Company Law

COMPANY AND ITS NATURE

When the principle of separate entity of the company may be discarded

Palmer in his Company Law has categorized the cases, in which the principle of separate entity of the company has been discarded by adopting the doctrine of lifting the veil, in various categories and some of which are as under—

(a) where companies are in relationship of holding and subsidiary companies;

(b) where a shareholder has lost the privilege of limited liability and has become directly liable to certain creditors of the company on the ground that, with his knowledge, the company continued to carry on business six months after the number of its members was reduced below the legal minimum;

(c) in certain matters pertaining to the law of taxes, death duty and stamps, particularly where the question of the ‘controlling interest’ is in issue;

(4) in the law relating to exchange control;

(5) in the law relating to trading with the enemy where the test of control is adopted;

(6) where a holding company or a subsidiary company was not working in an autonomous manner and thus was treated as forming an economic unit;

(7) where the new company was formed by the members of an existing company holding 9/10 shares in the existing company and only with an object of expropriating the shares of minority shareholders of the existing company;

(8) where the device of incorporation is used for some illegal or improper purpose;

(9) where several companies are promoted by the same controlling share-holders for defeating or misusing the loss pertaining to labour welfare. [Meenakshi Transmission Ltd. vs State, 2009 (238) ELT 554]

Briefly write about the kinds of corporation.

Kinds of corporation—Generally speaking, the corporations are of the following kinds—

(1) Corporation Aggregate—A corporation aggregate is a group of co-existing persons, a combination of persons who are united together with a view to promote their common interest which is generally the business or commercial interest. [Daman vs State of Punjab, 1985 AIR 973]

Corporations aggregate may be public or private. A public corporation is a corporation formed for a public purpose, e.g., local government authorities, and it is usually incorporated by an Act of Parliament. A private corporation is a corporation formed for profit, e.g., a limited company, and it is usually incorporated under a statutory enactment.

(2) Corporation Sole—It implies two persons to exist under the same name; one a human being, and the other, the corporation sole. Corporation sole is a creature of law and continues to exist, though the human beings change. In India, various offices like that of the Governor of the Reserve Bank of India, the State Bank of India, the Post Master General, the General Manager of Railways, the Registrar of Supreme Court and High Courts etc., which are created under different statutes are the examples of corporation sole.

Corporation sole is not endowed with a separate legal personality. It is composed of one person only who is incorporated by law. The same person has a dual character, one as a natural person and the other as corporation sole, the later being created by the statute. [Govind Menon vs Union of India, AIR 1967 SC 1274]

(3) Quasi-corporations—Halsbury also refers to a third class of corporations, namely, quasi-corporations, which only partially fulfill the definition of a corporation. Instances of quasi-corporations sole are the Lord Chancellor, the Lord Chief Justice and the Chamberlain of London. Churchwardens and Overseers formerly constituted a quasi-corporation aggregate, holding land for parochial purposes, and Churchwardens continue to possess a quasi-corporate capacity to hold personal property for church purposes.

CLASSIFICATION OF COMPANIES

How can a private company be converted into a public company? Discuss.

Conversion of Private Company into Public Company—Sometimes, in the beginning, the investor may form a private company and later on when there are opportunities to develop the business, they may be willing to convert it into public company to avail some privileges, viz., increasing the number of members for the purpose of accepting money from the public, convenient transfer of shares etc.

Law relating to conversion of private company into public company is discussed under sections 14 and 18 of the Companies Act, 2013, read with Rule 33 of Companies (Incorporation) Rules, 2014.

Alteration of articles [S 14]—According to the provisions of section 14 of the Companies Act, 2013, a company may, by a special resolution, alter its articles having the effect of conversion of—

(a) a private company into a public company; or

(b) a public company into a private company.

When private company ceases to be a private company—Where a private company alters its articles in such a manner that they no longer include the restrictions and limitations which are required to be included in the articles of a private company under this Act, the company shall, as from the date of such alteration, cease to be a private company.

Alteration only when approval by Tribunal—Any alteration having the effect of conversion of a public company into a private company shall not take effect except with the approval of the Tribunal which shall make such order as it may deem fit.

Every alteration of the articles and a copy of the order of the Tribunal approving the alteration shall be filed with the Registrar, together with a printed copy of the altered articles, within a period of fifteen days, who shall register the same. Any alteration of the articles shall be valid as if it were originally in the articles.

Conversion of companies already registered [S 18]—According to the provisions of section 18 of the Companies Act, 2013—

(1) A company of any class may convert itself as a company of other class by alteration of memorandum and articles of the company.

(2) Where the conversion is required to be done under this section, the Registrar shall on an application made by the company, after satisfying himself that the required legal provisions have been complied with, close the former registration of the company. After registering altered memorandum and articles of the company, the Registrar will have to issue a certificate of incorporation in the same manner as its first registration.

(3) The registration of a company shall not affect any debts, liabilities, obligations or contracts incurred or entered into, by or on behalf of the company before conversion. Such debts, liabilities, obligations and contracts may be enforced in the manner as if such registration had not been done.

Scrutiny of documents by Registrar of Companies—As per section 18, after receiving the documents for conversion of a private company into a public company, Registrar of Companies has to satisfy itself that the company has complied with the requisite provisions for registration of company. If so satisfied, the Registrar of Companies is required to close the former registration and issue fresh certificate of incorporation, after registering the documents submitted for change in the class of company.

FORMATION OF COMPANY

What are the documents needed for incorporation of a company?

Documents needed for incorporation of company—The following documents and information for registration are required to be filed with the Registrar—

(1) the memorandum and articles of the company duly signed by all the subscribers to the memorandum;

(2) a declaration by an advocate, a chartered accountant, cost accountant or company secretary in practice, who is engaged in the formation of the company, and by a person named in the articles as a director, manager or secretary of the company; this declaration is to the effect that all the requirements in respect of registration have been complied with;

(3) an affidavit from each of the subscribers to the memorandum and from persons named as the first directors, if any, in the articles. This affidavit on the part of subscriber mentions that—

(a) he is not convicted of any offence in connection with the promotion, formation or management of any company; and

(b) he has not been found guilty of any fraud or misfeasance or of any breach of duty to any company during the preceding five years; and

(4) the address for correspondence till its registered office is established;

(5) the particulars of name, including surname or family name, residential address, nationality and such other particulars of every subscriber to the memorandum along with proof of identity, as may be prescribed, and in the case of a subscriber being a body corporate, such particulars as may be prescribed;

(6) the particulars of the persons mentioned in the articles as the first directors of the company, their names, including surnames or family names, the Director Identification Number, residential address, nationality and such other particulars including proof of identity as may be prescribed; and

(7) the particulars of the interests of the persons mentioned in the articles as the first directors of the company in other firms or bodies corporate along with their consent to act as directors of the company.

Director Identification Number—Director Identification Number (DIN) is a unique identification number given to an existing or a proposed director of the incorporating company. According to section 152 (3), no person shall be appointed as a director of a company, unless he has been allotted DIN. A person below age of 18 years may not apply for DIN.

Certificate of Incorporation—The Registrar, on the basis of documents and information filed, shall register all the documents and information in the register and issue a certificate of incorporation to the effect that the proposed company is incorporated under this Act.

Corporate Identity Number—The Registrar has to allot to the company a corporate identity number. This corporate identity number is a distinct identity for the company.

What is the test to determine whether a company is incorporated for charitable purpose?

Test to determine charitable purpose—The test which is to be applied is whether the predominant object of the activity involved in carrying out the object of general public utility is to sub-serve the charitable purpose or to earn profit. Where profit-making is the predominant object of the activity, the purpose, though an object of general public utility would cease to be a charitable purpose. But where the predominant object of the activity is to carry out the charitable purpose and not to earn profit, it would not lose its character of a charitable purpose merely because some profit arises from the activity.

If the profits necessarily feed a charitable purpose under the terms of the trust, the mere fact that the activities of the trust yield profit will not alter the charitable character of the trust. The test now is, more clearly than in the past, the genuineness of the purpose tested by the obligation created to spend the money exclusively or essentially on charity.

If, for example, it is found that the publication of the monthly journal is carried on wholly on commercial lines and the pricing of the monthly journal is made on the same basis on which it would be made by a commercial organization leaving a large margin of profit, it may be inferred that the activity of publication of the journal is carried on for profit and the purpose is non-charitable.

