Escolar Documentos
Profissional Documentos
Cultura Documentos
Block - I
Company and its Incorporation
CONTENTS
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UNIT-1 HISTORY OF COMPANY LEGISLATION
STRUCTURE
1.0. Introduction
1.1. Objectives
1.2. History of Company Legislation in England
1.3. History of Company Legislation in India.
1.4. Summary
1.5. Test your knowledge
1.0. Introduction
1.1. Objectives
The main objective of this unit is to understand the development of the
Companies Legislation with the march of the progress in business and economy.
After going through this unit you will be able to:
→ Have a glimpse of development of Company law in England
→ Get an understanding of the development of Companies legislation in India.
→ Understand the various amendments brought about in the Companies Act,
1956 and the reasons which prompted them.
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1.2. History of Company Legislation in England
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Till then the only method of incorporating a Company was by Royal Charter
or by Act of parliament. The methods were quite expensive and time consuming.
Thus many Companies came into existence by agreement and without
incorporation. Consequently, there was spurt of many Companies having
speculative or even fraudulent schemes. The scheme of the South Sea Company is
the best example of the notorious Company floatation at that time.
To check the emergence of the Companies with speculative or fraudulent
motives the Bubble Act, 1720 was passed. The Act prohibited the floating of a
corporation unless authorized by an Act of Parliament or Royal charter. As a result
of the passing of the Bubble Act Companies disappeared like the bursting of the
bubble.
Through the Bubble Act prohibited the incorporation of a Company without
on Act of parliament or Royal charter, it did not legislate against the unincorporated
Company.
The Bubble Act was repealed in the year 1825 and in 1834, the Trading
Companies Act, 1834 was passed. This Act empowered the Crown to grant by
Letters Patent any of the privileges of incorporation except limited liability. The
Chartered Companies Act, 1837 provided for the first time that personal liability of
members might be limited to a specific amount per share through letters Patent.
The Joint Stock Companies Act was enacted in 1844 providing for the
registration of Companies with more than 25 members or with shares which are
freely transferable without any consent by the members. By this Act the office of
the ‘Registrar of Companies’ was created for the first time. The particulars
regarding the constitution of a Company, charges therein and annual returns are
required to be filed with the Registrar so that there shall be an official record of the
Company. Despite the incorporation of the Company, members are still personally
liable, but their liability was to cease three years after they had transferred their
shares by registered transfer and creditors has to first proceed against the Company.
Members could escape personal liability by an agreement to the contrary, providing
that the member’s liability shall be limited to unpaid part of the shares.
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In 1855, parliament enacted Limited Liability Act, 1855 which provides that
the Joint Stock Companies registered under the Act of 1844 might limit the liability
of its members to the amount unpaid on their shares.
In 1856, the English Companies Act was enacted (the Joint Stock
Companies Act, 1856), which repealed both the Acts of 1844 and 1855. Under the
Act of 1856, seven or more persons could form themselves into an incorporated
Company with or without limited liability by signing memorandum of association.
The Act of 1856 was repealed by the Act of 1862 The Act was further repealed by
the Acts of 1908, 1928, 1948, 1967, 1976, 1980, 1981 and 1983. In 1985, the whole
of the existing law relating to Companies was consolidated in the Companies Act,
1985 which is the present statute governing Companies in England.
1.3. History of Company Legislation in India
As discussed earlier, the Company legislation in India has closely followed
the English Companies Legislation. The Indian Company Law originates in the
year 1850 when the first Indian Companies Act was enacted on the lines similar to
the English Companies Act of 1844. The Act of 1850 provides for the first time in
India registration of joint stock Companies. In 1857, another Act, closely following
the English Companies Act of 1855, was passed, which extended the privilege of
limited liability to joint stock Companies excepting Banking and Insurance
Companies. The Indian Companies Act, 1860 was enacted on the lines of the
English Companies Act and extends the privilege of ‘limited liability’ to Banking
and Insurance Companies as well. The first comprehensive legislation was enacted
in the in the year 1866 on the model of the English Companies Act of 1862 and
provided for the incorporation, regulation and winding up of Companies. The Act
was amended several times in 1882, 1887, 1891, 1895 and 1910, till we had a
consolidating Act – ‘The Indian Companies Act, 1913’ – which brought Indian law
at par with English Companies Act of 1908. It was by this Act that the institution of
‘Private Company’ was for the first time introduced in the Indian Company Law.
The Act of 1913 was further amended in the year 1914, 1915, 1920, 1926, 1930
and 1932. The Act was extensively amended in 1936 on the lines of the English
Companies Act, 1929.
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Some formal amendments were made by the Adaptation of Laws Order.
1950 on the date on which constitution of India came into force i.e. 26 January
1950. At the end of 1950, the government appointed a committee under the
chairmanship of Sri. H.C. Bhabha to look into the Indian Companies Act and to
suggest some measures for improving the Companies Act taking into consideration
the development of Indian trade and industry through all these years.
The Bhabha committee submitted its report in April 1952 covering almost
all aspects of the Company law. Based on the recommendation of the Committee
Report, a Bill was introduced in the parliament in 1953 which later on took the
shape of the present Company Act viz. the Companies Act, 1956 The major
amendments in the Act of 1956 came in the years 1960, 1962, 1963, 1964, 1965,
1966, 1967, 1969, 1974, 1977, 1985, 1988, 1991, 2000, 2002 and 2006.
It is pertinent here to have brief a look at the amendments.
(1) The Companies (Amendment) Act, 1960 :-
a. The amending Act was based on the recommendations of Shastri Committee
which was appointed by the government on 15 May, 1957.
b. Some restrictions were imposed on management of Companies, managerial
remuneration and private Companies.
c. A new class of Companies namely ‘Deemed to be Public Companies’ was
introduced.
(2) The Companies (Amendments) Act 1963 :-
a. The amending Act was based on the report of the Vivian- Bose Commission
instituted to inquire into the administration of the Dalmia – Jain group of
Companies.
b. By this amending Act, certain changes were incorporated in the Companies
Act to improve the efficiency of the Company administration and to prevent
abuses of power of management e.g. Section 10E of the amending Act
provides for setting up a ‘Board of Company Law Administration’ and
under section. 10A, a provision was made for setting up of a ‘Companies
Tribunal’. [(Companies Tribunal was abolished in 1967 by the Companies
(Tribunal Abolition Act, 1967)].
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(3) The Companies Amendment Act, 1965 :-
a. This third major amendment was based on the recommendations of
Daphtary-Shastri Committee.
b. The Act amends sec. 13 and provided that the objects clause in the
Memorandum of Association of any Company may be divided into two sub
clauses – (i) the main objects, and (ii) Other objects.
c. Restrictions were imposed on the period of currency of blank transfers by
adding sub-section (1A) to section 108.
d. ‘Advisory commission’ attached to the ‘Company Law Board’ was to be
replaced by an ‘Advisory committee’ by amending section 410.
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g. The Act introduce new sections to prevent or regulate ‘take over’ of shares
in a Company by a ‘group’ or ‘combine’ having the common intention to
acquire control over the Company.
h. The central Government has been given the power to appoint as many
Directors as it thought necessary on the Board of Directors of a Company in
public interest. Previously it was two.
i. Compulsory appointment of a whole- time secretary for the Companies
having a paid a up share capital of rupees twenty five lakh or more.
(6) The Companies (Amendment Act, 1977.
a. By amending section 58 of the Companies Act, 1956 Central Government
has been empowered to prescribe, in consultation with the Reserve Bank of
India, The limits up to which and the condition subject to which, deposits
may be invited or accepted by a Company.
b. By amending section 220, it has been made absolutely essential for the
management to file copies of the Balance sheet and the Profit and Loss
Account with the registrar of Companies within a presided period, even
where the Annual General Meeting (AGM) has not been held in time.
c. Wide powers have been conferred on the Company Law Board in regard to
the execution of orders made by it under various sections.
d. The ceiling for donations for charitable purposes has been raised from Rs.
25,000 to Rs, 50,000.
(7) The Companies ( Amendment) Act, 1985-
The important changes brought about by that Act are:
a. Companies were permitted to make contributions, directly or indirectly, to
any political party or for any political purpose to any person, not exceeding
5% of their average net profits during the three immediately preceding
financial years, if a resolution authorizing such contributions are passed at a
meeting of the Board of Directors. Government Companies and Companies
which have been in existence for less than three financial years are
prohibited from making any political contribution. Prior to this Act, there
was a blanket ban on political contribution by all types of Companies.
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b. Section 396, dealing with the Central Government’s power to order
amalgamation of Companies in public interest, has been amended.
(8) The Companies ( Amendment Act, 1988 :-
This Amendment came as a result of the recommendations made by
the sacchar committee. Their salient features are:
a. Setting up of an independent Company Law Boards (LLB) having power to
regulate its own procedure. The decisions of the CLB on question of fact to
be final. However, the orders of the CLB will be appeal able to High Court
on question of law.
b. For a private Company to be treated as ‘Deemed public Company’ its
average annual turnover during three preceding years shall be Rs. 5 crores or
more instead of the existing Rs. 1 crore or more or if it accepts deposits from
the public through an advertisement.
c. It has been made obligatory for every Company intending to offer shores or
debentures to the public for subscription by the issue of prospectus, before
such issue, to make on application to one or more recognized stock
exchanges for permission to deal in the shares or debentures of the
Company.
d. Issuing of preference shares which are irredeemable or redeemable after a
period of 10 years, is prohibited hereafter.
e. Every public limited Company or a subsidiary thereof, having a paid up
share capital of Rs. 5 crores or more to compulsorily have a managing or
whole time director or a manager.
(9) The Companies (Amendment) Act, 1996 :-
The major change brought about by this Act are :-
a. Amendment to section 17 of the Companies Act enables the Companies to
change the objects clause in their Memorandum of Association without
seeking approval of the Company Law Board
b. The Amendment Act, by amending section. So has increased the period of
redeemable preference shares to 20 years in place of 10 years.
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c. Mutual fund, venture capital funds and other SEBI recognized funds have
been granted voting rights for shares they hold in other Companies. Earlier
Public Trustees alone were allowed to vote.
d. Companies have been provided with the facility to the file their documents
with the Registrar of Companies in computerized format ie. Soft copy.
10. The Companies (Amendment) Act, 1999 :-
This Amendment Act is deemed to have come into force with effect from
31st October, 1998, the date of promulgation of ordinance by the president in this
regard.
The main provisions are:-
a. Nomination facility provided for depositors, share holders and debenture
holders by amending section 58A and by introducing section 109A and
109B.
b. By inserting section 77A, 77AA and 77B the right have been given to the
Companies to purchase their own shares or other specified securities under a
“buy back” scheme subject to SEBI guidelines in case of listed Companies
or Central Government guidelines in case of unlisted Companies and private
Companies.
c. Provision has been made for issue of “sweat equity shares” to directors or
employees of Companies by inserting section 79A.
d. “Investor Education and Protection Fund” was established for propagation
of knowledge as to matters of investment, by inserting section 205C.
e. A new section – section 372A, was introduced replacing section 370 and
372, to facilitate inter-corporate capital flows for meeting the demands of
liberalization.
(11) The Companies (Amendment) Act, 2000 :-
This act came in order to provide certain measures of good corporate
governance and for ensuring meaningful share holders’ democracy in the working
of Companies. The changes brought about by this Act include: -
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a. Requirement of Minimum paid up capital: - Private Companies to have a
minimum paid up capital of not less then Rs. 1,00,000 and public
Companies must have a minimum period up capital of Rs. 5,00,000.
b. Small depositor :- Sections 58AA and 58AAA were introduced for the
protection of small depositors
c. Shelf Prospects, Information Memorandum and Red Herring Prospectus:-
Financial institution and banks, which have to make repeated offers of
securities in year, are permitted to issue a ‘shelf Prospectus’ instead of a
Prospectus. The Shelf Prospects to have a shelf life of one year. Any
changes in between can be told by issuing an ‘information memorandum’.
Information Memorandum as envisaged in section 60B recognizes book
building process. Information Memorandum is a document for eliciting the
demand for the securities and to ascertain the price and terms of the issue.
‘Red Herring Prospects’ is an incomplete prospectus. It does not contain
information regarding price and quantum of shares.
d. Non-voting equity shares – Section 86 was amended to allow issue of non-
voting equity shares by public Companies.
e. Postal Ballot – In order to get a wider participation of share holders voting
through postal ballot on a particular resolution has been allowed.
f. Audit committees – A new section – section 292A- has been added
providing for constitution of audit committees by every public Company
having a paid up capital of Rs. 5 crores or more. Further, the
recommendations of the audit committee on any matter relating to financial
management shall be binding on the Board.
g. Indian Depository Receipts – Section 605A permits Companies incorporated
outside India, whether having a place of business in India or not, to issue
Depository Receipts in India and thus raise capital funds from Indian public.
(12) Companies (Amendment) Act, 2001 :-
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This Act amended provision of section 77A relating to buy back of shares
allowing Board of Directors to buy-back shares up to 10% of the paid-up capital
and free reserves provided not more than one such buy-back is made during period
of 365 days. Prior to this special resolution is required for buy-back of shares.
(13) Companies (Amendments) Act, 2002 :-
In December 2002, two Companies (Amendment) Acts Viz. Companies
(Amendment) Act, 2002 and Companies (Second Amendment) Act, 2002, were
passed.
The Important provision made through these Acts are :-
a. Producer Companies: - Setting up and regulation of co-operatives as body
corporate under the Companies Act, 1956 and to be known as producer
Companies.
b. Sick Companies – The second amendment act attempts to rationalize the
winding up process and to facilitate rehabilitation of sick Companies by
repealing SICA and dissolving BIFR. It seeks to establish a National
Company Law Tribunal (NCLT) providing it with powers for expediting the
winding up process so that the Company’s resources may be utilized for
better purpose rather than blocking them in sick undertakings.
(14) Companies (Amendment) Act 2006 :-
This Act has introduced various provisions relating to:-
a. Directors identification number (DIN) : - DIN to be issued to Directors, and
no fresh appointment or re-appointment of any individual as director unless
such an individual has been allotted DIN.
b. Governance and E-filing – The central government has notified the
Companies (Electronic Filing and Authentication of Documents) Rules
2006, providing for e-tiling of forms, applications, documents and
declarations in Portable Document Format (PDF) and authentication thereof
using digital signature.
Summary
The origins and development of Company law in India is based on the English
Company Law. Whatever Company legislations have been passed in England from
time to time has been followed by the Indian law with certain modification. The
Companies Act, 1956 is said to follow the U.K. Companies Act, 1948. Charters
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were granted to the members of the guilds by the Crown which gives them a
monopoly in respect of particular trade. These associations were either formed as
‘Commenda’ or ‘Societas’.
During the 14th century certain merchants adopted the word ‘Company’ for their
overseas ventures. This ‘Company was an extension of the merchant guilds in
foreign trade. By the close of the 16th century Royal charter were issued which
granted monopoly of trade to members of the Company over a certain territory. The
Companies were known as regulated Companies, one example of which is East
India Company established by charter in 1600.
By the close of the 17th century all these Companies or merchant guilds had
established permanent fixed capitals represented by shares which were freely
transferable. The property of the Company was to be controlled by the governors or
directors for the purpose of carrying on the business and was not to be divided
between members at intervals of time.
Till then the only method of incorporation a Company was by Royal Charter
or by Act of parliament. The methods were quite expensive and time consuming.
Thus many Companies came into existence by agreement and without
incorporation. Consequently, there was spurt of many Companies having
speculative or even fraudulent schemes. The scheme of the South Sea Company is
the best example of the notorious Company floatation at that time.
To check the emergence of the Companies of the Companies with
speculative or fraudulent motives the Bubble Act, 1720 was passed. The Act
prohibited the floating of a corporation unless authorized by an Act of Parliament
or Royal charter. As a result of the passing of the Bubble Act Companies
disappeared like the bursting of the bubble.
In 1856, the English Companies Act was enacted (the Joint Stock
Companies Act, 1856), which repeated both the Acts of 1844 and 1855. Under the
Act of 1856, seven or more persons could form themselves into an incorporated
Company with or without limited liability by signing memorandum of association.
The Act of 1856 was repealed by the Act of 1962 The Act was further repealed by
the Acts of 1908, 1928, 1948, 1967, 1976, 1980, 1981 and 1983. In 1985, the whole
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of the existing law relating to Companies was consolidated in the Companies Act,
1985 which is the present statute governing Companies in England.
The Company legislation in India has closely followed the English
Companies Legislation. The Indian Company Law originates in the year 1850 when
the first Indian Companies Act was enacted on the lines similar to the English
Companies Act of 1844. The Act of 1850 provides for the first time in India
registration of joint stock Companies. In 1857, another Act, closely following the
English Companies Act y 1855, was passed, which extended the privilege of
limited liability to joint stock Companies excepting Banking and Insurance
Companies. The Indian Companies Act, 1860 was enacted on the lines of the
English Companies Act and extends the privilege of ‘limited liability’ to Banking
and Insurance Companies as well. The first comprehensive legislation was enacted
in the in the year 1866 on the model of the English Companies Act of 1862 and
provided for the incorporation, regulation and winding up of Companies. The Act
was amended several times in 1882, 1887, 1891, 1895 and 1910, till we had a
consolidating Act – ‘The Indian Companies Act, 1913’ – which brought Indian law
at par with English Companies Act of 1908. It was by this Act that the institution of
‘Private Company’ was for the first time introduced in the Indian Company Law.
The Act of 1913 was further amended in the year 1914, 1915, 1920, 1926, 1930
and 1932. The Act was extensively amended in 1936 on the lines of the English
Companies Act, 1929.
Some formal amendments were made by the Adaptation of Laws Order.
1950 on the date on which constitution of India came into force i.e. 26 January
1950. At the end of 1950, the government appointed a committee under the
chairmanship of Sri. H.C. Bhabha to look into the Indian Companies Act and to
suggest some measures for improving the Companies Act taking into consideration
the development of Indian trade and industry through all these years.
The Bhabha committee submitted its report in April 1952 covering almost
all aspects of the Company law. Based on the recommendation of the Committee
Report, a Bill was introduced in the parliament in 1953 which later on took the
shape of the present Company Act viz. the Companies Act, 1956 The major
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amendments in the Act of 1956 came in the years 1960, 1962, 1963, 1964, 1965,
1966, 1967, 1969, 1974, 1977, 1985, 1988, 1991, 2000, 2002 and 2006.
1. Discuss briefly the history of company legislation in India and bring out clearly
the special features of the Companies act, 1956.
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UNIT-2 CORPORATE PERSONALITY
STRUCTURE
2.0. Introduction
2.1. Objectives
2.2. Concept of corporate personality.
2.3. Characteristic features of a company
2.4. Distinction between company and partnership.
2.5. Doctrine of ‘lifting the veil’ of corporate personality.
2.6. Advantages and disadvantages of incorporation
2.7 Summary
2.8. Check your progress.
2.0. Introduction
In this unit we shall learn the concept and characteristics of corporate personality.
Literally the word company means a group of persons associated for any common
object such as business, charity, sports and research etc. Almost every partnership
firm having two or more partners may, therefore, style itself as a company. But this
company is not a company in the legal sense of the term. We shall be using the
word company strictly in legal sense, i.e. a company incorporated or registered
under the Companies Act. We shall also discuss the various circumstances
prompting the courts to lift the corporate veil or break the corporate shell to peep
inside and to identify the actual persons involved in case of fraud or any improper
conduct as these members/directors are the limbs of the company.
Also, we shall discuss the advantages and disadvantages of incorporation.
2.1. Objectives
The main objective of this unit is to understand the concept of corporate
personality. After completing this unit you will be able to:
Have an idea of the incorporation of a company.
Learn the characteristic features of a company.
Understand the circumstances in which the veil of corporate personality can
be lifted to see the actual persons behind the legal façade.
Understand the distinction between a partnership and a company.
Get an understanding of advantages and disadvantages of incorporation.
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2.2. Concept of Corporate Personality
Company:-
The word ‘company’ has no strict technical or legal meaning literally the
word means a group of persons associated for some common object or objects such
as business, sports, charity etc. But, in common parlance, the word ‘company’ is
normally reserved for those associated for economic purposes, i.e. to carry a
business for gain. Thus it can be said that ‘company’ in simple terms, may be
described as a voluntary association of persons who have come together for
carrying on some business and sharing the profits there from.
Section 3(1) (i) and (ii) of the companies Act, 1956 define a company as “a
company formed and registered under this Act or an existing company.” An
existing company means a company formed and registered under any by the
previous company law.
The above definition does not give any indication about the features of a
company. In order to understand the meaning of a company we should have a look
at the definition given by different authorities.
Lord Justice Lindley :- “A company is an association of many persons who
contribute money or monies worth to a common stock and employed in some trade
or business and who share the profit and loss arising there from. The common stock
so contributed is denoted in money and is the capital of the company. The persons
who contribute to it or to whom it pertains are members. The proportion of capital
to which each member is entitled is his share. The shares are always transferable
although the right to transfer is often more or less restricted.”
Chief Justice Marshall: - “A corporation is an artificial being, invisible, intangible,
existing only in contemplation of the law. Being a mere creation of law, it
possesses only the properties which the charter of its creation confers upon it either
expressly or as incidental to its very existence”.
A more comprehensive legal definition of a company giving its main
essentials has been given by Prof. Honey – “a company is an artificial person
created by law, having separate entity, with perpetual succession and common
seal.”
A company, thus, may be defined as an incorporated association which is an
artificial person, having a separate legal entity, with a perpetual succession, a
common seal, a common capital comprised of transferable shares and carrying
limited liability.
2.3. Characteristic features of a company :-
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1. Incorporated association: - A must necessarily to be incorporated or
registered under the Companies, Act. Minimum number required for this
purpose is seven in the case of a ‘Public company’ and two in case of a
'private company' (Section 12). Registration creates a joint stock company
and it is compulsory for all the associations having membership of more
then ten persons in the case of banking business and 20 persons in other
commercial activities, otherwise the association would become illegal (Sec.
11).
2. Distinct legal entity: - A company is a legal person having a distinct juristic
personality entirely independent of the individual persons who are for the
time being its members. The first case on the subject (even before the
famous soloman’s case) was that of Kondoli Tea Co. Ltd., Re ILR (1886). In
this case certain persons transferred a tea estate to a company and claimed
exemption from ad valorem duty on the ground that they themselves were
the shareholders in the company and therefore, it was nothing but a transfer
from them in one to themselves under another name. Calcutta HC rejected
this contention and observed that the company was a separate person, a
separate body altogether from the shareholders and the transfer was as much
a transfer of property, as if the shareholder had been totally different
persons. A Company is not merely the sum total if its component members,
but it is something superadded to them. Even if a shareholder owns virtually
the whole of its shares, the company is a separate legal entity in the eyes of
law as distinguished from such a shareholder. This principle was judicially
recognized by the house of lords in the famous case of Soloman V. Soloman
& Co. Ltd, [1895-99] A11.ER33(HL). In this case Soloman was a
prosperous leather merchant. He converted his business into a limited
company – Soloman & Co. Ltd. The Company so formed has Soloman, his
wife and five of his children as members. The company purchased the
business of Soloman for £ 39,000, the purchase consideration was paid in
terms of £ 10,000 debentures conferring a charge over the company’s assets,
£ 20,000 in fully paid £ 1 share each and the balance in cash. The company
in less then one year ran into difficulties and liquidation proceedings
commenced. On winding up the state of affair of company was that it has
assets of £ 6000 and liabilities of £ 10,000 towards Soloman as debenture
holder and £ 7,000 towards unsecured emendators. Thus its assets were
running short of its liabilities by £ 11,000. The unsecured creditors claimed
priority over the debenture holder (i.e. Soloman) on the ground that a person
cannot own to himself and that Soloman and the company were one and the
same person. They also conducted that the company was merely agent of
Soloman, the business was solely his, consented solely for him and by him
and the Company was a mere sham and raved.
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The house of Lords unanimously held that the company had been validly
constituted, since the Act only required seven members holding at least one
share each. It said nothing about their being independent, or that there
should be anything like a balance of power in the constitution of the
company. Hence the business belonged to the company and not to Soloman.
Soloman was its agent. The Company was not the agent of Soloman
Similarly in the case of Lee V. Lee’s Air farming Ltd. [1960] 3A11. ER
420(PC), Lee formed a company with a share capital of £ 3,000 of which £
2999 were held by Lee. He was also the sole governing director. In his
capacity as the controlling shareholder, he exercised full and unrestricted
control over the affairs of the company. Lee was a qualified pilot also and
was appointed as the chief pilot of the company under the articles and drew
a salary for the same. While flying the company’s plane he was killed in an
accident. As the workers of the company were insured, workers were
entitled for compensation on death or injury. The question was while
holding the position of sole governing director, could Lee also be an
employee of the company. It was held that the more fact that some one was
the director of the company was no impediment to his entering into a
contract to serve the company. If the company was a legal entity, there was
no reason to change the validity of any contractual obligations which were
created between the company and the deceased. The contract could not be
avoided merely because Lee was the agent of the company in its
negotiations. Accordingly, Lee was an employee of the company and,
therefore, entitled to the claim of compensation.
It is interesting to note that being a person a company even enjoys
fundamental rights similar to the natural persons. Thus, it was held in
Chiranjilal Chauthry V. Union of India (1951) 21 Comp. Cas 33(SC), that if
a fundamental right of a company is infringed, it is the company and not
shareholders which can challenge infringement.
Although a company is a legal person having nationality in accordance with
the country of its incorporation and a domicile in accordance with the place
or state of its incorporation or registration, it is not a citizen State Trading
Corporation of India Ltd. V. Commercial Tax Officer, (1963) S.C.J. 605. A
company cannot, therefore, claim the protection of those fundamental rights
which are expressly guaranteed to citizen only e.g. the right of franchise.
3. Artificial Person: - The company, through a justice person, does not
possess the body of a natural being. It exists only in the eyes of law. Being
an artificial person, it has to depend upon natural person, namely, the
directors, officers, shareholders, etc., for getting its various works done.
However, these individuals only represent the company and accordingly
whatever they do within the scope of the authority confirmed upon them and
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in the name and on behalf of the company, they bind the company and not
themselves.
4. Limited Liability : - One of the important advantages of formation of a
company is that the members of the company are only liable to contribute
towards payment of its debts to a limited extent. If the company is limited by
shares, the shareholders' liability to contribute towards the debt of the
company is limited to the amount unpaid on their shares howsoever heavy
losses the company might have suffered. However, companies may be
formed with unlimited liability of members or members may guarantee a
particular amount, and then their liability is limited to the guaranteed
amount.
5. Perpetual Succession :- Since company is an artificial person, it can not be
incapacitated by illness and does not have an allotted span of life. Being
distinct from the members, the death, insolvency or retirement of its
members does not affect the Company. Members come and go but the
company can go forever. It continues of may even if all its human members
are dead. Law creates it and law alone can dissolve it. “King is dead, long
live the king” very aptly applies to the company from of organisation.
6. Common Seal :- A company being an artificial person has no body similar
to a natural person. It does not have a mind or limbs of human being. It acts
through natural person namely, the directors and other officers and
employees of the company. But it can be held bound by only those
documents which bear its signature. Common seal is the official signature of
a company.
However, in SICAL – CWT Distriparks Ltd. v. Besser concrete systems Ltd.
(2003) 46 SCL 196 (Mad.) it was held that it is not necessary that agreement
executed on behalf of company should bear seal of company, but question
whether agreement is valid or not depend upon facts of each case.
7. Transferability of Shares :- The shares of a public company are freely
transferable and members can dispose of their shares whenever they like
without seeking any permission from the company or the other members. In
a private company, however, some restriction on the right to transfer shares
is essential in its articles as per section 3(i) (iii) of the companies Act, 1956,
but absolute restrictions on the right of the members to transfer shares
contained in the articles shall be void.
2.4. Distinction between Company and Partnership :-
The main points of distinction can be summarized as under :-
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1. Regulating Act :- A company is regulated by the companies Act, 1956
whereas a partnership firm as governed by the provisions of the partnership
Act, 1932.
2. Number of members :- The Maximum number of members in the case of a
firm is fixed at 10 banking business and at 20 for any other business; but no
such maximum limit is fixed in the case of a public company. However, the
maximum number of members of a private company must not exceed 50
excluding members who are or were in the employment of the company.
Maximum Number : - The maximum number of members in a public
company is seven and in case of a private company two. In case of a
partnership the minimum numbers of partners is two.
3. Liability :- In partnership each partner has unlimited liability and is
personally liable for all debts of the firm. In a company, a shareholder has
limited liability – limited to the extent of the unpaid amount on the shares
held by him or the amount guaranteed by him to be his contribution.
4. Entity- One important attribute of a company is that it is an artificial person
and has a distinct entity separate from its members. A partnership, on the
other hand, does not have a distinct legal entity separate from the members
composing it and an its existence comes to an end upon the death or lunacy
or insolvency of its partners.
5. Capital :- The capital of a firm can be changed by the mutual consent of the
partners while such a change in the case of a company involves certain legal
formalities.
6. Management :- All the partners of a firm are entitled to take part in the
management of the business, but in the case of a company management is in
the hands of the board of directors elected by the shareholders.
7. Transfer of interest :- A partner cannot transfer his interest in the firm
without the consent of all other partners. In the case of a private company,
the transfer of shares requires the prior permission of the board of directors.
But in the case of a public company a shareholder can transfer his shares
freely without restriction and the transferee gets all the rights of
membership.
8. Registration :- A partnership from may or may not be registered but in the
case of a company registration is essential.
9. Audit :- The audit of the accounts of a company is a legal obligation but not
so in the case of a partnership. For partnership audit is essential only if the
annual total sales, turnover or gross receipts in business exceed Rs. 40 lakes.
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10. Winding up :- If the partnership is ‘at will’ then it can be dissolved or wound
up at any time without going through any legal formalities, whereas in the
case of a company, no one member can require it to be wound up at will and
moreover winding up involves legal formalities.
2.5. Doctrine of ‘lifting the veil’ of corporate personality :-
The main advantage of incorporation from which all others follow is the
separate legal entity. Through a company has a distinct personality apart from its
members, but in reality the business of the artificial person (company) is always
carried on by, and for the benefit of some individual. In the ultimate analysis some
individuals are the real beneficiaries of the corporate advantage. It may, therefore,
happen that the corporate personality of the company is used to commit frauds or
improper or illegal acts. Since an artificial person is not capable of doing anything
illegal or fraudulent, the facade of the corporate personality might have to be
removed to identify the persons who are really guilty. This is known as ‘lifting the
corporate veil’.
“Thus where the law disregards the corporate entity and pays regard instead to the
individual members behind the legal façade, it is known as lifting the veil of
corporate personality” (Gower L.C. B., The principles of modern company Law”).
The circumstances under which the courts may lift the corporate veil may broadly
be grouped under the following two heads :-
I. Under statutory provisions.
II. Under judicial interpretations.
I. Under statutory Provisions : -
The veil of corporate personality may be lifted in the following cases as
per express provisions of the companies Act, 1956.
1. Reduction of membership below statutory minimum (Section 45).
If, at any time, the number of members of a company is reduced below the
statutory minimum i.e. below 7 in the case of public company, or below 2 in
case of a private company, and the company carries on business for more
than 6 months while the number is so reduced, every person who is a
member of the company at the time the company so carries on business after
those 6 months and is aware of the fact shall be severally liable for the
payment of company’s debts, contracted during that time. (Section 45).
Thus the law pierces the ‘corporate veil’ and makes persons behind the
company personally liable, and the privilege of limited liability of
shareholders is lost.
2. Misrepresentation in Prospectus. (Section 62 & 63) :-
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In case of misrepresentation in prospects, every director, promoter and every
other person, who authorizes such issue of prospectus is liable to the persons
who have subscribed for shares on the faith of untrue statement (Section -
62), Also, criminal liability may be imposed with imprisonment upto 2 years
or fine upto Rs. 50,000 or both. (Sec. 63).
3. Failure to return application money:(Sec. 69):-
As per Company Acts:- If the company fails to receive minimum
subscription within 120 days after the date of first issue of the prospectus, it
most refund the entire application money within next 10 days failing which
it shall have to refund the same with interest @ 6%.
SEBI Guidelines have brought in some changes in the above law and can be
reread as:-
If the company fails to receive minimum subsection on the closure of the
issue, if the issue is not underwritten and within 60 days closure of issue, if
the issue is underwritten, it most refund the entire application money within
next 8 days failing which it shall have to refund the same with interest
@15% per Annum.
4. Failure to deliver share certificate etc. Within stipulate time period (Sec.
113).
According to section 113 (2) it a company fails to deliver the share or
debenture stipulate within 3 month of allotment and within 2 months of
application for transfer, than the company as well as every officer of the
company who is at felt shall be punishable with fine up to Rs. 5000 Per day
till such default witness.
5. Mis-description of name ( Sec. 147)- where officer of a company signs on
behalf of the company any contract, bill of exchange, hundi, cheque
promissory note or order for money, such person shall be personally liable to
the holder if the name of the company is either not mentioned, or is not
properly mentioned.
6. Holding Subsidiary Company. (Sec. 212)- A holding company is required
under section 212 of the companies Act, 1956, to disclose to its members the
account of its subsidiaries. It provides that every holding company shall
attach to its balance sheet, copies’ of the balance sheet, profit and loss
account, director’s report and Auditor’s report, etc. in respect of each
subsidiary company. It amounts to lifting the corporate veil because in the
eyes of law a subsidiary is a separate legal person and through this
mechanism their identity is known.
