable or general object which they might choose. They could spend for he promotion of only such charitable objects as would be useful for the attainment of the company’s own objects. The company’s business having been taken over by the LIC it had no business left to promote.
The above Supreme Court decision is an authority for two propositions. Firstly, that a company’s fund cannot be diverted to every kind of charity even if there is an unrestricted power to that effect in the company’s memorandum. Secondly, that objects must be distinguished from powers.
The ultra vires doctrine confines corporate action within fixed limits. While it handicaps the ambitious managers, it lays a trap for the unwary creditors. That is why there has been a revolt against it almost ever since its inception. One of the methods of bypassing ultra vires is the practice of registering memorandum containing a profusion of objects and powers.
The courts have striven in two ways to curb evasion. First, they have applied the ejusdem generic rule to the construction of objects clauses, saying that when the main objects, specified in the first few paragraphs, were followed by wide powers expressed in general words, the latter should be construed as covering their exercise only for the purposes of the main objects. This, however, has been circumvented by the practice of inserting an express declaration in the objects clause to the effect that each of the specified objects or powers should be deemed to be independent and in no way ancillary or subordinate one to another.
For example, in Cotman V. Brougham, the House of Lords had to consider a memorandum which contained an objects clause with thirty sub-clauses enabling the company to carry on almost every kind of business which a company could adopt. Such a objects clause naturally defeats the very purpose for which it is there. In a bid to control this tendency the courts adopted the “main objects rule” of construction. The rule owes its origin to the decision in the Ashbury case where it was held that the words “general contractors” must be read in connection with the company’s main business.
Secondly, it was held in Re German Date Coffee Co. the memorandum of a company stated that it was formed for working a German Patent which would be granted for manufacturing coffee from dates; for obtaining other patents for improvements and extension of the said invention; and to acquire and purchase any other invention for similar purposes. The intended German patent was never granted, but the company purchased a Swedish patent, and also established works in Hamburg where they made and sold coffee from dates without any patent. A petition having been presented by two shareholders, it was held that the main object for which the company was formed had become impossible and, therefore, it was just and equitable that the company should be would up. The court said: “In construing a memorandum in which there are general words they must be taken in connection with what are shown by the context to be the dominant or main objects. It will not do under general words to turn a company for manufacturing one thing into a company for importing something else. Taking that as the governing principle, it seems to be plain that the real object of this company which is called German Date Coffee Co, was to manufacture a substitute for coffee in Germany under a patent. It is what the company was formed for and all the rest is subordinate to that.”
In Cotman V. Broughman the main objects rule was excluded by a declaration in the object clause that “every clause should be construed as substantive clause and not limited or restricted by reference to any other sub clause or by the name of the company and none of them should be deemed as merely subsidiary or auxiliary”. The House of Lords expressed strong disapproval of the inclusion of such a clause, but their Lordships held that it excluded the “main objects rule” of interpretation.
Thus the rule has failed to prevent the evasion of ultra vires. And now the decision of the Court of Appeal in Bell Houses Ltd. V. City Wall Properties Ltd has stamped its approval upon another technique of evasion. In this case a company’s objects clause authorised it to carry on any other trade or business which in the opinion of the board of directors could be carried on advantageously in connection with the company’s general business. The court held that the clause to be valid and an act done in bona fide exercise of it to be intra vires. But a clause of this kind does not state any objects at all. Rather, it leaves the objects to be determined by the directors bona fides.
Consequences of ultra vires transactions:
Whenever a company gets involved in an ultra vires transaction the question arises at to what are it’s effects.
1. Injunction: Whenever an ultra vires act has been or is about to be undertaken, any member of the company can get an injunction to restrain it from proceeding with it.
2. Personal liability of directors: It is one of the duties of directors to see that the corporate capital is used only for the legitimate business of the company. If any part of it has been diverted to purposes foreign to the company’s memorandum, the directors will be personally liable to replace it.
3. Breach of warranty of authority: It is the duty of an agent to act within the scope of his authority. For if he goes beyond he will be personally liable to the third party for breach of warranty of authority. The directors of a company are its agents. As much it is their duty to keep within the limits of the company’s powers.
4. Ultra vires acquired property: If a company’s money has been spent ultra vires in purchasing some property, the company’s right over that property must beheld secure. For, that asset, though wrongly acquired, represents the corporate capital.
5. Ultra Vires Contracts: A contract of a corporation which is ultra vires, that is to say outside the objects as defined by its memorandum is wholly void and of no legal effect. For example in Beauforte (Jon) (London), a company was authorised by its memorandum to carry on the business of costumiers, gown-makers and other activities of allied nature. The company decided to undertake the business of making veneered panels which was admittedly ultra vires and for this purpose erected a factory at Bristol. A firm of builders who constructed the factory claimed £ 2,078 as owing to them. Another firm supplied veneers to the company and had a claim of £ 1,011. A third firm sought to prove for a simple contract debt of £ 107 in respect of coke supplied to the factory. None of these applicants had actual knowledge that veneered business was ultra vires, yet none of them could make the company liable for his claim. The reason is that every one dealing with a company is supposed to know its powers.
In Bell House Ltd. V. City Wall Properties Ltd., the plaintiff company’s principal business was the acquisition of vacant sites and the erection thereon of housing estates. In the course of transacting the business, the chairman acquired knowledge of sources of finance for property development. The company introduced the financer to the defendant company and claimed the agreed fee of £ 20,000 for the same.
The trial judge held that the contract was ultra vires the plaintiff company and, therefore, void. But this was reversed on appeal. The court of Appeal relied on the clause in the memorandum which authorised the company “to carry on any other trade or business whatsoever which can, in the opinion of the board of directors, be advantageously carried on by the company in connection with its general business, and held that since the directors honestly believed that the transaction could be advantageously carried on as ancillary to the company’s main objects, it was not ultra vires
This decision of the Court was highly criticized all over. Many News magazines like Indian Law Review etc. addressed this decision as Death of Doctrine of Ultra Vires and as An Obituary to doctrine of Ultra Vires.