We may take by way of illustration another example given by Krishna Iyer J. in the case of Indian Chamber of Commerce, (1975) 101 ITR 796 (SC), where a blood bank collects blood on payment and supplies blood for a higher price on commercial basis. Undoubtedly, in such a case, the blood bank would be serving an object of general public utility, but since it advances the charitable object by sale of blood as an activity carried on with the object of making profit, it would be difficult to call its purpose charitable. Ordinarily, there should be no difficulty in determining whether the predominant object of an activity is advancement of a charitable purpose or profit-making. But cases are bound to arise in practice which may be on the border line. In such cases, the solution of the problem whether the purpose is charitable or not may present real difficulty.

Write an essay on Startups in India. What is the process of registration as a Startup?

Write short note on Standups in India.

Standups in India—The Standup India scheme is anchored by Department of Financial Services (DFS) to encourage Greenfield enterprises by SC/ST and women entrepreneurs. The scheme offers bank loans between Rs. ten lakh and one crore for scheduled castes and scheduled tribes and women setting up new enterprises. The scheme provides for refinance window through Small Industries Development Bank of India (SIDBI) with an initial amount of Rs 10,000 crore. Besides primary security, the loan may be secured by collateral security or guarantee from Credit Guarantee Fund Scheme for Standup India Loans (CGFSIL).

ELIGIBILITY FOR AVAILING STANDUP SCHEME

(a) SC/ST and/or women entrepreneurs, above 18 years of age.

(b) Loans under the scheme are available only for Greenfield Projects.

(c) In case of non-individual enterprises, 51 per cent of the shareholding and controlling stake should be held by either SC/ST and/or Women Entrepreneur.

(d) Borrower should not be defaulter of any bank/financial institution.

ARTICLES OF ASSOCIATION

What is the binding effect of articles of association? Can articles bind an outsider?

Articles binding on company and its members—The articles of association of a company serve as a contract between all the shareholders to comply with the regulations contained therein. They are binding on all the shareholders, until they are altered in the manner provided by the Companies Act, i.e., by a meeting duly called to pass a resolution for altering them. Any dispute that may arise among them must be decided with reference to the principles enshrined in these articles.

In Wood vs Odessa Waterworks Co., (1889) 42 Ch D 636 (N), one of the shareholders had sued the company on behalf of all the shareholders, seeking an injunction restraining the company to give effect to a resolution by which the shareholders were given debenture bonds, bearing interest and redeemable at par by annual drawing instead of paying dividends in cash. The argument for the plaintiff was that the resolution in question contravened the articles of association. Sterling J. in delivering an interlocutory judgment observed that the articles of association constitute a contract not merely between the shareholders and the company, but between each individual shareholder and every other.

Every member has to observe the provisions of articles and memorandum. In the case of Borland’s Trustee vs Steel Bros. Co. Ltd., (1901) 1 Ch 279, the articles of a company contained a clause that on the bankruptcy of a member, his share should be sold to the other persons and at a fixed price by the directors. B a shareholder was adjudicated bankrupt. His trustee in bankruptcy claimed that he was not bound by these provisions and should be at liberty to sell the shares at the true value. It was held that the trustee was bound by the articles as a share was purchased by B in terms of the articles.

Articles not binding on outsiders—The articles bind the members to the company and the company to the members. However, neither of them is bound to an outsider to give effect to the articles. No article can constitute a contract between the company and a third person.

In the case of Browne vs La Trinidad, (1887) 37 Ch D 1, the articles of association of a company contained a clause to the effect that B should be a director and should not be removable till after 1888. He was, however, removed earlier. Consequently, he brought an action to restrain the company from excluding him. It was held that there was no contract between B and the company. No outsider can enforce articles against the company even if they purport to give him certain rights.

In the case of Khusiram vs Hanutmal, (1948) 53 CWN 505, a member of a company who had a commercial dispute of private nature with another member could not be compelled to refer the dispute to arbitration in terms of the company’s articles. The court said “Articles do not affect or regulate the rights arising out of a commercial contract with which the members have no concern, or rights completely outside the company relationship.”

In Eley vs Positive Government Security Life Co., (1876) 1 Ex D 88, the articles of a company provided that E should be the solicitor of the company for life and could be removed from office only for misconduct. E took office and became a shareholder. After sometime, the company dismissed him without alleging misconduct. E sued the company for damages for breach of contract. It was held that the articles did not constitute any contract between the company and the outsider and as such no action could lie.

Explain the doctrine of constructive notice.

Doctrine of constructive notice—According to the doctrine of “constructive notice”, every person dealing or proposing to enter into a contract with the company, is deemed to have constructive notice of the contents of its memorandum and articles. Whether such person actually reads them or not, it shall be presumed that he has read these documents and has ascertained the exact powers of the company to enter into contract; the extent to which these powers have been delegated to the directors; and the limitations to such powers. He is presumed, not only to have read them, but also to have understood them properly. As a result, if a person enters into a contract which is ultra vires the memorandum, or beyond the authority of the directors conferred by the articles, then the contract becomes invalid. He cannot enforce it, notwithstanding the fact that he acted in good faith and money was applied for the purposes of the company.

The essential characteristic of this doctrine is that every person dealing with the company is presumed to have notice of all the documents filed with the Registrar of Companies. It means that every person dealing with the company has read these documents and understood them in their true perspective. Hence, if any party dealing with the company does not have actual notice of the contents of these documents, it is presumed that he has an implied (constructive) notice of them. Consequently, if a person enters into a contract which is beyond the powers of the company, as defined in the memorandum, or outside the limit set on the authority of the directors as per the memorandum or articles, he cannot, as a general rule, acquire any rights under the contract against the company.

Explain the doctrine of indoor management. State the exceptions to this doctrine.

Doctrine of indoor management—Doctrine of constructive notice is subject to the doctrine of indoor management. An outsider may be presumed to have the knowledge of the constitution of the company, but not what may or may not have taken place within the indoors which are closed to him.

In view of Lord Hatherly, when there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles of association, those so dealing with them externally are not to be affected by irregularities which may take place in the internal management of the company.

According to the doctrine of indoor management, an outsider dealing with the company is required to see that the authority of dealing had been given by the articles to the person with whom the outsider is dealing. However, the outsider cannot be assumed to do any more. He is not expected to enquire whether the proper procedure has been followed for the delegation of the authority to the person with whom the outsider is dealing. [Bigger Staff vs Rowatt’s Wharf, (1896) 2 Ch 93]

Object of the doctrine—The object of this doctrine is to protect the outsider with a company. The doctrine is based on the business convenience, for business could not be carried on, if everybody dealing with the apparent agents of a company was compelled to call for evidence that all internal regulations had been duly observed. Since memorandum and articles of association of the company are public documents, open to the public inspection, an outsider is presumed to have the knowledge of their contents. However, the details of internal procedure are not open to public inspection. Therefore, it would be unfair, if an outsider dealing with the company is presumed to have the knowledge of the details of internal procedure and the rule of internal management. [Balsara Wathi Ltd. vs A Parmeshwar, AIR 1957 Mad 122]

Exceptions to the Doctrine of Indoor Management—There cannot be any benefit under the doctrine of indoor management conferred upon a person in the following circumstances—

(a) If a person dealing with the company was negligent and, had he not been negligent, he could have discovered the irregularity.

(b) If the person dealing with the company has actual or constructive notice of any irregularity in the internal proceedings of the company.

(c) If a person enters into a contract with an agent or officer of the company and the act of the agent or officer is beyond the authority conferred upon him.

(d) If a person dealing with the company relies upon a forged document or the act done by the company is void.

(e) If the person did not, in fact, consult the memorandum and articles and, as a result, did not act on the basis of knowledge of these documents.

Doctrine of constructive notice and indoor management go hand in hand—On the one hand, the doctrine of constructive notice protects the company from the outsiders; on the other hand, the doctrine of indoor management offers protection to the outsiders while dealing with the affairs of the company. The doctrine of constructive notice comes into picture when an outsider fails to inquire about the company. However, the doctrine of indoor management can be invoked by any outsider dealing with the company and cannot be invoked by the company.

PROMOTERS

What are the remedies available in case there is breach of duties by promoter?

Remedies for breach of duties by promoter—The promoter owes a duty of disclosure to the company. In case, there is non-disclosure of essential facts by the promoter, the main remedy for the company is to proceed for rescission of any contract with him or for the recovery of any secret profits which he might have made.

Various remedies available in case there is breach of duties by promoter include the following—

(1) Rescission of contract—The remedy to rescind the contract must be resorted to when the company does not intend to ratify the agreement after discovery of the breach involving non-disclosure or misrepresentation.

(2) Recovery of secret profits—If a promoter makes a secret profit or does not disclose any profit made, the company has a remedy to recover the profits earned by him secretly.