7. For facilitating the task of an inspector appointed under section 235 or 237
to investigate the affairs of the company. (sec.239)-
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According to this section, if it is necessary for the satisfactory completion of
the task of an inspector appointed to investigate the affairs of the company
for alleged mismanagement or oppressive policy towards its members, he
may investigate into the affairs of another related company in the same
management or group.
8. For investigation of ownership of company (Sec. 247) –
As per section 247, the central Government may appoint one or more
inspectors to investigate and report on the membership of any company for
the purpose of determining the true persons who are financially interested in
the company and who control its policy or materially influence it.
9. Fraudulent Conduct (Sec. 542) :- Where in the case of winding- up of a
company it appears that any business of the company has been carried on
with intent to defraud creditors of the company or any other person, or for
any fraudulent purpose, those who are knowingly parties to such conduct of
business may, if the count thinks it proper, so to do, be made personally
liable without any limitation as to liability for all or any debts or other
liabilities of the company. Liability under this section may be imposed only
if its is proved that the business of the company has been carried on with a
view to defraud the creditors-Re, Augustus Bannett & sons Ltd. (1986) B
CLC 170 Ch.D.
10. Liability for ultra-vires Acts :- Directors and other officers of a company
will be personality liable for al those acts which they have done on behalf of
a company if the same are ultra-vires the company.
11. Liability under other statutes :- The Directors and other officers of the
company may be held personally liable under the provision of other statutes
eg. under the income Tax Act, where any private company is wound up and
if tax arrears of the company in respect of any income of any previous year
cannot be recovered, every person who was director of the company at any
time during the relevant previous year shall be jointly and severally liable
for payment of tax. In a similar manner, under Foreign Exchange
Management Act, 1999, the directors and other officer may be proceeded
individually or jointly for violations of the Act.
II- Under Judicial Interpretations: - There may be various circumstances under
which the court may feel compelled to lift the corporate veil in its judicial
pronouncements. Following are some of the indicative cases to get an idea as to the
kind of circumstances under which the facade of corporate personality will be
removed or the persons behind the corporate entity identified and penalised, if
necessary.
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1. Protection of revenue :- In sir Dinshaw Maneckjee Petit, Re AIR 1927
Bom. 371, the assessee was a millionaire earning huge income by way of
dividend and interest. He formed four private companies and transferred his
investments to each of these companies in exchange of their shares. The
dividends and interest income received by the company was handed back to
Sir Dinshaw as a pretended loan. It was held that the company was formed
by the assessee only as a means of avoiding tax and company was nothing
more than assesses himself.
2. Prevention of fraud or improper conduct :- Where the medium of a company
has been used for committing fraud or improper conduct, the courts have
lifted the veil and looked at the realities of the situation. A very important
case on the point is Gilford Motor company V. Horne (1933) 1 CH935. In
this case ‘Horne’ had been employed by the company under an agreement
that he shall not solicit the customers of the company or compete with it for
a certain period of time after leaving its employment. After ceasing to be
employed by the plaintiff, Horne formed a company which carried on a
competing business and allotted whole of its shares to his wife and an
employee of the company, who were appointed to be its directors. It was
held that since the defendant (Horne) in fact controlled the company, its
formation was a mere ‘cloak or sham’ to enable him to break his agreement
with the plaintiff. Accordingly, an injunction was issued against him and
against the company he had formed restraining them from soliciting the
plaintiff’s customers.
3. Determination of the enemy character of a company – Since the company is
an artificial person, it cannot be an enemy or a friend. However , during war,
it may because necessary to lift the corporate veil and see the persons behind
as to whether they –our enemies or friends. It is because, through company
enjoys a district legal entity, it affairs are essentially run by individuals. In
Daimler company Ltd. V. Continental Tyre and Rubber Co, (Great Britain)
Ltd. (1916) 2 AC 307, a Company was incorporated in London for the
purpose of selling tyres manufactured in Germany by a Herman Company.
Its majority shareholder and all the directors were Germans. On declaration
of was between England and Germany in 1914, it was held that since both
the decision making belies, the Board of Directors and the general body of
shareholders were controlled by Germans, the company was a German
company and hence, an enemy company. Accordingly, the suit fled by the
company to recover a trade debt was dismissed on the ground that such
payment would amount to traveling with enemy.
4. In case of economic offences – In case of economic offences a curt is
entitled to lift the veil of corporate empty and pay regard to the economic
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realities behind the legal façade Santanu Ray V. Union of Indian (1989) 65
Comp. CFas. 196 (Delhi).
5. Where company is used to avoid welfare legislation – Where the sole
purpose for the formation of the new company was to use it as a device to
reduce the amount to be paid by way of bonus to workmen, the supreme
count oplled the piercing of the veil) to look at the real transaction –
workmen of Associated Rubber industry Ltd. V. Associated Rubber Industry
Ltd. (1986) 59 Lone) G.S. 134.
6. To punish for contempt of court. – The case on the point is Jyoti Limited V.
Kanwaljit Kavr Bhasin (1987) 62 Comp. Cas-626 (Delhi) – A firm of two
partners agreed to sell two floors to parties but cancelled the agreement.
Litigation followed and the High Court restrained the firm from selling the
property. In the meantime, a private company was floated by the two
partners who being the only two shareholders became the chairman and the
Managing Director respectively and the property was transferred to the
Company. Inspite of the High Court’s restraint order the company sold off
the two floors. In answering to the contempt proceedings, the partners of the
firm took the plea that the sale had been made by the company and therefore
the firm had not disobeyed the Court’s order.
It was hold that – after lilting the corporate veil it has become clear that the
orders of the Court were disobeyed by the respondents. The company was
promoted by the respondents alone. They only were its shareholder and directors.
The entire interest in the company was of the respondent. Thus in reality the order
of the court was disobeyed by the respondent.
2.6. Advantages and disadvantages of incorporation
Advantages – An incorporated company has the following advantages when
compare to other types of associations.
1. Independent Legal Entity :- Being independent legal entity district from its
members the company remains free from the hazards of all personal
misfortunes of its members.
2. Limited Liability :- A company can be formed with the liability of its
members limited either to the paid part the share capital held by him (case
liability is limited by share) or to the amount guaranteed by him (in case
liability is limited by guarantee).
3. Perpetual Succession :- Section 34(2) declares that an incorporated company
has perpetual succession meaning thereby that motivate intending any
change in its members, the company will be the same entity with the same
privileges and immunities, estate and possessions. It can continue to exist
indefinitely till it is wound up in accordance with the provision of the
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companies Act, This is a district advantage over a partnership whore the
death, insolvency, insanity or separation of members/partners may result in
the dissolution of the firm.
4. Transferability of Shares :- According to section-82 of the companies Act
the shares, debentures or other interests of any member in a company shall
be movable property, transferable in the manner provided by the articles if
the company.
5. Infinite membership – One improvident advantage of incorporation is that
there is no limit to the maximum number of members in a public company.
Thus any number of person may join hands by purchasing shares. As a
consequence of this special feature large amount of capital can be collected
by a joint stock company enabling it to undertake business on a large scale.
6. Separate property :- The property of the company is not the property of the
shareholder, it is the property of the company Gramophone & Typewriter
Co. V. Stanley (1906) K.B. 856.
Thus no member or director can use the properties of the company to his
own personal advantage. Even a member holding majority shares or a
managing director of a company is held liable for criminal misappropriation
of the funds or property of the company, if he unauthorized takes it away
and uses it his personal purposes.
7. Base in Control and Management :- The company law provides for the
management of joint stock companies through elected representatives of the
members know was directors and therefore every shareholder has not to
worry about the management of the company. This is not so in the case of
partnership. Also, only majority voting power is needed to control a
company and not by consent of all members as in partnership.
Disadvantages :-
As against the advantage of incorporation discussed above, there are few
disadvantages also. Some very obvious disadvantages are:-
1. Formality and Expense :- An incorporated company involves a number of
formalities and expense throughout life. The affairs of company have to be
conducted strictly in accordance with the applicable legal provision, non-
compliance of which entails penal conferences. A number of documents are
to be filed with the Registrar of companies of the state in which the
registered office is to be situated and necessary stamp duty, registration fees
and filing fees are to be paid at the time of incorporation of a company,
various sections and documents are required to be filed with the Registrar of
companies certain books and registers are compulsorily required to be
maintained. Approvals and section of the company law board, the central
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Government, the count, the Registrar of companies or other appropriate
authority are required to be obtained for certain corporate activities.
Meetings of the directors or shareholders are to be held and conducted in
accordance with the provision of the Act.
Other forms of business organizations are comparatively free from these
legal compulsions and formalities.
2. Loss of privacy :- Another disadvantage of corporation is loss of privacy. A
public company will have to publish its constitution, directorates, capital
structure, charges on its assets, proceedings of general meetings and final
accounts etc., by filling prescribed documents with the Registrar of the
companies. The office of the Registries of companies is a public office. Any
member of the public can, on payment of prescribed fees, inspect any of the
documents filed by a public company with the Registrar y companies. Even
in the case of private companies the same exposure is there though some
what restricted.
3. Divorce of control from ownership : - Members of a company cannot have
as effective and ultimate control over its working as in partnership or
proprietary business. This is particularly so where the membership of the
company is too large. The company functions through the representatives of
the shareholders – the directors. Members, therefore, do not have any active
and complete control over the company’s working, as the partners may have
over the firms affairs or a sole protractor may have in his business.
4. Greater public accountability :- Any company and particularly a public
company has much greater public accountability in as much as, it con not act
against public interest. As and when public interest will come in conflict
with the corporate working, intervention by signatory authorities will come.
5. Possibility of frauds :- Since the control of economic resources is in few
hands, it is possible for those few to defraud other people who have
contributed funds to the company either as shareholder or debenture holder
or creditor or lender by diverting funds of the company to their private
channels. By the time the regulatory authorizes or other common stock
holders come to realize the matter, the damage is already clone and clever
manipulation offer makes it difficult to responsibilities and bring to book the
wrong doers.
2.7 Summary
'Company' in simple terms means a voluntary association of persons who
have come together for carrying on same business and sharing the profits there
from. Section (1) (i) and (ii) of the Companies Act defines a company as a
company formed and registered under those Act or an existing company.
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From the definitions givens by Lord Justice Lindley, Chief Justice Marshall, Prof.
Haney etc we can gather that the characteristics features of a company are
incorporated association, distinct legal entity, artificial personality, limited liability,
perpetual succession, common seal free transfer of shares.
The 'corporate veil' of the company may be lifted in certain cases to identify the
persons who are guilty of any fraud or improper conduct. There are certain
circumstances provided by the statue itself and certain circumstances provided
through judicial pronouncements under which the 'corporate veil' may be lifted viz.
reduction of membership below statutory minimum, misrepresentation in
Prospectus, failure to return application money, failure to deliver share certificate
etc. Within stipulate time period, mis-description of name, for investigation of
ownership of company, fraudulent Conduct, liability for ultra-vires Acts, protection
of revenue, prevention of fraud or improper conduct, determination of the enemy
character of a company, to punish for contempt of court, etc. The company from of
organisation offers certain distinct advantages over other association of persons.
These include: Independent legal entity, limited liability of members, perpetual
succession, transferability of shares, infinite membership, separate property, ease in
control and management.
Company form of organisation is however, not an unmixed blessing Disadvantages
of incorporation include: Formalities and expense, loss of privacy, divorce between
ownership and control, greater tax burden and detailed winding –up procedure.
A 'company' should however, be distinguished from a 'body corporate'. The
expression 'body corporate' is a wider expression than 'company'. 'Body corporate'
includes, besides a 'company', a company incorporated outside India, public
financial institutions, nationalized banks and any other association of persons
declared as a body corporate by the Central Government.
2.8 Check Your Progress
1. Discuss the notion of corporate personality in the light of the decision given in
Solomon v. Solomon & Co. Ltd.
2. Elaborate the doctrine of lifting the corporate veil. How far does it ensure
protection to third parties.
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UNIT – 3 KIND OF COMPANIES
Structure
3.0 Introduction
3.1 Objectives
3.2 Classification of Different Types of Companies
3.3 Kind of Companies According to Mode of Incorporation
3.3.1 Statutory Company
3.3.2 Incorporated Company or Registered Companies
3.4 Kinds of Registered Companies on the basis of Member's Liability
3.4.1 Companies Limited by Shares
3.4.2 Companies Limited by Guarantee
3.5 Kind of Registered Companies on the Basis of Number of Members
3.5.1 Private Company
3.5.2 Public Company
3.5.3 Exemptions and Privileges of a Private Company
3.5.4 Conversion of Private Company into Public Company
3.5.5 Conversion of Public Company into Private Company
3.6 Other Kinds of Companies
3.6.1 Licenced Companies or Companies not for profit
3.6.2 Foreign Companies
3.6.3 Government Companies
3.6.4 Holding and Subsidiary Companies
3.6.5 Investment Companies
3.6.6 Public Financial Institutions
3.6.7 Producer Companies
3.6.8 One Man Company
3.6.9 Unregistered Company
3.7 Summary
3.8 Test Your Knowledge
3.0 Introduction
After learning the concept of corporate personality, its main characteristics and its
advantages and disadvantages in Unit 2, we shall have a glimpse of the various
kinds of companies which can be incorporated under the Companies Act and
otherwise.
In this unit our emphasis will be on understanding the classification of different
kinds of companies and their characteristic features. We will make a detailed
analysis of the characteristics of private companies, public companies, their
conversion, exemptions granted to them and various new form of companies which
have emerged as the companies took up diverse functions viz. investment
companies, public financial institutions, producer companies etc.
3.1 Objectives
The main aim of this unit is to study the classification of the companies and the
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basis of such classification. After completing this unit you will be able to:
Learn the classification of companies.
Learn the characteristic features of different type of companies.
Understand the concept of Foreign companies, Government companies,
Investment companies, Public Financial Institutions, Producer companies
etc.
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Bank of India (SBI), Life Insurance Corporation (LIC), Food Corporation of India
(FCI), Unit Trust of India (UTI) etc. are same examples of statutory companies.
Statutory companies are not required to have a memorandum of association as the
powers which are to be exercised by such companies are defined by the Acts
constituting them. The audit of such companies is conducted under the supervision
and control of the auditor General of India. Although each standing companies is
governed by the provisions of its special Act, the provisions of the Companies Act,
1956 also apply to them, in so far as the said provisions are not inconsistent with
the previsions of the special acts under which these companies are farmed.
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3.4.1 Companies Limited by Guarantee
Section 12(2)(b) of the Companies Act defines company limited by guarantee as "a
company having the liability of its member limited by the memorandum to such
amount as the members may respectively thereby undertake to contribute to the
assets of the company in the event of its being wound up". The amount guaranteed
by each member cannot be demanded upto the company is wound up, hence it is in
the nature of 'reserve capital'.
Such companies may or may not have share capital. Generally they are formed
without the share capital for non-trading purposes e.g. for the promotion of
commerce, art, science, culture, sports, etc.
The chambers of commerce, trade, associations and sports, clubs are usually
guarantee companies because neither they require huge capital nor aim at making
profit. The articles of association of such a company must state the number of
member with which the company is to be registered.
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Under Section 32, a company registered as an unlimited company may
subsequently convert itself into a limited liability company, subject to the provision
that any debt, liabilities, applications or coulter its in regard to entered into, by or
on behalf of the unlimited liability company before such conversion are not
affected by such conversion.
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at least three directors in case of a public company.
4. A private company is not required to prepare and file 'prospectus' or
'statement in lieu of prospects' with the registrar. [Sec. 70(3)].
5. A private company can proceed to allot shares without waiting to receive
'minimum subscription' [Sec. 69].
6. A private company is exempted from the requirements of hading
statutory meeting and filing statutory report, whereas a public company
must hold such meeting after one month and before six months from the
date of obtaining the 'certificate to commerce business' in order to
acquaint the shareholders about the details of the company's working till
that day [Sec. 165].
7. A private company enjoys considerable freedom with regard to its
directors, managing director or manger.
8. That restrictions on inter corporate loans and investments that are
applicable on public companies do not apply to a private company. [Sec.
372 A].
9. A private company is free to make its own regulations by its articles in
respect of general meetings, manner of taking vote etc. [Sec. 170].
10. Quorum required for general meeting of shareholder in case of a private
company is two person personally present, unless provided otherwise in
the articles whereas in the case of a public company, it is five persons
personally present.[Sec. 174 (1)].
11. A private company in not required to keep an index of its members. [Sec.
151].
12. A private company can be registered with a paid up capital of Rs. 1 lakhs
whereas a public company is required to have minimum paid capital of
Rs. 5 lakhs.
13. No restrictions apply to the directors of a private company in respect of
the number of company he can be appointed as director, whereas a
director of a public can be director of not more than 15 public
companies.
14. Directors of private company are not required to hold any qualification
shares.
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Deliberate Conversion or Conversion by Choice – A private company may be
converted into a public company by following these steps:
Special resolution - A private company desiring to become a public company
must pass a special resolution deleting from its articles the four compulsory
restrictions given by section 3(1)(iii) as to membership, transfer of shares, public
subscription and acceptance of public deposits. Also within 30 days of passing of
special resolution, a copy of the special resolution so passed alongwith a copy of
the altered articles and a copy of the 'prospectus' or a 'statement in lieu of
prospectus' must be filed with the registrar.
For becoming a public company, the company will have to increase the number of
its members to at least seven and that of its directors to at least three, if already
their numbers was fewer than the aforesaid statutory minimum required in that
connection for a public company. Further, the company will also have to enhance
its paid up capital to at least Rs. 5 lakhs, if its existing paid up capital was less than
the above stated statutory minimum required for a public company. Upon becoming
a public company, the word 'private' will be deleted from the name of the company.
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Any association formed for promoting commerce, art, science, charity, religious or
any other useful object and which close not intend to apply its profits, if any, for
payment of any dividend to its members but instead to apply its income in
promoting its objects can obtain a licence from the Central Government and can get
itself registered as a company with limited liability. Such companies are allowed to
exclude the world 'limited' or 'private' form their names. They are registered
without paying any stamp duty on their memorandum and articles of association.
Such companies may be public or private companies and may or may not have
share capital. In case they have a share capital, they are exempted from complying
with the requirement of minimum paid up capital of Rs. 1 lakh for a private
company or Rs. 5 lakh for a public company.
It may also be noted that a partnership firm may become a members of such a
company. However on dissolution of the firm, its membership will come to an end.
[Sec. 25 (4)].
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(ii) holding meeting of shareholders or directors.
(iii) effecting sales through independent contractors
(iv) maintaining bank accounts
(v) creating or financing of debts, charges etc. on real or personal property.
(vi) soliciting or procuring order where such orders require acceptance of the
company for becoming binding contracts.
(vii) securing or collecting debts or enforcing claims to property of any kind.
(viii) conducting any isolated transactions.
Provisions Relating to Foreign Companies - As per section 592, a foreign
company has to furnish the following documents to the registers within 30 days of
the establishment of the business in India :
(i) a certified copy of the charter, statute, memorandum and articles of the
company containing the constitution of the company. If the instrument is
not in English language, a certified translation thereof.
(ii) The full address of registered or principal office of the company.
(iii) A list of directors and secretary of the company giving name in full,
usual residential address, nationality of origin, his business and
particulars of other directorship held by him.
(iv) The names(s) and address(es) of any person or persons resident in India,
authorized to accept service of legal process and notice on behalf of the
company.
(v) The full address of the company in India which is to be deemed to be
principal place business in India.
When any change occurs in the above particulars, the registrar must be notified
accordingly within the prescribed time. [Sec. 593].
The aforesaid documents shall be required to be field at two places, first, with the
registrar of the state where the principal place of business is situated and second
with the registrar at New Delhi. [Sec. 597].
Other Obligations [Sec. 595]- A foreign company is further bound by the
following objections :-
1. The company shall state the country of incorporation in every prospectus
inviting subscription, for its shares and debentures, in India.
2. It shall conspicuously exhibit on the outside of every office or place of
business, its name and the country of incorporation in English and
regional language;
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3. It shall give the name of the company and of the country of incorporation
in English language in all business letters, bill heads and letter papers and
in all notice and other official publications of the company;
4. It shall state in every prospectus and in all official publications and
exhibit outside every office or place of business, whether the liability of
member is limited.
5. Obligation regarding accounts [Sec. 594]- Every foreign company,
unless exempted by the Central Government is required to file with the
register every year three copies of its Balance Sheet and Profit and Loss
Account and other documents required under the Act. Alongwith these
documents three copies of list in the prescribed form of all the places of
its business in India, shall be sent to Registrar.
6. Obligation regarding Registration of Charges etc [Sec. 600]- The
provisions of the section 124 to 145 relating to registration of charges,
appointment of receivers etc. will apply to foreign companies, with
necessary changes. The provisions of sec. 188 relating to the rights of
members and debentures holders to have a copy of the 'trust deed' for
securing any issue of debentures of the company will also apply to
foreign companies. Further, section 209 shall also be applicable to
foreign companies to the extent of requiring them to keep at the principal
place of business in India, the book of account with respect to monies
received and expended, sales and purchases made, and assets and
liabilities in relation to their business in India.
The Companies (Amendment) Act, 1974 has also made certain other
section of the Act applicable to foreign companies. There are :
i. The provisionary section 159 relating to the filing of Annual Return
with the Registrar shall, subject to such modifications or adoptions
as may be made therein by the rules made under this Act, apply to a
foreign company.
ii. The provisions of section 209 A (inspection of books of the account,
etc), section 233 A (power of Central Government to direct special
audit in certain cases), section 233 B (audit of cost accounts in
certain cases) and sections 234 to 246 (Powers of registrar to call for
information or explanation and investigation of affairs of company
by Central Government) shall, so far as maybe, apply only to the
Indian business of a foreign company, as they apply to a company
incorporated in India.
7. Requirements as to Prospects [Sec. 603 to 608]- A foreign company
may issue a prospects offering shares or debentures for subscription even
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of its has no place of business in India. But, the prospects shall have to
comply with the provisions of section 603 to 608 of the act relating to
prospects. The prosecution of the foreign company has to contain
particulars with respect to the following matters also :-
a. the instrument containing or defining the constitution of the
company;
b. The provisions of law under which the company was incorporated.
c. An address in India where the above instrument and the enactments
or provisions of law may be inspected. If they are not in the English
language, the certified English copy should be made available.
d. The date and country of incorporation;
e. Whether the company has an established place of business in India
and if so, the address of its principal office in India.
8. Obligations regarding foreign companies in which not less than 50% of
the paid – up share capital is in Indian hands – According to section
591 (2), where not less than 50% of the paid up share capital (equity or
preference) of a company incorporated outside India, is held by one or
more citizens of India or by companies incorporated in India, such other
provisions of the Act as may be notified by the Central Government with
regard to business carried on by them in India, will become applicable to
such foreign companies as they apply to a company incorporated in
India.
9. Penalty [Sec. 598]- It any foreign company fails to comply with the
provisions applicable to it, the company and every officers or agent of
the company who is in default shall be punishable with fine upto Rs.
10,000 and in the cost of a continuing offence, with an additional fine
upto 1,000 for every day during which the default countries.
Further, a foreign company which has failed to comply with the
requirements applicable to it under the Companies Act, 1956 will be
liable to be sued in respect of any contract, dealing or transaction it may
have entered into; but shall not be entitled to enforce any contract by way
of suit, set off or counterclaim. It cannot also institute any legal
proceeding in respect of any such contract until it has complied with all
the provisions of the Act relating to foreign companies.
10. Winding up – Where a foreign company, which has been carrying on
business in India, ceases to carry on such business in India, it may be
wound up as an unregistered company under Part X (Section 582 to 590)
of the Companies Act.
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A foreign company's business in India can be wound up even in cases
where the company has been dissolved or otherwise ceased to exist under
the laws of the country under which it was incorporated [Sec. 584].
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under particular statutes."
A Government company is not a department of the government. In Andhra Pradesh
State Road Transport Corporation vs. ITO, AIR 1964 SC 1486, the Andhra Pradesh
Road Transportation Corporation claimed exemption form taxation by invoking
Article 289 of the Constitution of India accruing to which the property and income
of the State exempted from the Union of taxation. The SC rejected the corporation's
claim and held that trough it was wholly controlled by the State Government, it
held a separate equity and its income was not the income of the State Government.
To the same effect is the decision in Electronic Corporation of India Ltd. v. Secy.
Revenue Deptt., Govt. of A.P. [1999] 97 Comp. Cas. 470.
However, the Supreme Court in Ajay Hasia v. Khalid Muzib, AIR 1981 SC 496
held that a Government company state is for the purposes of Article 12 of the
Constitution of India.
The Companies Act is silent on the question whether a Government company
incorporated under the Act be private company or public company. As a result, a
Government Company may be incorporated either way.
Co.A.
Co. C is subsidiary of
Co. A also Co.C Subsidiary of Co. B
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unless:-
(i) it has been established or constituted by or under Central Act, or
(ii) Not less than 51% of the paid-up share capital of such an institution is
held or controlled by the Central Government.
The Central Government has inter alia, specified the following institutions to be
pubic financial institutions, namely
(1) The Industrial Investment Bank of India (Formerly, IRBI).
(2) The General Insurance Corporation of India (GIC)
(3) The National Insurance Company Limited.
(4) The New India Assurance Company Limited
(5) The Oriental Fire & General Insurance Company Limited
(6) The United Fire & General Insurance Company Limited
(7) The Shipping and Credit & Investment Company Limited (SCICI).
(8) Tourism Finance Corporation of India Ltd. (TFCI).
(9) Risk Capital & Technology Finance Corporation Ltd.
(10) Technology Development & Information Company India Ltd.
(11) Power Finance Corporation Limited.
(12) National Housing Bank (NHB)
(13) Small Industries Development Bank of India (SIDBI)
(14) Rural Electrification Corporation Limited.
(15) Indian Railway Finance Corporation Limited
(16) Industrial Finance Corporation of India Limited
(17) Andhra Pradesh State Finance Corporation
(18) Assam Finance Corporation
(19) Bihar State Financial Corporation
(20) Delhi Financial Corporation
(21) Gujarat State Financial Corporation
(22) Haryana Financial Corporation
(23) Himachal Pradesh Financial Corporation
(24) Jammu & Kashmir State Financial Corporation
(25) Karnataka State Financial Corporation
(26) Kerala Financial Corporation
(27) Madhya Pradesh Financial Corporation
(28) Maharashtra State Financial Corporation
(29) Orissa State Financial Corporation
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(30) Punjab Financial Corporation
(31) Rajasthan Financial Corporation
(32) Tamilnadu Industrial Development Corporation Limited.
(33) Uttar Pradesh Financial Corporation
(34) West Bengal Financial Corporation [Notification No. S.O. 247 (E), dated
28.03.1995].
(35) North Eastern Development Finance Corporation Limited (Notification
dated 23.07.1996).
(36) Indian Renewable Energy Development Agency Ltd.
(37) Housing and Urban Development Corpn. Ltd.
(38) Export –Import Bank of India
(39) National Bank for Agriculture and Rural Development (NABARD).
(40) National Co-operative Department Corporation (NCDC) added by
Notification No. 581E, dated 09.05.2003
(41) National Dairy Development Board
(42) The Pradeshiya Industrial and Investment Corporation of UP Ltd.
(43) Rajasthan State Industrial Development and Investment Corporation Ltd.
(44) State Industrial Development Corporation of Maharashtra Ltd.
(45) West Bengal Industrial Development Corporation Ltd.
(46) Tamil Nadu Industrial Development Corporation Ltd.
(47) The Punjab State Industrial Development Corporation Ltd. (Notification No.
S.O. 1531 (E) dated 25.10.2006].
(48) EDC Ltd. [Notification dated 09.01.2007]
(49) Tamil Nadu Power Finance and Infrastructure Development Corporation
Ltd.[Notification No. S.O. 20 (E) dated 09.01.2007].
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Act in an Act within an Act and most of the distinctive features of the companies
Act, 1956 are there. It can further be noted that this Amendment Act has principal
focus of multi-State co-operative societies.
3.7 Summary
The Companies Act provides for a variety of companies that may be promoted and
registered under the Act. However, two basis types of companies which may be
registered under the Act are 'private' and 'public' companies. These may further be
incorporated as limited liability companies or as unlimited liability companies.
A private company [as per Companies (Amendment) Act, 2000] means a company
which has a minimum paid-up capital of Rs. 1 lakh or such higher paid-up capital
as may be prescribed and which by its articles :
(i) restricts the right to transfer its shares, if any
(ii) prohibits invitations to the public to subscribe for any shares in, or
debentures of the company
(iii) limits the total number of members to 50
(iv) prohibits any invitation or acceptance of deposits form person other than
its members, director or their relatives.
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A pubic company [as per Companies (Amendment) Act, 2000] means a company
which :
(a) is not a private company
(b) has a minimum paid – up capital or Rs. 5 lakh or such higher paid – up
capital, as may be prescribed;
(c) is a private company which is a subsidiary of a company which is not a
private company.
A company registered under section 25, before or after the commencement of the
Companies (Amendment) Act, 2000 shall not be required to fulfill the requirement
'minimum paid –up capital' with respect to private or pubic company, as aforesaid.
A private company enjoys certain privileges and exemptions from the provisions of
the Companies Act, for instance, it can be formed with just 2 members; it can
commerce business on receipt of certificate of incorporation; it can issue any kind
of shares; it is not required to hold a statutory meeting or file a statutory reports; its
directors can be advanced loans with the Central Government's a approval and so
on.
A private company may become or convert itself into a public company. A private
company become a public company if it fails to observe any of the three restrictive
provisions of section 3(1)(iii). Likewise, under certain circumstance spelt out under
section 43A, a private company may be deemed to be a pubic company. A private
company may be converted into public company by passing special resolution and
meeting the minimum requirements of a public company like 7 members, 3
directors, etc. Similarly, a public company can also be converted into a private
company by passing a special resolution with the approval of the Central
Government.
A statutory company is a company created by a special Act of Parliament and is
accordingly governed by the statue creating it. However, the provisions of the
Companies Act, 1956 apply to them, insofar as the same are not inconsistent with
the special Acts under which these companies are formed.
Limited liability companies may limit the liability of their members by the amount
unpaid on the shares held by them or by the amount guaranteed or by both.
A company having no limit on the liability of its members is an unlimited
company.
Company form of organization is not merely relevant to economic organizations;
non – economic organization to promote art, commerce, science, culture, etc. may
also be incorporated and registered as companies and with liability of their
members limited. In fact, licence may be obtained from the Central Government
whereby the company may be freed from using he word 'limited' as part of its
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name. Even a partnership firm' can become a member of such a company,
commonly called 'Association not for profit'.
A Government company is one in which either the Central Government or the State
Government or both the Central and State Governments taken together hold not less
than 51% of its paid-up capital. The terms further includes a subsidiary of such a
Government company. A Government company may be incorporated as a private
Government company. A Government company may be incorporated as a private
company or a pubic company. A Government company is governed by the
provisions of the Companies Act unless exempted by the Central Government
under powers conferred under section 620. The Central Government has exempted
the Government companies from most of the provisions of the Companies Act.
A foreign company means a company incorporated outside India but having a place
of business in India. A foreign company is required to furnish to the Registrar
documents specified in the section 592. Besides, it is subjected to certain
obligation spelt out under section 594, 595, 600, 603-608. Where foreign
companies in which more than 50% of the paid-up share capital is in Indian hands,
section 591 (2) provides that it should be, for its ceases to carry on business in
India, may be wound up as n unregistered company. Even where foreign company
is a Government company, it may be wound up in India.
'Holding' and 'Subsidiary' companies are relative terms. A company shall be
holding company of another where (a) its controls the composition of its board of
directors; or (b) holds more than half in nominal value of its equity share capita; or
(c) its is subsidiary of its subsidiary.
Investment company' has been defined as a company whose principal business is
the acquisition of shares, stock, debentures or other securities.
Certain institutions have been specified as 'public financial institutions' under
section 4A. Central Government has been further empowered to notify nay other
institutional as a public financial institution provided it has been constituted under
any Central Act or not less than 51% of its paid-up share capital is held or
controlled by the Central Government. Fourteen such institutions have been
identified by the Central Government.
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(iii) Holding and Subsidiary Company (iv) Section 25 Companies
(v) Producer Companies
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Unit-4 : Formation and Incorporation of a Company
STRUCTURE
4.0 Introduction
4.1 Objectives
4.2 Promotion - What is?
4.3 Promoter
4.3.1 Legal Position
4.3.2 Liability
4.3.3 Remuneration
4.4 Pre-incorporation Contests
4.5 Incorporation or registration of a company
4.6 Certificate of incorporation.
4.7 Capital subscription or floatation
4.8 Commencement of business
4.9 Summary
4.10 Check your progress
4.0 Introduction
In this unit the emphasis will be on analysing the various stages in the
formation of a company, public or private, and also the legal position and liability
of a promoter to the company and to the third parties.
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third parties. How far company is responsible to such contracts as “two consenting
parties are necessary to a contract, whereas the company before its incorporation is
a non-entity (Kelner V. Baxter).” We will discuss the legal status of pre-
incorporation contracts prior to and after the enactment of specific relief Act, 1963.
4.1 Objectives
The basic purpose of this Unit is to make the students understand the
preliminary steps to be taken by anyone desirous of transforming his business idea
into a real enterprise. After going through this Unit, you will be able to :-
Promotion is a term of wide import denoting the preliminary steps taken for
the purpose of registration and floatation of the company. The whole process of
formation of a company is very lengthy and may be divided into four stages
namely:
1. Promotion
2. Incorporation
3. Capital Subscription or floatation
4. Commencement of business
Of these stages only the first two are necessary for the formation of a private
company, and of a public company not having any share capital. They may
commence business immediately after they have received a certificate of
incorporation. But a public company having a share capital has to go through all the
four states mentioned above before it can commence business.