It is sometimes suggested that there is an over-riding principle that, whatever the objects clause may provide, an activity not bona fide designed to enhance the financial prosperity of the company will necessarily be ultra vires since “charity cannot sit at the boardroom table” and “there are to be no cakes and ale except for the benefit of the company.”
6. Ultra Vires Torts: A company may be liable for torts or crimes committed in pursuance of its stated objects but should not be liable for acts entirely outside its objects. In other words, if the objects of the company are restricted to running a tramway it will be liable for anything which its officers do within the actual or usual scope of their authority in connection with or ancillary to running trams, but will not liable either civilly or criminally for anything which its officer do in connection with some entirely different business.
The nature and consequences of ultra vires rule points to some of its inherent complications resulting in occasional injustice. The statement of objects indicates the permissible range of corporate activity. Everything else beyond that is implicitly prohibited so that the corporate capital may be preserved for the benefit of shareholders and creditors. But that protection does not in any way suffer if the memorandum, like articles, is made a contract only between shareholders and the company. Every contract made on behalf of the company whether within or beyond its powers should be valid.
A question is posed in the present scenario i.e. whether Company should have a general contracting capacity or not. Or whether the Doctrine of Ultra Vires should be abolished.
In view of the present business scenario it will be right to remove the Doctrine of Ultra Vires. It has outlived its usefulness. Now the framers of the Memorandum of Association used to make the object clause of the companies so lengthy that it covers almost each and every possibility available under this sky within the scope of the companies. Apart from this the object clause of the company can also be altered by the Board of Directors even by special resolution.
In essence it can be said that now the object clause of the companies are so lengthy that the real object behind the incorporation of the company buried beneath the heaps of the multi utility objects. Now it may seem, the modern gold mining company may quite probably have power under its memorandum to operate fried fish shops.
The object behind the Doctrine of Ultra Vires has lost its relevance. The interest of shareholders and creditors are not much secured by this doctrine. Basically the shareholders are scattered all over the globe, therefore, it is not possible for them to attend the meeting of the company even AGM. Shareholders are concerned in the appreciation in the Share Value. They want to cash the gain at the shortest time possible. They are no more concerned with the business policies and the strategies of the Company.
Therefore, it should be reformed so that as regards 3rd parties a company would have all the powers of a natural person and the object clause in is memorandum would operate solely as a contract between the company and its members regarding the extent of the authority conferred on its directors and officers; in other words, companies would, in this respect be equated with partnerships.

Promoters

Before a company can be formed there must be some persons who have the intention to form a company, and who take the necessary steps to carry that intention to carry that intention into operation. Such persons are called promoters. The term ‘promoter’ is not a term of art, nor a term of law, but of business. The emphasis upon its business implication is quite apparent from the state meant that the term is used to sum up ‘in a single word a number of business operations, familiar to the commercial world by which a company is generally brought into existence.
A promoter is a person who brings about the incorporation and organization of a corporation. He brings together the persons who become interested in the enterprise, aids in procuring subscriptions, and sets in motion and machinery which leads to the formation itself. A promoter is one who undertakes to form a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose. A person may become a promoter even after the formation of the company, for example, by becoming party to the share issues or to procuring subscriptions.
A person who acts in a professional capacity is not a promoter. Thus a solicitor, who prepares on behalf of the promoters the primary documents of the proposed company is not a promoter similarly, an accountant or a valuer. The Companies Act, in Section 62, while providing for the liability of a promoter for misrepresentation in prospectus, also excludes such a person from the category. But any such person may become a promoter if he helps the formation of the company by doing an act outside the scope of his professional duty.
Duty and Liability:
Fiduciary Position:
The position of promoters in relation to the company was explained in Erlanger V. New Sombrero Phosphate Co. as they stands, undoubtedly in fiduciary position. They have in their hands the creation and moulding of the company. They have the power of defining how and when, in what shape and under what supervision the company shall start into existence and begin to act as a trading corporation.
The promoters is in the situation akin to that of a trustee of the company, and his dealings with it must be open and fair. Thus the first and the foremost duty of a promoter is that if he starts a company for the purpose of buying his property and wants to draw his payment from the money obtained from shareholders, he must faithfully disclose all facts relating to the property. In short, the chief duty of the promoters as a fiduciary agent is to disclose to the company his position, his profit and his interest in the property which is the subject of the purchase or sale by the company.
It was suggested in Erlanger case that it should be made to an independent and competent board of directors. A group of persons headed by E purchased an island containing phosphate mines for £ 55,000. A company was then incorporated to take over the island and to work the mines. E named five persons as directors. Two were abroad. Of the three others, two were persons entirely under E’s control. These three directors purchased the island for the company at a price of £ 1,10,000. A prospectus was then issued. Many persons took shares. The purchase of the island was adopted by the shareholders at their first meeting; but the real circumstances were not disclosed to them. The company failed and the liquidator sued the promoter for refund of the profit.
The only material contention urged on behalf of the promoters was that the company’s board of directors had full knowledge of the facts. Rejecting this the court said that if they propose to sell their property to the company, it is incumbent upon them to take care that they provide the company with an executive body who shall both be aware that the property which they are asked to purchase it the promoter’s property and who shall be competent and impartial judges as to whether the purchase ought or ought not be made. They should sell the property to the company through the medium of a board of directors who can and do exercise an independent and intelligent judgment on the transaction.
Subsequent experience, however, showed that it may not always be possible for the promoters to give to the company an independent board of directors. In the case of private company, or a public company which like that of Saloman & Co. consists of only the family members, it is just not possible to constitute an independent board of directors. In such a case the promoters hall disclose his interest and profit to the shareholders of the company. But it will not be enough to disclose the truth to the first few shareholders. The disclosure should be made to the whole body of persons who are invited to become the shareholders. This was emphasized by the House of Lords in their well known decision in Gluckstein V. Barnes.