In case of Re Ambrose Lake Tin & Copper Co., (1880) 14 Ch D 390, it was held that, if the property on which the profit was made had been acquired before the promoter became promoter, there could be no claim for the recovery of the profits as such. Thus, if a person acquires properties or had it before he takes any active steps in the promotion of a company and sells it to the company at a profit; he is entitled to retain that profit.

Remedies available to the subscriber—A subscriber who is deceived by any misleading statement or the inclusion or omission of any matter in the prospectus may seek the following remedies—

(a) As per section 37, a suit may be filed or any other action may be taken under section 34 or section 35 or section 36 by any person, group of persons or any association of persons affected by any misleading statement or the inclusion or omission of any matter in the prospectus.

(b) The subscriber may initiate proceedings to repudiate the contract and claim repayment of his money with interest.

(d) He may initiate action for damages against the directors and the other persons responsible for failure to disclose matters in a prospectus.

(e) He may initiate action against directors or those who are responsible for the prospectus.

Is a promoter entitled to recover remuneration from the company? In what ways, promoter may be remunerated?

Remuneration of promoter— In the case of English & Colonial Produce Company, (1906) 2 Ch 435 CA, it was held that a promoter is not entitled to recover any remuneration for his services from the company unless there is a valid contract, enabling him to do so, between him and the company. Indeed, without such a contract, he is not even entitled to recover his preliminary expenses or the registration fees.

In case of Touche vs Metropolitan Railway Warehousing Company, (1871) LR 6 Ch 671, it was held that the recovery of preliminary expenses and registration fees does not normally present any difficulty. The articles generally contain a provision, authorising the directors to pay the promoters. The provision in the articles does not impose any legal obligation on the company towards the promoters, but as they or their nominees will usually be the first directors of the company, there is little risk of the power being not exercised in their favour. However, it may well be that the promoters are not content with merely their expenses; a professional promoter expects to be handsomely remunerated. It cannot be said to be unreasonable either.

In practice, a promoter may be remunerated in following ways—

(a) The promoter may sell his own property to the company for cash or against fully paid-up shares in the business at an overvaluation after making full disclosure to an independent Board of Directors or to the intended shareholders.

(b) The promoter may take a commission on the shares sold.

(d) The promoter may make profits on transactions entered into by him with the company after making full disclosure to the company and its members.

(e) The promoter may be given an option to buy further shares in the company.

ALLOTMENT OF SECURITIES

What are the powers of the Securities and Exchange Board of India (SEBI) to regulate the matter relating to issue and transfer of securities?

The SEBI—The Securities and Exchange Board of India, popularly known as SEBI, is the apex body of Indian Stock Market. It is the regulator, controller and promoter for security market in India.

The SEBI has wide powers regarding the stock exchanges and intermediaries dealing in securities. It can seek information from the stock exchanges and intermediaries regarding their business transactions for inspection or scrutiny and other purposes.

Powers of the SEBI [S 24]—Section 24 of the Companies Act, 2013, empowers the Securities and Exchange Board of India (SEBI) to regulate the matters relating to issue and transfer of securities and non-payment of dividend by listed companies or those companies which intend to get their securities listed.

The Central Government, the Tribunal or the Registrar of Companies, as the case may be, has to exercise powers concerning prospectus, return of allotment, redemption of preference shares and any other matter specifically provided in the Act.

The powers relating to forward dealing and insider trading in relation to listed companies or the companies which intend to get their securities listed have been delegated to SEBI.

What are the functions performed by the Securities and Exchange Board of India (SEBI)?

Functions of the SEBI—According to section 11 of Securities and Exchange Board of India Act, 1992, it shall be the duty of the Board to protect the interests of investors in securities and to promote the development of, and to regulate the securities market, by such measures as it thinks fit. The measures may provide for the following—

(a) regulating the business in stock exchanges and any other securities markets;

(b) registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers and such other intermediaries who may be associated with securities markets in any manner;

(c) registering and regulating the working of the depositories, participants, custodians of securities, foreign institutional investors, credit rating agencies and such other intermediaries as the Board may specify in this behalf;

(d) registering and regulating the working of venture capital funds and collective investment schemes, including mutual funds;

(e) promoting and regulating self-regulatory organizations;

(f) prohibiting fraudulent and unfair trade practices relating to securities markets;

(g) promoting investors’ education and training of intermediaries of securities markets;

(h) prohibiting insider trading in securities;

(i) regulating substantial acquisition of shares and take-over of companies;

(j) calling for information from, undertaking inspection, conducting inquiries and audits of the stock exchanges, mutual funds, other persons associated with the securities market intermediaries and self-regulatory organizations in the securities market;

(k) calling for information and record from any bank or any other authority or board or corporation established or constituted by or under any Central, State or Provincial Act in respect of any transaction in securities which is under investigation or inquiry by the Board;

(l) performing such functions and exercising such powers under the provisions of the Securities Contracts (Regulation) Act, 1956, as may be delegated to it by the Central Government;

(m) levying fees or other charges for carrying out the purposes of this section;

(n) conducting research for the above purposes.

What do you mean by listing and delisting of securities?

Listing of securities—Listing means formal admission of a security into a public trading system of a stock exchange. A security is said to be listed when it has been included in the official list of the stock exchange for the purpose of trading. The securities listed in stock exchanges may be of any public limited company, Central or State Government, quasi-government and other corporations or financial institutions.

The principal objectives of listing are—

to provide ready marketability and impart liquidity and free negotiability to stocks and shares;
ensure proper supervision and control of dealings therein; and
protect the interests of shareholders and of the general investing public.

Delisting of securities—Delisting indicates removal of securities of a listed company from a stock exchange. As a consequence of delisting, the securities of that company would no longer be traded at that stock exchange. In the interest of orderly market in securities or in the interest of trade or in the public interest, the governing board or managing director or relevant authority has absolute discretion to impose restrictions on trading in any security admitted to dealings on the exchange. [Dr. CS Bansal: Corporate Governance Law & Practice]

What do you mean by Stock Exchange? Explain the importance of Stock Exchange.

Stock Exchange—Stock exchange means anybody of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities.

Importance of Stock Exchange—A Stock Exchange fulfils a vital function in the economic development of a nation. Its main function is to “liquify capital by enabling a person who has invested money in, say a factory or a railway, to convert it into cash by disposing of his share in the enterprise to someone else.” Investment in joint stock companies is attractive to the public, because the value of the shares is announced day after day in the stock exchanges. The shares quoted on the stock exchanges are capable of almost immediate conversion into money. In modern days, a company stands little chance of inducing the public to subscribe to its capital, unless its shares are quoted in an approved stock exchange. [Union of India vs Allied International Products Ltd., (1971) 41 Comp Cas 127 (SC)]

The legitimate function of a stock exchange is to provide, consistently with the larger public interest, a forum and a service which are so organized, in the interests of both buyers and sellers, as to ensure the smooth and continual marketing of shares. Buyers or sellers of shares are of different kinds. There are those who buy shares to invest or sell shares for ready cash. It is the interests of these that must be kept constantly in mind, since it is for them primarily that the stock exchange exists. There are also those who buy in the hope to sell at a profit or sell in the hope to buy at a profit. In popular language, they are speculators as distinguished from genuine investors, though the two groups of course are by no means mutually exclusive; for, by way of example, a man who has bought to invest may later persuade himself to sell to make profit. Nevertheless, the existence of a body of speculators is one of the main features of almost all the stock exchanges. [Norman Hamilton vs Umedbhai Patel, (1979) 81 BOM LR 340]

SHARE CAPITAL

What do you mean by sweat equity shares? When can a company issue sweat equity shares?

Issue of sweat equity shares [S 54]—According to section 2 (88) of the Companies Act, 2013, sweat equity shares means equity shares issued by a company to its employees or directors—

(a) at a discount; or

(b) for consideration other than cash;

(d) making available rights in the nature of intellectual property rights; or

(e) value additions, by whatever name called.

Conditions for the issue of sweat equity shares—A company may issue sweat equity shares of a class of shares already issued, if the following conditions are fulfilled, namely—

(a) the issue is authorised by a special resolution passed by the company;

(b) the resolution specifies the number of shares, the current market price, consideration, if any, and the class or classes of directors or employees to whom such equity shares are to be issued;

(c) not less than one year has, at the date of such issue, elapsed since the date on which the company had commenced business; and

(d) where the equity shares of the company are listed on a recognised stock exchange, the sweat equity shares are issued in accordance with the regulations made by the Securities and Exchange Board in this behalf and if they are not so listed, the sweat equity shares are issued in accordance with such rules as may be prescribed. [S 54 (1)]

Limits on issue of sweat equity shares—Rule 8 (4) of the Companies (Share Capital and Debentures) Rules, 2014, states that the company shall not issue sweat equity shares for more than fifteen per cent of the existing paid up equity share capital in a year or shares of the value of rupees five crores, whichever is higher. The issuance of sweat equity shares in the company shall not exceed twenty five per cent of the paid up equity capital of the company at any time.

