Company Law: Incorporation, Prospectus, Shares and Debentures

s.2(20): a company means a company incorporated under this Act or any previous company law. Characteristics: incorporated association; separate legal personality; perpetual succession; limited liability (in most kinds); common seal (optional after the 2015 amendment); transferable shares; capacity to sue and be sued; and separation of ownership from management.

Classification:

• By incorporation: chartered, statutory, and registered companies.

• By liability: company limited by shares, limited by guarantee (members guarantee a sum on winding up), and unlimited company.

• By members: private company (s.2(68)), public company (s.2(71)), and One Person Company (OPC) (s.2(62)).

• By control: holding (s.2(46)) and subsidiary (s.2(87)), associate company (s.2(6): significant influence, holding of 20% or more of total voting power), and government company (s.2(45): at least 51% of paid-up share capital held by the Central or State governments).

• Others: small company (s.2(85): paid-up capital up to Rs. 4 crore and turnover up to Rs. 40 crore, as revised in 2022; not a holding or subsidiary company, not a s.8 company, and not governed by a special Act); s.8 company (charitable or non-profit objects, licence from the Central Government, no dividend); Nidhi company; producer company; foreign company (s.2(42)); listed company; dormant company (s.455).

Private company (s.2(68)): by its articles it (a) restricts the right to transfer its shares, (b) limits the number of members to 200 (excluding employees, and ex-employees who were members while employed), and (c) prohibits any invitation to the public to subscribe to its securities. The 2015 amendment removed the minimum paid-up capital requirement (earlier Rs. 1 lakh for private and Rs. 5 lakh for public).

Minimum number of members (s.3): public company 7; private company 2; OPC 1 (with a nominee). A public company has no maximum. A private company can have a maximum of 200 members. OPC cannot be incorporated by a non-resident (s.3(1)(c), Rule 3: a natural person who is an Indian citizen and resident in India, with the residence defined as 120 days; the Companies (Incorporation) Second Amendment Rules 2021 permitted NRIs to form OPCs).

Minimum directors (s.149): public company 3, private company 2, OPC 1. At least one director must be resident in India (stayed at least 182 days in the previous financial year). At least one woman director for prescribed classes of companies (listed companies and public companies with paid-up capital of Rs. 100 crore or more or turnover of Rs. 300 crore or more). Maximum 15 directors (more by special resolution).

• Salomon v Salomon & Co. Ltd. (1897): a company is a distinct legal person, separate from its members; the person who held nearly all shares and was a secured creditor was not liable for company debts. Indian recognition: Tata Engineering v State of Bihar (1964) and Bacha F. Guzdar v CIT (1955: a shareholder is not an owner of the company’s assets).

• Lee v Lee’s Air Farming (1961): a sole shareholder can be an employee. Macaura v Northern Assurance (1925): a shareholder has no insurable interest in the company’s assets.

Lifting the veil:

• Statutory: reduction in membership below the minimum (s.? and continuing liability), misdescription of the company’s name (s.12(3)), fraud (s.7(7) incorporation by fraud, s.34/s.35 misstatement in prospectus, s.447 fraud), fraudulent trading (s.339), investigation (s.216), and holding–subsidiary accounts (consolidated).

• Judicial grounds: fraud or improper conduct (Gilford Motor Co. v Horne; Jones v Lipman); sham or façade; agency (Smith, Stone & Knight v Birmingham Corp.); enemy character (Daimler Co. v Continental Tyre); tax evasion (Juggilal Kamlapat v CIT, 1969; Re Sir Dinshaw Maneckjee Petit, 1927); welfare of workers and public interest (State of U.P. v Renusagar Power, 1988); group enterprises (DHN Food Distributors v Tower Hamlets). Cases: Delhi Development Authority v Skipper Construction (1996); Subhra Mukherjee v Bharat Coking Coal (2000); Vodafone International Holdings v Union of India (2012: the corporate veil is respected unless there is a sham or tax evasion; look-through is a ‘look at’ analysis); Singer India v Chander Mohan Chadha (2004). Adams v Cape Industries (1990) restricts veil-lifting in English law, and Prest v Petrodel (2013) holds that it applies only for evasion or concealment.