A syndicate of persons was formed to raise a fund, buy a property called ‘Olympia’ and resell it to a company. They first bought up some of the charges upon the property for sums below the amount which the charges afterwards realized, and thereby made a profit of £ 20,000. They brought the property for £1,40,000, formed a limited company and resold the property for £ 1,80,000 to the company, of which thy ewer first directors. They issued a prospectus inviting application for shares and disclosing the two prices of £ 1,40,000 and £ 1,80,000 but not the profit of £ 20,000. Shares were issued but the company afterwards went into liquidation.
It was held that the promoters ought to have disclosed to the company the profit of £ 20,000. The defendant, who was one of the promoters, contended that the fact was known to the parties to the transaction. Rejecting this contention the court said that it is too absurd to suggest that a disclosure to the parties to this transaction is a disclosure to the company. They were there by the terms of the agreement to do the work of the syndicate, that is to say, to cheat the shareholders; and this, forsooth, is to be treated as a disclosure to the company, when they were really there to hoodwink the shareholders, and so, far from protecting them, were to obtain from them the money, the produce of their nefarious plans.
Here it was held that a promoter cannot effectively contract out of his duties by inserting a clause in the articles whereby the company and the subscribers agree to waive their rights.
Disclosure is not the most appropriate word to use when a person who plays many parts announces to himself in one character what he has done and is dong in another. The duty continues even after incorporation until the profits are fully disclosed and fully accounted for.
The Companies Act now requires through Section 56 the promoters earnings to be disclosed in the prospectus itself. Disclosure has also to be made of any interest of the promoters in the promotion of the company or in any property acquired by the company during the two years or proposed to be acquired.
Remedies for breach of promoters’ duties:
The remedies available against the breach of duties by promoters are best explained in Lagunas Nitrate Co. Case. Here it was said that since the promoter owes a duty of disclosure to the company the primary remedy against him in the event of breach is for the company to bring proceedings for recession of any contract with him or for the recovery of any secret profits which he has made. So far as the right to rescind is concerned, this must be exercised on normal contractual principles, that it to say the company must have done nothing to show an intention to ratify the agreement after finding out about the non disclosure or misrepresentation.
In Erlanger Case, it was stated by the court that in view of the wide powers now exercised by the court whether the restitution in integrum rule operates as any real restraint at any rate where the promoters has been fraudulent or where he himself responsible for the dealings alleged to have resulted in restitution being impossible.
The only circumstances where this requirement seems likely to impose a serious limitation is where innocent third parties have acquired rights to the property concerned, and even there a monetary adjustment will often enable the third parties right to be satisfied.
If the contract is rescinded the promoter’s secret profit will normally disappear as a result, but if he has made a profit on some ancillary transaction there is no doubt that this too may be recovered. Moreover, a secret profit may be recovered although the company elects not to rescind. The classic illustration of this is Gluckstein V. Barnes itself.
There is, however authority for saying that if the property on which the profit was made was acquired before the promoter became a promoter, there can be no claim for the recovery of the profit as such. According to this view it may be necessary for this purpose to make the admittedly difficult, determination of the exact movement of time at which the promotion began.
In addition to the remedies of the company, the promoter may be liable to those who have acquired securities of the company in reliance on mis-statement in listing particulars on prospectuses to which the promoters was a party. The remedies available against him are the same as those against the officers of the company or others responsible for the listing particular or prospectuses.


















Doctrine of Indoor Management
(Constructive Notice)

Constructive Notice:
The memorandum and articles of association of every company are registered with the Registrar of Companies. The office of the Registrar is a public office and consequently the memorandum and articles become public documents. They are open and accessable to all. It is, therefore, the duty of every person dealing with a company to inspect its public documents and make sure that his contract is in conformity with their provisions. But whether a person actually reads them or not, “he is to be in the same position as if he had read them”. He will be presumed to know the contents of those documents. This kind of presumption notice is called constructive notice.
Kotla Venkataswamy V. Rammurthy, shows the practical effects of this rule. The articles of association of a company required that all deeds etc., should be signed by the managing director, the secretary and a working director on behalf of the company. The plaintiff accepted a deed of mortgage executed by the secretary and a working director only. It was held that the plaintiff could not claim under this deed. The court observed: “If the plaintiff had consulted the articles she would have discovered that a deed such as she took required execution by three specified officers of the company and she would have refrained from accepting a deed inadequately signed. Notwithstanding, therefore, she may have acted in good faith and her money may have been applied to the purpose of the company, the bond is nevertheless invalid.
Another effect of this rule is that a person dealing with the company is taken not only to have read those documents but to have understood them according to their proper meaning. He is presumed to have understood not merely the company’s powers but also those of its officers. Further, there is constructive notice not merely of the memorandum and articles, but also of all the documents, such as special resolutions and particulars of charges which are required by the Act to be registered with the Registrar.
Constructive notice is more or less an unreal doctrine. It does not take notice of the realities of business life.
Doctrine of Indoor Management:
The role of the doctrine of indoor management is opposed to that of the rule of constructive notice. The latter seeks to protect the company against the outsider, the former operates to protect outsiders against the company. It follows that there is no notice as to how the company’s internal machinery is handled by its officers. If the contract is consistent with the public documents, the person contracting will not be prejudiced by irregularities that may beset the indoor working of the company. The rule had its genesis in Royal British Bank V. Turquand.
The directors of a company borrowed a sum of money from the plaintiff. The company’s articles provided that the directors might borrow on bonds such sums as may from time to time be authorised by a resolution passed at a general meeting of the company. The shareholders claimed that there has been no such resolution authorizing the loan and, therefore, it was taken without their authority. The company was, however, held bound by the loan. Once it was found that the directors could borrow subject to a resolution, the plaintiff had the right to infer that the necessary resolution must have been passed.