Can there be the transfer of shares in the name of minors?

Transfer of shares to minors—Since the minor is incapable of entering into a contract because contract by a minor is void ab initio and thereby not eligible to agree in writing to be a member, he cannot be entered in the register of members. When a guardian of a minor applies to be a member of a company, the company can allot shares in the name of guardian.

A minor or lunatic, being incompetent to enter into a contract, cannot be allotted shares of a company. If directors, in ignorance of the fact of minority, allot shares to a minor, and enter his name on the register of members, the company can repudiate the allotment and remove his name from the register, when the fact of applicant’s minority comes to their knowledge. The minor can also repudiate the allotment at any time during his minority. In either case, the company must repay to minor all money received from him in respect of the allotted shares. Whether or not the minor should restore to the company, the benefits he might have derived from the shares would be for the court to decide in view of the facts and circumstances of each case.

After attaining majority, if the minor does not want to be a member, he may repudiate his liability on the shares on ground of minority. And, if he does so, the company cannot plead estoppel on the ground of his having received dividends during his minority or that he had fraudulently misrepresented his age in his application for shares. [Sadiq Ali vs Jai Kishori, (1928) 30 Bom LR 1346]

Nomination of shares in favour of minor—Nomination refers to the act of nominating a person in whom the shares would vest in the event of death of the shareholder.

Where a nomination has been made in accordance with the provisions of the Companies Act, 2013, on the death of the shareholder, (or in case of joint holdings, on the death of all the joint holders), the nominee becomes entitled to the rights in relation to such shares held by the deceased shareholder(s), to the exclusion of all other persons unless the nomination is revoked. [S 72 (3)]

A minor can be appointed as a nominee. In such case, the guardian will sign on behalf of the nominee. In addition to the name and photograph of the nominee, the name, address and the photograph of the guardian must be submitted

Write short notes on the following— (a) Blank transfer of shares; (b) Forged transfer of share certificate.

(a) Blank transfer of shares—Shareholder may transfer shares without filling in the name of the transferee on the instrument. This kind of transfer is called “blank transfer”. Blank transfers are done when the transferee does not want to keep the shares for long, but intends to sell his shares immediately to some other party.

In the case of blank transfer of shares, neither the transferee’s name, nor signature, nor the date of sale are filled in the transfer form. The transferee has full freedom to sell shares again without filling his name and signature to a successive buyer. The process of purchase and sale can be repeated again and again with the blank deed. Finally, when it reaches the hands of one who wants to retain the shares, he can fill in his name and date and get them registered in the company’s books. Until a transferee is registered as a shareholder, the transferor continues to be the shareholder of the company and remains liable for the unpaid amount if any.

(b) Forged transfer of share certificate—An instrument on which the signature of the transferor is forged is called “forged transfer”. It is a null and void transfer and does not confer any title. It is so because in case of forgery, there is not merely an absence of free consent, but there is no consent at all. Hence, a forged transfer does not confer ownership right upon the transferee, however important the transaction may appear to be. A forged transfer is a nullity and cannot affect the title of the shareholder whose signature is forged. If a company transfers shares under a forged instrument of the transfer, the true owner can compel the company to have his name restored in the register of members.

If a company has issued a share certificate under a forged transfer and he has sold the shares to an innocent person, the company is liable to compensate such a purchaser, if it refuses to register him as a shareholder. In such a case, he can claim damages from the company on the ground that he acted on the share certificate of the company. If the company has been put to loss by reason of the forged transfer, it can claim an indemnity from the person presenting the transfer for registration even though he is quite innocent of the forgery.

In case of Sheffield Corporation vs Barclay, (1905) AC 392, two persons were joint owners of stock. One of them in fraud of another forged a transfer of the stock, and borrowed money on the security of the stock. The bank sent the transfer to the corporation, and demanded that they should be registered as holder. The transfer was made in favour of the bank and the bank in its turn transferred it to holders for value. The corporation registered such holders and issued certificates. The forgery was discovered after the death of forger and the corporation had to restore the stock in favour of the surviving owner. Then the corporation sued the bank who caused them to act upon a forged transfer. The court holding the bank liable to indemnify the corporation stated that when an act is done by one person at the request of another, which act is not in itself manifestly tortious to the knowledge of the person doing it, and such act turns out to be injurious to the rights of a third party, the person doing it is entitled to an indemnity from him who requested that it should be done. And it makes no difference that the person making the request is not aware of the invalidity in his title to make the request, or could not with reasonable due diligence have discovered it.

DEBENTURES, BONDS AND CHARGES

How can there be the redemption of debentures or debenture stock?

Redemption of debentures or debenture stock—palmer has said that the principal methods by which debentures or debenture stock can be redeemed are—

(1) Out of the proceeds of a fresh issue of share or loan capital. It is not safe to rely on this method, as the redemption date may not be a favorable time for raising new capital.

(2) By setting aside a pre-determined annual sum by way of a sinking fund, such sum being calculated in a manner which ensures that the amount is available at the redemption date. Subject to the terms of issue, the sinking fund may be used for partial redemptions before the final redemption date.

(3) By purchase in the market, by tender or private treaty. The terms of issue of debentures or debenture stock usually authorize a company, at its option, to redeem a part of the issue at any time by purchase in the market or by tender available to all holders and to utilize the sinking fund payments for this purpose. The maximum price payable for debentures so redeemed is normally restricted to their nominal value. When the market price is lower than par, most companies will take advantage of purchasing stock for redemption on these favourable terms. Purchases by tender or private treaty are rarely resorted to by companies with listed debenture stock, but may be used by others when there is an opportunity of acquiring debentures for redemption at less than their nominal value. [See: Commissioner of Income Tax vs Shree Rajasthan Syntex Ltd., (2004) 186 CTR Raj 59]

Define debenture trustee. What are the eligibilities for becoming debenture trustee?

Debenture Trustee—According to SEBI Rules, 1993 “debenture trustee means a trustee of a trust deed for securing any issue of debentures of a body corporate.”

Debenture trustee plays a major role during the tenure of the debentures. He serves as a link between the company that issued the debentures and the debenture holders collecting interest payments.

Eligibility for being debenture trustee—According to Regulation 7 of the SEBI (Debenture Trustee) Regulations, 1993, no person shall be entitled to act as a debenture trustee unless he is either—

(a) a scheduled bank carrying on commercial activity; or

(b) a public financial institution; or

(d) a body corporate.

Briefly discuss the role and duties of debenture trustee.

Role of debenture trustee—Debenture trustee is an intermediary between the issuer of debentures and the holders of debentures. Accordingly, the main responsibility of debenture trustee is to protect the interest of holders of debentures including creation of adequate security by the company issuing the debentures and to redress their grievances. He may also take such steps as he deems fit—

(a) to ensure that the assets of the company issuing debentures and each of the guarantors are sufficient to discharge the principal amount and the interest at all times;

(b) to satisfy himself that the prospectus or the letter of offer does not contain any matter which is inconsistent with the terms of debentures or with the trust deed;

(d) to take such reasonable steps to remedy any breach of the covenants of the trust deed or the terms of issue of the debentures;

(e) to take steps to call a meeting of holders of debentures as and when such meeting is required to be held.

Duties of debenture trustee—Regulation 15 of the SEBI (Debenture Trustee) Regulations, 1993, prescribes the following duties of the debenture trustee—

(a) call for periodical reports from the body corporate, i.e., issuer of debentures;

(b) take possession of trust property in accordance with the provisions of the trust deed;

(d) ascertain and satisfy that the property charged to the debentures is available and adequate at all times to discharge the interest and principal amount payable in respect of the debentures and that such property is free from any other encumbrances save and except those which are specifically agreed to by the debenture trustee;

(e) exercise due diligence to ensure compliance by the body corporate with the provisions of the Act, the listing agreement of the stock exchange or the trust deed;

(f) to take appropriate measures for protecting the interest of the debenture holders as soon as any breach of the trust deed or law comes to his notice;

(g) to ascertain that the debentures have been converted or redeemed in accordance with the provisions and conditions under which they are offered to the debenture holders;

(h) inform the Board immediately of any breach of trust deed or provision of any law;

(i) appoint a nominee director on the board of the body corporate in the event of—

(A) two consecutive defaults in payment of interest to the debenture holders; or

(B) default in creation of security for debentures, or

Write short note on crystallization of floating charge.