Promoter (s.2(69)): a person named as such in a prospectus or annual return, or who has control over the company’s affairs directly or indirectly, or in accordance with whose advice the board is accustomed to act (professional advisers are excluded). Position: neither agent nor trustee, but fiduciary (Erlanger v New Sombrero Phosphate Co., 1878). Duties: full disclosure of secret profits; the company may rescind or recover the secret profit. Liabilities: for misstatements in the prospectus (s.34, s.35, s.447).

Pre-incorporation contracts: the company is not bound (it did not exist) and cannot ratify them (Kelner v Baxter; Newborne v Sensolid). In India, s.15(h) and s.19(e) of the Specific Relief Act, 1963 allow a company to enforce them if they are warranted by the terms of incorporation, the contract was entered into by the promoters before the company existed for its purposes, and the company has accepted the contract and communicated it. The promoter remains liable until the company adopts the contract by a fresh contract (novation).

Procedure (steps):

1. Name approval through RUN (Reserve Unique Name), or by SPICe+ (the integrated form INC-32). The name must not be identical or too nearly resemble an existing name or trademark (s.4(2)(a)), must not be undesirable, and must end with ‘Limited’ (public), ‘Private Limited’ (private), or ‘OPC’ in brackets for OPC (s.4(5)).

2. Obtaining DIN (Director Identification Number) and digital signature certificates (DSC) for subscribers and directors.

3. Preparation of the memorandum and articles (INC-33 and INC-34 in the integrated filing).

4. Filing (s.7) with the Registrar of Companies: the memorandum and articles; an agreement (if any) to appoint a managing director or whole-time director; a declaration by an advocate, chartered accountant, cost accountant or company secretary engaged in formation that all requirements have been complied with; an affidavit from each subscriber and the first directors that they are not convicted or disqualified; and the address of the registered office.

5. Certificate of incorporation (s.7(2)), which also has the CIN. It is conclusive evidence that all requirements have been complied with (s.7(2)). Under s.7(7), if it is found that the company was incorporated by furnishing false information or suppressing facts, the Tribunal may order regulation of liability, winding up, or removal of the name.

6. Registered office (s.12): within 30 days of incorporation; notice of verification of the registered office within 30 days of incorporation.

7. Commencement of business (s.10A): inserted in 2019 — a company incorporated after 2019 with share capital must file a declaration (Form INC-20A) within 180 days of incorporation that every subscriber has paid the value of the shares agreed.

Effect of registration (s.9): the subscribers become a body corporate with perpetual succession and a common seal, capable of exercising all functions of an incorporated company, with the liability of members limited as stated.

Memorandum of Association (s.4):

• Name clause; registered office clause (the State in which the registered office is to be situated); objects clause (main objects, and objects incidental or ancillary); liability clause; capital clause (in a limited-by-shares company: authorised share capital divided into shares of fixed amounts); association (subscription) clause: each subscriber agrees to take at least one share, and the number of shares taken by each subscriber is stated.

• Forms: Tables A–E in Schedule I (A: limited by shares; B: guarantee, no share capital; C: guarantee with share capital; D: unlimited, no share capital; E: unlimited with share capital).

• Alteration: name (s.13(2): special resolution and Central Government approval; after 2016 the Registrar approves under Rule; s.16 change of name if identical or resembling, directed within 3 months); registered office (s.13(4): shifting from one State to another requires a special resolution and the approval of the Regional Director); objects clause (special resolution, s.13(1)); capital clause (s.61); liability clause (s.? special resolution and consent of the members, and increase of liability needs the member’s consent).