In Premier Industrial Bank case, it was stated that if the directors have power and authority to bind the company, but certain preliminaries are required to be gone through on the part of the company before that power can be duly exercised, then the person contracting with the directors is not bound to see that all these preliminaries have been observed. He is entitled to presume that the directors are acting lawfully in what they do.
The rule is based upon obvious reasons of business convenience in relations. The Memorandum of association and article of association are public documents, open to public inspection. But the details of internal procedure are not thus open to public inspection. Hence an outsider is presumed to know the constitution of a company; but not what may or may not have taken place within the doors that are closed to him.
Gower explained that the lot of creditors of a limited company is not a particularly happy one; it would be unhappier still if the company could escape liability by denying the authority of the officials to act on its behalf.
Exceptions:
The rule is now more than a century old. In view of the fact that companies having come to occupy the central position in the social economic life of modern communities, it was expected that its scope would be widened. But the course of decisions has made it subject to the following exceptions.
1. Knowledge of irregularity:-
The first and the most obvious restrictions is that the rule has no application where the party affected by an irregularity had actual notice of it. Knowledge of an irregularity may arise from the fact that the person contracting was himself a party to the inside procedure.
In Howard V. Patent Ivory Manufacturing Co, the directors could not defend the issue of debentures of themselves because they should have known that the extent to which they were lending money to the company required the assent of the general meeting which they had not obtained. Similarly, in Morris V. Kanssen a director could not defend an allotment of shares to him as he participated in the meeting which made the allotment. His appointment as a director also fell through because none of the directors appointing him was validly in office. The trend of decisions has been slightly altered by Hely-Hutchinson V. Brayhead Ltd, according to which the mere fact that a person is a director does not mean that he shall be deemed to have knowledge of the irregularities practiced by the other directors. A newly appointed director entered into contracts of indemnity and guarantee with the company through a director whom the company had knowingly allowed to hold himself out as having the authority to enter into such transactions, although in fact he had no such authority. The new director had no knowledge of the irregularity. The company was held liable.
But apart from this, the principle is clear that a person who is himself a part of the internal machinery cannot take the advantage of irregularities. Any other rule would “encourage ignorance and condone dereliction from duty.”
2. Suspicion of irregularity:-
The protection of the “the Turquand rule” is also not available where the circumstances surrounding the contract are suspicious and, therefore, invite inquiry. In Anand Bihari Lal V. Dinshaw & Co., the plaintiff accepted a transfer of a company’s property from its accountants, the transfer was held void. The plaintiff could not have supposed, in the absence of a power of attorney, that the accountant had authority to effect transfer of the company’s property.
Where a person holding directorship in two companies agreed to apply the money of one company in payment of the debt of the other, the court said that it was something so unusual that the plaintiff were put upon inquiry to ascertain whether the persons making the contract had any authority in fact to make it. Any other rule would place limited companies without any sufficient reasons for so doing, at the mercy of any servant or agent who should purport to contract on their behalf.
3. Forgery:-
The Forgery may in circumstances exclude the Turquand rule. In Ruben V. Great Fingall Consolidated, the plaintiff was the transferee of a share certificate issued under the seal of the defendant company. The certificate was issued by the company’s secretary, who had affixed the seal of the company and forged the signatures of two directors. The plaintiff contended that whether the signature were genuine or forged was a part of the internal management and, therefore, the company should be estopped from denying the genuiness of the document. But it was held that the rule has never been extended to cover such a complete forgery. It was said that it is quite true that persons dealing with limited liability companies are not bound to inquire into their indoor management and will not be affected by irregularities of which they have no notice. But this doctrine, which is well established, applies to irregularities of which they have no notice. But this doctrine, which is well established, applies to irregularities which otherwise might affect a genuine transaction. It cannot apply to a forgery.
This statement has been regarded as a dictum, as the case was decided on the principle that the secretary did not have actual or implied authority to represent that a forged document was genuine and, therefore, there was no estoppel against the company.
In Official Liquidator V. Commissioner of Police, a document on which a company borrowed a sum of money was executed by the managing director who was the chief functionary of the company and, to comply with the requirements of the articles, the signatures of two other directors were forged, the company was not allowed to eschew liability under the document.
We hold the matter liable as a matter of social and economic policy. The basis of liability is the eminently practical view that if authority is conditioned on facts peculiarly within the agent’s knowledge, his representation express or implied should bind the principal.
4. Representation through Articles:-
This exception deals with the most controversial and highly confusing aspect of the Turquand rule. Articles of Association generally contains what is called the “power of delegation”. The effect of a delegation clause is that a person who contracts with an individual director of a company, knowing that the board has power to delegate its authority to such an individual, may assume that the power of delegation has been exercised.
If the act is one which is ordinarily within the powers of such an officer, then the company cannot dispute the officer’s authority to do the act, whether the director have or have not actually invested him with authority to do it.
In Freeman V. Buckhurst, ‘K’, who carried on business as a property developer, entered into a contract to purchase an estate. He had not enough money to pay for it and obtained financial assistance from H. They formed a limited company with certain capital subscribed equally by K and H to buy the estate with a view to selling it for development. K and H with a nominee of each, comprised the board. The quorum of directors was, by the articles of association, four. H was at all material times abroad. There was power under the articles to appoint a managing director, but the board did not in fact do so. K to the knowledge of the board acted as if he were managing director of the company in relation to finding a purchaser for the estate, and, again without express authority of the board, employed on behalf of the company, a firm of architects and surveyors for the submission of an application for planning permission etc. The firm claimed from the company their fees for work done.
The court laid down that the following conditions must be fulfilled to entitle a contractor to enforce against a company a contract entered into on behalf of the company by an agent who has no actual authority to do so:
(i) that a representation that the agent had authority to enter on behalf of the company into a contract of the kind sought to be enforced was made to the contractor.