Crystallization of floating charge—The conversion of floating charge into fixed charge is known as crystallization. Until a floating charge becomes a fixed charge, the company is free to deal with the property charged in any manner it deems fit. But once the floating charge crystallises, the company cannot dispose off the ‘charged assets’ without paying the charge holder. Otherwise, the charge holder can recover his dues from the proceeds.

A floating charge crystallises or becomes fixed in following situations—

(a) When the charge holder takes steps to enforce his charge, a floating charge becomes a fixed charge on the assets covered by that charge.

(b) When the proceedings for winding up of company commence.

(c) Where a debenture holder becomes entitled to realise the securities and he moves an application to the court for the appointment of receiver.

(d) Where the company ceases to carry on the business, whether the principal money has become payable or not, unless the debenture or trust deed contains the stipulation to the contrary.

MEMBERSHIP IN A COMPANY

Can there be variation of shareholders’ rights?

Variation of shareholders’ rights [S 48]—In case, share capital of the company is divided into different classes of shares, the rights attached to the shares of any class may be varied. This variation is to be when there is the consent in writing of the holders of not less than three-fourths of the issued shares of that class or by means of a special resolution passed at a separate meeting of the holders of the issued shares of that class—

(a) if provision with respect to such variation is contained in the memorandum or articles of the company; or

(b) in the absence of any such provision in the memorandum or articles, if such variation is not prohibited by the terms of issue of the shares of that class;

If variation by one class of shareholders affects the rights of any other class of shareholders, the consent of three-fourths of such other class of shareholders should also be obtained and the provisions of this section shall apply to such variation.

Where the holders of not less than ten per cent of the issued shares of a class do not consent to such variation or vote in favour of the special resolution for the variation, they may apply to the tribunal to have the variation cancelled. Where any such application is made, the variation shall become effective only when it is confirmed by the tribunal.

What is register of members? When can there be rectification of register of members?

Register of members [S 88]—Every company has to keep and maintain the following registers in such form and in such manner as may be prescribed, namely—

(a) register of members indicating separately for each class of equity and preference shares held by each member residing in or outside India;

(b) register of debenture-holders; and

Foreign register—A company may, if so authorised by its articles, keep in any country outside India, a ‘foreign register’. This foreign register contains the names and particulars of the members, debenture holders, other security holders or beneficial owners residing outside India. [S 88 (4)]

Rectification of register of members [S 59]—Section 59 of the Companies Act, 2013, empowers the tribunal or a competent court outside India in respect of foreign members or debenture-holders to order rectification of register of members of a company. This can be done by the tribunal or the foreign court, if an appeal is made by the aggrieved person or by any member of the company or the company on any of the following grounds—

(a) where the name of a person is without sufficient cause, entered in the register of members of a company;

(b) where his name, after having been entered in the register, is omitted without sufficient cause; or

(c) where default is made or unnecessary delay takes place in entering in the register of members the fact of any person having become, or ceased to be a member of company.

COMPANY MEETINGS

What are the powers of tribunal to call Annual General Meeting?

Annual General Meeting [S 97]—If any default is made in holding the annual general meeting of a company, the tribunal may call or direct the calling of an annual general meeting of the company. The tribunal may call this meeting on the application of any member of the company.

The tribunal is empowered to give such ancillary or consequential directions as it thinks expedient. Such directions may include a direction that one member of the company present in person or by proxy shall be deemed to constitute a meeting.

A general meeting shall, subject to any directions of the tribunal, be deemed to be an annual general meeting of the company under this Act.

What do you mean by voting right of the member of a company? Can there be the voting through proxy?

Voting Rights [S 47]—According to section 2 (93) of the Companies Act, 2013, “voting right” means the right of a member of a company to vote in any meeting of the company or by means of postal ballot.

According to section 47 of the Companies Act, 2013, every member of a company limited by shares and holding equity share capital enjoys the right to vote on every resolution placed before the company. The voting rights of shareholders during poll are in proportion to their share in the paid-up equity share capital of the company.

Every member of a company limited by shares and holding any preference share capital therein shall, in respect of such capital, have a right to vote only on resolutions placed before the company which directly affect the rights attached to his preference shares. Any resolution for the winding up of the company or for the repayment or reduction of its equity or preference share capital and his voting right on a poll shall be in proportion to his share in the paid-up preference share capital of the company.

Voting by proxy—Any member of a company entitled to attend and vote at a meeting of the company is entitled to appoint another person as a proxy to attend and vote at the meeting on his behalf. A proxy does not enjoy the right to speak at such meeting. He is also not entitled to vote except on a poll. A person appointed as proxy has to act on behalf of members not exceeding fifty and such number of shares as may be prescribed. [S 105]

The Central Government may prescribe the class of companies whose members shall not be entitled to appoint another person as a proxy.

Instrument appointing a proxy—The instrument appointing a proxy is to be in writing; and be signed by the appointer or his attorney duly authorised in writing. If the appointer is a body corporate, the appointment of proxy is to be under the seal of body corporate or be signed by an officer or an attorney duly authorised by it.

A proxy may be described as the agent appointed by a member to act on his behalf at the meeting. [Cousins vs International Brick Co. Ltd., (1932) 2 Comp Cas 108 (CA)]

It is for the chairman to decide the validity of the proxies. His decision in this regard will stand unless the contrary is proved. [Dawson vs Hormasji, AIR 1932 Rang 154]

The vote given by a proxy is valid notwithstanding its revocation provided no intimation in writing of the revocation is received by the company or by the chairman of the meeting before the vote is cast. [KP Chackochan vs Federal Bank, (1989) 66 Comp Cas 953 (Ker)]

A vote given in accordance with the terms of an instrument of proxy shall be valid, notwithstanding the previous death or insanity of the principal or the revocation of the proxy or of the authority under which the proxy was executed or the transfer of the shares in respect of which the proxy is given. However, no intimation in writing of such death, insanity, revocation or transfer should have been received by the company at its office before the commencement of the meeting or adjourned meeting at which the proxy is used. [Regulation 59 of Table F to Schedule I to the Act]

Voting by show of hands—Initially, in the course of general meeting, voting on some resolution has to take place by show of hands. A declaration by the chairman, on a show of hand, as regards the passing of a resolution is conclusive evidence of the fact of passing or not passing of such resolution. [S 107]

Voting through electronic means—The Central Government may prescribe the class or classes of companies and manner in which a member may exercise his right to vote by the electronic means.

What is resolution? What are the kinds of resolution?

Resolution—The items of business executed at a general meeting are presented in the form of motions. These motions are taken up for discussion and decision. If the motion so discussed is approved by the required majority of members present, it turns out to be a resolution. A resolution signifies the collective approval for an item taken up for discussion and decision in a meeting.

Kinds of Resolution [S 114]—There are two kinds of resolutions—

(1) ORDINARY RESOLUTION—The resolutions which are passed at a general meeting by a simple majority are called “ordinary resolutions”. In other words, an ordinary resolution is one where the votes cast for the resolution is more than the votes cast against the resolution.

MATTERS REQUIRING ORDINARY RESOLUTION

(a) Change of name after reservation of the name by furnishing wrong or incorrect information. [S 4]

(b) Change of name if the company’s name resembles the name of some other company and has been registered with such name. [S 16]

(d) Capitalization or reservation of profit for issuing fully paid-up bonus shares. [S 63]

(e) Acceptance of deposits. [S 73]

(f) Approval for appointment of auditor on casual vacancy created after resignation of an auditor. [S 139]

(g) Fixing remuneration of the auditor. [S 142]

(h) Appointment of directors. [S 152]

(i) Appointment of additional director. [S 161]

(j) Appointment of alternate director. [S 161]

(k) Removal of director. [S 169]

(l) Contribution to bona fide charitable and other funds. [S 181]

(m) Payment of remuneration exceeding 11 per cent to the directors of a public company. [S 197]

(n) Payment of remuneration exceeding 5 per cent to any managing director, whole-time director or manager of a public company. [S 197]

(o) Payment of remuneration beyond a certain limit to any director of a public company who is neither managing director nor whole time director. [S 197]

(p) Appointment of company liquidator. [S 310]

(q) Appointment of committee to supervise voluntary liquidation. [S 315]

(r) Laying the final winding up accounts. [S 318]

(2) SPECIAL RESOLUTION —A special resolution is a resolution in which the votes cast in favour of the resolution must be three times higher than the votes cast against it by the members present and entitled to voting on it at the general meeting.