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The “promotion” is the first stage in the formation of a company. It may be
defined as "the discovery of business opportunities and the subsequent organization
of funds, property and managerial ability into a business concern for the purpose of
making profits therefrom [C.W. Gerstenberg, Financial Organisation and
Management of Business].
4.3 Promoter
The expression “promoter” has not been defined under the companies Act,
although the term is used expressly in sections 62, 69, 76, 478 and 519. Even in
English law there is no general statutory definition of a “promoter”. Section
62(b)(a) gives a restrictive definition of promoter for a limited purpose only, as : a
promoter who was a party to the preparation of the prospectus or of a portion there
of containing the untrue statement, but does not include any person by reason of his
acting in a professional capacity in procuring the formation of the company.
Cockburn CJ., in Twycross V. Grant [1877]2 C.P.D. 469 C.A. described a promoter
as “One who undertakes to from a company with reference to a given project, and
to set it going, and who takes the necessary steps to accomplish that purpose”.
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In U.S.A. the Securities Exchange Commission Rule 405(a) defines a
promoter as a person who, acting alone or in conjunction with other persons
directly or indirectly takes the initiative in founding or organizing the business
enterprise.
However, section 626 of the companies Act makes it clear that person
assisting the promoter by acting in a professional capacity, eg. Counsels, solicitors,
accountants and other experts, do not thereby become promoters themselves. But
when, he goes further than this i.e., by introducing his clients to a person who may
be interested in purchasing shares in the proposed company, he would be regarded
as a promoter.
In India, the promoters are usually persons who, in forming the company,
secure for themselves the management of the company being formed or are persons
who convert their own private business into a limited company, public or private
and secure for themselves more or less a controlling interest into the company’s
management. [A. Ramaiya, Guide to the Companies Act, 12th Edn. P. 351).
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4.3.1 Legal Position
Lord Justice Lindley in Lidney Wigpool Iron Ore Co. V. Bird [1866] 33 Ch.
D. 85 thus describes the potions of a promoter -
“Although not an agent for the company, nor a trustee for it before its
formation, the old familiar principles of law of agency and of trusteeship have been
extended and very properly extended to meet such cases. It is perfectly well settled
that a promoter of a company is accountable to it for all monies secretly obtained
by him from it just as the relationship of principal and agent or the trustee and
cestui que trust had really existed between him and the company when the money
was obtained.
4.3.2 Liability
(1) Section 56 and Schedule II lays down matters to be stated and reports to be
set out in a prospectus. A promoter may be held liable for non-compliance of
the provisions as stated in the section and the schedule.
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(2) Section 62 and 63 provides for the liability of promoters for any untrue
statement in the prospectus to a person who subscribes for shares or
debentures on the faith of such prospectus. The liability of the promoter in
such a case shall be only towards original allottee of shares and would not
extend to the subsequent allottees. The remedies against the promoter may
include :-
(c) Prosecution that may led to imprisonment for a term upto two years or
fine upto Rs. 50,000, or both.
(3) Section 203 provides the power to the court to suspend a promoter from
taking part in the management of the company for a period of five years if:-
(i) he has been guilty of any offence for which he is punishable under
section 542, or
(ii) he while being an officer of the company has otherwise been guilty
of any fraud or misfeasance in relation to the company or of any breach
of his duty to the company.
(5) A company may also proceed against a promoter on action for deceit or
breach of duty under section 543, where the promoter has misapplied or
retained any property of the company or is guilty of misfeasance or breach
of trust in relation to the company.
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(6) Where these is more than one promoter, they are jointly and severally liable
and if one of the co-promoters is sued and damages are rewired from him, he
can claim contribution from the other co-promoters. In case of the death of a
promoter his estate remains liable, and upon the insolvency of a promoter
the company is entitled to prove its claim in the insolvency proceedings.
4.3.3 Remuneration
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, the power is generally exercised in their favour.
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4.4 Pre-incorporation Contracts
(1) Position before 1963 (i.e. before passing of Specific Relief Act,1963), and
(2) Position after 1963 (i.e. after passing of Specific Relief Act, 1963).
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Position since 1963 (i.e after passing of the specific relief Act, 1963). In
India, until the passing of the specific relief Act, 1963, the promoters found it very
difficult to carryout the work of incorporation. Since the contracts prior to
incorporation were void and also could not be ratified, people are not keen in
supplying any goods or services for the promotion of a company. Promoter also
does not want to take any personal responsibility. The Specific Relief Act, 1963 has
provided certain relief to the promoters. Section 15(h) of the Specific Relief Act,
1963 provides that where the promoters of a public company have made a contract
before its incorporation for the purpose of the company, and if the contact is
warranted by the terms of its incorporation, the company may enforce it.
“Warranted by the terms of incorporation” means that the contract is within the
scope of the company's objects as stated in the memorandum.
It is not only the company which is allowed, under the Specific Relief Act,
to adopt and enforce its pre-incorporation contracts against the third parties, section
19 of the Specific Relief Act also allows the other party to enforce the contract
against the company if -
(i) The company had adopted the same after incorporation, and
(ii) The contract is warranted by the terms of incorporation.
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1. Type of company to be formed :- The first thing to be decided by the
promoters is the type of the company to be floated. Companies Act provides
for registration of only two types of companies viz. public and private
companies.
The articles of association contains the rules and regulations relating to the
internal management of the company. Draft of memorandum and articles of
association should be prepared and typed, and the same shall be printed as
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required by section 15 after the vetting by the registrar/regional director.
Section 15 also requires that every memorandum should be signed by each
subscribes who should add his address, description and occupation, if any, in
the presence of at least one witness, who shall attest the signature and shall
also add his address, description and occupation. The subscribers to the
memorandum should also state clearly the number and nature of shares
subscribed by them. It is to be noted that the subscribers have to subscribe
the shares directly-accepting a transfer from any other subscriber etc., shall
not be valid.
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shares, if any, as provided by the articles is required to be submitted.
This document is, however, not to be filed in the case of :-
(a) A company without share capital
(b) A private company, and
(c) A company which was a private company prior to its becoming a
public company.
(ii) The particulars of director :- The particulars of the persons who are
named in the articles to act as director, manager, secretary etc. must be
filed in duplicate with the Registrar of the Companies.
Along with the above documents necessary filing fees and registration
fees at the prescribed rates are also to be paid. Schedule X, given at the
end of the companies Act, prescribe the rate of filing fees and
registration fees.
The Registrar, after scrutinizing these documents and finding them in order,
will register the company and issue a certificate of incorporation'. On obtaining this
certificate the company becomes a body corporate, with perpetual succession and a
common seal. [Sec. 34(2)].
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Conclusiveness the Certificate of Incorporation
According to section 35 of the Act, the certificate of incorporation give by
the Registrar shall be conclusive evidence that all the requirements of the Act have
been complied with and that the company has been duly registered. In other words,
once a certificate of incorporation has been granted no one can question the
regularity of incorporation. In the famous Peel’s case [(1867) 2Ch. APP. 674]. It
has been observed by Lord Cairns that - “if memorandum is found to be materially
altered after signature but before registration. When once the certificate of
incorporation is given nothing is to be inquired into as to the regularity of the prior
proceedings”. Also if the memorandum is signed by only one person for all the
seven subscribers or the signatories be all infants, the certificate would be
nevertheless conclusive and would not affect the status and existence of the
company as a legal person although such irregularities might give rise to claims
between the subscribers. The case under consideration is Moosa V. Ibrahim ILR
191340 Col. 1 (PC), - the memorandum of association of a company was signed by
two adults and by a guardian of other five members, who were minors. The
Registrar, however, issued the certificate of incorporation after registering the
company. The count held the certificate to be conclusive for all purposes. The
certificate prevents any one from alleging the company does not exist. To the same
effect is the decision in Jubilee Cotton Mills Ltd. V. Lewis [1924] A.C 1958, In this
case the registrar issued a certificate of incorporation on January 8, but dated it
January 6, which was the date of receipt of documents by him. On January 6, the
Company made an allotment of shares to Lewis. The court held that the certificate
was conclusive evidence of incorporation on January 6 and that the allotment was
not void on the ground that it was made before the company was incorporated.
However, if a company has been incorporated with illegal objects, the illegal
objects would not become legal by the issue of the certificate. If a company with
illegal objects happens to be registered, the effect will be that while the existence of
certificate precludes its corporate status from being questioned, the company is
forbidden to carry on any business in furtherance of its illegal objects. The legal
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personality of the company cannot be extinguished by cancellation of the certificate
of incorporation [Bowman. V. Secular Society Limited, (1917) A.C. 406]. The
remedy in such a case would be to 'wind up' the company.
According to section 70, every public company has to take either of the
following steps :-
(ii) deliver a statement in lieu of prospectus where the company has either
not issued a prospectus or though it has issued a prospectus it has not
proceeded to allot any of the shares offered to the public for
subscription.
Where prospectus has been issued inviting subscription to the shares, the
company cannot proceed to allot shares unless the amount stated in the prospectus
as minimum subscription has been subscribed and the money payable on
application in respect of such shares has been received by the company on the
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closure of the issue, in case the issue is not underwritten or within 60 days of
closing of the subscription list, where the issue is underwritten (SEBI guidelines,
2000). The minimum subscription as per schedule II and SEBI guidelines has to be
90% of the entire issue. In case the minimum subscription is not received, the
company has to refund forthwith the entire amount received with application. In
case the application money is not returned within next 8 days (within 10 days, as
per section 69), the company and the directors shall be liable to return the same
with interest at the rate of 15% per annum (at the rate of 6% as per section 69).
Note: SEBI guidelines with respect to public issues will be discussed in detail in a
subsequent chapter on Shares.
Section 149 (1) provides that a public company, having a share capital and
issuing a prospectus inviting the public to subscribe for its shares, will have to file
the following documents with the registrar to obtain the certificate of
commencement of business :-
(a) The declaration that shares payable in cash have been allotted upto the
amount of the minimum subscription as stated in the prospectus,
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(b) The declaration that every director has paid in cash the application and
allotment money on his shares in the same proportion as others.
(d) The statutory declaration in the prescribed form (Form No. 19) by one
of the directors or the secretary or, where the company has not
appointed a secretary, a secretary in whole time - time practice that
the above requirements as stated in classes (a), (b) and (c) mentioned
above, have been complied with..
(b) a declaration that every director has paid in cash the application and
allotment money on his shares in the same proportion as others;
(c) a statutory declaration in the prescribed form (Form No. 20) that clause
(b) as stated above, has been complied with and duly verified by one of
the directors or the secretary or, where the company has not appointed
a secretary, a secretary in the whole time public.
Penalty :-
4.9 Summary
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The Companies Act, 1956 contains no provisions regarding the duties of
promoters, it merely imposes liability on promoters for untrue statements in
prospectus, they are parties to, and for fraudulent trading. The Courts have,
however, charged them with two fiduciary duties, namely, (i) not to make any
secret profit out of promotion; and (ii) to disclose to the company any interest
which he has in a transaction entered into by it. The duties of a promoter do not
come to an end on the incorporation of the company, or even when Board of
Directors is appointed. They continue until the company has acquired the property
or business which it was formed to manage and has raised its initial share capital.
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. Alternatively, articles may authorise the directors to pay them.
After scrutinising the documents and on being satisfied that they are in
order, the R.O.C. issues the certificate of incorporation. The certificate of
incorporation is conclusive as to all the requirements of the Act with respect to
registration and matters precedent and incidental thereto having been duly complied
with.
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‘provisional contracts’. These contracts become binding, without any need for
ratification, on company becoming entitled to commence business.
On complying with the requirements of section 149, the R.O.C. grants the
company the certificate to commence business. Now, a public company can
commence its business.
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Block - II
Working of a Company
CONTENTS
Unit-7 : Prospectus
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UNIT 5 MEMORANDUM OF ASSOCIATION
Structure
5.0 Introduction
5.1 Objectives
5.2 Meaning and Importance of Memorandum
5.3 Content of Memorandum
5.4 Alternation of Memorandum
5.4.1 Alteration of Name Clause
5.4.2 Alternation of Registered Office Clause
5.4.3 Alternation of Object Clause
5.4.4 Alternation of Liability Clause
5.4.5 Alternation of Capital Clause
5.5 Doctrine of Ultra Vires
5.6 Consequences of Ultra Vires Transactions
5.7 Summary
5.8 Check Your Progress
5.0 Introduction
During the incorporation of a company one of the important document that is to be
filed with the registrar is the memorandum of association. This memorandum of
association is the constitution of the company. It contains various clauses viz. name
clause, registered office clause, object clause, liability clause and capital clause.
These clauses lay the foundation of the company formation. These clauses can also
be altered by following the prescribed procedure.
5.1 Objectives
The main objective of this unit is to enlighten the students with the importance of
memorandum of association and to study in detail the contents of the memorandum
and to understand the consequences in case on act is done outside the powers given
by the memorandum. After completing this unit you will be able to understand.
• The importance of memorandum of association in the functioning of a
company.
• The various clauses that a memorandum contains.
• The alterability of these closures.
• Doctrine of ultra-vires and it consequences.
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5.2 Meaning and Importance of Memorandum
The memorandum of association of a company is its principle document to be
prepared in order of formation of a company. The memorandum of association of a
company contains the fundamental conditions upon which alone the company has
been incorporated.
Section 2(28) of the Companies Act, 1956 defines memorandum as "Memorandum
means the memorandum of association of a company as originally framed or as
altered from time to time in pursuance of any previous company laws or of this
Act."
This definition, however, does not throw any light on the nature and importance of
this document.
Palmer, in his works, has opined that the memorandum of association is a
document of great importance in relation to the proposed company. it contains the
objects for which the company is formed and therefore identifies the possible scope
of its operations beyond which its actions cannot go. It defines as well as confines
the powers of the company. If anything is done beyond these powers, that will be
ultra vires (beyond powers of) the company and hence void. [Palmer's Company
Law, 20th Ed.; 1954]
Lord Cairns in the leading case Ashbury Railway Carriage Co. v. Riche, (1875),
L.R. 7 H.L. 653, observed that "The memorandum of association of a company is
its charter and defines the limitation of the power of company. It states
affirmatively the ambit and extent of vitality and power which by law are given to
the corporation and it states negatively, that nothing shall be done beyond its
ambit…"
Thus the memorandum serves two important functions. It enables shareholders,
creditors and all those who deal with the company to know what its powers are and
what is the range of its activities.
From the above discussion, the importance of the memorandum of association can
be clearly understood. The memorandum is the foundation on which the structure
of the company is based. The memorandum spells the name of the company, the
place of its registered office, the objects for which the company is incorporated, the
liability of the members of the company, and the capital with which the company is
going to start its venture. It also limits the capacity to contract of the company. A
company cannot undertake operations that are not mentioned in its memorandum.
Any act of the company that is outside the scope of activities that are made out in
the memorandum is said to be ultra-vires (beyond the power) and not binding on it.
The memorandum of association is the constitution of the company in its relation to
the outside world. It is a public document and persons dealing with the company
are presumed to have gone through its contents and shall be bound by its
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provisions. No company can temper with the contents of its memorandum of
association without the sanction of the Central Government or the court of law or
the Company Law Board.
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(ii) misleading, e.g. suggestion that the company connected with a
government department or any municipality or other local authority, or
that it is an associations of a particular type e.g. "co-operative society",
"Building society", etc. when this not the case.
In Ewing v. Buttercup Margarine Co. Ltd. [1917] 2 Ch. 1, the plaintiff who carried
on business under the name of Butter Cup Dairy Co. succeeded in obtaining an
injunction against the defendant on the ground that the public might think that the
two business were connected since the word 'Buttercup' was an unnecessary and
fancy one.
In Montari Overseas Ltd. v. Montari Industries Ltd. [1996] 20 CLA 313 (Delhi) it
was held that the name adopted was sufficiently close to the name under which the
respondent was trading, acquired a reputation and the public at large was likely to
be misled. The same principle of law which applied to an action for passing off of a
trademark would apply more strongly to the passing off a trade or corporate name
of one for the other. The appellant was liable for an action in passing off.
Merely that few words are common may not render the name too identical and thus
undesirable. In Society of Motor Manufactures & Traders Limited vs. Motor
Manufactures & Traders Mutual Assurance Limited [1925] 1 Ch. 675. the plaintiff
company brought an action to restrain the defendant company from using the said
name. But, Lawrence, J. held "anyone who took the trouble to think about the
matter, would see that the defendant company was an Insurance company and that
the plaintiff society was a trade protection society and I do not think that the
defendant company is liable to have its business stopped unless it changes its name
simply because a thoughtless person might unwarrantedly jump to the conclusion
that it is connected with the plaintiff society."
Executive Board of Methodist Church in India v. Union of India, [1985] 57 Comp.
Cas. 443 (Bom.), the Methodist Church in India sought registration of a company in
the name of 'Methodist Church in India Trust Association'. There was already
existing a company bearing the name Methodist Church in Northern India Trust
Association (P) Ltd. in Calcutta. The former secretary of the latter association
informed the Registrar that the said company had not functioned since 1970; that
no annual report or minutes has been filed with the Registrar since 1970; and that
some directors died and some had left. The question was whether in these
circumstances the Calcutta Company was a bar to the registration of the new
company.
If a company is practically defunct, it is not a bar to registration of a new company
with a similar name.
Guidelines / Principles for deciding availability of names : According to the
clarification issued by the Department of Company Affairs, a name is considered
undesirable and a company is not allowed to be registered with such name :
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(a) if the name is identical with or too nearly resembles the name by the which
a company is already registered. Names under which well-known firms and
other bodies are doing business are also considered undesirable for a new
company;
(b) if the proposed name is identical with or too nearly resembles the name of a
company in liquidation. It is because the name of the company in
liquidation is borne on the register till it is finally dissolved. A name which
is identical with or too closely resembles the name of a company dissolved
as a result of liquidation proceedings cannot also be allowed for a period of
two years from the date of such dissolution since the dissolution of the
company could be declared void within the period aforesaid by an order of
the Court under section 559 of the Act;
(c) if the proposed name differs from the name of an existing company merely
in the addition or subtraction of word like New, Modern etc. Thus names
such as New Bata Shoe Company, Nav Bharat Electronic etc. should not be
allowed:
(d) if the proposed name closely resembles a popular or abbreviated description
or names of important companies, for example, TISCO or ICI, WIMCO,
etc. Such words should not be allowed even though they have not been
registered as trade marks;
(e) it attracts the provisions of Emblem and Names (Prevention of Improper
Use) Act, 1950;
(f) if it connotes Government participation or patronage unless circumstances
justify (for example, National, Union, Central, President, Rashtrapati, etc.)
(g) if it implies association or connection with, or patronage of a national hero
or any person held in high esteem;
(h) if it includes the word Co-operative (or Sahkari or the equivalent word 'Co-
operative' in regional languages of the country);
(i) if it includes the word like 'bank', 'banking' 'insurance', 'investment', 'trust'
unless the circumstances of a particular case justify the inclusion of such a
word;
(j) if it includes a proper noun which is not a name or a surname of a director.
However, for sentimental reasons, sometimes the names of relatives such as
wife, son and daughter of the director may be allowed, provided one other
word suggested makes the name quite distinguishable;
(k) if it includes the name of a registered trade mark unless the consent of the
owner of the trade marks has been produced by the promoters;
(l) if it is intended or is likely to produce a misleading impression regarding
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the scope of its activities which would be beyond the resources at its
disposal, e.g., Universal Engineering Company Pvt. Ltd. operating only as a
small scale unit with limited range of product and financial resources;
(m) if the name suggests a business which is not proposed to be undertaken by
the company;
(n) if the proposed name is exact Hindi translation of the name of an existing
company.
There are further instructions to the effect that if a name falls within the categories
mentioned below it will not generally by made available. Thus –
(i) if it is not in consonance with the proper objects of the company as set
out in its memorandum of association;
(ii) if it includes any word or words which are offensive to any section of the
public;
(iii) if the name is only a general one, like Cotton Textile Mills Limited;
(iv) if the proposed name has a close phonetic resemblance to the name of a
company in existence, for example, J.K. Industries Limited and Jay Kay
Industries Limited;
(v) if it is different from the name / names of the existing company /
companies only to the extent of having the name of place within brackets
before the word 'limited' for example, Indian Press (Delhi) Limited
should not be allowed in view of the existence of the company named
Indian Press Limited.
Once the name is chosen and the company is registered in that name, section 147
mandates that the name along with the address of the registered office, must appear
on the outside of every office or place of business of the company in a conspicuous,
position, in letters easily legible and in the language in general use in the locality.
Also, the company should get its name engraven in legible characters on its seal
and have its seal and have its name and address of its registered office mentioned in
legible characters in all business letters, bill heads, negotiable instruments,
invoices, receipts, etc. of the company.
Penalty – If a company does not affix its name and address of its registered office
in the prescribed manner, the company and every officer of the company who is in
default shall be punishable with fine upto Rs. 500 per day till the default continues.
Section 147 (4) marks an officer of a company or any person on its behalf who
signs or authorises to be signed on behalf of the company any bill of exchange,
hundi, promissory note or cheque etc. wherein the name of the company is not
mentioned in the prescribed manner, personally liable to the holder of such bill of
exchange, hundi, promissory note cheque etc. for the amount thereof, unless it is
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paid by the company.
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amount of share capital, but the denomination of each share should be Rs. 10 or
Rs. 100 in case of equity shares and Rs. 100 in case of preference shares. However,
the companies whose shares are in dematerialized from, shall have the freedom to
issue equity shares in any denomination which should not be less than rupees one
(vide press release issue by SEBI on 11th June, 1999). An unlimited company
having a share capital is not required to have the capital clause in its memorandum.
For such a company, section 27(1) provides that the amount of shares capital with
which the company is to be registered must be stated in the articles of association
of the company.
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company may change its name by passing an ordinary resolution and by obtaining
the approval of the Central Government in writing [Sec. 22].
The rectification of the name must also be carried out if the Central Government so
directs within a period of 12 months from the date of registration of the company. If
a direction is issued, the company must change its name within three months from
the date of direction. Any default in complying with the direction of the Central
Government renders the company and its officers in default liable for punishment
with the fine which may extend to Rs. 1000 for every day during which the default
continues [Sec. 22(2)].
The Registrar shall enter the new name on the Register in place of the former name
and shall issue a fresh certificate of incorporation with necessary alterations. The
change of name becomes effective on the issue of fresh certificate of incorporation.
The registrar will also make the necessary alteration in memorandum of association
of the company [Sec. 23].
The change of name shall not affect any rights/ obligations of the company or
render the same defective in legal proceedings by or against it. Moreover, any legal
proceedings which might have been continued or commenced by or against the
company by its former name may be continued by or against the company by its
new name [Sec. 23(3)].
It has been held in Economic Investment Corporation Ltd. v. CIT, [1970] 40 Comp.
Cas. 1 (Cal.), that by change of name the constitution of the company is not
changed. The only thing that changes is its name; all the rights and obligations
under the law of the old company pass to the new company. It is not similar to the
reconstitution of a partnership, which in law means creation of a new legal entity
altogether.
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town or city or village in the same state [Sec. 17 A and Sec. 146] -
A company desiring to the change its registered office from one town, city or
village to another town, city or village in the same state has to pass a special
resolution at a general meeting of the shareholders, authorizing the change and file
its copy with the registrar within 30 days.
Section 17 A, which has been added by the Companies (Amendment) Act, 2000
provides that if the registered office is to be shifted from the jurisdiction of one
Registrar of Companies to another Registrar of Companies within the same state,
then in addition to passing of special resolution confirmation of the regional
director is also to be obtained. At present, this provision is applicable only to
companies situated in Tamil Nadu and Maharashtra which have more than one
office of Registrar of Companies. In Tamilnadu, one office is in Chennai and
another in Coimbatore . In Maharashtra, one office is in Mumbai and the other at
Pune.
A copy of the special resolution and of the confirmation by the Regional Director,
shall be filed with the Registrar of the Companies within 30 days and 2 months
respectively.
Within 30 days of the removal of the registered office, the notice of the new
location has to be given to the Registrar.
Penalty – A company must have a registered office and must give notice of the
situation of the registered office and of every change therein to the registrar of
companies within 30 days after incorporation of the company or after the date of
change and in case of default in complying with these provisions every officer of
the company who is in default shall be liable for punishment under section 146(4).
(c) Change of registered office from one state to another state -
Section 17 of the Companies Act Provides for the shift of the registered office from
one state to another and such shift involve alteration of memorandum. According to
this section, registered office of a company can be shifted from one state to another
by passing special resolution and getting confirmation from the Company Law
Board [Central Government, after the Companies (Amendment) Act, 2002]. The
Company Law Board (Now Central Government) before confirming a resolution
will satisfy itself that sufficient notice has been given to every creditor and all other
person whose interest are likely to affected by the alternation including the
Registrar of Companies and Government of the State in which registered office is
situated. All the interest parties must be given an opportunity to be heard by the
CLB (now Central Government).
Los of revenue or employment of State, whether Relevant Consideration to
Refuse Confirmation of Shifting :
In Orient Paper Mills Ltd. v. State, AIR 1957 Ori. 232, the Orissa High Court held
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that a state whose interests are affected by the change of the registered office to a
different state has a locus standi to oppose shift of the registered office of a
company. Accordingly the court declined to confirm change of registered office
from Orissa to West Bengal on the ground that in a Federal Constitution every state
has the right to protect its revenue and, therefore, the interest of the State must be
taken into consideration.
But in another case Minerva Mills Ltd. v. Govt. of Maharashtra [1975] 45 Comp.
Cas. 1 (Bom.), Bombay High Court held that the Company Law Board (now
Central Government) cannot refuse confirmation of the shifting of the registered
office on the ground of the loss of revenue to State or on the ground that such a
shift would have adverse effects on the general economy of the State. The Court
said : The question of loss of revenue to one State would have to be considered in
the prospects of total revenues for the Republic of India and no parochial
considerations should be allowed to turn the scale in regard to change of registered
office from one state to another within India.
A company can shift its registered office from one state to another for certain
purpose only. The grounds on which a company can shift its registered office from
one state to another are provided by Section 17 of the Companies Act as:
(i) To carry on its business more economically and more efficiently [Sec. 17
(1)(a)].
(ii) To attain its main purpose by new or improved means [Sec. 17(1)(b)].
(iii) To enlarge or change the local area of is operation [Sec. 17(i)(c)].
(iv) To carryon some business which under existing circumstances may
conveniently or advantageously be combined with the business of the
company [Sec. 17(1)(d)].
(v) To restrict or abandon any of the objects specified in the memorandum
[Sec. 17 (1)(e)].
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and if it appears that such a conclusion may be fairly arrived at, the court will not
go behind it to hold an enquiry whether the opinion of the directors is well founded
or is justified.
The Delhi High Court, in Delhi Bharat Gain Merchants Assn. Ltd., In Re [1974] 44
Comp. Cas. 214 (Delhi), has opined that the true legal position is that business must
remain substantially the same and the additions, alterations and changes should
only be steps-in-aid to improve the efficiency of the company.
(ii) To attain its remain purpose by new or improved means [Sec. 17 (1)(b)]-
The companies registered after 10th October, 1965 contain in their memorandum
their 'main object' as well as other object. But for the companies registered prior to
1965, apart from looking at the memorandum one has to look also to what actually
being done.
(iii) To enlarge or change the local area of its operation [Sec. 17(1) (c)]- A
company can change its object clause (as well as registered office clause) in order
to enlarge or change the local area of its operation.
(iv) To carry on some business which can be suitably combined with the present
business of the Company [Sec. 17(1)(d)]. – Most of the alterations in object clause
are sought on this ground. This clause enables the company to carry on any activity
which may conveniently or advantageously be combined with the existing business
of the company, e.g. a company formed for generating power was allowed to carry
on 'cold storage and other allied business'- In Re, Ambala Electric Supply Co. Ltd.,
[1963] 33 Comp. Cas. 585 (Punj); A company formed for business in jute was
allowed to add business in rubber- Juggilal Kamlapat Jute Mills v. Registrar of
Companies, [1966] 1 Comp. L.J. 292; However in Re, Cyelist Touring Club Ltd.
[1907] 1 Ch. 269, Cyclists Touring Club Ltd. was not allowed to change its objects
so as to admit motorists since one of the object was to protect cyclists from
motorists.
But, it was held in New Asiatic Insurance Co. Ltd., In Re [1967] 37 Comp. Cas.
331 (Punj), that confirmation of alternation of objects is not to be refused only
because new businesses in wholly different from existing business.
(v) To restrict or abandon any of the objects specified in the memorandum
[Section 17(1) (e)]: Even for deleting any portion of object clause the procedure as
laid down in Sec. 17 is to be followed. One important change made by the
Companies (Amendment) Act, 1996, is that now the confirmation of company Law
Board (CLB) is no more required in cause of abandonment of its objects.
(vi) To sell or dispose of the whole or any part the undertaking of the Company
[Sec. 17(1)(f)]:
When a company feels that it has grown too big or diversified in various directions
that management of the company has become difficult or uneconomical and want to
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adopt a cut-back or retrenchment strategy, it may alter its objects to sell or dispose
of any of its undertakings.
(vii) To amalgamate the company with any other company or body of persons
[Sec. 17(1)(g)]: .
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(c) It may convert its fully paid-up shares into "stock" or vice versa.
(d) It may cancel its unissued shares, i.e. shares which have not been subscribed for
by any person, and diminish the amount of its authorised shared capital by the
amount of the shares so cancelled. It is to be remembered that diminution of
authorised share capital by canceling of unissued shares does not amount to
reduction of share capital, for the cancelled shares have never been issued to
anyone. The object of such cancelling may be to get rid of an unissued class
carrying inconvenient rights.
A company can make any of these alterations by simply passing an ordinary
resolution, provided it is authorized by its articles to do so. If the articles do not
provide for it, then firstly article must be changed by passing a special resolution.
Within thirty days of the date of passing the resolution notice must be given to the
Registrar together with a copy of resolution and altered memorandum, who will
then register the altered memorandum. It is from the date of passing the ordinary
resolution that the change becomes effective.
It is worth nothing that is no necessity of passing a resolution for alteration of
authorised capital where it stands increased by reason of :
(a) an order made by the Central Government for conversion of any loans or
debentures into shares of the company; or
(b) an order made by the Central Government on the application of any 'public
financial institution' which proposes to convert any debentures or loans with
conversion clauses into shares of the company. [Section 94 A(1) and 94 A (2)].
(ii) Reduction of Share Capital : With a view to ensuring that the company's
assets (cushion of safety to the creditors) are not freely distributed to the
shareholders, the reduction of the share capital is closely guarded under the
Companies Act. It is permitted for legitimate purposes only. For instance, a
company may be allowed the reduction of share capital (1) to write off lost capital
(capital unrepresented by any tangible asset owing to heavy trading losses or
unsound investments, or (2) to pay off surplus capital. Sometimes a company may
find itself over-capitalised, that is its rate or earnings may be less than the average
rate of return in similar other companies. In such a case it may genuinely decide for
reduction of share capital as a corrective step for improving its rate of earnings vis-
à-vis other companies in the same industry by accepting pro-rata surrender of
shares by members.
In so far as the methods of reducing the share capital are concerned, the Companies
Act leaves the company free to adopt any method it likes. Section 100, however,
specifies the following three methods which a company may adopt fro reducing its
share capital:
(a) it may reduce the liability of members an any shares not fully paid-up, to the
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extent of uncalled capital; or
(b) it may write off the lost capital, e.g. capital unrepresented by any available
assets; or
(c) It may pay off any paid – up share capital which is in excess of the need of the
company.
The other methods of reduction may be cancellation of fully paid-up shares which
the holders is willing to get cancelled for the benefit of the company, or reduction
of share capital by means of canceling the 'reserve capital' (i.e. that portion of
uncalled capital which cannot be called up except in the event of winding up) is not
permitted [Natal Land Company v. Paulin Colliery Syndicate, (1904) A.C. 120].
It must, however, be noted that "forfeiture of shares" for non-payment of calls and
"redemption of redeemable preference shares" are not treated as a reduction in
share capital. The reason for not treating these as reduction of capital is that by
resorting to any of these act, the fund, out of which creditors are to be paid does not
diminish.
(iii) Variation of the rights of shareholder - An alternation of the memorandum
will also result from a modification of the rights of a class of shareholders where
such rights are conferred by the memorandum. When there are different classes of
shareholders in a company enjoying different dividend and voting rights, then any
change in their rights without prejudice to any existing rights of other classes of
shareholders may be brought in accordance with the procedure laid down under
Section 106-107 of the Act. Accordingly, for effecting the variation of the rights of
different classes of shareholders – Firstly, memorandum or articles of company or
terms of issue of that class of shares must permit such a variation of rights.
Secondly, a special resolution sanctioning the variation must be passed at a
separate meeting of the shareholder of the class affected.
Under Section 107 the shareholders who dissent from the variation have a special
right of appeal. Dissenting members, holding not less than ten per cent of the issued
shares of the class affected, may, within twenty –one days after passing of
resolution, apply to the Court to cancel the variation. If such an application is made,
then variation shall not take effect until it is confirmed by the Court. If the Court is
satisfied that the variation would unfairly prejudice the interests of the class of
shareholders which have moved the application, it may disallow the variation,
otherwise it will confirm the variation.