(ii) that such representation was made by a persons or person who had ‘actual’ authority to manage the business of the company either generally or in respect of those matters to which the contract relates;
(iii) that contractor was induced by such representation to enter into the contract that is, he in fact relied upon it; and
(iv) that under the memorandum and article of association the company was not deprived of the capacity either to enter into a contract of the kind sought to be enforced or to delegate authority to enter into a contract of the kind to the agent.
It was held that the company was liable for the fees claimed because K throughout acted as managing director to the knowledge of the company and thus was held out by the company as being managing director, and the ostensible authority thus conferred could bind the company since its articles of association in fact provided for there being a managing director of the company.
K’s act in employing the plaintiff was within the ordinary ambit of the authority of such a managing director. The fact that the plaintiffs had not examined the company’s articles and had not enquired whether K was a properly appointed managing director did not prevent them from establishing their claim against the company based on their reliance on K’s ostensible authority.
Thus the principle that emerges from these authorities that once it is shown that the contract in question is within the ostensible authority of the officer through whom it was made, a company cannot escape liability. Unless, it can show that under its memorandum or articles of association it had no capacity either to enter into a contract of that kind or to delegate the authority in the matter to the officer.
5. Acts outside apparent authority:
Lastly, if the act of an officer of a company is one which would ordinarily be beyond the powers of such an officer, the plaintiff cannot claim the protection of the Turquand rule simply because under the articles power to do the act could have been delegated to him. IN such a case the plaintiff cannot sue the company unless the power has, in fact, been delegated to the officer with whom he dealt. A clear illustration is Anand Behari Lal V. Dinshah & Co. The plaintiff accepted a transfer of a company’s property from its accountant. Since such a transaction is apparently beyond the scope of an accountant’s authority, it was void. Not even a ‘delegation clause’ in the articles could have validated it, unless he was, in fact, authorised.
In Kreditbank Cassel V. Schenkers Ltd., the defendant company, by its memorandum, had power to draw and accept bills of exchange by articles, the directors were empowered “to determine who shall be entitled to sign, draw, accept, etc, bills on company’s behalf”. The defendant’s business was that of forwarding agents. They had a branch at Manchester under a branch manager who, without having received any authority from the company, and in fraud, drew seven bills purporting to do so on company’s behalf. The company was sued on these bills as drawers.
It was held that having regard to his position, drawing of bills was not within the ostensible authority of this branch manager and, therefore, the company was not bound, unless it had given him actual authority or was otherwise precluded from setting up the want of authority.
Directors Duties

Directors are professional men hired by the company to direct its affairs. Yet they are not the servants of the company. They are rather the officers of the company. A director is not a servant of any master. He cannot be described as a servant of the company or of anyone. A director is in fact a director or controller of the company’s affairs.
The general principles of agency, therefore, govern the relations of directors with the company and of persons dealing with the company through its directors. Where the directors contract in the name, and on behalf of the company, it is the company which is liable on it and not the directors.
If the company is considered as large partnership, directors can be treated as managing partners as they are charged with the responsibility of managing the affairs of the company; and other shareholders are virtually dormant partners.
The directors are also treated as trustees of the company. On the position of the directors as trustees, the Nigerian Act contains the provision. Directors are trustees of the company’s money, properties and their powers and as such must account for all the money over which they exercise control and shall refund any money improperly paid away, and shall exercise their powers honestly in the interest of the company and all the shareholders, and not their own sectional interests.
The directors are persons selected to manage the affairs of the company for the benefit of the shareholders. It is an office of trust, which if they undertake, it is their duty to perform fully and entirely. Some of their duties to the company are of the same nature as those of a trustee.
In the first place it should be noted that whereas the authority of the directors to bind the company as its agents normally depends on the directors to bind the company as its agents normally depends on their acting collectively as a board, their duties of good faith are owed by each director individually. One of several directors will not as such be an agent of the company with power to saddle it with responsibility for his acts, but he will be fiduciary o it. To this extent, directors again resemble trustees who must normally act jointly but each of whom severally owes duties are owed to the company and to the company alone. In general the directors owe no duties to the individual members as such.
In Regal’s case it was said that ‘director have sometimes been trustees, or commercial trustees, and sometimes they have been called managing partners, it does not matter what you call them so long as you understand what their true position is, which is that they are really commercial men managing a trading concern for the benefit of themselves and all other share holders in it.’ Later, after pointing out that traders have discretion vested in trustees of a debt under a settlement, it was said that ‘again directors are called trustees. They are not doubt trustees of assets which have come to their hands, or which are under their control, but they are not trustees of a debt due to the company. A director is the managing partner of the concern and although a debts is due to the concern it doesn’t give right to call him a trustee of that debt which remains cases and in some respects be analogous to the liability of trustee.’
However, it is a quite obvious that to apply to directors the strict rules of the courts with respect to ordinary trustees might fetter their action to an extent which would be exceedingly disadvantageous to the companies they represent.
The directors are trustees of the company and not of individual shareholders. This principle was laid down in Percival V. Wright, and still holds grounds as a basic proposition. In this case, negotiations for the sale of a company’s undertaking were on foot and without disclosing this the directors purchased shares from the plaintiff shareholders. The selling shareholders had written to the company’s secretary asking him if he knew anyone willing to purchase their shares. Three directors offered to buy the shares at a price assessed by an independent valuer but they did not disclose that they were in the process of negotiating the sale of the company at a price per share considerably higher than the amount offered to the shareholders. The negotiations proved to be abortive, but the plaintiffs claimed that the non-disclosure was a breach of the fiduciary duty entitling them to repudiate the sale.
But the court held that there was no such fiduciary duty towards individual shareholders and, therefore, the directors were not bound to disclose negotiation which ultimately proved abortive. The court also pointed out that a premature disclosure of this kind might well be against the best interests of the company.