In other words, resolution becomes a special resolution when the votes cast in favour of the resolution are not less than three times the number of the votes, if any, cast against the resolution by members so entitled and voting.

MATTERS REQUIRING SPECIAL RESOLUTION

(a) Entrenchment. [S 5]

(b) Change in registered office of the company. [S. 12]

(d) Change in object of a public company which has raised money from public through prospectus and still has unutilized amount. [S 13]

(e) Alteration of articles of association. [S 14]

(f) Variation in terms of a contract referred to in the prospectus or objects for which the prospectus was issued. [S 27]

(g) Issue of depository receipts in any foreign country. [S 41]

(h) Variation in rights attached to the shares of any class. [S 48]

(i) Issue of sweat equity shares. [S 54]

(j) Increase in subscribed capital by the issue of further shares. [S 62]

(k) Reduction in share capital. [S 66]

(l) Purchase of its own shares or other specified securities by a company (buy-back). [S 68]

(m) Issue of debentures with an option to convert such debentures into shares. [S 71]

(n) Registers of the company to be kept at a place other than the registered office. [S 94]

(o) Removal of auditor appointed under section 139 before the expiry of his term. [S 140]

(p) Appointment of more than 15 directors. [S 149]

(q) Reappointment of independent directors. [S 149]

(r) Specification of any lesser number of companies in which a director of the company may act as director. [S 165]

(s) Exercise of certain powers by Board of Directors. [S. 180]

(t) Giving of loan or guarantee or providing any security or the acquisition beyond certain limit. [S 186]

(u) Related party transaction. [S 188]

(v) Appointment of a managing director, whole-time director or manager. [S 196 (3)]

(w) Fixing of remuneration of director. [S 197]

(x) Investigation by Central Government. [S 210]

(y) Removal of names of companies from the register of companies. [S 248]

(z) Conferring certain powers on the company liquidator. [S 319 (1)]

(aa) Authorizing company liquidator to exercise certain powers. [S 343]

(ab) Disposal of books and papers of the company upon winding up. [S 347]

DISTINCTION BETWEEN ORDINARY AND SPECIAL RESOLUTION

(1) In the case of ordinary resolution, a simple majority is required to move the resolution at the general meeting. In the case of special resolution, special majority is required to pass the resolution at the general meeting.

(2) If ordinary resolution is to be passed, consent of a minimum of 51 per cent of members is required. If special resolution is to be passed, consent of a minimum of 75 per cent of members is required.

(3) There is the need of filing of the copy of ordinary resolution with the Registrar only in certain cases. A printed or hand written copy of special resolution is to be essentially filed with the Registrar of Companies

DECLARATION AND PAYMENT OF DIVIDEND

What are the profits used for the declaration of dividend?

Declaration of dividend [S 123]—According to section 123 (1) (a) of the Companies Act, 2013, dividend can be paid out of following—

(a) profit of the current year after providing for the depreciation; or

(b) profit of the previous financial year or years after providing for depreciation for previous years; or

(c) out of the money provided by Central or State Government for payment of dividend in pursuance of guarantee given by that government if any.

A company may, before the declaration of any dividend in any financial year, transfer such percentage of its profits for that financial year as it may consider appropriate to the reserves of the company.

No dividend shall be declared or paid by a company from its reserves other than free reserves.

No company shall declare dividend unless carried over previous losses and depreciation not provided in previous year or years are set off against profit of the company for the current year.

What is Investor Education and Protection Fund? What kind of amount is credited in Investor Education and Protection Fund?

Investor Education and Protection Fund (IEPF) [S 125]—According to sub-section (1) of section 125 of the Companies Act, 2013, the Central Government has to establish a Fund to be called the Investor Education and Protection Fund (IEPF).

Amounts credited to IEPF—The following amount is to be credited to this fund—

(a) the amount given by the Central Government by way of grants;

(b) donations given by the Central Government, State Governments, companies or any other institution for the purposes of the fund;

(d) the amount in the general revenue account of the Central Government which had been transferred to that account under sub-section (5) of section 205A of the Companies Act, 1956, as it stood immediately before the commencement of the Companies (Amendment) Act, 1999, and remaining unpaid or unclaimed on the commencement of this Act;

(e) the amount lying in the Investor Education and Protection Fund under section 205C of the Companies Act, 1956;

(f) the interest or other income received out of investments made from the Fund;

(g) the amount received under sub-section (4) of section 38 [i.e., punishment for personation for acquisition of securities]

(h) the application money received by companies for allotment of any securities and due for refund;

(i) matured deposits with companies other than banking companies;

(j) matured debentures with companies;

(k) interest accrued on the amounts referred to in clauses (h) to (j);

(l) sale proceeds of fractional shares arising out of issuance of bonus shares, merger and amalgamation for seven or more years;

(m) redemption amount of preference shares remaining unpaid or unclaimed for seven or more years; and

(n) such other amount as may be prescribed. [S 125 (2)]

No such amount referred to in clauses (h) to (j) shall form part of the Fund unless such amount has remained unclaimed and unpaid for a period of seven years from the date it became due for payment.

USE OF THE INVESTOR EDUCATION AND PROTECTION FUND

The Fund shall be utilised for—

(a) the refund in respect of unclaimed dividends, matured deposits, matured debentures, the application money due for refund and interest thereon;

(b) promotion of investors’ education, awareness and protection;

(c) distribution of any disgorged amount among eligible and identifiable applicants for shares or debentures, shareholders, debenture holders or depositors who have suffered losses due to wrong actions by any person, in accordance with the orders made by the court which had ordered disgorgement;

(d) reimbursement of legal expenses incurred in pursuing class action suits under sections 37 and 245 by members, debenture holders or depositors as may be sanctioned by the Tribunal; and

(e) any other purpose incidental thereto, in accordance with such rules as may be prescribed. [S 125 (3)]

Disgorged amount—The disgorged amount refers to the amount received through disgorgement or disposal of securities.

AUDIT AND AUDITORS

Define audit. What are the objects of audit?

Audit—An audit is a systematic and independent examination of books of accounts, statutory records, and other documents of an organization to find out how far the financial statements contained therein present a true and fair view of the organization. Auditing also makes sure that the books of accounts are accurately maintained by the concern as required by law. It also provides assurance to various stakeholders that the subject matter is free from material misstatement.

An audit may be either detailed or administrative, and is usually both. A detailed audit is a comparison of vouchers with entries of payment, in order that the party whose accounts are audited may not debit his employer with payments not in fact made. An administrative audit is a comparison of payments with authorities to pay, in order that the party whose accounts are audited may not debit his employer with payments not authorized. [Jowitt’s Dictionary of English Law]

OBJECTIVES OF AUDIT

Ronald Irish in his book “Practical Auditing” states that an audit may be said to be a skill and examination of such books, accounts and vouchers as will enable the auditor to verify the balance-sheets. The main objectives of audit are—

(a) to certify the correctness of the financial position as shown in the balance-sheet and accompanying statements;

(b) detection of error; and

Audit is examination of the activities, records, and reports of an enterprise by accounting specialists who are not the same accountants responsible for their preparation. Public auditing by independent accountants has acquired professional status and become increasingly common with the rise of large business units and the separation of ownership from control. The public accountant performs tests to determine whether the management’s statements fairly present the firm’s financial position and operating results; such independent evaluations of management reports are of interest to actual and prospective shareholders, bankers, suppliers, lessors and government agencies. [Encyclopaedia Britannica]

Audit is concerned with the verification of accounting data with determining the accuracy and reliability of accounting statements and reports. Auditing primarily involves testing the reliability, competency and adequacy of evidence in support of monetary transactions. The main objective of the company audit is to conduct an independent review of the financial statements and offer an opinion about their reliability in representing the organization’s financial condition and working results. [Trisure India Ltd. vs AF Ferguson & C0., (1987) 61 Comp Cas 548 (B0m)]

Importance of audit quality—Audit quality refers to the auditor conducting the audit in accordance with Generally Accepted Auditing Standards (GAAS) to provide reasonable assurance that the audited financial statements and related disclosures are (a) presented in accordance with GAAP, and (b) are not materially misstated, whether due to error or fraud.

How is an auditor appointed?

Appointment of auditors [S 139]—According to section 139 (1) of the Companies Act, 2013, every company in its first annual general meeting has to appoint an individual or a firm as an auditor. The auditor so appointed holds office from the conclusion of that meeting till the conclusion of its sixth annual general meeting and thereafter till the conclusion of every sixth meeting.