(iv) Re-arrangement of share capital (Sec. 391) . The capital clause will also be
altered where the share capital is stated by the memorandum to consist of
preference share and equity shares and its is proposed to consolidate all such shares
into one class of equity shares, or where the capital is stated by the memorandum to
consist entirely of equity shares and it is proposed to convert a part of those into
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preference shares. The change is effected by means of a "scheme of arrangement"
under Section 391.
Note : It may be recalled that an unlimited company having a share capital is not
required to have the Capital Clause in its memorandum. In the case of such a
company, Section 27(1) provides that the amount of 'Registered Share Capital'
must be stated in the 'articles' of the company. Alteration of capital clause,
therefore, does not involve alteration of memorandum in the case of companies
with unlimited liability and having a share capital.
In the end, it may be noted that where an alteration is made in the memorandum of
a company, every copy of the memorandum subsequently issued must be in
accordance with the alteration. For non-compliance with this requirement, the
company and every officer of the company who is in default, shall be punishable
with fine which may extend to Rs. 100 for each copy so issued (Sec. 40).
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(i) to protect investors of the company so that they may known the objects
in which their money is to be employed, and
(ii) to protect the creditors by ensuring that the company funds to which they
must look for payment are not dissipated in unauthorized activities.
In Lakshamanawami Mudaliar v. LIC, AIR 1963 SC 1185, the Supreme Court of
India has affirmed that an ultra vires contract remains ultra vires even if all
shareholders agree to ratify it. In this case, the directors of the company were
authorized 'to make payment towards any charitable or any benevolent object or for
any general public or useful object.' In accordance with the shareholder resolution,
the directors paid Rs. 2 lakhs to a trust for the purpose of promoting technical and
business knowledge. The company's business having been taken over by LIC, it had
no business left of his own. The court held that the payment was ultra vires the
company. They could spend for the promotion only on such charitable objects as
would be useful for the attainment of the company's own objects.
One important facts is to be noted that the ultra vires doctrine is now a days very
largely frustrated by the ingenuity of company promotes who, by enumerating all
objects possible under the sun have in actual practice made the doctrine ineffective,
except in very rare cases. For example in the case of Bell Houes Ltd. v. City Wall
Properties Ltd. [1966] 36 comp. Cas. 779, the object clause included a power 'to
carry on any other trade or business whatsoever we can, in the opinion of the Board
of Directors, be advantageously carried on by the company. The said clause was
held to be valid by the court.
Therefore, the 'doctrine of ultra vires' was dropped by the English Companies
(Amendment) Act, 1989. Any document signed or contract entered by any office on
behalf of the company even beyond the power of the company is now binding
against the company in England. The company is allowed to proceed against the
officer at fault.
Here, it is important to note that section 13(1)(d) of the Companies Act, 1956
provides that objects incidental to or ancillary to the main objects can well be
pursued. In case, any such incidental objects has not been specified, it would be
allowed by the principle of reasonable construction of memorandum.
It is also to be noted, that if the act instead of being ultra vires the company is ultra
vires the directors only, the whole body of the shareholders can ratify it by passing
an ordinary resolution and make it binding upon the company. Also, if an act is
ultra vires the articles, the company can alter the articles by passing a special
resolution, so as to make the same intra vires (within the powers) the articles with
retrospective effect.
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could prove for their debts in the company's liquidation as every one dealing with a
company is supposed to know its objects and if he acts carelessly, he takes the risk.
However, in Deonarayana Prashad v. The Bank of Borada Ltd., 58 Bom. L.R.
1056, it was held that if money or property obtained under ultra vires contract has
been used to pay intra vires debts of the company, then by the principle of
subrogation the creditor can, to that extent, stand in the shoes of those creditors
who have been paid off, but he cannot claim any securities held by such creditors
for their debits.
Also, is Sinclair v. Brogham, (1914) A.C. 398, it was held that if the property
handed over to the company or money lent to the company under an ultra-vires
contract, exists in specie or if it can be traced in specie, or if it has been expanded
in purchasing some particular assets, the person handing it over can get it back, and
obtain an injunction restraining the company from parting with it, provided he
intervenes before the money is spent or the identity of the property is lost or the
property passes into the hands of the bonafide purchasers for value.
(v) Ultra Vires Torts :
A company cannot be liable for torts committed by its officers in connection with a
business which is entirely outside its objects. The company can be made liable in
tort only if these are committed in the course of intra vires transactions by its
officers within the course of their employment.
(vi) Injunction :
If a company is about to undertake an ultra vires act, any member or members of
the company can get an order of injunction from the court restraining the company
from going ahead with the ultra vires act – Attorney General v.G.R. Eastern
Railway Company, [1880] 5 AC 473.
5.7 Summary
Memorandum of association of a company is a document of great importance. It
defines as well as confines the power of the company. Ay act beyond the scope of
the memorandum is ultra vires the company and thus unenforceable. Section 13
requires the memorandum of a limited company to contain information about its
name (with 'limited' or 'private limited' as the last word(s), as the case may be ); the
name of the State in which registered office is to be situated; the objects stating
separately the 'main objects' and 'other objects' the liability being limited; the
amount of authorised share capital and its division into shares of fixed amounts.
Nothing should contain in the memorandum which is contrary to the provisions of
the Companies Act.
Under Name Clause : Promoters are free to choose any suitable name for the
company provided (i) the last word / (s) is / are 'limited' or 'private limited' as the
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case may be (except in case of 'association not for profit' if licensed by the Central
Govt.); (ii) the name chosen is not undesirable.
Every company is required to paint or affix it name and address of its registered
office outside of every office or place of business in a conspicuous position and in
letters which are easily liable and in the language in general use in the locality.
Registered office clause : This clause statues the name of the State in which the
registered office of the company will be situated. Registered office of a company
established its domicile.
The Objects Clause : Section 13(1)(d) of the Companies Act, 1956 requires the
company to divide its objects into three parts :
(i) the main objects;
(ii) objects incidental or ancillary thereto; and
(iii) other objects.
Any Act beyond the objects stated in the memorandum is ultra-vires the company
and thus void. However, besides the powers stated in the memorandum, every
company has certain implied powers like the power to borrow, power to sell and
purchase. But power likes acquiring a business similar to company's own entering
into partnership, promoting other companies or helping them finically have been
held to be outside the scope of implied powers of a company.
Liability clasue : This clauses states the nature of liability of the members. In the
case of a limited company, it must also state that the liability of its members is
limited. Memorandum of an unlimited liability company need not have this clause.
Association or Subscription Clause: At the end of the memorandum of every
company there is an association or subscription clause. Each subscriber must write
opposite his name the number of shares he takes.
Alternation of Memorandum: The contents of a memorandum can be altered only in
the manner and to the extent provided in the Companies Act.
Name of a company can be changed by passing a special resolution and obtaining
the approval of the Central Government. However, approval of the Central
Government is not necessary where the only change sought is addition or deletion
of word 'private'.
Where a company has been registered by undesirable name, the Central
Government may direct it to alter its name. In such a case, the company may
change its name by passing an ordinary resolution and then obtaining confirmation
of the Central Government for the new name.
Registered office of a company may be shifted from one premises to another
premises by passing a resolution of the Board of directors and intimating the
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change of RoC within 30 days thereof. But where the registered office is proposed
to be shifted from one city to another city within the same State, special resolution
at a general meeting of shareholders must be passed. However, if shift of registered
of office from one city / town, etc. to another but within the same State result in
change of jurisdiction of one RoC to the other, approval of Regional Director shall
also be necessary. The change should be intimated to RoC within 30 days of
passing the resolution. However, shifting of registered office from one State to
another State is considered a serious matter and is allowed only on ground stated
under section 17(1) and subject to passing special resolution of shareholders as well
as the approval of the Company Law Board (now Central Government).
The grounds for altering objects are the same as required for shifting of registered
office from one State to another. But no longer, the approval of Company Law
Board is necessary. However, in case of shifting of registered office, intimation
shall be required to be set not only to the Registrar wherefrom the office is
proposed to be shifted but also to the Registrar of the State to which it is proposed
to be shifted.
Liability of the member cannot be increased unless the member agrees in writing.
However, the liability of members of an unlimited liability company may be made
limited or reduced by re-registration of the company.
Alteration of capital clause may involve increase or decrease of authorized capital
of the company, or sub-division or consolidation of shares or cancellation of shares
not taken or agreed to be taken by any person. Any of these changes can be done,
as per Sec. by passing an ordinary resolution in general meetings of shareholders.
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Unit-6 : Articles of Association
Structure:
6.1 Meaning
6.2 Relation between Memorandum and Articles
6.3 Contents of Articles
6.4 Alteration of Articles
6.5 Binding Force of Memorandum and Articles
6.6 Doctrine of Constructive Notice
6.7 Doctrine of Indoor Management
6.8 Summary
6.9 Check Your Progress
6.1 Meaning
The articles of association of a company contain the rules, and bye-laws that govern
the management of its-internal affairs. They are similar to the ‘partnership deed’ in
a partnership. They prescribe rules and regulations for the general management of
the company and for the attainment of its objects as given in its memorandum.
Section 2(2) of the Companies Act, 1956 defines articles as ‘articles’ mean the
articles of association of a company as originally framed or as altered from time to
time in pursuance of any previous companies laws or the present Act i.e., the Act of
1956.
The Article define the power of its officers. They also create a contract between the
company and the members and between the members inter-se. They also provide
for the matters like the making of calls, forfeiture of shares, qualifications of
directors, appointment of auditors, powers and duties of auditors, procedure for
transfer and transmission of shares and debentures.
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The general functions of articles of association were clearly stated by Lord Cairns
in Ashbury Railway Carriage Co. vs. Riche [(1875),L.R.7H.L.653, p.670.] where
he observed that “the articles play a part subsidiary to the memorandum of
association. They accept the memorandum as the charter of incorporation of the
company, and so accepting it, the articles proceed to define the duties, the rights
and the powers of the governing body as between themselves and the company at
large, and the mode and form in which the business of the company is to be carried
on, and the mode and form in which changes in the internal regulations of the
company may from time to time be made.” Being subordinate to the memorandum,
they cannot extend the objects as defined in the memorandum.
Section-26 states that a public company limited by shares may register articles,
while company limited by guarantee or an unlimited company or a private company
limited by shares must register articles along with the memorandum at the time of
registration. In other words, it is optional for a public company limited by shares to
register-articles, whereas other types of companies are required to do so
compulsorily. There arises a question as to what happens if a public company
limited by shares does not register any articles. The answer to this question is
provided by Section 28(2) which states that if a public company limited by shares
does not register any articles, “Table A” (the model set of 99 articles given in
Schedule 1 at the end of the Companies Act) shall automatically apply to such a
company. Even if such a company registers articles of its own, “Table A” will still
apply automatically on all such points on which the said articles are silent, unless
its regulations have expressly been excluded by the company in its articles.
The articles of association shall be (a) printed, (b) divided into paragraphs
numbered consecutively, and (c) signed by each signatory of the memorandum in
the presence of at least one attesting witness (Sec. 30).
The memorandum of a company defines the company’s objects and various powers
of the company whereas the articles regulate the manner in which the company’s
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affairs will be managed and how the objects of the company shall be achieved and
how the powers are to be exercised. The articles of a company are subordinate to
the memorandum of association. The memorandum, being the fundamental
document, can be altered only in certain circumstances provided by the Act. But the
articles are only internal regulations and can be altered by the company as and
when it thinks fit. The only precaution to be taken is to see that the regulations
provided for in the articles do not exceed the powers of the company as given in its
memorandum. Despite the rule that the memorandum prevails in case there is any
conflict between the memorandum and articles, they are contemporaneous
documents and must be read in conjunction and any ambiguity and uncertainty in
one document may be removed by reference to the other document. But if the
memorandum is perfectly clear, a doubt as to its meaning cannot be raised by
reference to the articles and in such a case the articles are supply inconsistent with
the memorandum and are disregarded.
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the company beyond which the actions of the company cannot go. The articles are
the internal regulations of the company and are subsidiary to the memorandum.
(2) The memorandum is subordinate to the Act only, while the articles are
not only subordinate to the Act but also to the memorandum..
(3) The memorandum must compulsorily be filed with the Registrar by all
types of the companies at the time of incorporation while a public company limited
by shares need not file a separate set of articles at the time of incorporation as it
may choose to adopt Table ‘A’ - the model set of articles.
(4) The memorandum defines the relation between the company and the
outsiders, i.e., creditors, buyers, sellers, debtors and members, etc. Articles govern
internal relationship between the company and the members and generally have
nothing to do with the outsiders.
(5) The memorandum cannot be easily altered while articles are easily
alterable by passing a special resolution only.
(6) Acts done by a company ultra vires the memorandum are void and
cannot be ratified by the shareholders. But acts done by a company ultra vires the
articles but intra vires the memorandum are simply irregular and not void and can
be ratified subsequently by the shareholders.
(7) Outsiders have no remedy against the company for contracts entered into
ultra vires the memorandum, while they can enforce contract against the company
even if it is ultra vires the articles, i.e.. where some formality relating to internal
regulation like passing of the required resolution, might have not been performed,
provided they act carefully and had no notice of the irregularity.
Articles usually deal with the rules and bye-laws on matters like :
(1) The extent to which “Table A” is applicable.
(2) Different classes of shares and their rights.
(3) Procedure of making an issue of share capital and allotment thereof.
(4) Procedure of issuing share certificates and share warrants.
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(5) Forfeiture of shares and the procedure of their re-issue.
(6) Procedure for transfer and transmission of shares.
(7) The time lag in between calls on shares.
(8) Conversion of shares into stock.
(9) Lien on shares.
(10) Payment of commission on shares and debentures to underwriters.
(11) Rules for adoption for 'preliminary contracts', if any.
(12) Re-organisation and consolidation of share capital.
(13) Alteration of share capital.
(14) Borrowing powers of directors.
(15) General meetings, proxies and polls.
(16) Voting rights of members.
(17) Payment of dividends and creation of reserves.
(18) Appointment, powers, duties, qualifications and remuneration of directors.
(19) Use of the Common Seal of the company.
(20) Keeping of books of account and their audit.
(21) Appointment, powers, duties, remuneration, etc., of auditors.
(22) Capitalisation of profits.
(23) Board meetings and proceedings thereof.
(24) Rules as to resolutions.
(25) Appointments, powers, duties, qualifications, remuneration, etc., of
managing director, manager and secretary, if any.
(26) Arbitration provisions, if any.
(27) Provision for such powers which cannot be exercised without the authority
of articles, for example, the issue of redeemable preference shares; issuing
share warrants to bearer; refusing to register the transfer of shares; reducing
share capital of the company; accepting payment of Calls in advance; the
appointment of additional or alternate director(s).
(28) Winding up.
In addition to the above matters, the articles of an unlimited company should state
the number of members with which the company is to be registered and if it has a
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share capital, the amount of share capital with which it is to be registered [Sec.
27(1)]. In the case of a company limited by guarantee, the articles must state the
number of members with which the company is to be registered [Sec. 27(2)]. The
articles of a private company having a share capital must contain the four
restrictions as given by Section 3(1) (iii) under sub-clauses (a), (b), (c) and (d),
namely:
In the case of a private company not having a share capital, the articles must
contain provisions relating to the matters specified in the above mentioned sub-
clauses (b), (c) and (d) only. [Sec. 27(3)].
It must, however, be remembered that articles should not contain anything which is
against the law of the land, the Companies Act, the public policy and ultra vires the
memorandum. Any such clauses shall be inoperative and void.
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6.4 Alteration of Articles
As already told that being the internal regulations of the company, the articles can
be freely altered by the company. The right to alter the articles is expressly
conferred by Section 31 which states that a company may alter its articles, as often
as required, by passing a special resolution only. A copy of special resolution
authorising the alteration together with a printed copy of the altered Articles must
be filed with the Registrar within 30 days of passing the said resolution. The
alteration will be effective from the date of registration by the Registrar.
It is to be observed that this power to alter articles is a statutory power and cannot
be negatived in any way. A company cannot deprive itself of this statutory right
either by inserting a clause in the articles or by a contract with any one (Andrews
vs. Gas Meter Co.) [(1897), 1 Ch. 361]. Further, articles can be re-altered by
passing a special resolution and they can also be altered with a retrospective effect
(Allen vs. The Gold Reefs of West Africa Ltd.) [91990), 1 Ch. 656, Also see All
India Railwaymen’s Benefit Fund vs. Bareshwar Nath, I.L.R. (1945) Nag. 599].
The freedom of the company to alter its articles is, however, subject to certain
limitations.
(1) The alteration must not be inconsistent with the provisions of the
Companies Act or any other statue (Sec.3). Thus a company cannot alter its
articles so as to exclude or limit the rights of its shareholders to present a petition
for the winding up of the company, because this right is conferred by Section 439.
The alteration cannot be made so a to increase the liability of any member without
his written consent, for, it shall be contrary to Section 38 of the Act. However, it is
possible that the articles may impose on the company conditions stricter than those
provided under the law, for example, they may provide that a resolution should be
passed by a special majority when the Act requires it to-be passed by an ordinary
majority. Similarly, the articles may provide that all the directors would be liable to
retire by rotation when the Act provides that in the case of a private company all
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the directors can be permanent and in the case of a public company one-third of the
total number of directors can be permanent.
(2) The alteration must not be inconsistent with the conditions contained in
the memorandum (Sec. 31). The articles are subject to the memorandum and so
must not over-ride the memorandum. As such they cannot be altered so as to give
powers which are not given by the memorandum. In the event of conflict between
the memorandum and the articles, the memorandum will prevail.
(3) The alteration must not be inconsistent with the alteration ordered by
the Company Law Board (now Tribunal). In the exercise of its powers to remedy
“oppression” and “mismanagement” under Section 397 and 398, the Company Law
Board has power to alter a company’s memorandum and articles in any way it
thinks fit. When the Company Law Board (now Tribunal) has amended the
memorandum or articles, the company can make no alteration which is inconsistent
with the Company Law Board’s (now Tribunal) order without the permission of the
Board (Sec. 404).
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beyond the limits prescribed in Schedule XIII (Sec. 310 read with Schedule
XIII).
Where the alteration has been approved by the Government, a printed copy of the
Articles as altered shall be filed by the company with the Registrar within one
month of the date of receipt of order of approval.
(5) The alteration must not deprive any person of his rights under a
contract. Alteration should not destroy any of the rights possessed by any person
by virtue of a contract. In British Murac Syndicate Ltd. v. Alperton Rubber Co.
[1915] 2 Ch. 186 ..... (p.171 Majumdar). In Allen vs. The Gold Reefs of West Africa
Ltd., [(1900), 1 Ch. 656]. Lord Lindley observed “................. Thus a person
appointed in accordance with the provisions of the articles as a director on a fixed
remuneration of Rs. 2,000 p.m. under an independent contract of services, cannot
be made to accept a lesser amount by altering the articles.” It is to be observed,
however that in case a person accepts the appointment purely on the terms of the
articles, the alteration shall be valid and binding upon such a person. For example,
in C. Chettiar vs. Krishna Ajyanger’s case the articles provided Rs. 250 p.m. as pay
for the company’s secretary. The post was accepted by the plaintiff and in the
specific agreement with him the articles were referred to show the terms of the
contract. Later on the company changed the articles so as to reduce the secretary’s
pay to Rs. 25 p.m. The alteration was held valid and operative. It was stated that
any one accepting an appointment purely on the terms of the articles takes the risk
of those terms being altered.
The facts of Hari Chandra vs. Hindustan Insurance Society [A.I.R. (1925)
Cal. 690] also involved a situation of this kind. In this case the plaintiff had taken
out a policy of life insurance in the defendant company. Under the Policy the
plaintiff was entitled to draw from the company a certain sum on a certain date.
Later the company altered its articles to the effect that such withdrawals of money
could be made only out of a special fund. At the time the amount became payable
to the assured, there was no money in the special fund. The plaintiff sued for his
payment under the original contract. Held, the alteration of articles was not valid
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because it involved a fundamental breach of contract which the company had
previously entered into with the plaintiff.
(6) The alteration must not constitute a fraud on the minority by the
majority. An alteration to the articles must not discriminate between the majority
shareholders and minority shareholders so as to give the former an advantage over
the later. Alteration would be liable to be invalid if the effect of it were to defraud
or oppress the minority shareholders, so as to give the majority shareholders an
advantage of which the minority shareholders were deprived. This principle was
laid down in the case of Menier vs. Hooper’s Telegraph Works [(1874), 9 Ch. App.
350]. In this case the majority of the members of Company A were also members
of Company B. At a meeting of Company A, they passed a resolution to
compromise an action against Company B in a manner alleged to be favourable to
Company B but unfavourable to Company A. On an action by the minority of
Company A, the resolution was held invalid and the compromise was set aside. The
Court observed, “It would be a shocking thing if that could be done, because the
majority have put something into their pockets at the expense of the minority.”
Similarly, the Court will certainly intervene if the majority pass a resolution
sanctioning a sale of the company’s property to themselves at an undervalue. Again
in Brown v. British Abrasive Wheel Co. [1919] 1 Ch. 290, the majority which held
98% of the shares passed a special resolution that upon the request of holders of
9/10th of the issued shares, a shareholder shall be bound to sell and transfer his
share to the nominee of such holder at a fair value. The alteration was held to be
invalid since it amounted to oppression of minority.
(7) The alteration must be bonafide for the benefit of the company as a
whole. Alteration shall not be valid if it has been made for the benefit of an
aggressive or fraudulent majority. On the other hand, alteration made bonafide in
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the interests of the company shall be valid even if it is likely to inflict hardship on
an individual shareholder. Thus, in Sidebottom vs. Kershaw, Leese & Co. [1920), 1
Ch. 154], the Court upheld an alteration of the articles of a private company, which
authorised the directors to order any shareholder, carrying on a competitive trade to
that of the company, to transfer his shares at a fair value to the persons nominated
by the directors, on the ground that the alteration was for the benefit of the
company as a whole, individual hardship being irrelevant. The distinction between
these two cases must, however, be noted. Whereas in the former case the alteration
was clearly for the benefit of an aggressive majority, in the latter it was not,
because under the given circumstances it would likewise have operated against the
majority.
Regarding the binding force or legal effect of the memorandum and articles of the
Act provides that, “subject to the provisions of the Act, the memorandum and
articles shall, when registered, bind the company and the members thereof to the
same extent as if they respectively had been signed by the company and by each
member, and contained covenants (agreements) on its and his part to observe all the
provisions of memorandum and of the articles.” It follows from the language of the
Section that the memorandum and articles bind the company to its members, the
members to the company, the members to each other in an exceptional case. But in
relation to articles, neither a company nor its members are bound to outsiders. To
clarify the position we shall now see the legal effect of this provision (i.e., Sec. 36)
under the following heads in some details :
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The members can retain a company from spending money on ultra vires
transaction. An individual member can make the company fulfill its obligation to
him, such as to send the notice for the meetings, to allow him to cast his vote in the
meeting etc. In Johnson vs. Lyttle’s Iron Agency [(1877), 5Ch. 687], a forfeiture of
shares, irregularly effected by the company, was set aside at the instance of the
aggrieved member as the company did not comply with the provisions of the
articles.
It must be noted that these documents bind the company to members and vice versa
in respect of their membership rights only and not contractual rights of other kinds.
Even a member enjoying certain rights in capacity other than a member cannot
enforce them against the company. Thus, where the articles provided that the
company should purchase certain property belonging to a member, there was held
to be no contract between the company and the member to that effect (Re Tavarone
Mining Co.). [(1873), 8 Ch. App. 956].
In Wood v. Odessa Waterworks [1889] 42 Ch. D. 636, the directors proposed to pay
dividend in kind by issuing debentures. The articles provided for payment of
dividends. The court held that payment means payment in cash and therefore the
company could be compelled to pay dividend in terms of the articles.
Normally, action for breach of articles against the company can be brought only by
majority of the members. Individual or minority members cannot bring such a suit
except when it is intended for enforcement of personal rights of members or to
prevent the company from doing any ultra vires or illegal act, fraud, or acts of
oppression and mismanagement.
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articles provide to refer any dispute between the company and its member to
arbitration, the court will stay an action by the member, in such a dispute on an
application made by the company. In Borland Trustees vs. Steel Brothers & Co.
Ltd. [(1901), l Ch.279], the articles of the defendant company provided that the
shares of any member who became bankrupt should be sold to certain other persons
at a certain price to be fixed by the directors. ‘B’ a shareholder became bankrupt.
His trustee in bankruptcy claimed that he was not bound by the articles and he
could dispose of the shares as he liked. It was held that he was bound by the terms
of the articles and could not claim the shares against the company.
But this binding force on members is only in respect of their rights and obligations
as members. In Beattie vs. Beattie [(1938), Ch. 708], the articles provided that a
dispute arising between the company and any member would be referred to
arbitration. A director, who was also a member of the company, was sued for
wrongs done in his capacity as director. It was held that the arbitration clause was
not applicable to this dispute because it did not relate to the rights of director as
member but as director.
The article of association are the regulations of the company binding on the
company and its shareholders. Shareholders, therefore, cannot, among themselves.
Enter into an agreement which is contrary to or inconsistent with the articles of
association of the company [V.B. Rangaraj v. V.B. Gopalkrishnan (1992) 73
Comp. Cas. 201 (SC)].
3. Members bound to members. The articles bind the members inter-se as far as
rights and duties arising out of the articles are concerned.
In Smt. Claude-Lila Parulekar v. Sakal Papers (P) Ltd. [(2005) 59 SCL 414 (SC)]
it was held that the articles of association will have a contractual force between the
association or company and its members as also between members inter-se in
relation to their rights as such members.
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to sue another member directly for any wrong done to the Company or to recover
money alleged to be due to the company. The action must be brought by the
company itself or if it is in liquidation, by the liquidator (Borland v. Earle) [(1902),
A.C. 83]. If a shareholder defaults in making payment of a call made, only the
company may sue him because if other members are allowed to sue him, there may
be thousands of suits (if the number of members is that large) filed against him,
which shall be absurd.
In Rayfield v. Hand [1960] Ch. 1, the articles of a company provided that whenever
any member wished to transfer his shares, he was under an obligation to inform the
directors of his intention and the directors were under an obligation to take the said
shares equally between them at a fair value. The directors refused to take shares of
a particular member on the ground that the articles did not impose an enforceable
liability upon them. It was held that the directors were under an obligation to
purchase the shares, as members of the company, in terms of the provisions of the
articles. There was a personal liability of members amongst themselves.
However, articles do not create an express content among the members of the
company. A member of a company cannot bring a suit to enforce the articles in his
own name against any other member or members. The company alone is
empowered to sue the offender in order to protect the aggrieved member.
A shareholder may, however, sue in his own name to restrain others from doing
fraudulent or ultra-vires act. Thus, in Jahangir R. Modi v. Shamji Ladha [1866-67]
4 Bom HCR [1855], the Bombay HC held that - “a shareholder can maintain an
action against the directors to compel them to restore to the company the funds of
the company that have been employed by them in ultra-vires transactions, without
making the company a party to the suit.
The only exception, where articles form a contract between individual members
qua members and where an individual member in his personal capacity, may sue
other member or members directly without joining the company as a party to the
action, is when the persons against whom relief is sought control the majority of
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shares and will not allow an action to be brought in the name of the company and
the acts complained of, are either fraudulent or ultra vires (The Dhakeshwari
Cotton Mills Ltd. vs. Nilkamal) [(1937), A.I.R. Cal. 645].
4. Neither; the company nor, the members are bound to outsiders. The articles
and memorandum do not create any contract with outsiders, even though the name
of the outsider is mentioned in the articles e.g., solicitors, secretary, etc. A member
is also an outsider, if the matter in question is not connected with his membership
rights and obligations. An outsider cannot take advantage of these documents to
found a claim thereon against the company or its members, even though his name
may have been mentioned in the articles, for, such a person is not a party to the
contract constituted by the articles and memorandum. Thus, for instance, where the
articles provided for remuneration to be paid to promoters, it was held that the
promoters had no right of action againstthe company (Re Rotherham Alum & Co.)
[(1883), 25 D. 103].
Similarly in the case of Eley vs. Positive Goyernment Life Assurance Co. Ltd.
[(1876), 1 Ex. D.88] :
The articles provided that Eley should be the company's solicitor for life. Eley was
employed by the company and he also purchased certain shares of the company.
But the .specific contract with him did not contain the term that he shall be the
company’s solicitor for life.. After sometime the company dismissed him. He then
sued the company for damages for breach of contract. It was held that he had no
cause of action, because the articles did not constitute any contract between the
company and himself.
It may be noted that outsiders may acquire rights under the articles and can enforce
them against the "company if articles have been referred to show the terms of the
contract in the specific agreement between the outsider and the company. Thus,
where the directors were appointed under a specific contract referring to therein the
provisions of the articles in that regard which provided a remuneration of Rs. 5,000
p.m. to a director, the terms of the articles become apart of the contract which the
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directors could enforce against the company (Re New British Iron Co.) [(1898), 1
Ch. 324].
After registration with the Registrar of Companies, the memorandum and articles
become “public documents” and every one who deals with the company is
presumed to have the knowledge of these documents (Mahony vs. East Holyford
Mining Co.) [(1875), 7 H.L. 869]. This is called the “Doctrine of Constructive
Notice.” The legal effect of this doctrine is that if a person deals with a company in
a manner which is inconsistent with the provisions contained in its memorandum or
articles (i.e., enters into a transaction which is beyond the powers of the company
as set out in those documents), he must be deemed to have dealt with the company
at his own risk and cost and shall have to bear the consequences thereof. For
example, if the articles provide that a bill of exchange must be signed by two
directors, a person who has a bill signed by only one director cannot claim payment
upon such bill.
Thus, persons dealing with a body corporate are bound to take notice of disabilities
imposed on the body corporate and its officials by the memorandum and articles or
other documents of constitution.
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these public documents will give no indication whether the required condition or
procedure has been complied with. Also, the outsider cannot be deemed to have
constructive notice of any procedural failure, which he has no means of
discovering. It is for this reason that the courts have allowed an exception to the
“doctrine of constructive notice” and have enunciated a rule for the protection of
persons dealing with companies. The rule is that persons dealing with the company
in good, faith have a right to assume that the' internal requirements prescribed in
public documents have been observed. They are not bound to enquire into the
regularity of the internal proceedings.
This rule is known as the “Doctrine of Indoor Management.” The genesis of the
doctrine of indoor management could be traced back to the year 1856; when the
decision in the famous case of Royal British Bank vs. Turquand [(1856), 6E. & B.
327],was delivered. In this case the directors of a company were authorised by the
articles to borrow on bonds such sums of money as should from time to time, be
authorised to be borrowed, by a resolution of the company in general meeting. The
directors gave a bond to ‘T’ without the authority of any such resolution. The
question arose whether the company was liable on the bond. It was held that the
company was liable on the bond, as T was entitled to assume that the resolution of
the company in general meeting had been passed. The observation made by V.
Haldane in the case of Pacific Coast Coal Mines Ltd. vs. Arbuthnot [(1917), A.C.
607] is worth noting in this connection : “A person can be presumed to know the
constitution of the company, but not what may or may not have taken place within
the doors that are closed to him.”
The facts of County of Gloucester Bank vs. Rudry Merthyr & Co. [(1895), 1 Ch.
629], case provide another good illustration on the point. In that case a person was
issued a mortgage deed to which the seal of the company had been affixed at a
Board meeting at which no quorum was present. It was held that mortgage deed
was valid because the mortgagee had no means of knowing the internal irregularity
in the management.
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Briefly stated the “doctrine of indoor management” lays down that 'persons dealing
with the company are only required to see that the proposed dealings are
apparently regular and consistent with the memorandum and articles. They need
not enquire into the regularity of the internal proceedings of the company. They are
entitled to presume that the directors are acting lawfully in what they do, and can
hold the company liable even if the internal formalities are found hot to have been
completed.’ The doctrine is of great importance in the world of commerce, because
in its absence the general plight of the persons dealing with companies would have
been miserable, for, the company, very often, could have escaped liability by
denying the authority of the officials to act on its behalf.
Thus, it is clear from the foregoing discussion that the ‘doctrine of constructive
notice’ put a burden on people entering into contracts with a company by making
presumption that they would have read the memorandum and articles of the
company even though they might not have actually read them. The ‘doctrine of
indoor management on the other hand allows all those who deal with the company
to assume that the provisions of the articles have been observed by the officers of
the company or, in other words the persons dealing with the company are not
bound to require into the regularity of internal proceedings.
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(2) Negligence on the part of the outsiders. If the circumstances are so suspicious
as to invite further enquiry and the outsider had not made proper enquiries which
would have revealed the irregularities, he would not be entitled to the protection of
the “doctrine of indoor management.” For example, if an officer acts outside his
apparent authority, the outsider cannot claim the protection of this rule under the
pretext that he presumed that the relevant power might have been delegated to the
officer, as per the articles. In such a case he must make further enquiries otherwise
he is taking the risk. A clear illustration is the case of Anand Bihari Lal vs.
Dinshaw & Co. [(1942), A.I.R. Oudh. 417)], where the plaintiff accepted a transfer
of company’s property from its accountant, the transfer was held void. The plaintiff
should have insisted on seeing the ‘power of attorney’ executed in favour of the
accountant by the company before accepting the transfer, as the transaction is
apparently beyond the scope of an accountant's authority. Even the unusual
magnitude of the transaction may. put a person dealing with a company upon
enquiry as to its being authorised (Houghton & Co. vs. Nothard Law & Wills)
[(1928), A.C. 1].