Doctrine of ultra vires: acts beyond the powers in the memorandum are void and incapable of ratification (Ashbury Railway Carriage & Iron Co. v Riche, 1875). Indian case: A. Lakshmanaswami Mudaliar v LIC (1963). Remedies: injunction, personal liability of directors, and recovery of company property by tracing. Acts intra vires the company but beyond the directors’ powers can be ratified by members; acts that are irregular may be ratified.

Articles of Association (s.5): the regulations for the management of the company’s internal affairs, subordinate to the Memorandum and the Act. A public company may adopt Table F (Schedule I), and companies may adopt provisions. Entrenchment (s.5(3)): specified provisions can be altered only if conditions or procedures stricter than special resolution are met; notice to the Registrar. Binding effect (s.10): the memorandum and articles bind the company and the members to the same extent as if signed by each member. Cases: Hickman v Kent or Romney Marsh Sheepbreeders’ Association (1915: the articles constitute a contract between the company and the members only in their capacity as members); Eley v Positive Government Security Life Assurance Co. (1876: an outsider cannot enforce); Salmon v Quin & Axtens; Naresh Chandra Sanyal v Calcutta Stock Exchange (1971). Alteration (s.14): by special resolution, filed with the Registrar within 15 days; conversion of a public company into a private company needs the approval of the Tribunal; the alteration must be bona fide for the benefit of the company as a whole (Allen v Gold Reefs, 1900; Brown v British Abrasive Wheel Co.) and must not be retrospective to the detriment of a member.

Doctrine of constructive notice: every person dealing with a company is deemed to have read the registered documents (memorandum and articles) (Ernest v Nicholls). Doctrine of indoor management (Turquand’s rule): an outsider dealing in good faith may assume that the internal procedures have been regularly complied with (Royal British Bank v Turquand, 1856; Mahony v East Holyford Mining Co.).

Exceptions to the Turquand rule: (a) knowledge of irregularity (Howard v Patent Ivory Manufacturing Co.); (b) suspicion that should have prompted inquiry (Anand Bihari Lal v Dinshaw & Co., 1946); (c) forgery (Ruben v Great Fingall Consolidated); (d) documents or acts not within the apparent authority or outside the memorandum (ultra vires); (e) no reliance on the articles and no actual dealing with the company (Rama Corporation v Proved Tin & General Investment Co.). Also, the Indian Companies Act s.? (Turquand’s rule) is not codified.

Definition (s.2(70)): any document described or issued as a prospectus, including a red herring prospectus (s.32) or shelf prospectus (s.31), or any notice, circular, advertisement or other document inviting offers from the public for the subscription or purchase of any securities of a body corporate.

Modes of raising securities (s.23): a public company may issue securities (a) to the public through a prospectus (public offer), (b) through private placement, or (c) through a rights issue or bonus issue. A private company may issue securities by private placement, rights issue or bonus issue (not to the public). s.24: SEBI regulates the issue and transfer of securities by listed companies (and those that intend to list), through the SEBI (ICDR) Regulations, 2018.

Types:

• Red herring prospectus (s.32): does not include complete particulars of the price of the securities offered or the quantum of securities. It must be filed with the Registrar at least three days before the opening of the subscription list. Used in book-building.

• Shelf prospectus (s.31): for companies (such as public financial institutions and banks) that issue securities in one or more issues over a period without a separate prospectus each time. The validity period is up to one year (as stated in the prospectus). An information memorandum is filed before each subsequent offer.

• Abridged prospectus (s.33): a memorandum containing the salient features of the prospectus, issued with every application form.

• Deemed prospectus (s.25): where a company allots, or agrees to allot, securities to an issue house or any other person with a view to their offer for sale to the public, any document by which the offer is made is deemed to be a prospectus.

Contents and registration (s.26): the prospectus must be dated, and signed by every person named as a director or proposed director, and must be filed with the Registrar for registration (on or before the date of publication). Required content (Schedule II, ICDR): objects of the issue, the details of capital structure, risk factors, the reports of the auditors and experts, financial information, promoters’ contribution, litigation, the management, and the terms. Experts’ consent is required, in writing, before the issue of the prospectus (s.26(5)).