Directorships will always be susceptible to abuse. Some directors will always be faithless to their trust. They can capitalize their strategic position in the company to serve their own interest. The law, therefore, continues to struggle against their wile and imposes upon them certain duties which, when properly enforced, will without driving away from the field competent men, materially reduce the chance of abuse.
In applying the general equitable principle to company directors four separate rules have emerged. These are : (1) that directors must act in good faith in what they believe to be the best interests of the company; (2) that they must not exercise the powers conferred upon them for purposes different from those for which they were conferred; (3) that they must not fetter their discretion as to how they shall act; and (4) that, without the informed consent of the company they must not place themselves in a position in which their personal interests or duties to other persons are liable to conflict with their duties to the company.
Fiduciary Obligation:
Liability for breach of trust:- Traditionally the duties of the directors were non-statutory. They were fashioned out essentially from the common law as developed through the cases. But now company legislation of some countries has made a departure from this tradition. The Nigerian Act contains the provisions in this regard. It says that a director of a company stands in a fiduciary relationship towards the company and shall observe the utmost good faith towards the company in any transaction with it or on its behalf.
Greatest good faith is expected in the discharge of their duties. Good faith requires that all their endeavours must be directed to the benefit of the company.
Business Opportunities:- A director should not exploit to his own use the corporate opportunities. The doctrine of corporate opportunity has been described as an act of a director or controlling shareholders in diverting from the benefit of the corporation any enterprise or transaction in which reasonable persons would agree that the corporation had some expectancy or interest.
In Cook V. Deeks, the directors of a company diverted a contract opportunity of the company to themselves and by their votes as holders of three fourths majority resolved that the company had no interest in the contract. It was held that the benefits o the contract belonging in equity of the company and the directors could not validly use their voting power to vest it in themselves. The court observed that it is quite right to point out the importance of avoiding the establishment of rules as to directors’ duties which would impose upon them burdens so heavy and responsibilities to great that men of good position would hesitate to accept the office. But, on the other hand, men who assume complete control of a company’s business must remember that they are not at liberty to sacrifice the interests, which they are bound to protect, and while ostensibly acting for the company, divert in their own favour business which should properly belong to the company they represent.
Trading In Corporate Control:
A director who acquires property while in office will, however, be able to account for his profits upon resale if two elements are present. He must have acquired property only by reason of fact that he was a director and in the course of the exercise of the office of director.
Regal (Hastings) Ltd. V. Gulliver carries the principle to the farthest limit. The plaintiff company were the owners of a cinema in Hastings and then to sell the whole property of the company as a going concern. For the purpose of acquiring the new cinemas they formed a subsidiary company with a capital of £5,000 divided into shares of £ 1 each. They were offered a lease of the two cinemas, but the landlord required a guarantee of the rent by the directors unless the paid-up capital of the subsidiary company was £5000. The original intention was that the plaintiff company should hold all the shares in the subsidiary, but it was unable to provide for more than 2000 shares. The matter was, therefore, rearranged: 2000 shares were allotted to the plaintiff company; 500 shares were taken by each of the three directors, 500 shares by the solicitor of the company and the remaining 500 were allotted to certain persons found by the chairman of directors. And thus a capital of £5000 was raised. Two cinemas were taken and all the shares in the plaintiff company and the subsidiary company were sold. The 3000 shares allotted to the directors, the solicitor and the chairman were sold at a profit. The action was brought by the plaintiff company to recover this profit.
It was held that in the circumstances the directors, other than the chairman, were in a fiduciary relation to the company and liable, therefore, to repay to it the profit they had made on the shares. The solicitor was not in a fiduciary relationship and was not liable. They acquired these shares only by reason of the fact that they were the directors of the Regal and in the course of their execution of that office. The plaintiff company has to establish two things: first, that what the directors did was so related to the affairs of the company that it can properly be said to have been done in the course of their management and in the utilization of their opportunities and special knowledge as directors and, secondly, that what they did resulted in a profit to themselves.
The real ground for the decision seems to be that the opportunity to take 5000 shares was the corporate opportunity. The directors, however, took the shares in good faith because the company was financially unable to make use of the opportunity. But if they were permitted to retain the profit, there would be temptation to induce such inability on the part of the company and to profit by it. The liability of the directors to account, therefore, seems to be just and clear. But to hand over this profit to the purchaser shareholders would be to give them the benefit of any undeserved reduction in the price which they had willingly paid up. Recovery, therefore, should have been in favour of the old shareholders who had really suffered.
Court held that ‘it appears, to the court, very important that we should concern in laying down again and again the general principle that in this court no agent in course of his agency is allowed to make any profit without the knowledge of his principal, that the rule is an inflexible rule, and must be applied inexorable by this court, which is not entitled, in my judgment, to receive evidence, or suggestion or arguments, as to whether the principal did or did not suffer any injury in fact, by reason of the dealing of the agent, for the safety of mankind acquires that no a gent shall be able to put his principal to the danger of such as a inquiry as that.
Further it was said that ‘it is of the highest importance that it is the duty of directors of companies to use their best exertions for the benefit of those whose interests are committed to their charge, and that they are bound to disregard their own private interest whenever a regard to them conflicts with the proper discharge of such duty.
Case of Keech Vs. Sandford, is an illustration of articleness of the rule of equity in this regard and of how far the rule is independent of those outside considerations. A lease of the profits of a market had been devised to infant was refused. It was absolutely unobtainable. The trustee, finding that impossible to get a renewal of the benefit of the infant, took a lease for his own benefit. Though his duty to obtain it for the infant was incapable of performance, nevertheless be that, if a trustee on the refusal to renew might have a lease for himself, on renewals would be made for the benefits of ‘a person to whose use lands or other hereditaments were held by another person(Centui que use). The court said that this may seems hard, that the trustee is the only person of all mankind who might not have the leave, but it is very proper that the rule should be strictly pursued, and not in the least relaxed.