(3) Forgery. The rule is of no avail where the outsider is found to have relied upon
a document which is a forged one, forgery is a nullity (i.e., void ab initio). In the
case of forgery it is not that there is absence of free consent but there is no consent
at all.
Thus, in Ruben vs. Great Fingall Ltd. [(1906), A.C. 439], the secretary of the
company forged the signatures of two of the directors, as required under the
articles, on a share certificate and issued the same to the plaintiff. The company
refused to accept him as a shareholder. The plaintiff pleaded that whether the
signatures were genuine or forged was a part of internal management and,
therefore, the company should be estopped from denying genuineness of the
document. But it was held that the plaintiff was not a shareholder and the certificate
was a nullity because this doctrine only applies to irregularities which otherwise
might affect a genuine transaction and it cannot apply to a forgery which is void ab-
initio.
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Similarly in Kreditbank Cassel GmbH v. Schenkers Ltd. [1927] 1 KB 826, a bill of
exchange signed by the manager of a company with his own signature under words
stating that he signed on behalf of the company when actually it was drawn in
favour of a payee to whom the manager was personally liable, was held to be a
forgery. The bill is this case was held to be forged because it purported to be a
different document from what it was in fact.
It must, however, be observed that although a company is not liable for forgeries
committed by its officers, yet it may be held [Cf. Lectures on Company Law by
S.M. Shah, p. 55 (1975 ed.)] liable for fraudulent acts of its officers acting under
their ostensible authority on its behalf. Thus, where (Ibid) a director or a manager
of a company with ostensible authority under the memorandum. and articles of the
company, practices a fraud upon the company by not placing the money borrowed
by him on a hundi or a bill of exchange in the coffer of the company, the company
is bound to honour the hundi or the bill of exchange, as the case may be, and cannot
defeat a bonafide creditor’s claim for recovery of the money on the ground o own
officers (Shri Kishan vs. Mondal Bros. & Co.) [(1967), A.I.R. Cal. 75].
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case where oppression is alleged - Navin R. Shah v. Simshah Estates and Trading
Co. (P) Ltd. [2007] 74 SCL 372 (CLB).
(6) Acts beyond authority. Doctrine is also not applicable where a pre-condition is
required to be fulfilled before company itself can exercise a particular power, or,
the act done is not merely ultra vires the directors/officers but ultra vires the
company itself - Pacific Coast Coal Mines v. Arbuthnot [1917] AC 607.
6.8 Summary
The articles of association of a company contain the rules and by-laws that
govern the management of its internal affairs. The articles also define the power of
its officers and create a contract between the company and the members and
between the members inter-se. Articles are subordinate to the memorandum and in
case of conflict between the two, the memorandum prevails.
Since the articles and memorandum are the public documents hence
‘doctrine of constructive notice’ presumes that anyone desirous of dealing with the
company has read those documents and also understood them, whether, in fact, the
parties have the knowledge of the contents or not.
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with the company are not bound to inquire into the irregularity of internal
proceedings.
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Unit-7 : Prospectus
Structure:
7.0 Introduction
7.1 Meaning of Prospectus
7.2 Contents of Prospectus
7.3 Issue of Prospectus
7.4 Guidelines of SEBI relating to Issue of Prospectus
7.5 Abridged Prospectus
7.6 Statement in lieu of Prospectus (Sec. 70)
7.7 Deemed Prospectus or Prospectus by Implication
7.8 Shelf Prospectus & Information Memorandum
7.9 Misstatements in Prospectus and its Consequences
7.10 Remedies for Misstatements and Omissions in a Prospectus
7.10.1 Remedies against the Company
7.10.2 Remedies against the Directors, Promoters and Experts
7.0 Introduction
A public company may also choose not to invite public to subscribe to its share
capital and arrange its share capital from friends and relatives just like a private
company. In this case, the public company has to submit a ‘statement in lieu of
prospectus’ with the Registrar.
But if the promoters and directors of a public company, decide to invite the public
to subscribe to its shares or debentures, they have to issue a document called
“Prospectus”. The object of a prospectus is to arouse the interest of the potential
investors in the company and induce them to invest in its shares or debentures. Lest
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the prospective investors be misled, there are a large number of statutory
provisions, aimed at their protection, relating to the form and contents of a
prospectus. If a company needs more funds for expansion in future, a prospectus
may also be issued at a later stage.
Section 2(36) defines the term prospectus, in these words : “a prospectus means any
document described or issued as a prospectus and includes any notice, circular,
advertisement, or other document inviting deposits from the public or inviting
offers from the public for the subscription or purchase of any shares in, or
debentures of, a company”. The term ‘prospectus’, therefore, includes any
document, however informal, which invites deposits from the public or offers
shares or debentures of a company for subscription to the public.
The responsibility of the company, its directors and promoters remains the
same in the case of “offer for sale to public” by an Issue House, as that in the case
of direct issue of prospectus by a company.
The amendment is a welcome step since it seeks to plug the loophole of raising
capital from public under the garb of ‘private placement’ by simply inviting
subscriptions through letters addressed as ‘private and confidential’. As the
invitations sent to such persons could be accepted only by the persons to whom
they were sent, such offers were not regarded as ‘public offer’. After the
amendment such ‘private placement’ will come under the purview of ‘public offer’,
if such offer or invitation is made to fifty persons or more.
The stipulation laid down in the above said amendment shall not apply to the non-
banking financial companies or public financial institutions specified in Section 4A
of the Act. As a result, these institutions will be free to offer securities through the
route of ‘private placement’.
The word ‘subscription’ in the definition means taking the shares for cash. Hence a
circular by a company offering the new shares to the shareholders of two existing
companies in exchange for their shares in these companies was not an offer for
subscription within the definition (Government Stock Investment Co. Ltd vs.
Christopher) [(1966) 1 AII. E.R. 490]. Therefore, the document making the offer
could not be called a prospectus within the meaning of the term in Section 2(36).
In New Brunswick, etc., Co. vs. Muggeridge [(1860), 1 Drew, and Sm. 363,
381], it has been opined that prospectus is the only window through which the
potential investor can look into the soundness of the company’s venture. Hence the
Companies Act intends to secure the fullest disclosure of all material and essential
particulars in a prospectus. The Act provides that every prospectus issued by or on
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behalf of a company must state the matters and set out the reports specified in
“Schedule II” given at the end of the Companies Act, 1956 [See Section 44(2) and
56(1)].
The Government has revised the format of prospectus given in Schedule II of the
Companies Act; 1956 with effect from 1st November, 1991. The revised format of
prospectus requires the prospectus to be divided into three parts. This has been
done to provide for greater disclosure of information regarding the company, its
management, the project proposed to be undertaker, by the company and the
management perception of risk factors so as to enable the investors to take an
informed decision regarding investment in shares or debentures offered through
public issue.
(1) The main objects of the company, its history and present business.
(3) The date of opening and closing of the subscription list and the date of
earliest closing of the issue.
(4) The name and address of the trustee under debenture trust deed (in case
of debenture issue).
(5) The names and addresses etc., of company promoters, and their
background.
(7) The names, addresses and occupation of manager, managing director and
other directors (giving their directorships in other companies).
(8) The amount payable on application and allotment of each share, along
with details about availability of forms, prospectus and mode of payment.
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(9) The names and, addresses of the company secretary, legal advisor,
auditors, lead managers, bankers and brokers to the issue.
(10) The details of option to subscribe for securities in the depository mode
[Inserted by the Depositories Act, 1996. For details of the ‘Depository System’
refer to Chapter 12].
(11) The procedure and time schedule for allotment and issue of share
certificates.
(12) The size of present issue giving separately reservation for preferential
allotment to promoters and others.
(a) For non-underwritten public issues: If the company does not receive the
minimum subscription of 90% of the issued amount on the date of closure of the
issue, or if the subscription level falls below 90% after the closure of issue on
account of cheques having been returned unpaid or withdrawal of applications, the
company shall forthwith refund the entire subscription amount received. If there is
a delay beyond 8 days after the company becomes liable to pay the amount, the
company shall pay interest at the rate of 15% per annum, as prescribed in Section
73.
(b) For underwritten public issues : If the company does not receive the
minimum subscription of 90% of the net offer to public including devolvement of
Underwriters within 60 days from the date of closure of the issue, the company
shall forthwith refund the entire subscription amount received. If there is delay
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beyond 8 days after the company becomes liable to pay the amount, the company
shall pay interest at the rate of 15% per annum, as prescribed under Section 73.
(16) The names of Regional Stock Exchange and other stock exchanges
where application has been made for listing of present issue.
(18) The material details about the project, namely, its location, plant and
machinery, technology, process etc., collaboration, any performance guarantee or
assistance in marketing by the collaborators, infrastructure facilities for raw
materials and utilities like water, electricity etc., schedule of implementation of the
project and progress so far.
(20) Future prospects - expected capacity utilisation during the first three
years from the date of commencement of production, and the expected year when
the company would be able to earn cash profits and net profits.
(21) Stock exchange quotations - the high/low stock exchange price in each
of the last three years and monthly high/low during last six months (where
applicable).
(22) The particulars of public issues made during the last three years by the
company and other listed companies under the same management.
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(25) Management perception of risk, factors, e.g., sensitivity to foreign
exchange rate fluctuations, difficulty in availability of raw materials or in
marketing of products, cost/time over-run, etc.
(26) The disclosure of credit rating obtained from CRISIL (Credit Rating
and Information Services of India Limited) or any recognised rating agency for the
proposed debenture/preference shares issue. If the company has not obtained any
rating, the prospectus should state that no rating has been obtained.
(28) Particulars of any property to be acquired by the company and the price
whereof is to be paid out of the proceeds of the issue, together with the names,
addresses, etc., of the vendors, the purchase price and the mode of payment.
(29) Amount of benefit paid or given within two preceding years to any
promoter or officer of the company and the consideration thereof.
(31) Particulars of the length during which the business has been carried on
by the company - profit & loss and balance sheet particulars for the last five years.
(32) Particulars of any revaluation of the assets of the company during the
last five years.
(33) Any special tax .benefits for company and its shareholders.
(34) A reasonable time and place at which copies of all balance sheets and
profit and loss accounts, if any, on which the report of auditors is based, may be
inspected.
(35) A declaration that all the relevant provisions of the Companies Act,
1956, and the guidelines issued by the Government or the guidelines issued by the
Securities and Exchange Board of India, as the case may be, have been. compiled
with and no statement made in prospectus is contrary to the provisions of the
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aforesaid Act or rules or guidelines [This declaration has been substituted by
Notification No. GSR 650(E) dated 17-9-2002, effective from 17-9-2002].
(1) the “guidelines for disclosure and investor protection” issued by SEBI
(Securities and Exchange Board of India), as amended from time to time, regarding
capital issues to the public must have been complied with for the proposed issue of
shares or debentures to the public, and a statement to that effect must be made in
the prospectus.
(2) A copy of the prospectus, duly dated and signed by all the directors, must
have been registered with the Registrar. The copy for registration must be
accompanied with:
(a) the consent in writing of the expert if his report is to be published in the
prospectus. The expert should be unconnected with the formation or management
of the company;
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(c) a written statement relating to adjustment, if any, made by the auditors or
accountants in their reports relating to profits and losses, assets and liabilities or the
rates of dividends, etc.;
(d) the consent in writing of auditors, legal advisor, banker and broker, etc.,
of the company to act in that capacity. (Sec.60)
(3) The prospectus must be issued within90 days of the date on which a copy
thereof is delivered for registration. If it is not issued within this period, it shall be
deemed to be a prospectus, a. copy of which .has not been delivered to the
Registrar. The reason for imposing the time limit is that if the issue of the
prospectus is delayed too long, conditions may alter and what is stated in the
prospectus may no longer be valid. The company and every person who is
knowingly a party to the issue of the prospectus without registration shall be
punishable with fine upto Rs.50,000 [Substituted for “Rs.5,000” by the Companies
(Amendment) Act, 2000]. (Sec.60)
The company should ensure strict compliance with the guidelines issued by
SEBI (Securities and Exchange Board of India), regarding advertisements issued in
connection with capital, issues. For the purpose of these guidelines the expression
“advertisement” means notices, brochures, pamphlets, circulars, showcards,
catalogues, hoardings, playcards, posters, insertions in newspapers, pictures, films,
radio/television programmes and would also include the cover pages of offer
documents. The code of advertisements set out in these guidelines is reproduced
below:
1. An issue advertisement shall be truthful, fair and clear and shall not
contain any statement which is untrue or misleading.
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(i) Statements made about the performance or activities of the company in
the absence of necessary explanatory or qualifying statements, which may give an
exaggerated picture of the performance or activities, than what it really is.
(iii) As investors may not be well versed in legal or financial matters, care
should be taken to ensure that the advertisement is set forth in a clear, concise and
understandable language. Extensive use of technical, legal terminology or complex
language and the inclusion of excessive details which may detract the investors
should be avoided.
(8) No advertisement shall be issued stating that the issue has been fully
subscribed or over-subscribed during the period the issue is open for subscription,
except to the effect that the issue is open or closed. No announcement regarding
closure of the issue shall be made except on the last closing date. If ^he issue is
fully subscribed before the last closing date as stated in the prospectus, the
announcement should be made only after the issue is fully subscribed and such
announcement is made on the date on which the issue is to be closed.
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(9) No models, celebrities, fictional characters, landmarks or caricatures or
the likes shall be displayed on or form part of the offer documents or issue
advertisements.
(11) If any advertisement carries any financial data, it should also contain
data for the past three years and shall include particulars relating to sales, gross
profit, net profit, share capital, reserves, earnings per share, dividends and the book
values.
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Exceptions. There are, however, certain exceptions to the above provision,
where ‘an abridged prospectus’ containing all the prescribed details need not
accompany the Application Forms sent out. These exceptions .are :
(b) Where the shares or debentures are not offered to the public. [Sec.
56(3)(b)].
(c) Where the offer is made only to existing members or debenture holders
of the company, whether with or without the right of renunciation. [Sec.
56(5)(a)]
(d) In the case of issue of shares or debentures which are in all respects
similar with those previously issued and dealt in oh a recognised stock exchange.
[Sec. 56(5)(b)]
The logic behind these exceptions should be noted. In the first two
exceptions the public are not involved hence no need of protection. In the case of
last two, the offeree, being already a member or the shares being quoted one, must
have enough information about the company to protect himself.
SEBI guidelines with respect to obridged prospectus provide that the Lead
Merchant Banker shall ensure that :
(ii) Abridged prospectus shall contain a disclosure under the heading ‘IPO
Grading’, stating all the grades obtained for the IPO, alongwith the
rationale/description furnished by the credit rating agency(ies) for each
of the grades obtained.
(iii) The application form may be stapled to form part of the Abridged
Prospectus. Alternatively, it may be a perforated part of the Abridged
Prospectus.
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(iv) The Abridged Prospectus shall not contain matters which are
extraneous to the contents of the prospectus.
(v) The Abridged Prospectus shall be printed at least in point 7 size with
proper spacing.
(vi) Enough space shall be provided in the application form to enable the
investors to file in various details like name, address, etc.
Let us not forget that a private company is free from filing either a
prospectus or a statement in lieu of prospectus with the Registrar.
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64 now covers documents issued by the Issue Houses. it provides that all
documents containing offer of shares or debentures for sale shall be included within
the definition of the term ‘prospectus’ and shall be deemed as prospectus by
implication of law, provided it is shown :
(i) that the offer was made within six months offer the allotment or
agreement to allot to the issue those; or
(ii) that at the date of offer to the public, the whole consideration in respect
of the shares or debentures had not been received by the company.
The Companies (Amendment) Act, 2000 has introduced two new sections
viz. Section 60A and 60B relating to ‘Shelf Prospectus’ and ‘Information
Memorandum’ respectively. ‘Shelf prospectus’ means a prospectus issued by any
financial institution or bank for one or more issues of securities or class of
securities specified in that prospectus.
(1) Any public financial institution, public sector bank or scheduled bank
whose main business is ‘financing’ is entitled to file a ‘shelf prospectus’.with the
Registrar of Companies.
(2) The ‘shelf prospectus’ will be valid for one year from the date of
opening of the first issue of securities under the prospectus. A company filing a
'shelf prospectus' with the Registrar need not file a fresh prospectus as and when it
makes any offer of securities during the currency of the prospectus.
Information Memorandum
Section 60B seeks to provide a provision for ‘Information Memorandum’.
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price offered for the same, it should contain major information regarding the issuer
company.
(2) The company is required to file a prospectus, prior to the opening of the
subscription lists and the offer, as a ‘red-herring prospectus’, at least three days
before the opening of the offer.
(4) Any variation between the ‘information memorandum’ and the ‘red-
herring prospectus’ shall be highlighted by the issuing company and shall be
individually intimated to the persons invited to subscribe the issue. Non-intimation
of the variations will tentamount to a mis-statement in the prospectus.
(5) In the event of the issuing company or the underwriters to the issue have
received advance subscription by way of post-dated cheques or stock invest, they
shall not encash such subscription moneys before the date of opening of the issue,
without having individually intimated the prospective subscribers of the variation
and without having offered an opportunity to such prospective subscribers to
withdraw their application. The prospective subscriber shall have a right to
withdraw his application within 7 days of an intimation of variation.
(6) Once the offer of securities is closed, a ‘final prospectus’ stating therein
the total capital raised, whether by way of debt or share capital, the closing price of
securities and any other details which were not complete in the ‘red-herring
prospectus’ shall be filed in the case of a listed public company with the Securities
and Exchange Board of India (SEBI) and Registrar of Companies, and in any other
case with the Registrar of Companies only.
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By introducing these concepts the Companies (Amendment) Act, 2000, has
sought to legally recognise the issue of securities through the “Book Building
Process” by introducing the concept of ‘Information Memorandum’, and ‘Red-
herring Prospectus.’
A prospectus constitutes the basis of the contract between the company and
the shareholders arid .therefore, it must disclose all material facts (i.e., facts likely
to influence the judgement of a prospective investor in deciding whether to take
shares or debentures or not) very accurately. It must not misrepresent or conceal
material facts and thereby improperly influence and mislead the prospective
investor into becoming an allottee of shares or debentures and in consequence
suffer Joss (Peek vs. Gurney) [(1873), L.R. 6 H.L. 377]. A prospectus containing
false, misleading, ambiguous or fraudulent statements of material facts, is termed as
“misleading prospectus”, and in that case a misled investor (original allottee of
shares who had relied on the prospectus and not a buyer in the open market) is
entitled to proceed against those who misled him.
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the truth was that the company had been incurring substantial trading losses during
the seven years preceding the date of the prospectus and dividends could be paid
only out of accumulated earnings in the abnormal war period. It was held that the
prospectus was false not because of what it stated, but because of what it did not
state and of what, as a whole, it implied.
The facts of Smith vs. Chadwick [(1884), 9 A.C. 187] also provide a good
illustration on the point. The prospectus, in this case stated that the ‘present value
of the turnover’ is £ 10 lakhs per annum. The statement ‘present value of the
turnover’ might bear two meanings — ‘actual produce’ or ‘capable of producing’.
It was held that as the statement is ambiguous — might bear two meanings, one of
which, i.e., actual produce is false, liability for misstatement cannot be escaped.
Lord Blackburn observed : “if they put forth a statement which they knew may bear
two meanings one of which is false to their knowledge and thereby the plaintiff
putting that meaning on it is misled, they cannot escape by saying — he ought to
have put the other”.
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The remedies available to a person who has subscribed for shares on the
faith of a misleading prospectus, may broadly be grouped into two categories :
The following two remedies are available to an injured party against the
company for misrepresentation in the prospectus under general law: (1) Rescission
of the contract, (whether the statement is a fraudulent or an innocent one), (2)
Claiming damages, (where the statement is a fraudulent one).
(I) Rescission of the contract. Under the Indian Contract Act, a contract
induced by a mis-statement of any material fact, either innocent or fraudulent, is
voidable at the option of the aggrieved party. The subscriber [The word
‘subscriber’ has been used in the text for one who takes shares by allotment
directly from the company], therefore is entitled to rescind his contract and return
the shares and receive back his money. If necessary, he may apply to the Court for
a declaration of rescission of the contract. It may be noted here that if a statement is
true when it is made, but subsequently becomes untrue before allotment, of shares
is made, the contract to take shares may be rescinded (Re Scottish Petroleum Co.)
[(1823),23Ch.D.413]. For example, if a director named in the prospectus has
meanwhile resigned, the subscriber could rescind the contract. The contract can
also be rescinded where misrepresentation is made in a document by which an
“offer for sale” is made to the public by an Issue House and which is deemed to be
a prospectus issued by the company under Section 64.
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(a) The prospectus was issued by the company or on its behalf by the
directors or it was deemed to be a ‘prospectus issued by the company by
implication’ under Section 64. Thus responsibility of the company for the issue of
prospectus must, in the first instance, be established,
(d) Lastly, it must be proved that the subscriber has actually relied upon the
statement in question while applying for shares. Thus, where it is proved that, he
did not read it or that he knew that the statement in question were untrue, or he
made the investigations himself to verify, or purchased shares in the open market,
or subscribed to the memorandum before the company came into existence, the
subscriber shall not be allowed to rescind the contract, for, in any such case he
cannot claim to have been misled by the prospectus.
Loss of the right of rescission. The right of rescinding the contract, however,
is lost in the following circumstances:
(i) If the allottee does not start the proceedings within a reasonable time after
coining to know the misrepresentation (Shiromani Sugar Mills Ltd. vs. Debt
Prasad) [(1950, A.I.R. All. 508].
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(ii) If he expressly or impliedly affirms his contract after becoming aware of
the falsity of the statements, e.g., attends meetings, accepts dividends, pays calls or
tries to sell the shares.
(iii) If the company goes into liquidation before he has started the
proceedings to rescind the contract, for, upon the commencement of liquidation the
rescission of the contract and the repayment of money to the subscriber would
injure the interest of the creditors by decreasing the assets available for the payment
of their debts (Oakes vs. Turqucmd) [(1867), L.R. 2, H.L. 325].
(2) Claiming damages for fraud. The subscriber is also entitled to claim
damages by way of interest. But to avail this remedy the subscriber must prove : (a)
that the mis-statements were mate fraudulently (and not innocently in which case,
only the right of rescission is available), and (b) that he has actually been deceived,
in addition to proving other facts necessary to succeed in a suit of rescission
mentioned earlier. “Fraud” was defined by Lord Herschell in Derry vs. Peek
[(1889), 14 A.C. 337] as “a false statement made : (a) knowingly, or (b) without
belief in its truth, or (c) recklessly, careless whether it be true or false”. It must be
noted that this right can be exercised only after the rescission of the contract and
the allottee cannot both retain the shares and get damages against the company
(Houldsworth vs. City of Glasgow Bank) [(1880), 5 A.C. 317]. It follows from this,
therefore, that this right of claiming damages for fraud against the company shall
also be lost under the same circumstances in which the right to rescind the contract
is lost (these circumstances have been discussed in detail under the preceding sub-
heading ‘Loss of the Right of Rescission’).
It is to be remembered that the right to bring an action for damages for fraud
is an elective one. An action under this right may be brought either against the
company or the directors. If the subscriber chooses to sue the directors, he need not
rescind the contract.
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7.10.2 Remedies against the Directors, Promoters & Experts
At the very outset it must be noted that these remedies are available Id a
misled investor whether he rescinds his contract or not. In other words, rescission
of the contract is not necessary for availing these remedies. Usually these remedies
are resorted to when the mislead subscriber does not want to rescind the contract or
cannot rescind the contract because the company goes into liquidation.
A misled investor may also make all or any of the following persons
[Section 62(1)] liable to pay compensation or/and penalty for mis-statements in the
prospectus.
(a) The directors at the time of issue of the prospectus.
(b) Every person who has authorised himself to be named and is named in
the prospectus as present or future director.
(c) Every promoter.
(d) Every other person who has authorised the .issue of prospectus.
The liability of the above mentioned persons can be studied under the
following heads:
(1) Damages for fraud. An action of deceit to recover damages, against all
or any of the persons authorising the issue of prospectus, may be brought by a
subscriber, if he chooses not to bring an action of deceit against the company. (The
right to bring an action of deceit being an elective one.) Here the damages will be
equal to the difference of the amount paid and the market value of shares at the date
of allotment. The subscriber will have to prove:
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(a) that the defendant was guilty of fraudulent misrepresentation of material
facts; and
(b) that he. has actually been deceived.
It is to be noted that this action can be taken even if the company goes into
liquidation (Derry vs. Peek) [(1889), 14 A.C. 337] because in an action against
directors, etc., interest of creditors of the company is not involved.
(2) Damages for misrepresentation (Sec. 62). Here the remedy to claim
damages is available for any loss sustained by the subscriber by reason of any
untrue statements in a prospectus, irrespective of whether they were made
fraudulently or innocently. Notice that in the absence of this provision, the misled
investor could have only rescinded his contract on the basis of misrepresentation.
But now he can keep his contract and claim the loss as damages. “The true measure
of damage is the difference between the amount paid and the value of the shares at
the date of allotment” (Adams vs. Thrift) [(1915), 2 Ch. 21].
This action can also be taken after the company goes into liquidation.
Defences available to directors, etc. The person (other than expert) so
sought to be made liable may escape liability, if he proves [Section 62(2)]:
(i) that, he withdrew his consent to acting as director before the prospectus
was issued and it was issued without his consent; or
(ii) that, the prospectus was issued without his knowledge or consent, and on
becoming aware of its issue he gave reasonable public notice that it had been so
issued; or
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(iii) that, he was ignorant of the untrue statement and on becoming aware of
the same, after the issue of the prospectus and before allotment, he withdrew his
consent and gave a public notice to that effect; or
(iv) that, he believed on reasonable grounds that the statement was true; or
(v) that, the statement was in fact made on the authority of a competent
expert and the expert had given his consent as required by Section 58 and had not
withdrawn it; or
(vi) that, the statement was .a correct and fair copy of an official document or
was based on the authority of an official person.
(i) that, having given his consent under Section 58 he withdrew it in writing
before delivery of a copy of the prospectus for registration; or
(ii) that, after delivery of a copy of the prospectus for registration and before
allotment, he, on becoming aware of the untrue statement, withdrew his consent in
writing and gave a reasonable public notice to that effect; or
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3. A number of subscribers may join as plaintiffs in one action but each will
have to prove separately the untruth of the statement, and also a subscriber may
combine in the same action his claim for rescission and damages for fraud or
compensation for misrepresentation against the company, directors and other
persons.
(3) Liability for omissions. Section 56 imposes liability for omissions, ie.,
leaving out items which the II Schedule of the Act, requires to be disclosed in a
prospectus. Omission need not make the prospectus false or misleading. The simple
fact that certain clauses (necessary to be included as per II Schedule of the Act)
have been omitted from the prospectus shall make the persons responsible for the
issue of prospectus liable to pay damages to the subscriber for shares. The
subscriber must, however, satisfy the court (i) that if the said omissions would not
have been there in the prospectus he would not have taken the shares and (ii) that
he has actually sustained loss.
(4) Criminal liability (Sec. 63). Criminal liability involves a fine or a term
of imprisonment on the guilty party whereas civil liability (as discussed under the
above points) involves a remedy to the aggrieved party, e.g., paying damages by
way of compensation.
(a) any agreement for; or with a view to acquiring, disposing of, subscribing
for, or underwriting shares or debentures; or
(b) any agreement the purpose of which is to secure profit to any of the
parties from the yield of shares or debentures or by reference to fluctuations in
value of shares or debentures;
shall be punishable with imprisonment for a term which may extend to five
years or with a fine which may extend to Rs. l,00,000 [Submitted for “Rs. 10,000”
by the Amendment Act, 2000] or with both.
Thus, there are heavy liabilities prescribed for persons making mis-
statements in a prospectus both under the general law and the Companies Act. All
these heavy liabilities have saved the innocent investors from being misled by an
extravagant and flattering prospectus to a very great extent.
7.11 Summary
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the company should give explanation of certain terms and expressions used under
Part-I and Part-II of the schedule.
(1) If a public company does not invite public for subscription, in which
case it is required to issue a ‘statement in lieu of prospectus’ with the
Registrar of Companies.
(3) If the issue relates to shares which are uniform in all respects with shares
previously issued and quoted on a recognised stock exchange.
(4) Where the shares are offered to existing holders of shares by way of
right.
Public financial Institutions and Scheduled Banks can file ‘Shelf Prospectus’
which will remain valid for one year. Thus, they do not have to issue a prospectus
every time they offer securities to public. They are required to file an ‘information
memorandum’ with respect to new charges created and other change in financial
position.
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Registrar of either it does not issue a prospectus or where it issued a prospectus but
does not proceed to allot any of the shares offered thereunder.
3. What are the remedies available to a shareholder who on the faith of the
misstatements in a prospectus is induced to enter into a contract for the
purchase of shares or debentures?
4. Explain -
(i) Shelf Prospectus.
(ii) Information Memorandum.
(iii) Red Herring Prospectus.
(iv) Deemed Prospectus.
(v) Book Building.
{143}
Block - III
Management of Company
CONTENTS
Mismanagement
Amalgamation.
Unit 12 : Winding Up
{144}
Unit - 8
Structure
8.0 Introduction
8.1 Director - Definition
8.2 Legal Status of Directors
8.3 Maximum and Minimum Number of Directors
8.4 Qualification and Disqualification of Directors
8.5 Appointment of Directors
- By the Board
- By Central Government
- By Third Parties
8.6 Number of Directorships
8.7 Vacation of Office of a Director
8.8 Removal of a Director
8.9 Resignation by a Director
8.10 Powers of Directors
8.11 Duties of Directors
8.12 Liabilities of Directors
8.13 Remuneration of Directors
8.14 Managing Director
8.15 Whole-time Director
8.16 Distinction between Managing Director and whole-time Director
8.17 Manager
8.18 Summary
8.19 Check your Progress
{145}
8.0 Introduction
Marshall J has very aptly stated in Trustees of Darmouth College v.
Woodward, (1819) 17 US 518, 636 that “A corporation is an artificial being,
invisible, intangible and existing only in contemplation of law”. It has neither a
mind nor a body of its own. Thus the actual working of a company must be
entrusted to some human agents who acts as limbs of the company in conducting
the business. Proper management of companies is a matter of public interest
because on the one hand the interest of countless persons in the capacity of a
shareholder or an employee or a creditor is involved in their efficient working and
on the other, there are unscrupulous people who are bent upon to exploit the
innocent members of the society. It is perhaps for this reason that the Companies
Act contains stringent provisions regarding appointment, powers and functions of
the managerial personnel of a company. The expression ‘managerial personnel’ in
relation to companies refers to part-time directors (usually referred to as
‘directors’), whole-time directors, managing directors or managers (chief
executive), and excludes other executives irrespective of the salary paid to them.
Under the Companies Act while the Board of Directors is a must for the
management and administration of a company, other kinds of managerial
personnel—managing director’s) or manager—are only optional, the company may
or may not have them. The companies can be managed either by the Board of
Directors itself, or by the Board of Directors with the help of managing director(s),
or manager. Of these two modes of management, the companies prefer the latter
mode of management.
We shall now see in detail the legal provisions relating to : (1) Directors, (2)
Managing Director, (3) Whole-time Director and (4) Manager.
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Section 2(13) of the Companies Act defines a director as ‘any person
occupying the position of director, by whatever name called’. This is clearly not a
very precise definition. Director can be defined thus, ‘a director is one of those
persons, who are responsible for directing, governing, or controlling the policy or
management of a company’. Directors collectively are called as “Board of.
Directors” or “Board” [Sec. 252(3)]. The board of directors is the top
administrative organ of the company. If company is the body, then directors are the
brain of the company and the company can and does act only through them. Section
291 expressly vests the management of the business of a company in its directors.
The task of the shareholders is almost over with the selection of directors. Only the
most important matters of the Board's policy may be referred to the shareholders
for decision at the periodical general meetings. In fact the "Board" is the supreme
policy framing and decision making organ of a company.
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articles of association. Their acts, within the scope of their authority, are acts of the
company itself, and the company is liable for them. They enter into contracts and
put their signatures on behalf of the company like as agent.
But then, agents are not elected but appointed. They are also expected to
work without reward. This indicates that directors are not agents in the true sense
but in fact proprietors or managing partners.
But a director has no authority to bind the other directors and shareholders
like partners in a firm. Directors are subject to retirement. This shows that they are
not managing partners or proprietors in the full sense.
But a director is never allowed to enter into a contract for himself. He enters
into contracts for his principal, i.e., the company. He cannot sue on such contracts
{148}
nor be sued on them while acting intra vires. Whereas a trustee in the legal sense is
one who is the owner of property which he holds in trust and contracts with third
parties in relation to trust property in his own name as principal or owner, subject
only to an equitable obligation to account to those (beneficiaries) to, whom he
stands in the relation of trustee. In fact a director does not hold any property in/trust
for the company, for the company itself is the legal owner.
Thus, the directors are neither agents nor managing partners or proprietors,
nor trustees, in the full sense of the term. They combine in themselves all these
positions. In fact they stand in a fiduciary position towards the company and in the
terms of section 2(3) may be called as “officers” of the company.
In the case of a public company, any increase beyond the maximum limit
fixed by the articles must be approved by the Central Government except where the
increase in the number of directors does not make the total number of directors
more than twelve. (Sec. 259)
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In the light of the above provisions, the following points may be inferred:
(2) Only ‘small shareholders’ can vote on the election of the nominee
director of small shareholders, and they shall include both equity shareholders as
well as preference shareholders, because the expression 'paid-up capital' includes
equity share capital and preference share capital.