Dating and effect: the date on the prospectus is the date of publication (s.26(?)). A prospectus issued more than 90 days after registration is invalid (the old 90-day rule). The minimum subscription and application money are regulated by SEBI (ICDR); the allotment must be made within the time prescribed, and money must be refunded in case of failure (s.39(3): within 15 days of the closing of the issue; interest at 15% beyond that period).

Misstatements in the prospectus:

• s.34: criminal liability. Where a prospectus includes an untrue or misleading statement, every person who authorised the issue is liable under s.447 (fraud), unless he proves that the statement was immaterial or that he had reasonable grounds to believe it true.

• s.35: civil liability. Every person who is a director at the time of the issue, who authorised the issue, who agreed to become a director, the promoter, and the expert (for the part contained in his report), is liable to pay compensation to every person who subscribed for securities on the faith of the prospectus for any loss or damage sustained by reason of any untrue or misleading statement or omission. Defences (s.35(2)): withdrew consent before issue; issued without his knowledge; reasonable belief; the statement was an expert’s (and he believed in the expert’s competence).

• s.36: punishment for fraudulently inducing persons to invest money (under s.447). s.37: class actions — compensation to depositors. s.38: punishment for personation to acquire securities (liable under s.447).

• Remedies of the investor: rescission of the contract (for misrepresentation or non-disclosure, within a reasonable time and before winding up), damages for fraud (Derry v Peek), and statutory compensation (s.35).

• Case law: Derry v Peek (1889: fraud needs knowledge or recklessness); Rex v Kylsant (1932: a half-truth may mislead); New Brunswick & Canada Railway v Muggeridge (1860: the duty to disclose all material facts); Central Railway Co. of Venezuela v Kisch (1867: promoters’ duty); Re Pilot. Also, a material misstatement includes statements of opinion where the opinion is not honestly held.

s.2(84): a share is a share in the share capital of a company, and includes stock. A share is movable property (s.44) transferable as per the articles, and has a nominal value. Types (s.43):

• Equity share capital: with voting rights, or with differential rights as to dividend, voting or otherwise (subject to the Companies (Share Capital and Debentures) Rules, 2014).

• Preference share capital: (a) a preferential right for the payment of dividend (a fixed amount or at a fixed rate) and (b) a preferential right to return of capital on winding up. s.55: a company limited by shares cannot issue irredeemable preference shares; they must be redeemed within 20 years (30 years for infrastructure projects, subject to conditions). Redemption is only out of profits available for dividend or from the proceeds of a fresh issue, and fully paid. A Capital Redemption Reserve (CRR) must be created where redeemed out of profits.

Kinds of preference shares: cumulative and non-cumulative; participating and non-participating; convertible and non-convertible; redeemable.

Share capital terms: authorised (nominal/registered), issued, subscribed, called-up, paid-up, uncalled and reserve capital (only on winding up, s.? and Act).

Issue of shares:

• s.23 and s.39: allotment. Allotment must be made within the time prescribed after minimum subscription. A return of allotment (Form PAS-3) must be filed within 30 days. An irregular allotment is voidable at the instance of the applicant within a reasonable time, and the Act prohibits allotment unless the application money is received.

• s.52: securities premium account: the premium on shares must be credited to this account, and can be used only for (a) issuing fully paid bonus shares, (b) writing off preliminary expenses, (c) writing off expenses of or commission paid or discount allowed on the issue of securities or debentures, (d) providing for the premium on redemption of preference shares or debentures, and (e) purchase of its own securities (buy-back).

• s.53: no issue at a discount (any such issue is void), except sweat equity shares (s.54). s.54: sweat equity shares may be issued to employees or directors at a discount or for consideration other than cash (know-how, IPR, value additions), after one year from commencement (startups: ten years), by special resolution.