Industrial Development Consultants Ltd. V. Cooley, is a reaffirmation of the belief in the Regal standard of honesty. The managing director of a company tried to get from the Gas Board a Government contract for the company. But the Gas Board plainly told him that the Government would not allow the contract to the company, but was willing to deal with him personally. He resigned from the company, under the pretence of ill-health and then promptly obtained the contract for himself. Having earned a handsome profit, he had to face an action from the company to account for it. The court held that the managing director had acted in breach of his duty and, therefore, must account.





























Winding Up

According to Professor Gower, “Winding up of a company is the process whereby its life is ended and its property administered for the benefit of its creditors and members. An administrator, called a liquidator, is appointed and he takes control of the company, collects its assets, pays its debts and finally distributes any surplus among the members in accordance with their rights.”
The company is not dissolved immediately at the commencement of winding up. Its corporate status and powers continue. “Winding up precedes dissolution. The Act provides for two types of winding up:
1. Compulsory winding up under the order of the Tribunal.
2. voluntary winding up, which itself is of two kinds, namely:
(a) Members voluntary winding up, and
(b) Creditors’ voluntary winding up.
Winding up by Tribunal:
Section 433 has been recast. The power of the court of order winding up has been vested in the Tribunal. Three additional grounds of winding up have been added.
A company ma be wound up at the order of the Tribunal. This is also called compulsory winding up. The cases in which a company may be wound up are given in Section 433. They are as follows:
1. Special resolution: If the company has, by special resolution, resolved that it be wound up by the Tribunal. Where the company itself was the petitioner and the financial position of the company was eroded, the court ordered winding up in public interest. The Tribunal is, however, not bound to order winding up similarly because the company has so resolved. The power is discretionary and may not be exercised where winding up would be opposed to the public or company’s interests.
2. Default in holding Statutory meeting: If a company has made a default in delivering the statutory report to the Registrar or in holding the statutory meeting, it may be ordered to be wound up. The petition for winding up on this ground can be presented either by the Registrar or by a contributory. If it is brought by any other person e.g., a creditor, it must be filed before the expiration of fourteen days after the last day on which the statutory meeting ought to have been held. The power of the Tribunal is discretionary and instead of making a winding up order the Tribunal may direct that the statutory report shall be delivered or that the meeting shall be held. But this principle does not apply to private companies since they are not required to hold such a meetings.
3. Failure to commence business: If a company does not commence its business within a year from its incorporation or has suspended business for a whole year, it may be ordered to be wound up. Here again the power is discretionary and will be exercised only when there is a fair indication that there is no intention to carry on business. If the suspension is satisfactorily accounted for and it appears to be due to temporary causes, the order may be refused. An illustration is the decision of the Calcutta High court in Murlidhar V. Bengal Steamship Co.
To carry on its business, a company employed a steamer and two flats. The flats were acquired by the Government during the First World War and the company was not able to replace them immediately in view of the rise in prices. This resulted in suspension of business for more than a year. In a petition to wind up the company, it was held that the suspension of business for a whole year is sufficiently accounted for and does not furnish an indication that there is no intention to carry on the business.
A long line of decisions of the line point thus established, among others, the following propositions of law:
(1) That the mere fact that business has not been commenced within a year of that business has been suspended for a whole year or more by itself is not a ground for a court to order winding up, although they give the jurisdiction to the court to do so.
(2) That it has to be found out whether the non-commencement or suspension of business was for some good reasons accounting for it.
(3) That the fact of non-commencement or suspension of business is an evidence which indicates that the company has no intention of carrying on business or that it is not likely to do so.
(4) That the decisive question is whether there is a reasonable hope of the company commencing or resuming business and doing it at a profit, and whether the substratum of the company has disappeared.
There is yet another consideration in the matter or order for winding up and that is taking into consideration the wishes of the majority of the shareholders. In a case where, however, there was failure to resume business for five years and the prospects also seemed gloomy, winding up may be ordered.
After ordering winding up on this ground, the Tribunal can direct the liquidator to take care of the interests of the financial institutions which had advanced large sums of money to the company and also to investigate whether a secured creditor bank had sold the company’s assets at prices lower than their real value.
4. Reduction in Membership: If the number of members is reduced, in the case of a public company, below seven and in the case of a private company, below two, the company may be ordered to be wound up.
5. Inability to pay debts: A company may be ordered to wound up if it is unable to pay its debts. Inability to pay debts is explained in Section 434. According to this section a company shall be deemed to be unable to pay its debts in the following three cases:
(a) Statutory Notice: Firstly, if a creditor to whom the company owes a sum exceeding one lakh rupees has served on the company, a demand for payment and the company has for three weeks neglected to pay or otherwise satisfy him. Where there was no 21 days notice, the defeat was held to be not curable even by a subsequent notice during the pendency of the proceedings. The expression “neglects to pay the sum demanded” in Section 434(1)(a) is not equivalent to the word ‘omitted’. Neglect to pay a debt on demand is omission to pay without reasonable cause. Failure to pay in spite of several communications including service or statutory notice was held to be evidence of neglect and inability.
The debt must be presently payable and the title of the petitioner demanding it should be complete. The debt must be really due. In British India General Insurance Co. case where a cricket match, being insured, had to be abandoned on account of rains, the insurance company appointed a surveyor to determine whether this type of loss was covered by the terms of the policy, it could not be said that the company had neglected to pay.
The principles on which the company court acts are: (1) that the defence of the company is in good faith and one of substance; (2) the defence is likely to succeed in point of law; and (3) the company produces prima facie proof of the facts on which the deference depends.
However, where the dispute is not real, but is put forward by the company as a cloak to hide its inability to pay its debts, the application for winding up would be allowed.