The Central Government has notified [Vide Notification No. GSR 168(E)
published in the Gazette of India Extraordinary dated 9.3.2001] the Rules called the
“Companies (Appointment of Small Shareholders’ Director) Rules, 2001”. These
Rules have been made effective from 9th March, 2001. The Rules, inter-alia,
provide as follows:
(i) A company may act suo-motu to elect a small shareholders’ director from
amongst small shareholders or upon the notice in writing of at least one-tenth of
total small shareholders proposing the name of a small shareholder for the post of
director. The notice must be given at least 14 days before the meeting.
(ii) The tenure of such small shareholders' director shall be for a maximum
period of 3 years and he shall not be subject to retirement by rotation.
(iii) Such a director shall be treated as director for all other purposes except
for appointment as whole-time director or managing director.
(iv) No person shall hold office at the same time as small shareholders’
director in more than two companies.
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The Companies Act does not lay down any academic or share-holding
qualifications for a director. Unless the articles provide otherwise, a director need
not necessarily be a shareholder of the company. Financial prudence, however,
requires that directors must have some stake in the company. It is why articles
usually provide for certain qualification shares for a director. If the articles so
provide then, as per Section 270, the directors must obtain their qualification
shares, within two months after their appointment unless they already hold shares
of that amount. But they cannot be required to hold such qualification shares within
a period shorter than two months of their appointment. In the case of a newly
floated company, directors must pay for their qualification shares before the
Certificate to Commence Business is obtained (Sec. 149). The nominal value of the
qualification shares must not exceed five thousand rupees. Bearer shares will not
count for purposes of qualification shares (Sec. 270).
If a director does not purchase qualification shares within the prescribed
period or thereafter does not possess such shares at any time, he ceases to be a
director automatically [Sec. 283(1)]. Moreover, he also becomes liable to a penalty
which may extend to five hundred rupees [Subs, for “Rs. 50” by the Companies
(Amendment) Act, 2000] for every day during which he continues to act as a
director after the expiry of the said period. (Sec. 272).
Disqualifications of Directors
Section 274, as amended by the Companies (Amendment) Act, 2000 states
that a person shall not be capable of being appointed director of a company, if —
(1) he has been adjudged to be of unsound mind;
(2) he is an undischarged insolvent;
(3) he has applied to be adjudged insolvent;
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(4) he has been convicted by a court and sentenced to at least six months of
imprisonment for an offence involving moral turpitude and five years have not
elapsed form the date of expiry of the sentence:
(5) he has failed to pay any call on his shares for six months:
(6) he has been disqualified by the court for fraudulent activities in company
promotion or management under Section 203.
(7) he is already a director of a public company which -
(a) has not filed the annual accounts and annual returns for any continuous
three financial years commencing on or after
(b) has failed to repay its deposits or interest thereon on due date or redeem
its debentures on due date or redeem its debentures on due date or pay dividend and
such failure continues for one year or more.
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under Section 274 (stated above) and who holds the minimum qualification shares,
if any, may be appointed as director of a company.
It may thus be noted that Section 255 permits one-third of the total number
of directors of a public company and all the directors of a private company to be
appointed otherwise than by the shareholders at a general meeting, in such manner
as provided in the articles. It follows that within the aforesaid limit as to the number
of directors, a power of appointment of directors can be validly conferred by the
articles on a third party, e.g., debenture-holders or other specified creditor nr any
other specified person, and such nominee directors may be appointed on a non-
rotational basis for any duration of time even for life as permanent directors.
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At every subsequent annual general meeting, out of the two-thirds directors
liable to retire by rotation, one third or the number nearest to one-third must retire.
The directors longest in office shall retire in the first place, but as between persons
who became directors on the same day, those who are to retire shall be determined
by lot, if there is no agreement among them [Sec. 256(2)]. The directors who are to
retire by rotation at an annual general meeting would automatically vacate office on
the last day on which the annual general meeting -ought to have been held. They
cannot prolong their tenure by not holding a meeting in time (B.R. Kundra vs.
Motion Pictures Association) [(1976), 46 Comp. Cas. 339, Delhi].
The retiring directors shall be eligible for re-election. If a new person, i.e.,
one who is not a retiring director, is to be appointed, a notice in writing must be
given to the company at least 14 days before the meeting. The notice must be given
by the person seeking appointment as director or by some member intending to
propose him as director, provided the said member is eligible to vote on the
resolution of such appointment. The person sending such notice must also deposit
Rs. 500 with the company. The company is then required to inform the members at
least 7 days before the annual general meeting about the candidature. The deposit
referred above shall be refunded to the depositor if the person succeeds in getting
elected as a director, otherwise it would be forfeited by the company [Sec.-257(1),
as amended by the Companies (Amendment) Act, 1988]. Section 257(1) does not
apply to a private company, [Sec. 257(2)].
The 'vacancies thus created must be filled up at the same meeting but if the
company fails to do this, the meeting shall be deemed to have been adjourned for a
week. If at the reassembled meeting also, the places of retiring directors are not
filled up, the retiring directors shall be deemed to have been re-elected
automatically, unless :
(a) it is resolved not to fill the vacancy, or
(b) a resolution for his re-election is lost, or
(c) he has expressed in writing his unwillingness to continue, or
(d) he has incurred a disqualification.
{154}
It should, however, be noted that each director has to be elected through a
separate resolution passed by simple majority, unless the meeting unanimously
resolves otherwise (Sic?263p Again, the appointment of a director, who is not a
retiring director will not be valid unless written consent to act as a director is filed
with the Registrar within 30 days of appointment (Sec. 264). Section 265 gives an
option to companies to provide in their articles, a system of proportional
representation of the minority interests on the Board, whether by the system of
single transferable vote or by the system of cumulative voting or otherwise.
(iii) Alternate directors. Similarly, the articles may empower the Board to
appoint an alternate director, during the absence of a director for more than three
months, from the State in which the meetings of the Board are ordinarily held. Such
an alternate director shall vacate office either on expiry of the original director's
term or on return of the original director to the state (Sec. 313).
{155}
The Company Law Board was not at all in picture] may, by order in writing,
specify as being necessary to effectively safeguard the interests of the company, or
its shareholders, or the public interest, for a period not exceeding three years. The
Company Law Board may pass the above order on a reference made to it by the
Central Government or on the application of at least one hundred members of the
company or members holding at least ten per cent voting rights. Any directors
appointed by the Central Government shall neither be required to hold any
qualification^ shares nor they shall be subject to retirement by rotation. They will
also not be included in the total number of directors for the purpose of counting
twp-thirds or any other proportion. It follows from the above that the nominee
directors together with non-rotational directors may be more than one-third of the
total number of directors, since they shall not be included in the total number of
directors for the purpose of counting two-thirds or any other proportion. Further, no
change in the Board of Directors, after such appointment as aforesaid, shall have
effect unless confirmed by the Company Law Board [Sec. 408 as amended by the
Amendment Act, 1988].
{156}
industrial concerns. These special Acts (namely, IDBI Act, UTI Act, LIC Act and
SFC Act) also provide that any appointment of directors made in pursuance of the
Tight of nomination conferred by the relevant Act shall be valid and effective
notwithstanding anything to the contrary contained in the Companies Act, and in
the Memorandum/Articles of Association of the assisted companies in regard to the
appointment of directors, retirement of directors, etc.
It may thus be noted that the directors nominated by the said special
financial institutions shall neither be included in the total number of directors for
the purpose of counting two-thirds or any other proportion, nor they shall be subject
to retirement by rotation. It follows from the above that the nominee directors of
these institutions together with non-rotational directors may constitute more than
one-third of the total membership of the Board and this will not be treated as
contravention of the provisions of Section 255 of the Companies Act.
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(2) Directorships of unlimited companies.
(3) Directorships of associations not run for profits or which prohibits the
payment of a dividend.
(1) he does not purchase the qualification shares, if any, within two months
of his. appointment or does not possess such shares at any time thereafter;
(4) he does not disclose his interest in any contract with the company before
the Board;
(5) he ceases to hold such office in the company by virtue of which he was
appointed a director;
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(Sec.314) [For details refer to the heading Directors’ etc., not to hold Office of
Profit discussed later in the chapter];
(8) he has been removed from office for fraud, misfeasance, breach of trust,
etc., by Central Government under Section 388-E [For details refer to the heading
Removal by Central Government discussed later in the chapter];
(10) he has been convicted of an offence under Section 209A. (This Section
makes it obligatory on the part of every director to produce books of account, etc.,
and to furnish information or explanation which the inspecting officer may require
in the course of inspection of books of account.)
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members. The director sought to be so removed shall have the right of being heard
at the general meeting.
(b) A director of a private company holding office for life on April 1, 1952
(2) Removal by Central Government (Sec. 388E). The Central Govt. may,
by order, remove from office any director against whom an adverse judgement has
been given by the Company Law Board, on a reference made by the Government
under Section 388B, for an alleged fraud, misfeasance, gross negligence or breach
{160}
of trust, etc., in carrying out his legal obligations. The person so removed shall not
hold the office of a director or any other office connected with the conduct and
management of the affairs of the company for a period of five years, unless the
period is remitted by the Central Government with the prior concurrence of the
Company Law Board. Again, no compensation is payable to him for the
termination of office. The company may, with the previous approval of the Central
Government, appoint another person to that office.
(3) Removal by Company Law Board (Sec. 402). The Company Law
Board also has the power to remove a director on an application made to it for
prevention of oppression (under Sec. 397) or mismanagement (under Sec. 398).
(For details refer to Chapter 19). The person so removed is disabled from holding a
managerial office in the company for a period of five years without the leave of the
Company Law Board. Further, he cannot claim compensation for the termination of
his appointment (Sec. 407).
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company. Accordingly they are not the servants of the company and have no right
to remuneration unless there is specific provision to the effect in the articles or the
shareholders resolved for the same in the general meeting. The articles, however,
generally provide for directors’ remuneration which is in the nature of honorarium.
With a view to understanding fully the legal provisions relating to the remuneration
of directors, we shall be studying the provisions concerning managerial
remuneration as a whole.
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of the annual net profits), a public company may pay remuneration to a managerial
functionary up to Rs. 24,00,000 per annum or Rs. 2,00,000 per month, varying
from Rs. 75,000 per month to Rs. 2,00,000 per month, depending on the effective
capital of the company as specified in section II Part II of Schedule XII The above
monetary ceiling limits may be doubled in case of companies which satisfy a few
additional conditions. Such remuneration may be paid as ‘minimum remuneration’
without the approval of the Central Government. Hence approval of the Central
Government for payment of remuneration upto the aforesaid ceiling limits to a
managerial functionary in case of loss or inadequacy of profits is now not required
so long as their appointment and remuneration are in accordance with Schedule
XIII.
(a) any expenditure incurred by the company in providing any rent free
accommodation or any other benefit or amenity in respect of accommodation free
of charge;
(b) any expenditure incurred by the company in providing any other benefit
or amenity free of charge or at a concessional rate;
(d) any expenditure incurred by the company to effect any insurance on the
life of, or to provide any pension, annuity or gratuity for, the person or his spouse
or child.
The term ‘remuneration’ however, shall not include: (i) any sitting or
attendance fees payable to directors for attending eac meeting of the Board or a
Committee thereof [Sec. 198(2)], and (ii) remuneration payable for acting as
technical expert [Sec. 309(1)]. However, in case of Managing Director and Whole-
time Director, the payment of sitting fees forms a part of managerial remuneration
{163}
and if they are appointed in accordance with Schedule XIII, no such sitting fees is
payable to them. A company is not allowed to make any tax-free payment of
remuneration (Sec.200). If the articles do not provide for the payment of travelling
expenses to the directors, they are not entitled to be paid travelling expenses
incurred in attending meeting of the Board or a Committee thereof or general
meeting.
Section 309 throws light upon the maximum limits of remuneration payable
to various categories of managerial personnel, viz., directors, managing/whole-
time director(s) or manager separately, of course within the overall limit mentioned
earlier. This Section states that :
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A director who is neither in the whole-time employment of the company nor
a managing director may be paid remuneration either (a) by way of monthly,
quarterly or annual payment with the approval of the Central Government; or (b) by
way of commission if the company by special resolution authorizes such payment.
But the remuneration paid to such category of directors shall not exceed (i) one per
cent of the net profits of the company if the company has a managing/whole-time
director or a manager, and (ii) three per cent of the profits if the company has no
managing/whole-time director or manager. These limits may, however, be
increased by the company in general meeting and with the approval of the Central
Government [Sec. 309(4)].
If any director has been paid in exceed of the above limits, he shall refund
such sum to the company and until such sum is refunded, hold it in trust for the
company. The company shall not waive the recovery of any such sum unless
permitted by the Central Government [Sec. 309(5A) and (5B)].
{165}
articles are vested in the directors [John Shaw & Sons (Salford) Ltd. vs. Shaw
(1935), 2 K.B. 113]. There, are certain exceptional cases, however, where the
majority of shareholders in a general meeting may intervene and exercise a power
vested in the Board -
(a) when the directors act for their own personal interests in complete
disregard to the interests of the company ;-
(b) when the Board has become incompetent to act, e.g., where all the
directors are interested in a dealing ;
(c) when the directors are either unable-or unwilling to act (Barron vs.
Potter) [(1941), 1 Ch. 895, See also Vishwanathan vs. Tiffins B.A. and P. Ltd.
(1953), A.I.R., Mad. 520].
{166}
The Board may, however, by a resolution passed at a meeting, delegate to
any committee of directors, the managing director, the manager or any other
principal officer of the company, the powers to borrow money, to invest the funds
and to make loans. The resolution should specify the extent, nature and purpose in
each case.
Besides the above mentioned powers, the Companies Act, under several
other Sections, provides for some other powers which must also be exercised at the
Board meetings only. For example:
(i) The power to fill up casual vacancies among directors (Sec. 262), to
appoint alternate directors (Sec. 313), and to appoint additional directors (Sec.
260), subject to any regulations in the Articles.
(ii) The power to accord sanction to such contracts in which any directors or
their relatives, etc., are interested (Sec. 297).
(iv) The power to appoint the first auditors of the company and to fill any
casual vacancy in the office of the auditor unless such a vacancy is caused by
resignation of the auditor (Sec. 224).
(c) The power to make loans to, or to invest in any shares and debentures of
any other body corporate under Section 372A.
{167}
Restrictions on the Power of Directors
The restrictions on the powers of directors are contained in Section 293 of
the Act. In case of public companies, the Board of Directors cannot exercise any of
the following powers without the consent of the shareholders in general meeting.
(1) sell, lease or otherwise dispose of the whole or substantially the whole of
the undertaking of the company;
Under sub-section 2(a) it has been further provided that the title of innocent
purchasers and lessees who have acted in good faith and after exercising due care
and caution (i.e., who have acted without the knowledge of non-compliance of the
above restriction) will not be affected. Moreover, this restriction does not apply to
the case of company whose ordinary business is to sell or lease property [Sub-
section 2(b)].
(2) remit or give time for the repayment of any debt due by a director;
(4) borrow moneys exceeding the aggregate of the paid-up capital of the
company and its free reserves (i.e., reserves not set apart for any specific purpose).
Borrowing here, does not include temporary loans for the company’s bankers.
(5) contributions in any year to charitable and other funds not directly
relating to company’s business or the welfare of its employees, of amount
exceeding Rs. 50,000 or 5% of the average net profits for the last three financial
years, whichever is greater. It is worth noting here that Section 293-B empowers
the Board of Directors of companies or any persons or other authorities exercising
the powers of the Board of Directors to make contributions to the National Defence
Fund or any other Fund approved by the Central Government for the purpose of
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national defence, without any limit and without obtaining the sanction of the
company in general meeting.
As per Section 318, a company may pay ‘compensation for loss of office’ or
for retirement from office to a managing director or a director holding the office of
manager or a wholetime director. No other director is entitled to such
compensation. Even in the case of former category, no payment shall be made:
{169}
(1) Where the director resigns in view of the reconstruction or amalgamation
of the company and takes an appointment as the managing director, manager or
other officer in the reconstructed or amalgamated company;
(a) Section 203 - Power of the court to restrain fraudulent persons from
managing companies;
(b) Section 283 - Vacation of office by directors [For details refer to the
Side-Heading - ‘Vacation of Office’ discussed earlier in the present chapter];
(4) Where the company is wound up due to the negligence or default of the
director;
(5) Where the director has been guilty of fraud or breach of trust or gross
negligence or gross mismanagement either in respect of the company or its holding
or subsidiary company;
(6) Where the director has instigated of has taken part directly or indirectly
in bringing about the termination of his office.
The amount of compensation shall not exceed the remuneration for the
unexpired time of office or for three years, whichever is shorter. Further, in the case
of commencement of winding up of the company any time within twelve months
after he ceased to hold office, no compensation shall be paid if the assets of the
company are not sufficient (after deducting the winding up expenses) to repay to
the shareholders the share capital (including the premiums, if any) contributed by
them.
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(i) its directors or to directors of its holding company or to their partners or
relatives;
(iv) any company where such director or directors may exercise or control
25 per cent of the total voting power;
(v) any company where the persons incharge of its management are
accustomed to act in accordance with the directions of the Board or any directors)
of the lending company.
This Section also prohibits the company from giving any guarantee or
security for a loan made by some other person to any of the above parties.
Every person, including the director or any person .to whom the-loan is
made, who is knowingly a party to any contravention of the above provisions, shall
be punishable either with fine which may extend to Rs.50,000 [Subs. for “Rs.
5,000” by the Companies (Amendment) Act 2000] or with simple imprisonment for
a period not exceeding six months. Further, every such person shall also be liable
jointly or severally to make good-the amount of loan or guarantee to the lending
company. In addition, the defaulting director shall have to vacate his office.
Section 370 and 372 which governed ‘inter-corporate loans’ and inter-
corporate investments’ respectively have been abrogated with effect from the
commencement of the Companies (Amendment) Act, 1999 (i.e., 31.10.98). They
have been replaced by a single Section, namely, Section 372A, introduced by the
Companies (Amendment) Act, 1999. In the new provisions, the restrictions on
inter-corporate loans and investments have been liberalised. For example ‘inter-
corporate loans’ and ‘inter-corporate investments’ have been put on equal footing
and without any separate ceilings (earlier separate ceilings of 30 per cent of the
subscribed capital and free reserves of the lending or investing company existed
under Sections 370 and 372). Further, the requirement of seeking Central
Government approval for exceeding the specified ceilings for inter-corporate loans
and investments has been dispensed with.
(2) Any inter-corporate investment, loan, guarantee or security for any loan
proposed to be given by a company must be approved by the Board of Directors by
a unanimous resolution passed at its meeting with the consent of all the directors
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present and entitled to vote thereon, and no circular resolution can be passed. It is
important to note that each individual proposal of investment, loan, guarantee or
security for any loan will require Board of Directors unanimous approval regardless
of the amount and whether the same is within the specified ceiling or not. However,
if the proposed investment, loan, guarantee or security is in excess of the specified
ceiling, then prior approval of shareholders by a special resolution is also required,
apart from the approval of the public financial institutions where any term loan is
subsisting. But no approval of public financial institution is required if the loans
and investments etc., are within the specified ceiling and there is no default in
repayment of loan installment or payment of interest to the public financial
institution.
(3) The Board of Directors may give ‘guarantee’ without being previously
authorised by a special resolution of shareholders, if the following three conditions
are satisfied :
(4) Corporate loans should not be made at a rate of interest lower than the
prevailing bank rate as administered by the Reserve Bank of India.
(5) A company which has defaulted in the repayment of any deposit or part
thereof or interest thereupon in accordance with the terms and conditions of such
deposit, will not be permitted to make any inter-corporate loan, investment or
provide any guarantee until the default is made good.
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(6) It is obligatory on every company to keep a “Register of Inter-corporate
Investments, Loans and Guarantees” and to enter in it with seven days of the
transaction the following particulars :
(v) to any loan made by a holding company to its wholly owned subsidiary;
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Penalty. If default is made in complying with the provisions of Section
372A, other than the provision relating to maintaining the “Register of Investments
and Loans”, the company and every officer of the company who is in default shall
be punishable with imprisonment upto two years or with fine upto Rs. 50,005,
Where, however, the loan made in violation of this Section has been repaid in full,
no punishment by way of imprisonment shall be imposed, and where it has been
repaid in part, the maximum term of imprisonment of two years will he
proportionately reduced. In addition to this criminal liability, all persons who are
knowingly party to such contravention shall be liable, jointly as well as severally,
to the lending company for the repayment of the loan or making good the amount
which the company may be required to pay in respect to the guarantee given or the
security provided by it.
Explanation. The explanation provided under this Section states that for the
purposes of this Section, -
(b) “free reserves” means those reserves which, as per the latest audited
balance-sheet of the company, are free for distribution as dividend and shall include
balance to the credit of the 'Securities Premium Account' but shall not include share
application money (which is due for refund but has not been encashed).
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(1) The Board of Directors of any company or any person or authority
exercising the powers of the Board of Directors of a company, or the company in
general meeting, may, notwithstanding anything contained in Sections 293 and
293A or any other provision of this Act or in the memorandum, articles or any
other instrument relating to the company, contribute such amount as it thinks fit to
the National Defence Fund or any other Fund approved by the Central Government
for the purpose of national defence.
(2) Every company shall disclose in its Profit and Loss Account the total
amount or amounts contributed by it to the Fund referred to above during the
financial year to which the amount relates.
It may be noted that this Section enables the Board of Directors to make
contributions to the National Defence Fund and other similar funds without any
limit and without obtaining the sanction of the general body of the company. The
Section also authorises persons or other authorities exercising the power of the
Board of Directors to make the contributions.
(1) In the case of a Government company and a company which has been in
existence for less than three financial years there shall be a blanket bah on making
of contributions to any political party or for any political purpose to any person.
(2) A company, not being a company referred to above, shall be allowed to
contribute any amount or amounts, directly or indirectly, to any political party or
for any political purpose to any person, provided that -
{176}
(a) the amount or the aggregate of the amounts os contributed in any
financial year shall not exceed five per cent of its average net profits during the
three immediately preceding financial years, and
(ii) where such publication is not by or on behalf of but for the advantage of
a political party, to be a contribution for a political purpose to the person publishing
it.
(4) The company is also required to disclose in its profit and loss account
any amount or amounts contributed by it to any political party or for any political
purpose to any person during the financial year to which that account relates, giving
particulars of the total amount contributed and the name of the party or person to
which or to whom such amount has been contributed.
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(a) the company shall be punishable with fine which may extend to three
times the amount so contributed; and
(b) every officer of the company who is in default shall be punishable with
imprisonment for a term which may extend to three years and shall also be liable to
fine.
It is worth noting that prior to the Companies (Amendment) Act, 1985 there
was a blanket ban on political contributions by all types of companies.
(3) In case of a company having a paid up share capital of rupees fifty lakhs
or more, the appointment of a sole selling agent shall require the approval of
shareholders by special resolution and also the approval of the Central Government.
But if the paid up share capital of the company increases to Rs. 50 lakhs or more
subsequent to the appointment of sole selling agents, no fresh approval of,
shareholders by special resolution and, the Central Government is required for their
continuance for the remaining duration of their current tenure.
The Section further states that these provisions shall equally apply to the
appointment of sole buying or purchasing agents.
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Compensation for loss of office (Sec.294A). No compensation shall be
payable to the sole selling agent for the loss of his office in the following cases :
(d) Where he has been guilty of fraud or breach of trust or gross negligence
in the conduct of his duty as the sole selling agent;
The amount of compensation shall not exceed the remuneration for the
unexpired term of office or for three years, whichever is shorter.
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“his” would indicate that the office contemplated was one held by the director at
the time of assignment. An appointment to an office can be made only if the office
is vacant. It is legitimate, therefore, to infer that by using the word “his” the
Legislature indicated that an appointment by a director to the office which he
previously held but did not hold at the date of appointment, was not to be included
within the word “assignment”.
It may be recalled that Section 255 of the Act which provides for the
subsequent appointment of directors expressly permits one-third of the total number
of directors of a public company and all the directors of a private company to be
appointed otherwise than by the shareholders, if the articles make provision in this
regard. It thus becomes evident that Section 255 approves of a person having power
to appoint a succession of directors and thereby to have the power of perpetual
management.
The Section imposes restriction upon the directors and their associates in
regard to their holding an office or place of profit in the company or a subsidiary
thereof. It provides that, unless the company approves by a special resolution:
The Madras High Court in A.R. Sudersanam vs. The Madras Purasawalkam
Hindu Janopakara Saswatha Nidhi Ltd. [(1985), 57 Comp. Cases. 776] after
analysing clauses (a) and (b) of Sub-section (1) of Section 314 (stated above) held
{181}
that clause (a) of subsection (1) deals with a case of a director holding any office or
place of profit, while clause (b) has to be read in conjunction with clause (a). If so
read, it is amply clear that the prohibition under clause (b) is restricted to a relative
etc., of such director, namely, the director holding any office or place of profit
referred to in clause (a), jut not to any ordinary sitting director. Therefore,
according to this judgement, clause (b) of Section 314 is not attracted where an
ordinary sitting director's relative holds any office or place of profit under the
company. Thus, if the son of an ordinary director is appointed to a place under the
company carrying a salary of Rs. 12,000 without the requisite formalities, the
provisions of Section 314(1) are not violated and he is not bound to vacate his
office.
It is further provided that in case any such appointment has been made
without the sanction of shareholders, the consent of the shareholders accorded by a
special resolution must be obtained in the first general meeting of the company held
after such appointment Again, if the appointment of a relative of a director or the
firm in which such a relative is a partner is made without the knowledge of the
director, the consent of the company may be obtained either in the general meeting
aforesaid or within three months after the date of appointment, whichever is later. If
a special resolution is passed for appointment of a director's relative in the first
instance, and subsequently the employee concerned is given a higher remuneration,
a special resolution is required again for giving such higher remuneration, except
where an appointment on a time scale was already approved by the earlier special
resolution.
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shall require not only the prior approval of shareholders by a special resolution but
also of the Central Government:
(a) Partner or relative of a director or manager.
(b) Firm in which such a director or manager, or relative of either, is a
partner.
(c) Private company of which such a director or manager, or relative of
either, is a director or member.
The observation made by the Delhi High Court in Dalmia Cement (Bharat)
Ltd., and Another vs. Union of India and Another [(1980), 58 Comp. Cas.] is worth
noting here: “The object of Section 314(IB) is to see that the moneys of the
company are not siphoned into the pockets of the relatives of directors without such
persons being otherwise competent to fill the office or without rendering real
services to the company...”
(1) For the holding of office of :(a) Managing Director, (b) Manager, and (c)
Banker or trustee for debenture holders.
{183}
Penalty. If any office or place of profit is held in contravention of the above
provisions, then the director, partner, relative, firm, private company or the
manager concerned, shall be deemed to have vacated his or its office, as from the
date next following the date of the general meeting of the company at which the
appointment was not approved and shall be liable to refund the amount or monetary
equivalent of any prequisite or advantage enjoyed. The company cannot waive the
recovery of any sum so refundable to it unless permitted to do so by the Central
Government. It may be noted that a director shall be deemed to have vacated his
office only when he himself had contravened and not when his relative or partner,
etc., is guilty of contravention.
In view of its far reaching effects, the Section applies to all companies,
whether public or private.
The provisions of Section 314 do not apply to a person who, holds an office
of profit in the company, is appointed by the Central Government under Section
408^ as a director of the company.
Whenever a company has to deal for the sale, purchase or supply of any
material or service or has to enter an underwriting contract, with any director or his
associate or partner, etc., the consent of the Board of Directors must be obtained.
The consent of the Board has to be accorded by a resolution passed as its meeting.
It is not enough to obtain the consent by means of a resolution passed by
circulation: Such approval of the Board is, however, not necessary in the following
cases:
(a) where the contract relates to purchase and sale of goods for cash at the
current market prices; or
(b) where the value of the goods and material does not exceed Rs. 5,000 in
any year and it is an item of regular trade or business of such director, relative or
partner, etc.; or
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(c) where the transaction is by a banking or insurance company in the
ordinary course of business.
In an emergency, however, a company may enter into any contract for the
purchase and sale of goods with any director or his relative or partner, etc., (even
for a value beyond Rs. 5,000), without obtaining the consent of the Board. But in
such a case the consent of the Board must be obtained within three months. If
consent is not accorded to any such contract, the contract shall be voidable at the
option of the Board.
In the case of companies having paid up share capital of rupees one crore or
more, it is further necessary that the previous approval of the Central Government
[The Central Government's power in this regard has been delegated to the Company
Law Board] must also be obtained for entering into any contract with any director
or his associate or partner, etc., for sale, purchase or supply of goods, materials or
services, whatever its value and whether for cash or otherwise. It may be noted that
failure to obtain such prior permission of the Central Government will make the
contract illegal and void.
{185}
the Amendment Act, 2000] and shall also be accountable for any secret profits
made by him, and the contract shall be voidable at the option of the Board (Hely-
Hutchimon vs. Brayhead Ltd)[(1976), 2 All. E.R. 14.].
Section 300 provides that the interested director can neither participate in the
discussion nor vote on the matter of his interest in the meeting of the Board.
Moreover, his presence shall not be counted for the purpose of quorum. The
penalty for contravention-may be up to fifty thousand rupees1. Note that where
interested director votes, the proceedings are not thereby invalidated, but only his
vote will be void, that is to say, it will not be counted (Sundaraja Pillai vs. Sakti
Talkies Ltd.) [(1967), Comp. Cases, 463].
In case the original memorandum does not contain any such provision, a
company may, if so allowed by its articles, alter its memorandum by a special
resolution and make the liability of any of the above managerial personnel
unlimited. But such an alteration shall not apply to existing managerial personnel
unless they accord their consent to it.
Meeting of Board
We have observed earlier that the directors can only exercise their powers
collectively at Board meetings, unless the articles otherwise provide (Re Cleadon
Trust Ltd [(1939), Ch. 286]). As such as per Section 285 it has been made
obligatory on the part of every company to hold a meeting of its Board of Directors
at least once in every three months and at least four such meetings must be held in
every year. The Central Government may, however, by notification in Official
{186}
Gazette, direct that this provision shall not apply in relation-to any class of
companies.
If a meeting of the Board could not be held for want of quorum, then, unless
the articles otherwise provide, the meeting shall automatically stand adjourned till
the same day in the next week and at the same time and place. If a meeting could
{187}
not be held for want of a quorum, it shall alright be counted towards the minimum
number of meetings which must be held in every year under Section 285. (Sec.
288).
Each director has one vote for each resolution put to vote at the meeting.
However, if the articles do not provide otherwise the Chairman has a ‘second’ or
‘casting vote’ in the event of equality of votes. Voting normally takes place by
show of hands, there being no provision for polls and proxies in the case of Board
meetings.
{188}
It must have been noted from the foregoing provisions that if a proper notice
has not been given to all the directors or/and the quorum is not present throughout
the meeting, the Board's meeting is invalid. This invalidity, however, does not
affect the interests of third parties, who have no notice of the irregularity, on the
principle of ‘Indoor Management’ following the decision in Royal British bank vs.
Turquand [(1856), 6 E. & B. 327]. Thus, where the quorum of the Board was three
and at a meeting of two, the secretary was asked to affix the seal to a mortgage, it
was held that as between the company and the mortgagee, who had no notice of
irregularity, the execution of the deed was valid (County of Gloucester Bank vs.
Rudry Merthyr & Co.) [(1895), 1 Ch. 629]. A subsequent properly convened and
legally constituted Board meeting can always ratify and confirm what was done at
the prior irregular meeting, and it will then be valid ab-initio (Re State of Wyoming
Syndicate) [(1901), 2 Ch. 431].
For further protecting the interests of outsiders dealing with the company,
Section 290 contains a very important provision regarding the validity of acts of
directors. The Section provides that acts of a director shall be valid notwithstanding
that it may afterwards be discovered that his appointment was invalid by reason of
any defect or disqualification or had terminated by virtue of any provision in the
Act or in the articles of the company, but the acts done by such a director after his
appointment has been shown to the company to be invalid or to have terminated
shall not have any validity.
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terminated by reason of any irregularity in their appointment or because of
incurring any disqualification, as contained in Section 283, leading to vacation of
office (already discussed in the present chapter). Thus, the acts of a director
appointed at a meeting of which insufficient notice was given would be validated
by the Section (British Medical, etc. .Association vs. Jones) [(1889), 61 L.T. 394].
Similarly, a call made by the directors one of whom had ceased to hold his
qualification shares for a very short period was held to be valid (Dawson vs.
African Consolidated Land Trading Co.) [(1898), 1 Ch. 6]. The Section does not
apply to a case where there was no appointment at all or where a director continues
to act after the expiry of his term of office (Karnal Distillery Co. vs. Ladli
Prashad) [(1960), A.I.R. Punj. 655].
It may be noted that the Section aims to protect persons dealing with the
company — outsiders as well-as members, in the case of bonafide acts only and not
where they are done with notice that they were done wrongfully or illegally.
Further, it validates only the acts of directors and not the acts of managing director
or manager.
(i) It is the duty of the Board to see that all moneys received from applicants
for shares is deposited in a schedule bank until the 'certificate to commence
business1 is obtained under Section 149 or the money is returned to the applicants
under Section 69(5). [Sec. 69(4)]
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(ii) Section 165 requires the Board of Directors to forward a copy of the
Statutory Report at least 21 days before the Statutory Meeting to every member of
the company and to the Registrar.
(iii) The Board is required to call, on the requisition of the specified number
of members, an extraordinary general meeting of the company. [Sec. 169(1)].