The company is required to place the matter relating to such appointment for ratification by members at every annual general meeting. Before such appointment is made, the written consent of the auditor to such appointment, and a certificate that the appointment, if made, shall be in accordance with the conditions as may be prescribed, is to be obtained from the auditor. The certificate has to indicate whether the auditor satisfies the criteria relating to eligibility, qualifications and disqualifications of auditors.

The company has to inform the auditor or the firm of auditor concerned about the appointment. Thereafter, there is to be the filing of a notice of such appointment with the Registrar within fifteen days of the meeting in which the auditor is appointed.

Appointment of auditor by CAG—In the case of a government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, the Comptroller and Auditor-General of India shall, in respect of a financial year, appoint an auditor duly qualified to be appointed as an auditor of companies. This appointment of auditor is to be made within a period of one hundred and eighty days from the commencement of the financial year. The auditor so appointed holds office till the conclusion of the annual general meeting. [S 139 (5)]

Appointment of first auditor of a company, other than a government company—The first auditor of a company, other than a government company, shall be appointed by the Board of Directors within thirty days from the date of registration of the company. If the Board does not appoint such auditor, it has to inform the members of the company. Thereafter, the members have to appoint such auditor within ninety days at an extraordinary general meeting. The auditor so appointed holds office till the conclusion of the first annual general meeting. [S 139 (6)]

Appointment of first auditor of government company—In the case of a government company or any other company owned or controlled, directly or indirectly, by the Central Government, or by any State Government, or Governments, or partly by the Central Government and partly by one or more State Governments, the first auditor is to be appointed by the Comptroller and Auditor-General of India. This auditor is to be appointed within sixty days from the date of registration of the company.

If the Comptroller and Auditor-General of India does not appoint such auditor within the said period, the Board of Directors of the company appoints such auditor within the next thirty days.

In the case of failure of the Board to appoint such auditor within the next thirty days, it has to inform the members of the company. Thereafter, the members have to appoint such auditor within the sixty days at an extraordinary general meeting. The auditor so appointed holds office till the conclusion of the first annual general meeting. [S 139 (7)]

APPOINTMENT AND QUALIFICATIONS OF DIRECTORS

Who can be appointed as independent director?

Independent director—An independent director in relation to a company, means a director other than a managing director or a whole-time director or a nominee director. Section 149 (6) of the Act prescribes the following conditions for the appointment of an independent director—

A person who, in the opinion of the Board, is a person of integrity and possesses relevant expertise and experience;
A person who is or was not a promoter of the company or its holding, subsidiary or associate company;
A person who is not related to promoters or directors in the company, its holding, subsidiary or associate company;
A person who has or had no pecuniary relationship with the company, its holding, subsidiary or associate company, or their promoters, or directors, during the two immediately preceding financial years or during the current financial year;
A person none of whose relatives has or had pecuniary relationship or transaction with the company, its holding, subsidiary or associate company, or their promoters, or directors, amounting to two per cent or more of its gross turnover or total income or fifty lakh rupees or such higher amount as may be prescribed, whichever is lower, during the two immediately preceding financial years or during the current financial year;
A person who, neither himself nor any of his relatives holds or has held the position of a key managerial personnel or is or has been employee of the company or its holding, subsidiary or associate company in any of the three financial years immediately preceding the financial year in which he is proposed to be appointed;
A person who neither himself nor any of his relatives is or has been—

(A) an employee or proprietor or a partner, in any of the immediately preceding three financial years, in the firm of auditors, company secretaries in practice or cost auditors of the company or in its holding company or subsidiary company or associate company; or

(B) in any legal or consulting firm that has or had any transaction with the company, its holding company, subsidiary company or associate company, amounting to 10 per cent or more of the gross turnover of such firm; or

(D) a person who is chief executive or director, or by whatever name called, of any non-profit organization that receives twenty five per cent or more of its receipts from the company or any of its promoters, directors or its holding, subsidiary or associate company or that holds 2 per cent or more of the total voting of the company. [S 149 (6)]

Disqualifications for an independent director—Clause 49 of the Listing Agreement prescribes a list of disqualifications for an independent director. A person is not an independent director, if—

(a) he has any material or pecuniary relationship other than director’s remuneration including sitting fees and commission which may affect his independence;

(b) he is related to the promoters or persons occupying management positions at the Board level or at one level below the Board;

(d) he is a partner or an executive or was a partner or an executive during the preceding three years with a statutory audit firm or internal audit firm associated with the listed company whether such relationship is material or not;

(e) he is a partner or an executive of or was a partner or an executive at any time during the past three financial years in any legal or consulting firms that have a material association with the listed company;

(f) if he holds 2 per cent or more of the voting share capital of the company or voting power of the company as per the list of share holdings or beneficial owners.

What are the disqualifications for appointment of director?

Conditions when a person is not eligible [S 164 (1)]—Section 164 (1) of the Companies Act provides that a person shall not be eligible for appointment as a director of a company in the following cases—

(a) he is of unsound mind and stands so declared by a competent court;

(b) he is an undischarged insolvent;

(d) he has been convicted by a court of any offence, whether involving moral turpitude or otherwise, and sentenced in respect thereof to imprisonment for not less than six months and a period of five years has not elapsed from the date of expiry of the sentence. If a person has been convicted of any offence and sentenced in respect thereof to imprisonment for a period of seven years or more, he shall not be eligible to be appointed as a director in any company;

(e) an order disqualifying him for appointment as a director has been passed by a court or tribunal and the order is in force;

(f) he has not paid any calls in respect of any shares of the company held by him, whether alone or jointly with others, and six months have elapsed from the last day fixed for the payment of the call;

(g) he has been convicted of the offence dealing with related party transactions at any time during the last preceding five years; or

(h) he has not complied with sub-section (3) of section 152. According to sub-section (3) of section 152, no person shall be appointed as a director of a company unless he has been allotted the Director Identification Number.

Ineligibility for not filing of statements [S (2)]—No person who is or has been a director of a company which—

(a) has not filed financial statements or annual returns for any continuous period of three financial years; or

(b) has failed to repay the deposits accepted by it or pay interest thereon or to redeem any debentures on the due date or pay interest due thereon or pay any dividend declared and such failure to pay or redeem continues for one year or more,

shall be eligible to be reappointed as a director of that company or appointed in other company for a period of five years from the date on which the said company fails to do so. [S 164 (2)]

Where a person is appointed as a director of a company, which is in default of clause (a) or clause (b), he shall not incur the disqualification for a period of six months from the date of his appointment.

Disqualifications in case of private company—A private company may by its articles provide for any disqualifications for appointment as a director in addition to those specified in sub-sections (1) and (2). It should be noted that the disqualifications referred to in clauses (d), (e) and (g) of sub-section (1) shall continue to apply even if the appeal or petition has been filed against the order of conviction or disqualification.

What is Director Identification Number (DIN)? Why is DIN necessary?

Director Identification Number—DIN is a unique identification number for an existing director or a person intending to become the director of a company. DIN Directory contains all the information regarding directors, such as their name, PAN number and also their present address. DIN can identify a person and relate his role as director in all his past and present companies. It is the responsibility of the DIN holder to inform the authority about changes when they occur and get those changes incorporated into his DIN.

Whatever the number of companies a director may have, he can use DIN allotted to him for all of his companies. DIN is specific to the individual who has obtained it, and not for the company he might have obtained for. If a director is already having DIN allotted to him, and he wants to start another company, and act as a director, he can do so, with the same DIN.

Why is DIN mandatory—? DIN has been made mandatory for the following reasons—

(a) creation of a reliable database of and for all the directors;

(b) authentication of the existence of directors in the companies and hold them legally responsible;

(c) avoidance of financial scams, such as in the cases where fake companies are formed to raise public capital, and later, the directors run away with the money.

MEETINGS OF BOARD AND ITS POWERS

What do you mean by related party transactions? When are related party transactions allowed?

Related party transactions [S 188]—The transactions between a company and its related entities such as subsidiaries, associates, joint ventures, substantial shareholders, executives, directors and their relatives, or entities owned or controlled by its executives, directors, and their families are known as Related Party Transactions. A related party transaction is a business deal or arrangement between two parties who have a relationship before that deal or arrangement.

Important for protection of interests of shareholders—Transactions with related parties are of crucial interest for shareholders. It is highly desirable that the interests of shareholders are given due protection, particularly when control of the company or the Board rests in a single person. Normally, related party transactions in normal course of business, involve no risk. However, there may be ‘related party transactions’ giving rise to higher risks of abuse than transactions entered into with unrelated parties. It may happen that related party transactions are not conducted in accordance with the normal market terms and conditions. There may even be some related party transactions conducted with no consideration at all or with inadequate consideration.