(b) Decreed Debt: Secondly, a company shall be deemed to be unable to pay its debts if execution or order process issued on a decree or order of any Court in favour of a creditor of the company is returned unsatisfied in whole or in part. Even in the case of a decretal debt, question of bona fide dispute may be raised and the court may, instead of passing winding up order, allow the petition to stand over on an undertaking by the company to file a suit for setting aside the decree.
(c) Commercial Insolvency: Lastly, if it is proved to the satisfaction of the Tribunal that the company is unable to pay its debts. In reference to the concept of “unable to pay debts: it has been observed that though it is not necessary that there should be a statutory demand or any demand at all, the court would not be easily satisfied that a company is unable to pay its debts from the mere non-payment of a debt which was never demanded of it. In determining this, the court shall take into account the contingent and prospective liability of the company. “What has to be ascertained is not whether if all assets were converted into cash, the company would be able to discharge its debts, but whether in a commercial sense the company is solvent.” A perusal of the balance-sheet of the company must show that its assets are sufficient to meet its liabilities. If it is not so, the company may be regarded as commercially insolvent.
In Shree Shanmaugar Mills V. Dharmaraja Nadar, a company resisted a petition on the ground that while its liabilities amounted only to Rs. 8,72, 414, its assets were of the value of Rs. 10,79,130. It was found that these assets included building and machinery, excluding which only a sum of Rs. 3,00,000 would be available to discharge the debts.
The Court held that the value of such assets without which the company could not carry on business, should not be taken into account. The proper test is whether in a commercial sense the existing liability would be paid by it while it continued to carry on as a company. However, the company is entitled to regard its uncalled capital as money available for the discharge of its debts. Moreover, “where at the relevant time there is reasonable hope of tiding over the difficulty and emerging into a region in which the company might reasonably expected to carry on at a profit”, it may not be ordered to be wound up on this ground.
6. Just and Equitable: The Tribunal can order the winding up of a company when “the Tribunal is of the opinion that it is just and equitable that the company should be wound up”. This gives the Tribunal a very wide discretionary power to order winding up whenever it appears to be desirable.
Though the Court is not bound to construe this clause (ejusdem generis) as only covering ground of a like nature with those specified in clauses 1 to 5 yet it will require grounds of a like magnitude before acting under the clause. For a long period edjusdem generis dominated interpretation of the just and equitable provisions. But the rule has been entirely abandoned and the widest character and the courts are left to work out for themselves for the principles on which such orders should be granted. The circumstances in which the courts have in the past dissolved companies on this ground can be resolved into general categories. And they are as follows:
(i) Deadlock: Firstly, when there is a deadlock in the management of a company, it is just and equitable to order winding up. In Yenidje Tobacco Co. Ltd. W and R, who traded separately as cigarette manufacturers, agreed to amalgamate their business and formed a private limited company of which they were the shareholders and the only directors. They had equal voting rights and, therefore, the articles provided that any dispute would be resolved by arbitration, but one of them dissented from the award. Both then became so hostile that neither of them would speak to the other except through the secretary. Thus there was a complete deadlock and consequently the company was ordered to be wound up although its business was flourishing.
(ii) Loss of Substratum: Secondly, it is just and equitable to wind up a company when its main object has failed to materialize or it has lost its substratum. A good illustration is German Date Coffee Co. Company was formed for the purpose of manufacturing coffee from dates under a patent from Germany and also for working other patents of similar kind. The German patent was never granted and the company embarked upon other patents. But, on the petition of a shareholder, it was held that “the substratum of the company had failed, and it was impossible to carry out the objects for which it was formed; and, therefore, it was just and equitable that the company should be wound up.”
(iii) Losses: Thirdly, it is considered just and equitable to wind up a company when it cannot carry on business except at losses. It will be needless, indeed, for a company to carry on business when there is no hope of achieving the object of trading at a profit. But a mere apprehension on the part of some shareholders that the assets of the company will be frittered away and that loss instead of gain will result has been held to be no ground.
(iv) Oppression of Minority: Fourthly, it is just and equitable to wind up a company where the principle shareholders have adopted an aggressive or oppressive or squeezing policy towards the minority.
(v) Fraudulent Purpose: It is just and equitable to wind up a company if it has been conceived and brought forth in fraud or for illegal purposes. In Universal Mutual Aid and Poor Houses Association V. Thopa Naidu, Court observed that where the main object of the company is the conduct of a lottery, the mere fact that some of its objects were philanthropic will not prevent the company from being ordered to be wound up as being one formed for an illegal purpose.
Besides above mentioned grounds for winding up of a company another three grounds for the winding up of a company is provided in the amendment of Company Act in the year 2002. These grounds are:
7. Default in filing Balance Sheet etc.: If the company has made a default in filing with the Registrar its balance-sheet and profit and loss account or annual return for any five consecutive financial years. Yet there is no summery available on this matter though the application of this clause is can be presumed on the basis of clause 2 of the section accordingly the powers of the Tribunal is discretionary and it may provide the company with a chance to file the documents.
8. Act of company against Sovereignty and interest of India: If the company has acted against the interests of the sovereignty and integrity of India, the security of the State, friendly relations with foreign States, public order, decency or morality;
This clause is of very wide amplitude and vague so far as the term “decency or morality” is concerned. It is very possible to define these terms in relation to an artificial person which itself is represented by natural persons. Act of a company for promotion of its business/products like advertising may appear decent or immoral to someone. For example ad campaign of any undergarments company or fashion designer may appear immoral or indecent to any class of the society. So this matter is entirely based on the discretion of the court to decide what is moral and decent. The provision to this clause provides a safeguard to the company that application under this clause can only be filed by the Central or State government
9. Winding up under circumstance of S. 424-G: A company may be wound up by the order of the Tribunal if it is of the opinion that the company should be would up under the circumstances specified in Section 424-G as a sick industrial company. If Tribunal is of the view that the company can’t exceeds its accumulated losses while meeting its financial obligations then it can order for its winding up.