(iv) At every Annual General Meeting of a company, the Board shall lay
before the company a Balance Sheet and a Profit and Loss Account. [Sec.210(1)]
(vi) At the meeting of the creditors in a “creditors voluntary winding up”, the
Board of Directors of the company must (a) cause a full statement of the position
of-the company's affairs together with the list of creditors and the estimated amount
of their claims to be laid before the meeting; and (b) appoint one of their number to
preside at the said meeting., [Sec. 500(3)].
The duties of directors under the general law may briefly be put as follows:
(1) They must always act bonafide for the benefit of the company. They
stand in a fiduciary relationship with the company and therefore must not make any
secret profit.
(2) They must discharge their duties with such care as is reasonable in a
person of their knowledge and experience.
(3) They must not be negligent. The directors must attend Board's meeting
unless impossible otherwise.
(4) They must perform their duties-personally. The maxim "delegates non
potest delegare” (a delegate cannot delegate further) applies to them like all agents.
Hence, unless permitted by the articles specifically, the directors must not delegate
any of their-powers to some other person.
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8.12 Liability of Directors
So long as the directors act intra vires, in good faith, bonafide and take
reasonable care in the discharge of their duties, they incur no personal liability. But
they may become personally liable to make good the loss to the company:
(i) For ultra vires acts - where they enter into contracts ultra vires the
memorandum or ultra vires their powers, e.g., selling the whole undertaking.
(ii) For breach of trust - where they make secret profits or use company’s
funds for their personal use.
(iii) For acting dishonestly, e.g., purchasing goods in thewir own name first
and then selling it to the company at a higher price with intention to make profits.
(iv) For gross negligence in the performance of their duties, e.g., delegation
of power when the articles do not permit or paying dividends when there are no
profits. It is to be noted that an error of judgement will not make them liable so
long as they are honest and careful.
(vi) For the acts of his co-director where he habitually absents himself from-
the Board meetings.
(ii) For acting in their own name, e.g., signing a negotiable instrument
without mentioning the name of the company.
(iii) For breach of implied warranty of authority — where they enter into
any contract which is ultra vires the company or ultra vires their powers, e.g.,
where moneys are borrowed beyond the powers of the company from a lender who
advanced the loan in good faith and without knowledge that the limits imposed by
the Articles had been exceeded (Weeks vs. Property) [(1873), 42 L.J. (CP) 149].
(iv) Where their liability has been made unlimited by a provision in the
memorandum.
{192}
(v) For the debts and liabilities of the company at the time of winding up, if
the court hold them so liable because of fraudulent trading by them. (Sec. 542).
Criminal Liability. The directors also incur criminal liability for fraud and
non-compliance of the various provisions of the Act. Here they are punishable with
fine or imprisonment or both under various Sections of the Act. For example, they
will be liable to penalty under the following Sections of the Act:
(i) Section 63 — for misstatements in the prospectus.
(ii) Section 75 — for failure to file return as to allotments with the Registrar.
(iii) Section 95 - for failure to give notice to the Registrar of consolidation of
share capital, conversion pf shares into stock, etc.
(iv) Section 113 - for failure to issue certificates of shares and debentures
within specified time limits.
(v) Section 142 - for default in filing with the Registrar for registration the
particulars of .any charge created by the company requiring registration or of any
fact connected therewith.
(vi) Section 150 - for not keeping registers of members and debenture -
holders.
(viii) Section 210 - for failure to lay before the company at every annual
general meeting annual accounts and balance sheet:
(ix) Section 239 - for holding office as director in more than fifteen
companies in contravention of the provisions of the Act.
(x) Section 295 - for taking loan from the company without the approval of
Central Government, thus contravening the provisions of this Section.
In all the penal provisions of the Act, the person sought to be made liable is
described as officer who is in default. The expression ‘officer in default’ means and
{193}
includes all (a) the managing directors); (b) the wholetime director(s); (c) the
manager; (d) the secretary; (e) any person charged by the Board with the
responsibility of complying with that provision, irrespective of the fact whether
they were responsible for the commission of that offence or not. In case of a Board
managed company (i.e., where there are no managing or wholetime dirctor(s) or
manager), the Board may specify any directors) in this behalf, failing which all the
directors will be held liable [Sec.5, as substituted by the Companies (Amendment)
Act, 1988].
{194}
Board meeting, under a separate service contract setting out his powers and duties
and terms of employment. As such a managing director is a service director and he
is to act under the control and supervision of the Board. As a managing director
must necessarily be a director his appointment is automatically terminated if he
ceases to act as a director either because of any disqualification, e.g. not purchasing
qualification shares within two months of his appointment as director or because of
his retirement by rotation.
(1) Every public company having a paid-up share capital of Rs. five crores
or more shall have a managing or whole-time director or manager [Sec. 269(1)].
(2) If the conditions specified in Schedule XIII [Schedule XIII has been
reproduced at the end of the Chapter in the Appendix] are fulfilled, the managing or
whole-time director or manager in a public company can be appointed/ reappointed
{195}
without the approval of Central Government. A return in the prescribed form no.
25C is, however, required to be filed within 90 days of appointment [Sec. 269(2)].
(3) If the conditions specified in Schedule XIII [Ibid] are not complied with,
an application seeking approval to the appointment must be made to the Central
Government within 90 days from the date of such appointment/ reappointment
[Sec. 269(2X3)].
(4) The Central Government may grant approval for a period lesser than the
period for which the proposal has been made. The Government can also reject the
application in case in its opinion the appointee is not a ‘fit and proper, person’ or
his appointment is ‘not in public interest’, or if the terms and conditions of his
appointment are not fair and reasonable [Sec. 269(4)(5)].
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whose appointment is invalidated, will be deemed to be valid [Sec.
269(7)(8X9X10X12)].
(9) The maximum term of appointment can be five years at a time. Re-
appointment is possible but it may be made within the last two years of his present
term only (Sec. 317); There is, however, no restriction regarding the term of
appointment of a wholetime director.
It is important to note that the person ceases to be managing director with his
ceasure of directorship on account of his retirement by rotation at the Annual
General Meeting. But, if such a person is re-elected as director at the Annual
General Meeting and thereby he continues as a director of the company, he shall
continue as a managing director also for the period for which he is so elected by the
Annual General Meeting and for the unexpired period of his present term of
appointment as managing director.
(10) No person can act as a managing director of more than two companies
at a time, including both public, and private (where at least one of the two
companies is a public company) [person can at a time be a managing director of
more than two private companies]. Where a person who is already a managing
director of some other company is to be appointed as managing director in the
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company, an unanimous resolution of the Board of directors is required. The
Central Government may, however, permit any person to be appointed as a
managing director of more than two companies, if it is satisfied that the companies
should have a common managing director for their proper working (Sec. 316). A
wholetime director, being a wholetime employee of the company, cannot obviously
act in more than one company at a time.
In practice, however, the Company Law Board does not ordinarily approve a
person's appointment as managing director in two companies of large size except in
cases where they are engaged in more or less similar or allied business or situated
in the same area. The remuneration approved for the appointment in the second
company is also regulated suitably.
In brief, the above Section provides that a managing or whole time director
should be a man of character and integrity that he should never have been adjudged
an insolvent, or suspended payment or made composition with his creditors and
should never have been convicted of an offence involving moral turpitude. This
Section applies to private companies also.
From the above description we find that the term ‘managing director’ is used
side by side with the term ‘whole-time director’ in several Sections of the Act and
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most of the provisions apply to both of them equally. Obviously, this may pose a
question to the mind of a careful reader as to whether these two terms - ‘managing
director’ and ‘wholetime director’ - denote the same business executive under two
different names or whether they donote two altogether different personalities in a
company?
A close study of the definitions and of the legal provisions relating to the .
status and powers, etc., of managing or wholetime director reveals that they are not
exactly the same. They differ from each other in the following respects:
(2) The appointment of a managing director does not require the consent of
the shareholders but for the appointment of a wholetime director the sanction of
the sharehplders. be means of a special resolution, is necessary except when he is
appointed in the capacity of trustee for debenture-holders or manager (Sec, 314).
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(4) A managing director can be a managing director of more than one
company (Sec.316) but a wholetime director, being a wholetime employee of the
company. cannot be a wholetime director in more than one company.
It may, thus, be observed that the two offices, namely, that of a managing
director and whole-time director denote altogether different positions in a company
with marked difference in the magnitude and extent of powers and responsibilities.
8.15 Manager
In the present context the term 'manager1 means the chief executive officer
of a company, appointed as the Genera! Manager. The term does not refer to such
executive personnel as factory manager, works manager, sales manager, etc.
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(2) There cannot be more than one manager in a company whereas there
may be more than one managing director in a. company, each incharge of only a
division or activity of the business.
(a) is an undischarged insolvent or has at any time within the preceding five
years been adjudged an insolvent; or
(b) suspends or has at any time within the preceding five years suspended,
payment to his creditors, or makes or has at any time within the preceding five
years made a composition with them; or
(c) is or has any time within the preceding five years been convicted by a
court in India of an offence involving moral turpitude.
It may, thus, be noted that while judging the competence of a person for the
office of a managing director, the whole life of that person is taken into account as
per Section 267 (discussed already) whereas in the case of appointment of a manger
the corresponding period is limited to only five years immediately preceding the
date of his appointment.
(5) In the case of managers, the Central Government may remove the
disqualifications (as stated in point No. 4 above) either generally or in relation to
any company or companies by notification in the Official Gazette [Sec. 385(2)], but
in the case of managing directors the law does not make any similar provision.
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(6) The maximum remuneration payable to a manager cannot exceed 5% of
the annual net profits (Sec. 387) but in the case of managing directors (where there
is more than one) the maximum limit is fixed at 10 per cent of the annual net profits
[Sec. 309(3)].
8.16 Summary
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and each director must acquire his qualification shares within two months after his
appointment. Further, the nominal value of the qualification shares must not exceed
Rupees five thousand or the nominal value of one share where it exceeds Rupees
five thousand. Share warrants are not to be counted for the purpose of share
qualification.
If a director fails to obtain his qualification shares within two months, his
office automatically falls vacant on the expiry of two months from the date of his
appointment.
The first directors of a company are usually appointed by name in the Articles or in
the manner provided therein. Where the Articles do not provide for the appointment
of first directors, the subscribers to the Memorandum, who are individuals shall be
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deemed to be the first directors o the company subject to the regulation of the
company’s articles. The first directors can hold office until the directors are duly
appointed in accordance with the provisions of section 255.
Directors may also be appointed by the Central Government where an order to that
effect is passed by the Company Law Board. The Company Law Board may pass
such an order either on a reference by the Central Government or on the application
of not less than one hundred members of the company or of members holding not
less than 1/10th of the total voting power. Such appointments shall be ordered by
the Company Law Board (now Tribunal) where it finds that the affairs of the
company have been conducted in a manner oppressive to any member of the
company or in a manner prejudicial to the interests of the company or to public
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interest. Such a director may be appointed for any term but not exceeding three
years.
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companies and alternate directorships for computing the aforesaid fifteen
directorships.
Powers of the Board of Directors - As per section 291, the Board of Directors have
been conferred what are called the general powers. As per the said section, the
Board of directors of a company shall be entitled to exercise all such powers, and to
do all such acts and things, as the company is authorised to exercise and do.
However, the said provision of section 291 is subject to the restrictions contained in
the Companies Act, any other statute, the Memorandum or Articles, the resolution
passed at the general body meeting.
Office or place of profit - As per section 314, certain restrictions have been placed
on the holding of office or place of profit in a company by the directors and their
associates.
Liabilities of directors - The liability of a director to the company may arise from
breach of fiduciary duty, ultra vires act, negligence and mala fide acts. On these
counts directors can be held liable to compensate the company or the members for
any loss that may have occasioned.
Besides liability towards company and the members, directors may also be held
liable towards third parties. Under the various provisions of the Companies Act
directors may be held personally liable to the third parties in respect of matters
which may include failure to state any particulars as per Schedule II to the Act or
is-statements of facts, allotment of shares in contravention of section 69, section 70,
section 73 etc. Directors can also be held liable to the third parties for exceeding the
authority conferred upon them under the Act or the Articles.
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Apart from civil liability under the Companies Act or under the common law,
directors of a company may also incur criminal liability under the common law as
well as under the Companies Act and certain other statutes.
In case of loss making companies, Schedule XIII places further limitations on the
remuneration payable to managing director, whole time director or manager. In
case of loss making companies or companies having inadequate profits, monetary
ceilings have been placed varying with the effective capital of the company
concerned.
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powers subject to the superintendence, control and direction of the Board of
directors.
Section 269(1), as amended by the Act of 1988, makes it obligatory for a public
company or a private company which is a subsidiary of a public company having a
paid up share capital of Rupees five crores or more to appoint a managing or whole
time director or a manager.
The tenure of a managing director cannot exceed five years at a time. However,
section 317 permits the reappointment or re-employment or extension of his term
but not beyond five years on each occasion.
Under section 267 certain categories of persons have been disqualified from
appointment to the post of a managing director. These disqualifications are in
additions to the disqualifications relevant to a director provided under section 274.
Manager - Under section 2(24), a manager is defined as an individual who has the
management of the whole or substantially the whole of the affairs of the company.
The expression includes a director or any other person occupying the position of a
manager by whatever name called and whether under a contract of service or not.
Like a managing director, a manager is to function subject to the superintendence,
control and directions of the Board of Directors. Once again, like a managing
director, only an individual can be appointed a manager of a company. Further,
section 385 renders certain categories of persons disqualified from being appointed
to the post of a manager.
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Whole time director - The term ‘whole time director’ has been used in the Act side
by side with that of the managing director. However, unlike ‘Managing director’,
‘whole time director’ has not been defined. One may infer that the expression
‘whole time director’ has been used in the Act to suggest a director who is in the
whole time employment of the company but does not enjoy the substantial powers
of management. Besides, a managing director may be appointed in that capacity in
two or more companies at the same time but a whole time director cannot act as
such in more than one company. Further, there is no restriction in terms of the
tenure of appointment of a whole time director as contrasted with that of a
managing director who at one time cannot be appointed for more than five years.
(i) Manager
{209}
Unit – 9 Company Meetings
Structure
9.0 Introduction
9.1 Kinds of General Meetings
9.2 Statutory Meeting and Statutory Report
9.3 Annual General Meeting
9.4 Extra-ordinary General Meeting
9.5 Requisites of a valid Meeting
9.6 Voting Rights and Methods
9.7 Resolution
- Ordinary
- Special
- Requiring Special Notice
- By Postal Ballot
9.8 Members’ Resolution
9.9 Minutes of Meetings
9.10 Summary
9.11 Check your Progress
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9.0 Introduction
{211}
not a general meeting but similar rules relating to convening and conducting of a
meeting apply to it (Sec. 170).
Statutory Meeting
Statutory Report
In order to enable the members to make the best use of this opportunity the
directors are required to prepare and send to every member a document known as
the “statutory report” at least 21days before the day on which the meeting is to be
held. If the report is sent later it will still be valid if it is so agreed to by a
unanimous vote of the members entitled to attend and vote at the meeting [Sec.
165(2)]. The report should be certified as correct by at least two directors, one of
whom shall be the managing director where there is one, and must also be certified
by the auditors [Sec. 165(4)]. A copy of this report must be filed with the Registrar
forthwith at the time of sending it to members [Sec. 165(5)].
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The statutory report must set out the following information [Sec 165(3)] :
(ii) the total amount of cash received by the company in respect of all the
shares allotted;
(iii) an abstract of the receipts and payments up to a date within seven days
of the report and the balance in hand. The abstract must show under distinctive
headings the receipt of the company from shares, debentures and other sources and
shall give an account or estimate of the preliminary expenses qt the company
showing separately any commission or discount paid or to be paid on the issue or
sale of shares or debentures;
(vi) the extent to which any underwriting contract has not been carried out
and the reasons therefor;
(vii) the details of arrears of calls due from directors and managing director
or manager; and
It any default is made in filing the statutory report with the Registrar or in
holding the statutory meeting, every director or other officer of the company
responsible for the default shall be punishable with a fine up to Rs. 5000 [Subs. for
“Rs. 500” by the Companies (Amendment) Act, 2000] [Sec. 165(9)] Further, if the
statutory meeting is not held in time, the court may, under Section 433 order the
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compulsory winding up of the company, on a petition filed by the Registrar or by
any member after the expiry of 14 days from the date on which statutory meeting
was to be held [Sec. 439(7)].
Every company must in each year hold in addition to any other meeting a
general meeting as its annual general meeting [Se. 166(1)]. It is the most important
meeting of the members of a company. It is held each year with a view to
reviewing and evaluating the overall progress of the company during a year. The
annual general meeting is sometimes called ordinary general meeting as usually it
deals with the so called ‘ordinary businesses’. The following ordinary business
must be transacted at the annual general meeting of a public company [Sec.
173(1)(a)]:
(a) the consideration of the Annual Accounts, Balance Sheet and the Reports
of the Board of Directors and Auditors,
(d) the appointment of, and the fixation of the remuneration of the auditors.
Any other business on agenda except that listed above shall be considered as
special business. It is to be noted that in the case of extraordinary general meeting
all business shall be treated as “special business” (Sec. 173(l)(b)]. It is relevant to
state-that the ordinary business requires an ordinary resolution while the special
business may require ordinary or special resolution as per Articles or the Act. A
special resolution is, however, required for any appointment of auditors, although it
is an item of ordinary business, in the case of a company in which not less than
25% of the subscribed share capital is held, whether singly or jointly, by a public
financial institution or a Government company or Central Government or any State
Government or a nationalised bank or a general insurance company (Sec. 224A).
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It may be noted that a private company may make its own provisions touts
articles in respect of ‘ordinary business’ to be transacted at an annual general
meeting [Sec. 170(1)(ii)].
Statutory Requirements
(1) The first annual general meeting of a company must be held within 18-
months from the date of its incorporation and if such general meeting is held within
that period, it shall not be necessary for the company to hold any annual general
meeting in the year of its incorporation or in the following year. It may be noted
that there can be no extension of period beyond 8 months in case of this meeting
even by the Registrar [Sec. 166(1)].
(2) Subsequent annual general meeting must be held each year within six
months of the end of the company’s financial year [Sec. 210(3)(b)], but the interval
between any two annual general meetings must not be more than fifteen months.
The Registrar may, however, for any special reason extend the above time by a
period not exceeding three months [Sec. 166(1)].
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(3) The annual general meeting must be held on a working day during
business hours the registered office of the company, or at some other place within
the city where the registered office of the company is situated [Sec. 166(2)].
(4) At least twenty-one days written notice to call an annual general meeting
must be given to every shareholder, directors and auditors of the company, and to
every such person on whom the shares of any deceased or insolvent member may
have developed (Secs. 171(1) and 172(2)]. The meeting may be held with a shorter
notice, if it is so agreed unanimously by all members entitled to vote in such a
meeting [Sec. 171(2)]. A private company may, however, by its . articles make its
own regulations as regards length of period of notice and to whom it should be
given [Sec. 170(l)(ii)].
Further the company and every officer who is in default is liable to a fine
which may extend to fifty thousand rupees [Subs, for “Rs. 5,000” by the
Companies (Amendment) Act, 2000] and in the case of a continuing default, with a
further fine which may extend to Rs. 2,500 [Subs. for “Rs. 250” by the Companies
{216}
(Amendment) Act, 2000] for every day after the first during which such default
continues (Sec. 168).
(b) the amounts, if any, which the Board proposes to carry to any reserves in
the Balance Sheet;
(c) the amount, if any, which the Board recommends should be paid by way
of dividend;
The Section further provides that the Directors’ Report shall, so far as is
material for the appreciation of the state of the company’s affairs by its members
and will not in the Board's opinion be harmful to the business of the company or of
any of its subsidiaries, deal with any changes which have occurred during the
financial year —
(a) in the nature of the company's business;
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(b) in the company's subsidiaries or in the nature of the business carried on
by them; and
(c) generally in the classes of business in which the company has an
interest.
As per sub-section (2A) of Section 217, the report of the Board of Directors
shall also include a statement showing the name of every employee of the company
who was in receipt of remuneration of two lakh rupees or more per month or
twenty four lakh rupees or more per annum inclusive of the Value of perquisites
during the financial year [These monetary ceilings were increased from Rs. one
lakh to Rs. two lakhs and form Rs. twelve lakhs to Rs. twenty four lakhs
respectively w.e.f. 17-4-^002 vide The Companies (Particulars of Employees)
(Amendment) Rules, 2002]. Further, if any employee alongwith his spouse and
dependent children holds at least two per cent of the equity shares of the company,
then his particulars are also to be disclosed in the said Statement provided he was in
receipt of remuneration which is in excess of that drawn by the managing director
or whole-time director or manager. The said Statement is also required to indicate
whether any such employee is a relative of any director or manager of the company
and if so, the name of such director, and such other particulars as may be
prescribed.
(i) that in the preparation of the annual accounts, the applicable accounting
standards had been followed along with proper explanation relating to material
departures;
(ii) that the directors had selected such accounting policies and applied them
consistently and made judgments and estimates that are reasonable and prudent so
as to give a true and fair view of the state of affairs of the company at the end of the
financial year and of the profit or loss of the company for that period;
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(iii) that the directors had taken proper and. sufficient care for the
maintenance of adequate accounting records in accordance with the provisions of
the Act for safeguarding the assets of the company and for preventing and detecting
fraud and other irregularities;
(iv) that the directors had prepared the annual accounts on a going concern
basis.
The directors are also bound to give fullest information and explanations in
their report on every reservation, qualification or adverse remark contained in the
Auditors’ report.
The Boards’ report and any addendum thereto must be signed by the
chairman of the Board if he is authorized to do so or it shall be signed by such
number of directors as are required to sign the Balance Sheet and the Profit and
Loss Account of the company. Failure to take all reasonable steps to comply with
the above provisions would render every director or other officer of the company
responsible for the default liable to imprisonment up to six months, or fine up to
Rs. 20,000 [Subs, for “Rs. 2000” by the Companies (Amendment) Act, 2000], or
both.
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All general meetings other than the statutory and annual general meetings
are called extraordinary, general meetings. Regulation 47 of ‘Table A’ defines: “All
general meetings other than annual general meetings shall be called extraordinary
general meetings”. These meetings may be convened by the company at any time.
The business transacted at an extraordinary general meeting comprises anything
which cannot be postponed till the next Annual General meeting, e.g. changes in
memorandum and articles of association, reduction and reorganisation of share
capital, issue of debentures etc. All business transacted at this meeting is called
‘special business’ [Sec. 173(l)(b)]. The convening and conducting of this meeting is
governed, like the annual general meeting by Sections 171 to 186 which will be
discussed under the heading 'Requisites of a Valid Meeting' later in the present
chapter.
(1) By the directors. The directors, may, whenever they think fit, convene
an extraordinary general meeting by passing a resolution to that effect in the
Board’s meeting.
(2) By the directors on requisition (Sec 169). The directors must convene
all extraordinary general meeting on the requisition (written demand) of members
holding not less than 1/10th of total voting rights on the matter of requisition. The
requisition must state the matters for the consideration of which the meeting is to be
called. It must be signed by the requisitionists and deposited at the registered office
of the company. The directors should, within 21 days from the date of the deposit
of a valid requisition, move to call a meeting and should give 21 days’ notice to
members for calling such a meeting and the meeting should actually be held within
45 days from the date of the requisition.
It may be noted that the requisitionists are not bound to disclose reasons for
the resolution they propose to move at the meeting (Life Insurance Corporation vs.
Escorts Ltd.) [(1986), 59 Comp. Cases 548 (SC)]. Further, no business other than
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the business for which the meeting has been expressly convened can be transacted
at the requisitioned meeting.
(3) By the requisitionists themselves (Sec. 169). If the directors fail to call
the meeting within aforementioned time limits, the requisitionists, or such of the
reguisitionists as represent not less than 1/10th of the total voting rights of all the
members, may themselves convene a meeting within three months of depositing the
requisition. Such a meeting should be called in the same manner, as nearly as
possible, as that in which meetings are called by the Board. Any reasonable
expenses incurred by the requisitionists must be repaid to them by the company,
and any sum so paid shall be retained by the company out of any sums due or likely
to become due to the directors in default.
(4) By the Company Law Board (Sec. 186). If for any reason it is
impracticable to call or conduct an extraordinary general meeting, the Company
Law Board may, either of its own motion or on the application of any director or
any member who would be entitled to vote, order a meeting to be called, held and
conducted in such manner as the Company Law Board thinks fit and may give such
directions as it thinks expedient, including a direction that one member present in
person or by proxy shall be deemed to constitute a meeting.
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conducting the meeting shall invalidate the proceedings of the meeting. Such
invalidation, however, does not affect the interests of third parties, who have no
notice of the irregularity, on the ‘Principle of Indoor Management’ following the
decision in Royal British Bank v. Turquand [(1856), 6 E. & B. 327. For details of
the Case refer to Chapter 6].
Sections 171 to 186 of the Companies Act contain provisions relating to the
holding of valid general meetings which must be compulsorily followed by every
public company, in addition to any other rules provided in the articles of the
company [Sec. 170(1)(i)]. A private company is free to make its own regulations by
its articles with respect to general meetings and the provisions of Sections 171 to
186 shall apply to such a company only if its articles do not provide otherwise [Sec.
170(1)(ii)].
The following are the requisites of a valid meeting as per the Companies
Act:
(1) Proper convening authority. A valid meeting should be called by a
proper authority. The proper authority to convene a general meeting of shareholders
is the directors who should pass a resolution at a Board meeting for the same. Of
course in the event of default by the directors, the reguisitionists or the Company
Law Board shall become the proper authority to call such a meeting. It may be
noted that the resolution to call a general meeting must be passed at a valid Board’s
meeting, otherwise the notice calling the general meeting will itself become invalid
and the proceedings of the meeting shall not be effective (N.V.R. Nagappa Chettiar
vs. The Madras Race Club) [(1949), M.L.J. 662].
(2) Proper notice. A proper notice of the meeting should be given to every
shareholder (equity and preference), auditors of the company, each director of the
company an3 to every such person who is entitled to attend the meeting, i.e., the
persons on whom the shares of any deceased or insolvent member may have
devolved. Deliberate omission to give notice to a single member may invalidate the
meeting, although an accidental omission to give notice to, or the non-receipt of
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notice by, any member or other persons to whom it should be given shall not
invalidate the proceedings of the meeting [Sec. 172(2)(3)].
The notice should be in writing and must be given at least 21 days before the
date of the meeting (Sec. 171). In calculating 21 days, 48 hours from the date of
posting should be excluded (Sec. 53). Further, in the leading case of N.V.R.
Nagappa Chettiar vs. The Madras Race Club [Ibid.], it was held that ‘days’ means
‘clear days’, i.e., excluding both the date on which the notice for a meeting is
served or expected to be served and the date of the meeting. Thus a valid notice
must be sent at least 25 days before the date of the meeting so that 21 ‘clear days’
notice may be given to the recipients. The meeting may Id with a shorter notice if it
so agreed (i) by all members entitled to vote in case of an annual general meeting,
and (ii) by members holding not less than 95 per cent of the total voting powers in
the case of any other meeting (Sec. 171). The members can consent to a shorter
notice either before or at the meeting. They may also consent after the meeting and
the post-consent will validate the proceedings of the meeting (Re Parikh
Engineering & Body Building Co.) [(1975), 45 Comp. Cas. 157 (Pat.)].
The notice must specify the place, day and hour of the meeting, and must
contain a statement of the business to be transacted threat [Sec. 172(1)]. The object
of mentioning the various items of business in the Notice is to give the persons
concerned sufficient opportunity to consider the different items before they come
for discussion in the general meeting. In the case of ‘special business’, there must
be annexed to the notice of the meeting an ‘explanatory statement’ mentioning all
the material details concerning each such item of business, including in particular
the nature of interest, if any, therein of every director or other managerial personnel
[Sec. 173(2)]. The notice must also state that a member is entitled to appoint a
proxy, where allowed under the Act of the Articles, and that a proxy need not be a
member [Sec. 176(2)].
It is worth noting here that no fresh notice need be given in the case of an
adjourned meeting because such a meeting is regarded in law as a continuation of
the original meeting (Seaddingvs. Lorant) [(1851), 3 H.L.C. 418] and as a rule must
be held in the next week on the same day and at the same time and place, unless
declared otherwise by the chairman. Of course fresh notice of the adjourned
meeting must be given if the original meeting is adjourned sine die (i.e., without
fixing a day for the holding of adjourned meeting) or if fresh business other than
such business as is left uncompleted at the original meeting, is to be discussed. It
may also be noted that if it is not possible to hold the meeting at the specified place
for some valid reason, the meeting may be held at some other place if the members
so agree and the business transacted at such a meeting shall be valid (Rl Chettiar
vs. M. Chettiar) [(1951), A.I.R. Mad. 542].
(3) Requisite quorum. The third important condition for a valid meeting is
that the quorum must be present. A quorum is the specified minimum number of
qualified persons (members) whose presence is necessary for transacting legally
binding business at the meeting. The members constituting the quorum must be
effective members - entitled to vote at the meeting. Thus, if the agenda of .the
meeting does not include any item that will affect the rights of the preference
shareholders, their presence should not be taken into account for purposes of
determining the quorum but where the agenda includes any item directly affecting
the rights of preference shareholders, their presence should not be taken into the
account for the purposes of the quorum. Where no quorum is present the meeting or
any resolution passed thereat becomes invalid. However, third parties without
notice are not affected by reason of any irregularity in the quorum (County of
Gloucester Bank vs. Rudty Merthyr) [(1895), 1 Ch. 629].
Unless the articles provide for a larger number, the quorum shall be two
members personally present in the case of a private company and five members
personally present in the case of a public company for all general meetings of the
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members [Sec. 174(1)]. Please note that the articles cannot provide for a smaller
quorum than fixed by the Act and only members present in person, and not proxies,
can be counted for purposes of quorum. Further Joint-holders of shares are treated
as one member for the purpose of quorum.
The Act is silent on the point of ‘time of presence’ of the quorum at the
meeting, Regulation 49(1) of ‘Table A’, however, states. “No business shall be
transacted at any general meeting unless a quorum of members is present at the
time when the meeting proceeds to business”. It follows from these wordings that
quorum is required to be present at the beginning of meeting. It need not be present
throughout or at the time of taking votes on any resolution. Similar ruling was
given in Re Hartley Baird Ltd., Case [(1954), 3 A.E.R. 695]. It may be recalled that
a quorum must be present throughout in the case of Board's meetings.
Regarding the procedure for observing quorum, Section 174 states that
unless the articles provide otherwise, the following provisions shall apply to every
company, public or private:
(a) If within half an hour from the time appointed for holding a meeting of
the company, a quorum is not present, the meeting, if called upon the requisition of
members, shall stand dissolved. In any other case, the meeting shall stand
adjourned to the same day in the next week at the same time and place unless, the
Board of Directors determine otherwise.
It may be noted that the attendance of one member only at the reassembled
meeting, even though he holds proxies from other members, cannot form a quorum
since the word ‘meeting’ prima facie means a coming together of more than one
person. Sometimes, however, one member may form a quorum e.g., in the case of a
meeting of a particular class of shareholders, when one person holds all the shares
of that particular class (East vs. Bennett Bros. Ltd.) [(1911), 1 Ch. 163] or when the
{225}
Company Law Board orders for calling an annual general meeting or an extra-
ordinary general meeting under Section 167 or Section 186 respectively and directs
that one member present in person or by proxy shall be deemed to constitute a
meeting.
(4) Proper person in the chair. The fourth requisite for a valid meeting is
that there must be a Chairman to preside over the proceedings of the meeting. In
this regard Section 175 lays down:
(3) If some other person is elected chairman as a result of the poll, he shall
be chairman for the rest of the meeting.
It may, however, be noticed that this Section leaves the appointment of the
chairman to be regulated by the articles of the company and the provisions of this
Section shall apply only if the articles do not otherwise provide. The articles
generally contain provisions on the lines of ‘Table A’ - Regulations 50-52. These
Regulations are reproduced below:
Regulation. 50. The chairman, if any, of the Board shall preside as chairman
at every general meeting of the company.
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the meeting, the members present shall choose one of their number to be chairman
of the meeting.
The chairman has prima facie, authority to decide all incidental questions
which arise at the meeting. But he has no power to stop or adjourn a meeting unless
there is absence of quorum or there is disorder or there remains some uncompleted
business at the meeting or the meeting so directs in accordance with the articles. If
he wrongly adjourns the meeting, the meeting may appoint another chairman and
continue the business (Narayanan Chettiar vs. Kaleshwar Mills Ltd.) [(1952),
A.I.R. Mad. 515]. He has also no power to change the order of the items of
business to be transacted at the meeting as set out in the Agenda. However, the
order of items on the Agenda may be changed with the consent of the meeting, if
necessary. Again, the chairman has no right to prevent discussion upon a matter
which forms part of the notice convening the meeting. Of course he may refuse a
member to talk as much as he likes.
Note that the chairman is entitled to a casting or second vote in the case of
an equality of votes, unless the articles of the company specifically provide
otherwise.
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sense of the house. The ‘articles’ prescribe regulations and procedure for voting at
general meetings subject to the provisions of the Act.
Voting Rights
Every holder of “equity shares with voting rights”, whose name appears on
the register of members has a right to vote on every resolution placed before the
company at a general meeting. In other words, the holder of such equity shares
possesses normal voting rights. Further, his voting rights on a ‘poll’ (a method of
voting) shall be in proportion to his share of the paid up equity capital of the
company [Sec. 87(1)].