• s.62: further issue of share capital: (a) rights issue: offer to existing shareholders in proportion to their holdings, with a notice of not less than 15 days and not more than 30 days (the MCA has at times allowed shorter periods) giving them the right to renounce in favour of another; (b) employee stock option (ESOP): special resolution; (c) preferential allotment: special resolution and compliance with the Rules.

• s.63: bonus shares: from free reserves, the securities premium account or the capital redemption reserve account only (not from revaluation reserves), authorised by articles; may be issued in lieu of dividend not. Once declared, a bonus issue cannot be withdrawn.

• s.64 and s.65: notice of alteration of share capital to the Registrar within 30 days.

• s.46: share certificate within two months of allotment (or one month from the date of lodging an instrument of transfer; 15 days from a request for a duplicate). A share certificate is prima facie evidence of title (s.46(1)) and creates estoppel against the company as regards the matters stated (Re Bahia & San Francisco Railway; **Sri Mahadeo? **).

• s.29: a public company must issue and transfer securities in dematerialised form (and unlisted public companies from October 2018). Depositories Act, 1996.

Calls, forfeiture and lien: the articles (Table F) govern calls on shares (at least 14 days’ notice; no call may exceed 25% of the face value, and an interval of at least one month between calls, under the old rules), forfeiture for non-payment of calls (only for non-payment; the power must be exercised in good faith and for the purpose of the call), and surrender. The company’s lien (Table F) is a first and paramount lien on partly paid shares (not on fully paid shares in a public company). Transfer s.56: an instrument of transfer (Form SH-4) duly stamped and delivered; the company shall deliver certificates within one month. s.58: a private company may restrict the transfer in its articles, whereas the shares of a public company are freely transferable; if a private company refuses to register, an appeal lies to the Tribunal within 30 days; s.58(4) the transferee may appeal. Transmission (s.56(2)) by operation of law (death, insolvency). Distinguish transfer (voluntary act) and transmission (by operation of law). s.59: rectification of the register by the Tribunal. s.59(4) the Tribunal may order rectification, and s.88 is the register of members.

Alteration and reduction of capital (ss.61–66):

• s.61: a company limited by shares, if authorised by the articles, may by ordinary resolution: increase its authorised capital; consolidate and divide shares into larger amounts; convert fully paid shares into stock and vice versa; sub-divide; and cancel unissued shares.

• s.66: reduction of share capital: by special resolution (if authorised by articles) and confirmation by the Tribunal (NCLT), after notice to the Central Government, SEBI and the creditors. A reduction affecting the creditors requires their consent or discharge. The Tribunal may order publication of reasons.

• s.67: a company may not purchase its own shares or give financial assistance for the purchase of its shares except by buy-back (s.68) and permitted exceptions (for example by a private company with employee-held shares and a scheme for employees).

• s.68 (buy-back): from free reserves, the securities premium account, or the proceeds of an issue of other shares or specified securities (not from the proceeds of an earlier issue of the same kind); the buy-back must not exceed 25% of the total paid-up capital and free reserves; a board resolution is enough if up to 10% of the paid-up capital and free reserves, and a special resolution beyond that; the debt-equity ratio after the buy-back must not exceed 2:1; only fully paid-up shares; the buy-back must be completed within one year of the resolution; a declaration of solvency is required; the bought-back securities must be extinguished and physically destroyed within seven days; a company cannot make another buy-back offer for a period of one year after the closure of the previous one; and a company cannot buy back if it has defaulted on repayment of deposits, interest, redemption of debentures, preference shares or payment of dividend until the default is remedied. s.70: prohibition on buy-back through subsidiaries and investment companies, and through any fraudulent device.

Dividends (ss.123–127): dividend is payable only out of profits of the current or previous years (after providing for depreciation), or out of free reserves; interim dividend may be declared by the board; it must be deposited in a separate bank account within five days of declaration and paid within 30 days (s.127: failure to distribute within 30 days is an offence); unpaid or unclaimed dividend is transferred to the Unpaid Dividend Account within seven days (s.124), and then, after seven years, to the Investor Education and Protection Fund (IEPF) (s.125); the shares to which dividends have not been paid for seven consecutive years are also transferred to the IEPF (s.124(6)).