Examples of related party transactions—Granting of loans, writing off loans and dues, selling assets to a related entity for a price much below the price prevailing in the market are the examples of related party transactions. Usually, related party transactions are resorted to by dominant shareholders, exercising considerable control over company’s affairs. A number of high-profile accounting frauds in recent years, as for example, Enron in US and Satyam Computers in India could be possible due to related party transactions.

Meaning of related party—Section 188 of the Companies Act, 2013, provides that “no company shall enter into any contract or arrangement with a related party.” According to section 2 (76) of the Companies Act, 2013, ‘related party’ with reference to a company, means—

(a) a director or his relative;

(b) a key managerial personnel or his relative;

(d) a private company in which a director or manager is a member or director;

(e) a public company in which a director or manager is a director or holds along with his relatives, more than two per cent of its paid-up share capital;

(f) any body corporate whose Board of Directors, managing director or manager is accustomed to act in accordance with the advice, directions or instructions of a director or manager;

(g) any person on whose advice, directions or instructions a director or manager is accustomed to act; Provisions of sub-clauses (f) and (g) do not apply to the advice, directions or instructions given in a professional capacity.

(h) any company which is—

(A) a holding, subsidiary or an associate company of such company; or

(B) a subsidiary of a holding company to which it is also a subsidiary;

(i) such other person as may be prescribed.

Meaning of relative—The term ‘relative’ is defined under section 2 (77) of the Companies Act, 2013, as—‘relative’ with reference to any person, means any one who is related to another, if—

(a) they are members of a Hindu Undivided Family;

(b) they are husband and wife; or

When related party transactions are allowed—Entering into contract or arrangement with a related party is allowed only when there is the consent of the Board of Directors and subject to such conditions as may be prescribed. The following kinds of contract or arrangement can be entered into only with the consent of the Board and subject to the prescribed conditions—

(a) sale, purchase or supply of any goods or materials;

(b) selling or otherwise disposing of or buying property of any kind;

(d) availing or rendering of any services;

(e) appointment of any agent for purchase or sale of goods, materials, services or property;

(f) such related party’s appointment to any office or place of profit in the company, its subsidiary company or associate company;

(g) under-writing the subscription of any securities or derivatives thereof, of the company.

What is the meaning of forward dealing? What are the prohibitions on forward dealing?

Forward dealing [S 194]—Forward dealing consists of transaction of a purchase or sale where settlement, in terms of price or delivery of commodity, occurs at some specified future date. Very often, the stockbrokers and traders have inside information regarding the investments which a firm is planning to make. Brokers and traders may use this inside information to their advantage through investments which are profitable for them.

In forward dealing, there is postponement of the delivery of or payment for securities. Contracts of this kind are made by buyers willing to cover themselves against price fluctuations, and sellers willing to benefit from them. Forward contracts are bought and sold in the “future markets”.

In forward dealing or forward contract, there is an obligation in the form of a contract to buy (or sell) a specified asset on a specified date, at a specified price. There is no money given and taken, until the specified date.

Prohibition on forward dealings—Section 194 of the Companies Act imposes a ban on directors and key personnel of the company from dealing in securities of the company on a forward basis.

Directors and other key managerial personnel are prohibited from buying in the company, or in its holding, subsidiary or associate company—

(a) a right to call for delivery or a right to make delivery at a specified price and within a specified time, of a specified number of relevant shares or a specified amount of relevant debentures; or

(b) a right, as he may elect, to call for delivery or to make delivery at a specified price and within a specified time, of a specified number of relevant shares or a specified amount of relevant debentures. [S 194 (1)]

Relevant shares and relevant debentures—Relevant shares and relevant debentures means shares and debentures of the company in which the concerned person is a whole-time director or other key managerial personnel or shares and debentures of its holding and subsidiary companies

MANAGERIAL PERSONNEL

Give a brief account of various Key Managerial Personnel appointed under the Companies Act, 2013.

Key Managerial Personnel [S 203]—In view of section 203 (1) of the Companies Act, 2013, every company belonging to such class or classes of companies as may be prescribed shall have the following whole-time key managerial personnel—

(a) managing director, or chief executive officer or manager and in their absence, a whole-time director;

(b) company secretary; and

In view of the first proviso to section 203, an individual shall not be appointed or reappointed as the chairperson of the company, in pursuance of the articles of the company, as well as the managing director or chief executive officer of the company at the same time after the date of commencement of this Act, unless—

(a) the articles of such a company provide otherwise; or

(b) the company does not carry multiple business.

It should be noted that nothing contained in the first proviso shall apply to such class of companies engaged in multiple businesses and which has appointed one or more chief executive officers for each such business as may be notified by the Central Government.

COMPROMISES, ARRANGEMENTS AND AMALGAMATIONS

What are the powers of tribunal to enforce compromise or arrangement?

Powers of tribunal [S 231]—According to section 231 (1) of the Companies Act, 2013, where the tribunal makes an order under section 230 sanctioning a compromise or an arrangement in respect of a company, it—

(a) shall have power to supervise the implementation of the compromise or arrangement; and

(b) may, at the time of making such order or at any time thereafter, give such directions in regard to any matter or make such modifications in the compromise or arrangement as it may consider necessary for the proper implementation of the compromise or arrangement.

Order for winding up the company—If the tribunal is satisfied that the compromise or arrangement sanctioned under section 230 cannot be implemented satisfactorily with or without modifications, and the company is unable to pay its debts as per the scheme, it may make an order for winding up the company and such an order shall be deemed to be an order made under sec. 273. [S 231(2)]

Court’s supervising role—The framers of the Company Law in India have conferred statutory powers on the High Court to make such modifications in the compromise or arrangement as the court may consider necessary for the proper working of the compromise and arrangement. The court has a continuing supervision over the implementation of compromise and arrangement. Unenvisaged, unanticipated, unforeseen or even unimaginable hitches, obstruction and impediments may arise in the course of implementation of a scheme of compromise and arrangement. If on every such occasion, sponsors have to go back to the parties concerned for seeking their approval for a modification and then seek the approval of the court, it would be a long drawn out; protracted, time-consuming process with no guarantee of result and the whole scheme of compromise and arrangement may be mutilated in the process.

The Parliament has, therefore, thought it fit to trust the wisdom of the court rather than go back to the interested parties. The Parliament has conferred power on the court, not only to make modifications even at the time of sanctioning the scheme, but at any time thereafter during the period the scheme is being implemented.

WINDING UP OF A COMPANY

Comment on the statement, “Remedy for winding up of company is in the nature of a last resort and could not be invoked when other remedies are efficacious enough to protect the general interest of the company.”

Winding up as a last resort—Section 271 (1) (e) of the Companies Act, 2013 provides that the tribunal can order winding up of the company when it is of the opinion that it is just and equitable that the company should be wound up. It is the “remedy of the last resort”. In this case, the Tribunal has the wide powers and has complete discretion to decide when it is “just and equitable” to order winding up of the company. The discretionary authority of the tribunal even enables it to subject the exercise of the illegal rights to equitable considerations. The discretion of the tribunal under this clause is very wide.

Just and equitable winding up represents a remedy of last resort—Hence, the shareholders should be mindful of, and consider, alternative courses of action, where they have a dispute. If they consider that company affairs are being conducted in a manner that is unfairly prejudicial to their interests, then it is important to note that they have the ability to seek relief through an alternative statutory based remedy.

In M Mohan Babu vs Heritage Foods India Ltd., (2002) 108 Comp Cas 771 (AP), the company judge dismissed the application observing that the remedy under the said provisions is in the nature of a last resort and could not be invoked when other remedies are efficacious enough to protect the general interest of the company.

In Prashant Glass Works Pvt. Ltd. vs Banaras Beads Ltd., (2002) 111 Comp Cas 71 (All), a petition for winding up of the respondent-company was filed under the “just and equitable” ground, alleging that the respondent-company had not complied with the statutory requirements of the Act as the company did not submit the annual returns and failed to prepare and audit the accounts of the company. Therefore, the respondent-company was said to have acted in oppression to the minority shareholders’ interest in the company. However, it was noticed that there were disputes between the two groups holding major shares and the matter was referred to an arbitrator. The arbitrator gave an award, in which a scheme of arrangement was proposed in conformity with the award of the arbitrator. Therefore, it was held that the petitioner had an alternative and efficacious remedy, but without availing of the said remedy, he had approached the court for winding up. The said petition was, therefore, dismissed