Members: a member (s.2(55)) is a subscriber to the memorandum or a person who agrees in writing to be a member and whose name is entered in the register of members, or a beneficial owner whose name is in the register of a depository. Distinction between member and shareholder (a shareholder may be a bearer of a share warrant). s.88: registers of members and debenture holders. s.90: registers of significant beneficial owners (SBO: an individual who holds at least 10% of shares, voting rights, or the right to receive or participate in dividends, or exercises significant influence or control).

Definition (s.2(30)): a debenture includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the assets of the company or not. A debenture is a document acknowledging a debt; the holder is a creditor, not a member.

Differences between shares and debentures:

Kinds: secured (mortgage) and unsecured (naked); redeemable and irredeemable; registered and bearer; convertible (fully or partly) and non-convertible; fixed charge and floating charge debentures. Debenture stock: a borrowing of one aggregate sum, divided into units.

Provisions of s.71:

• s.71(1): a company may issue debentures with an option to convert into shares, wholly or partly, only with the approval of a special resolution. No voting rights in debentures.

• s.71(2): secured debentures may be issued subject to prescribed terms; the security must be a charge on the company’s assets, registered under s.77.

• s.71(5): debenture trustee is appointed before the issue of the prospectus or letter of offer, to protect the interests of the debenture holders; the trust deed is executed within 60 days of the closure of the issue (reduced in 2019 from three months). The trustee is regulated by the SEBI (Debenture Trustees) Regulations, 1993.

• s.71(4): Debenture Redemption Reserve (DRR): the 2019 amendment (Companies (Share Capital and Debentures) Amendment Rules, 2019) exempted listed companies from creating DRR for public issues or private placement; unlisted companies (other than NBFCs and HFCs regulated by RBI/NHB) must create DRR of 10% of the value of outstanding debentures maturing within a year. Companies must also invest or deposit at least 15% of the amount of debentures maturing during the year ending on 31 March of the next year, before 30 April, in specified instruments.

• s.71(10)–(13): the debenture holders’ remedies: the Tribunal may, on application by a debenture holder or trustee, order the company to redeem the debentures forthwith on payment of principal and interest if the company fails to redeem or pay interest; the debenture certificate must be delivered within two months of allotment. s.72: nomination facility for debenture holders.

Fixed charge: on specific, ascertained assets (such as land and buildings); the company cannot dispose of them without the consent of the charge holder. Floating charge: on a class of assets present and future, which in the ordinary course of business changes from time to time; the company may deal with the assets until the charge crystallises (on default, on the appointment of a receiver, or on winding up). Features of a floating charge are in Re Yorkshire Woolcombers Association (1903: (a) a charge on a class of assets, present and future; (b) the class is one which, in the ordinary course of business, would be changing from time to time; (c) the company may carry on business until some step is taken by the chargeholders). Related cases: Illingworth v Houldsworth; Holroyd v Marshall. Priority: a fixed charge usually has priority over a floating charge, and a floating charge is postponed to preferential creditors (workmen’s dues, and secured creditors, under the Insolvency and Bankruptcy Code, 2016, s.53).

Registration (s.77): every charge created by a company must be registered with the Registrar within 30 days of its creation, in the prescribed form (CHG-1 / CHG-9). The Registrar may allow registration within a further period of 300 days on payment of additional fees (Companies (Amendment) Act, 2019); beyond that, the matter goes to the Central Government (Regional Director) under s.87. Unregistered charges are void against the liquidator and any creditor (but the debt remains a valid simple contract debt, and the money becomes immediately payable). s.82: the satisfaction of the charge must be filed within 30 days. s.85: the company must keep a register of charges at the registered office. s.86: offence.