The preference shareholders do not possess normal voting rights. They are,
however, entitled to vote in the following two cases :
(b) When the dividend due (whether declared or not) on their preference
shares or part thereof has remained unpaid -
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has placed all the preference shares issued by a public company, whether issued
before or after April 1, 1956, on the same footing so that no extra voting right is
enjoyed by the preference shares issued before 1st April, 1956.
It may be observed that when the dividend due on their preference shares has
remained unpaid for periods specified above, the preference shareholders become
entitled to vote on every resolution placed before the company at any general
meeting.
The Act further provides that where a preference shareholder has a right to
vote on any resolution in accordance with the provisions mentioned above, his
voting right on a ‘poll’ shall be in the same proportion as the capital paid up in
respect of the preference shares bears to the total paid up equity capital of the
company [Sec. 87(2)(b)]. It is important to note that the above provisions relating
to voting rights of preference shareholders do not apply to a private company. Such
a company can issue preference shares carrying normal voting rights or even
disproportionate voting rights [Sec. 90(2)].
In the case of joint shareholders, the vote of the senior joint holder (whose
name appears first in the register of members) shall be accepted. An insolvent
shareholder is entitled to exercise the votes which are attributed to his status as a
member provided his name appears on the register of members (Morgan vs. Gray)
[(1953), 1, All. E.R. 213].
Methods of Voting,
Voting at a general meeting takes place by : (1) show of hands, and (2) poll.
Voting by secret ballot is not allowed by the Companies Act. However, in case of
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licensed companies under Section 25 of the Act, i.e., companies not carrying on
business for profit or prohibiting the payment of a dividend to their members such
as clubs, chambers of commerce, etc., voting by ‘ballot’ can be provided by their
articles (Sec. 263A).
Who can demand a poll [Sec. 179, as amended by the Amendment Act,
1988]. A poll may be ordered by the chairman of his own motion. But he shall be
bound to take a poll if demanded:
(a) in the case of a public company having share capital, by any member or
members, having the right to vote on the resolution and present in person or by
proxy, holding at least one-tenth of the total paid-up capital of that class, or holding
shares of the paid-up value of at least Rs.50,000 [Prior to the Amendment Act, of
1988, at least five members present in person or by proxy having the right to vote
on the resolution or any member or members present in person or by proxy holding
at least one-tenth of the total paid-up capital could demand a ‘poll’. Thus, this
amendment seeks to ensure that shareholders having some minimum specified
interest should alone demand a ‘poll’.];
(b) in the case of a private company having a share capital, by one member
entitled to vote on the resolution and present in person or by proxy if not more than
seven such members are personally present, and by two such members present in
person or by proxy if more than seven such members are personally present;
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(c) in the case of any other company by any member or members present in
person or by proxy holding at least 1/10th of total voting power in respect of the
resolution.
The demand for a poll may be withdrawn at any time by the person or
persons who made the demand. When a poll is taken a member is free to split his
votes for and against the same resolution. He has the right to distribute his votes in
any manner he likes (Sec. 183). When more than one resolution is to be passed, a
poll is to be taken on each separately.
Proxies
A proxy is a member's authorised agent for the purpose of voting. The term
is also applied to the instrument by which the appointment to act on his behalf is
made by the member. As per Section 176 the provisions relating to proxies are as
follows:
(1) Members of a company having share capital have a statutory right to
appoint proxies, notwithstanding anything to the contrary in the articles. In other
companies proxies may be appointed if allowed in the articles.
(2) Unless the articles otherwise provide a proxy shall not be allowed to vote
except on a poll.
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(3) Unless the articles otherwise provide a member of a private company is
not entitled to appoint more than one proxy to attend on the same occasion. (For
every resolution poll is taken separately and for every resolution separate proxy
may be appointed in a public company).
(4) A proxy must be in writing, in the proper form duly signed by the
appointer and stamped. If the appointer is a body corporate the instrument of proxy
should be under its seal and be signed by a duly authorised officer.
(5) A proxy may be lodged at the company's office not later than 48 hours
before the commencement of the meeting. If the articles of a company, other than a
private company, require a longer period than 48 hours, that will be inoperative and
the shareholders will have the right to deposit proxies 48 hours before the meeting.
(8) A proxy shall not have any right to speak at the meeting.
(9) Every notice calling a general meeting must state with reasonable
prominence that a member is entitled to appoint a proxy and that the proxy need not
be a member. If default is made in complying with this provision every defaulting
officer is punishable with a fine up to Rs. 5000 [Subs, for “Rs. 500” by the
Amendment Act, 2000].
(10) No invitation to appoint any person as proxy shall be issued at
company's expense and if any such invitation is issued every officer of the
company who is knowingly in default shall be punishable with fine which may
extend to ten thousand [Subs. for “Rs. 1000” by the Amendment Act, 2000] rupees.
(11) After giving three days notice to the company, members may inspect,
proxies lodged with the company during 24 hours (within business hours) before
the time fixed for the meeting and till the conclusion of the meeting.
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company is necessary. Moreover, a member can prevent the proxy from: exercising
the right to vote by himself attending and voting at the meeting.
It may be noted that a private company is free to make its own provisions by
its articles as regards 'proxies' and the provisions of Section 176 (as stated above
under points 1 to 11) shall apply to such a company only if its articles do not
otherwise provide [Sec. 170(l)(ii)].
9.7 Resolutions
The Companies Act provides for three kinds of resolutions that may be
passed at the general meeting of a company :
(a) Ordinary resolution;
(b) Special resolution;
(c) Resolution requiring special notice.
The Companies Act and the Articles of Association lay down the type of
resolution required for any particular matter.
1. Ordinary Resolution
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words, this is a resolution passed by simple majority, of votes of members present
in person or by proxy. Those absenting or remaining neutral are not counted.
2. Special Resolution
A resolution shall be a special resolution when the votes cast in favour of the
resolution by members present in person or, where proxies are allowed, by proxy,
are not less than three times the number of votes, if any, cast against the resolution
and the intention to propose the resolution as a special resolution has been duly
specified in the notice calling the meeting [Sec. 189(2) ]. In other words, this is a
resolution passed by a majority of at least 75 per cent of votes of members present
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in person or by proxy (those absenting or remaining neutral are not counted) and a
mention of the fact that the resolution shall be passed as a special resolution must
have already been made in the notice of the meeting and the notice should have
been duly given at least 21 days before the date of the meeting.
The articles of the company may specify purposes for which a special
resolution required. The Companies Act has also specified certain matters for
which a special resolution must be passed, for example, (i) to alter the
memorandum of the company (Sec. 17), (ii) to alter the articles of the company
(Sec. 31), (iii) to issue sweat equity shares (Sec. 77A), (iv) to issue further shares
without pre-emptive rights (Sec. 81), (v) for creation of Reserve Capital (Sec. 99),
(vi) to reduce the share capital (Sec. 100), (vii) for variation of rights of
shareholders (Sec. 106), (viii) to pay interest out of capital to members (Sec. 208),
(ix) for authorising a director to hold an office or place of profit (Sec. 314), (x) for
voluntary winding up of a company (Sec. 484). A copy of special resolution must
be filed with the Registrar within 30 days of the date of its passing.
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The articles of a company may specify purposes in respect of which special
notice is required. Under the Act a special notice is required before moving a
resolution relating to the following matters:
(a) Appointment of an auditor other than the retiring auditor (Sec. 225).
(b) Provision that a retiring auditor shall not be re-appointed (Sec. 225).
(c) Removal of a director before the expiry of his term (Sec. 284).
(d) Appointment of another person as a director in place of the director
removed (Sec. 284).
The Companies (Amendment) Act, 2000 has added a new Section 192A to -
provide for passing of resolution by postal ballot only by a listed public company.
Postal ballot shall include voting by electronic mode also. According to the new
provision, a listed public company may get any resolution passed by means of a
postal ballot, and it shall get any resolution passed by means of a postal ballot
relating to such business as the Central Government may by notification declare to
be conducted only by postal ballot, instead of transacting the business in general
meeting of the company. [Sec. 192A(1)].
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After a ballot paper has been received, if any person fraudulently defaces or
destroys the ballot paper or declaration of identity of the shareholder, such person
shall be punishable with imprisonment upto six months or with fine or with both.
For any non-compliance of the aforesaid provisions, the company and every officer
who, is in default shall be punishable with fine upto fifty thousand rupees in respect
of each such default. [Sec. 192A(5)(6)].
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(viii) election of small shareholders’ director under Section 252(1);
(ix) variation in the rights attached to a class of shares or debentures or other
securities as specified under Section 106.
(1) The Notice calling the general meeting is to be sent either under
Registered Post with Acknowledgement Due, or under Certificate of Posting, and
an advertisement must be published in a leading English Newspaper and. in one
vernacular Newspaper circulating in the State in which the Registered Office of the
company is situated, about having despatched the Notices along with the Ballot
Papers.
(2) The Notice of the general meeting shall give by way of a note the serial
number of the business which requires consent of the shareholders through postal
ballot.
(3) The Board of Directors shall appoint one scrutineer, who is not in
employment of the company and who, in the opinion of the Board, can conduct the
postal ballot voting process in a fair and transparent manner. The scrutineer may be
a retired judge or any person of repute.
(4) The scrutineer shall submit his report as soon as possible after the last
date of receipt of Postal Ballots.
(6) The scrutineer shall maintain a register to record the consent or otherwise
received, mentioning the particulars of name, folio number, number of shares, etc.,
of shareholders. He should also maintain a record for postal ballot which are
received in defaced or mutilated form. The Postal Ballot and other related papers
will be under the safe custody of the scrutineer till the Chairman approves and signs
the minutes of the meeting. Thereafter the scrutineer shall return the ballot papers
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and other related papers/register to the company. The company should preserve the
ballot papers etc., safely till the resolution is given effect to.
(7) The consent or otherwise received after 30 days from the date of issue of
Notice will be treated as if the reply from the member has not been received.
Note that in the light of the above provisions, it may be inferred that the
items which require approval by the shareholders through postal ballot need not be
transacted at the general meeting because as per sub-section (4) of Section 192A
“the resolution assented to by a requisite majority of the shareholders by means of
postal ballot shall be deemed to have been duly passed at a general meeting
convened in that behalf.” In other words, in case of resolutions declared to be
passed only by means of a postal ballot, the resolutions can be passed only by a
postal ballot and not at a general meeting.
(1) any number of members holding at least 5 per cent of the total voting
rights of all the members having a right to vote on the resolution or business to
which the requisition relates; or
(2) at least one hundred members having the rights aforesaid and holding
paid-up capital of the company of at least one lakh of rupees.
Further, the requisitionists are also required to deposit with the requisition a
sum reasonably sufficient to meet the company's expenses in giving effect thereto,
unless the company otherwise resolves.
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A certified copy, under the signatures of an officer of the company, of the
following resolutions and agreements must be registered with the Registrar within
30 days after passing or making thereof:
(b) resolutions which have been agreed to by all the members of a company,
but which, in the absence of such an agreement,-would have to be passed as special
resolutions;
(d) resolutions or agreements which have been approved by all the members
of a class of shareholders, and all resolutions and agreements which bind all the
members of a class of shareholders though not approved by all those members;
(i) to sell or lease the whole or substantially the whole of the company's
undertaking; or
(ii) to borrow money beyond the limit of the paid-up capital plus free
reserves of the company; or
(h) copies of the terms and conditions of appointment of a sole selling agent
appointed under Section 294 or Section 294AA.
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If default is made in complying with this provision, the company and its
every officer who is in default shall be punishable with fine which may extend to
two hundred rupees [Subs. for ‘Rs. 20’ by the Amendment Act, 2000] for every day
during which the default continues.
The term ‘minutes’ means a concise and accurate official record of the
business, transacted at company meetings. It normally includes only the resolutions
actually passed. It is not necessary to record therein the discussion which preceded
the adoption of a resolution. “Minutes are more analogous to a telegram than to a
letter, to a precis than to a narrative.”
(a) in the case of the Board or Committee meetings, by the Chairman of the
meeting of the next succeeding meeting;
(b) in the case of a general meeting, by the Chairman of the same meeting
within a period of 30 days of the conclusion of the meeting or in the event of death
or inability of the Chairman within that period, by a director duly authorised by the
Board for that purpose [Sec. 193(1A)].
The minutes of each meeting shall contain a fair and correct summary of the
proceedings thereat. The Chairman shall, however, enjoy an absolute discretion in
regard to non-inclusion of any matter in the minutes which in his opinion is
defamatory of any person, is irrelevant or detrimental to the interests of the
company. In the case of a meeting of the Board or of a Committee of the Board, the
minutes must include the names of the directors present at the meeting and the
names of the directors, if any, dissenting from the resolution passed at the meeting.
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The minutes of meeting kept in accordance with the above provisions are
prima facie evidence of the proceedings recorded therein (Sec. 194) and the
meeting to which such minutes relate shall be deemed to have been duly called and
held, (he proceedings to have duly taken place and the appointments of directors or
liquidators made at the meeting shall be deemed to be valid, until the contrary is
proved (Sec. 195).
9.10 Summary
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Board of directors, meetings of the debenture holders, meetings of creditors and
meetings of contributories in winding up.
In some cases even one person may be held to constitute a valid quorum.
These circumstances include the following :
(i) if all the shares of a particular class are held by one person.
(ii) where the Company Law Board (now Central Government) directs under
section 167 or CLB (now Tribunal) under section 186 that one member
present in person or by proxy shall constitute quorum.
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Quorum for the meetings of the Board of directors is 13th of the total
strength of the Board or two directors, whichever is higher. However, for the
purposes of quorum, interested directors, if any, shall be excluded.
In case of voting, voting rights are essentially conferred upon the equity
shareholders. Preference shareholders shall have the right to vote only on
resolutions which directly affect the rights attached to the preference shares held by
them. Voting, in the first instance, is to be by show of hands unless a poll is
ordered/validly demanded.
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summary of all proceedings of the meetings of members. The minutes must also be
duly signed as per the provisions of the Act.
A company being an artificial person, can act only through the agency of
human beings. Members of a company are empowered under the Companies Act to
do certain things by way of resolutions passed in general body meetings. Under the
Companies Act, different types of meetings of members are contemplated. These
include statutory meeting, annual general meeting, extraordinary general meeting
and class meetings.
The members may discuss any matter relating to the formation of the
company or arising out of the statutory report.
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Annual General Meeting - Every company, whether public or private,
having a share capital or not, limited or unlimited must hold an Annual General
Meeting. The first Annual General Meeting of a company may be held within
eighteen months from the date of its incorporation. In respect of subsequent
AGM’s, section 166 read along with section 210 provides as follows :
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Extraordinary general meeting (EGM) - all general meetings other than the
statutory and annual general meeting shall be called as extraordinary general
meetings.
An EGM may be called: (i) by the Board of directors of its own accord; (ii)
by the directors on requisition; (iii) by the requisitionists themselves; (iv) by the
Company Law Board (now Tribunal).
On a valid requisition being made as per section 169, the Board of directors
are under an obligation to convene the meeting within forty-five days of the receipt
of the valid requisition. In case, the Board of directors fails to call the meeting as
aforesaid, the requisitionists or such majority of them as spelt out under section 169
may call and hold the meeting within three months of the date of the requisition.
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6. What is an extraordinary general meeting?
STRUCTURE
10.0 Introduction
10.1 The Rule of Majority
10.2 Protection of Minority
10.3 Exception to ‘The rule in Foss v. Harbottle’
10.4 Meaning of Oppression
10.5 Prevention of Oppression
10.6 Parties entitled to apply to Company Law Board
10.7 Powers of Company Law Board
10.8 Powers of Central Government
10.9 Appeals against the orders of the Company Law Board
10.10 Difference between winding up proceedings and proceedings under section
397 and 398.
10.11 Summary
10.12 Check your progress.
10.0 Introduction
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delegated to the directors, the wish of the majority shareholders will prevail in the
administration of a company.
Sections 397 to 409 of the Companies Act, 1956 lay down specific
provisions whereby both the Company Law Board and the Central Government are
empowered to interfere in the affairs of the company for preventing “oppression
and mismanagement”. These provisions are summarised below: According to
Sections 397 and 398 the specified minimum number of members of a company,
may make an application to the Company Law Board for appropriate relief, on any
of the following grounds:
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Court to make good to the company the losses caused by the wrongful acts
complained of. The Court dismissed the action holding that the conduct with which
the defendants are charged is an injury not to the plaintiffs exclusively, it is an
injury to the whole corporation and therefore the corporation alone, and not the
plaintiffs, could bring the action at law. Otherwise the Court might be acting vainly,
for the alleged breach of duty could be ratified by the company (majority
shareholders) in general meeting.
The judgment in Foss vs. Harbottle case established that on a suit filed by
the minority, the Court will not interfere with the internal management of
companies acting within their powers even though negligence and inefficiency on
the part of the management is proved. For, it is pointless to have legal actions based
on matters which can be ratified, by a general meeting. It was further expounded in
this case that if any injury is done to the company, it is logical that the company
itself should bring an action to get it redressed and individual members cannot
assume to themselves the right of suing in the name of the company, because in law
a company is a separate legal person from the members who compose it. Moreover,
there will be no use in permitting the minority to bring a suit for any injury done to
the company, if the majority of shareholders do not object to that, for, in such a
case, a meeting can be called and the injury be authorised by a majority vote.
The rule laid down in Foss vs. Harbottle has been followed in many other
cases since then. For instance, Mellish, L.J. observed in Mac Dougall vs. Gardiner
[(1875), 1 Ch. D. 13.]- “If the thing complained of is a thing which, in substance,
the majority of the company are entitled to do, or if something has been done
irregularly which the majority of the company are entitled to do regularly, or if
something has been done illegally which a majority of the company are entitled to
do legally, there can be no use in having litigation about it, the ultimate end of
which is only that a meeting has to be called and then ultimately the majority get
their wishes.”
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ground that they had been negligent in selling a mine owned by the company for
£1,82,000, whereas its real value was about £10,00,000. It was held that the action
was not maintainable. The judge observed, “It was open to the company, on the
resolution of a majority of the shareholders to sell the mine at a price decided by
the company in that manner, and it was open to the company by a vote of majority
to decide that if the directors by their negligence or error of judgment has sold the
company’s mine at an under value, proceedings should not be taken against the
directors.”
From the rule in Foss vs. Harbottle it becomes clear that the majority
decisions are binding upon the company and a minority, even as great as 49%, has
no voice in the control and management of the company's affairs. Obviously there
are dangers in such a situation. Suppose the majority are rogues and are not acting
bona fide for benefit of the company as a whole, on a strict application of the rule
in Foss vs. Harbottle the minority could be exploited by the majority against which
the former could take no action; it would be a shocking thing indeed. Certain
exceptions have therefore been admitted in the interests of justice to the rule of
supremacy of the majority of share-holders.
In the following circumstances the will of the majority shall not prevail and
individual shareholder or minority shareholders may bring an action against the
company to protect their interest:
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1. Where the act done is ultra vires the company or illegal. As pointed
out earlier the basis of the rule in Foss vs. Harbottle is that it is pointless to have
legal actions based on matters which can be ratified by a general meeting. It
follows, therefore, that the rule does not apply to acts which are ultra vires the
company or which are illegal because no majority of shareholders can ratify such
acts. As such every shareholder has a right of preventing the company from doing
such acts by filing a suit of injunction [Bharat Insurance Company Ltd. vs.
Kanhaya Lal (1956), A.I.R. S.C. 213].
{254}
majority passed a resolution to compromise an action against company B, in a man-
ner alleged to be favourable to company B but unfavourable to company A. The
Court on the application of the minority, declared that the compromise was invalid
and granted an injunction restraining further proceedings. The Court observed, “It
would be a shocking thing if that could be done, because if so the majority might
divide the whole assets of the company, and pass a resolution that everything must
be given to them, and that the minority should have nothing to do with it.” It must
be noted that in the instant case the majority tried to put something into their
pockets at the cost of the minority.
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5. Where the provisions of Sections 397 to 409 of the Companies Act
1956, apply. The Companies Act itself contains provisions which protect minority
in the case of oppression and mismanagement. These provisions are discussed
below in detail.
For alleging oppression within the scope of Section 397, the complaining,
shareholder must show that he is under a burden which is unjust or harsh or
tyrannical There must be continuous acts on the part of the majority share-holders,
continuing up to the date of petition, showing that the affairs of the company were
being conducted in a manner oppressive to some part of the members (Shanti
Prasad Jain vs. Kalinga Tubes Ltd). To illustrate, oppression implies - depriving
certain members of their right to vote, to attend general meetings, to elect directors,
to receive dividends, or asking certain members to buy additional shares otherwise
their existing holdings of shares shall be forfeited, or removing the name of a
member illegally from the register of members, or where the company’s interest is
being seriously prejudiced by the activities of rival groups of shareholders, e.g.,
where two different registered offices have been set up or two rival Boards are
holding meetings [Re Sindhri Iron Foundry (P) Ltd. (1963), 68 C.W.M. 118]. An
unreasonable refusal to accept a transfer or transmission of shares has been held to
{256}
be oppressive [Mrs. Gajarabai vs. Patny Transport Co. A.I.R. (1966), A.P. 226)].
Even amending the Memorandum of Association in a way, so as to authorise the
use of company's money in a [business altogether different from one envisaged in
its objects clause may in [circumstances amount to oppression. Note the following
case in this regard:
{257}
its day-to-day administration (Mohta Bros. vs. Calcutta Landing & Shipping Co.
Ltd. 73, C.W.N. 425).
For alleging mismanagement as contemplated by the Act in Section 398, there must
be an unfair abuse of power and the persons in charge of management of the
company must be guilty of fraud, misappropriation or misfeasance. It may be
emphasised that these Sections also empower the Company Law Board/ Central
Government to interfere in cases where the oppression or mismanagement
complained of is prejudicial to the public interest, that is, the national interest and
the general welfare of the community. For, a company today is not considered to be
mere device of profiteering but- is considered to be a viable socio-economic entity
to cater to the needs of the society by supplying goods and services the society
requires at a price the consumer is willing and able to pay. Mr. Justice Douglas of
American Supreme Court observes: “Today it is generally recognised that all
corporations possess an element of public interest. A corporation director must
think not only of the stock-holder but also of the labourer, the supplier, the pur-
chaser and the ultimate consumer.” The Act, therefore, aims to ensure that the
affairs of a company shall not be conducted in a manner detrimental to public
interest
{258}
10.6 Parties Entitled to Apply to the Company Law Board
Section 399 and 401 specify the persons who may apply to the Company
Law Board for relief in cases of oppression and mismanagement, and they are as
follows :
(a) In the case of companies with share capital, at least one hundred
members of the company or one-tenth of the total number of its members,
whichever is less, or any member or members holding at least one-tenth of the
issued share capital free of calls.
The applicant members may be holders of equity shares or preference
shares.
(b) In the case of companies without share capital, at least one-fifth of the
total members of the company.
(c) Any lesser number of members, if so authorised by the Central Gov-
ernment.
(d) The Central Government itself.
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The powers of the Company Law Board in these cases are very wide. On
receiving such an application, the Company Law Board may make such order as it
may deem fit, if in its opinion -
(a) the company’s affairs are being conducted in a manner prejudicial to
public interest or to the interests of the company or in a manner oppressive to any
member or members, or that by reason of any material change in the management
or control of the company, it is likely that the affairs of the company will be
conducted as aforesaid, and
(b) the winding up of the company would unfairly prejudice such member or
members; but that otherwise the facts would justify the making of winding up order
on the ground that it was just and equitable that the company should be wound up.
It must be noted that before passing a final order, the Company Law Board
is required to give notice of every application made to it under Section 397 or 398
to the Central Government and to take into consideration the representations, if any,
made to it by that Government (Sec. 400).
Section 402 expressly lays down the wide discretion which the Company
Law Board enjoys in disposing of such an application. The Company Law Board's
order may provide for -
(i) the regulation of the conduct of the company’s affairs future (i.e., making
necessary alterations in the Memorandum and Articles of the company);
(ii) the purchase of the shares of interests of any members of the company
by other members thereof or by the company;
(iii) the reduction of the share capital of the company, where it has been
ordered to purchase its share;
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(v) the termination or modification of any agreement between the company
and any person not referred to in clause (iv) above, provided due' notice has been
given to the party concerned and his consent obtained ;
(vi) the setting aside of any fraudulent preference made within three months
before the date of the application;
(vii) any other matter which appears to the Company Law Board to be just
and equitable under the circumstances of a particular case.
The facts of Bennet Coloman & Co. vs. Union of India[(1977) 47 Comp.
Cas. 92 (Bom)] provide a good illustration of the wide discretionary powers which
the Company Law Board enjoys for preventing “oppression and mismanagement”.
In that case, on an application of the Government, the Court (‘Company Law
Board’ by the Companies (Amendment) Act, 1988,) ordered that the Board of
Directors of the company should consist of 11 directors of which 3 should be
shareholders' directors, 3 should be nominated by the Central Government and 5
should be nominees of the Court. The shareholders' directors were required to retire
at each annual general meeting of the company. The order was challenged on the
ground that Section 255 requires at least 2/3 of the directors of a public company to
retire by rotation. The Bombay High Court negatived this contention on the ground
that Section 255 deals with corporate management of a company through directors
in normal circumstances while Section 402 deals with prevention of oppression and
mismanagement and therefore, covers circumstances when the normal corporate
management has failed. Therefore, powers of the Court (now Company Law
Board) under Section 402 cannot be read as subject to the provisions contained in
other chapters of the Act.
Under Section 403 the Company Law Board is also empowered to make an
interim order on such terms as it thinks fit. Section 404 further provides that where
an order by the Company Law Board makes an alteration in the memorandum or
articles of a company, then the company shall not have power to make, without the
permission of the Company Law Board, any alteration whatsoever which is
inconsistent with the order.
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Section 407 states that where the Company Law Board’s order terminates or
modifies an agreement with any managerial personnel, it will not give rise to any
claim for damages or for compensation for loss of office or in any other respect
whatsoever. Further, no managerial personnel whose agreement is so terminated
shall be appointed or act in any managerial capacity of the company, without the
leave of the Company Law Board, for a period of five years from the date of the
order.
Instead of passing an order in the above manner, the Company Law Board
may direct the company if it is a public company or its subsidiary to amend its
articles so as to provide for proportional representation (under Sec. 265) for
appointment of directors so that minority interests may be properly represented, and
make fresh appointments of directors in pursuance of the articles so amended,
within such time as may be specified [Sec: 408(1)]. Till fresh appointments of
directors are made as aforesaid, the Central Government may appoint such number
∗
Prior to the Companies (Amendment) Act, 1988, the Central Government was itself empowered to decide
about the number of directors to be appointed under Section 408.
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of persons as the Company Law Board may by order specify as being necessary to
effectively safeguard the interests of the company or its shareholders or the public
interest to hold office as additional directors of the company [Sec. 408(2)].
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effect unless confirmed by it. It is to be noted that the powers conferred by this
Section cannot be exercised in the case of a private company.
Also, on the basis of the report submitted by the Inspector, the Central Gov-
ernment may decide to take any or all of the following actions :
1. The Government may launch to prosecution of all those persons who have
committed any offence for which they are criminally liable not only under the
Companies Act but under the Penal Code as well (Sec.242).
2. The Government may authorise any person to present a petition for the
winding up of the company, or for an order for prevention of oppression and
mismanagement under Section 397 and 398, or may resort to both these steps (Sec.
243).
3. The Government may itself file a suit in the name of the company to
recover damages or property from the guilty parties, if from the report it appears
that a fraud or misappropriation of property has been committed (Sec. 244).
In so far as the expenses are not recovered from the above mentioned
persons, they shall be paid out of the moneys provided by Parliament (Sec. 245).
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Besides the power to order investigation into the affairs of a company, the
Central Government also has the power to investigate the ownership of a company
(Sec. 247). Where it appears to the Central Government that there is good reason so
to do, or if the Company Law Board, in the course of any proceedings before it, by
order so declares, the Central Government may appoint one or more inspectors to
investigate and report on the membership of any company and other matters
relating to the company, for the purpose of determining the true persons -
(a) who are or have been financially interested in the success or failure of
the company; or
(b) who are or have been able to control or materially to influence the policy
of the company [Sec. 247(1) and new sub-section (1A) added by the Companies
(Amendment) Act, 1988],
(a) where a transfer of shares has already taken place, (i) the voting rights in
respect of those shares shall not be exercisable for such period not exceeding three
years as may be specified in the order, and (it) no resolution passed to effect a
change in the composition of the Board of Directors before the date of the order
shall have effect unless confirmed by it;
(b) where a transfer of shares is likely to take place, any transfer of shares
during such period, not exceeding three years, as may be specified in the order,
shall be void [Sec. 250(3)(4)].
Section 10F allows appeal to a High Court against any order of the CLB under any
provision of the Companies Act, within 60 days from the date of the
communication of the decision of the decision or order of the CLB. However the
appeal is restricted only to the question of law arising out of the decision or order of
CLB. In Scientific Instruments Co. Ltd v. Rajendra Prasad Gupta[1999]19 SCL
451, Allahabad High Court has held that when the CLB findings on matters of
sections 397 and 398 was based on no evidence or on surmises, conjecture and
assumptions, then the reference under section 10 F assumes the presence of
question of law.
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By the Companies (Second Amendment) Act, 2002, section 10FQ was introduced
which replaces the ‘CLB’ by the ‘Tribunal’ and provides appeal against the order
of the Tribunal. Any person aggrieved by the order or decision of the Tribunal may
prefer an appeal to the ‘National Company Law Appellate Tribunal’ (NCLAT)
ordinarily within 45 days of the date of receipt by him of the copy of order or
decision. An appeal against the order of the NCLAT shall have to be made to the
Supreme Court of India.
Petition under sections 397 and 398 Petition for winding up under sec.433(f)
1. Petition under sections 397 and 1. Petition for winding up is to be
398 is to be made to the CLB. made to the Court.
2. Notice to Central Government is 2. No such notice is necessary.
necessary under section 400.
3. Share qualification is required 3. No minimum share qualification
for an application vide section is required.
399 unless otherwise allowed by
the Central Government.
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4. Under section 401, the Central
Government may itself apply or 4. The Central Government cannot
it can cause the application to be apply but the Registrar of
made by a person authorized by Companies can apply under
it. section 439(5). Contributory or
any other person can also apply.
Even the Company itself can
apply.
5. Nature of relief is much wider. 5. Nature of relief is narrower.
6. Remedy is of preventive nature 6. Winding up results in death of
and helps the company to the company.
continue.
10.11 Summary
Sections 397 to 409 of the Companies Act, 1956 lay down specific provisions
whereby both the Company Law Board and the Central Government are
empowered to interfere in the affairs of the company for preventing “oppression
and mismanagement”. According to Sections 397 and 398 the specified minimum
number of members of a company, may make an application to the Company Law
Board for appropriate relief, on any of the following grounds:
3. Where the act complained of constitutes a fraud on the minority and those
responsible for it are in control of the company.
5. Where the provisions of Sections 397 to 409 of the Companies Act 1956, apply.
1. What are the powers of the CLB to prevent oppression and mismanagement
and under what circumstances these powers can be exercised?
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Introduction: Corporate restructuring refers to a broad array of
activities that expand or contract a firm’s operations or substantially modify its
financial structure or bring out a significant change in its organizational structure
and internal functioning. Inter-alia it includes activities such as mergers, purchase
of business units, takeovers, slump sales, demergers, leveraged buyouts,
organizational restructuring and performance improvement initiatives (commonly
called as corporate restructuring).
The pace and intensity of corporate restructuring has increased since the
beginning of the liberalization era due to greater competitive pressure and a more
permissive environment.
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Corporate Restructuring
Acquisitions Organizational
Restructuring
Mergers
Purchase of Units or Organizational
plant redesign
Take overs Ownership Major
Business alliances performance
Restructuring enhancement
programmes.
Going private
Leveraged buyouts.
Divestitures
Sell offs
Demergers
Equity carve outs
VAB > VA + VB
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Reasons : -
1. Strategic Benefits
(ii) It offers a special ‘timing advantage' because the merger alternative enables
a firm to 'leap frog' several stage in the process of expansion.
2. Economies of Scale – When two or more firms combine, certain economies are
realized due to the larger volume of operations of the combined entity.
3. Economics of Scope – Company may use a specific set of skills or assets that it
possesses to widen the scope of its activities. E.g. Proctor & Gamble acquires a
consumer product company.
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be realized, e.g. merger of a Company engaged in oil exploration and production
(line ONGC) with a Company engaged in refining and marketing (like HPCL) may
improve coordination and control.
8. Managerial Effectiveness.
Sec. 391 to 394 of the Companies Act, 1956 provides the procedure to be
followed in case of merger of two companies as :
Stock exchanges where the shares of both companies are listed are to be
intimated of the proposed merger.
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Copies of all notices, resolution and orders should be marked to concerns
stock exchanges.
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After hearing and ascertaining that the amalgamation scheme is fair and
reasonable, the NCLT will pass an order sanctioning the same. However, the
NCLT is empowered to modify the scheme and pass orders accordingly.
9. Transfer of Assets and liabilities – After final order by NCLT, all the assets
and liabilities of the amalgamating company will have to be transferred to the
amalgamated company.
The amalgamated company, after fulfilling the provisions of the law, should
issue shares and debentures of the amalgamated company (or cash payment in some
cases). The new shares and debentures so issued will then be listed on the stock
exchange.
Tax Aspects –
(a) All the properties and liabilities of the amalgamating Co. immediately
before the amalgamation become the prospects and liabilities of the
amalgamated Co. by the victims of amalgamation.
(b) Shareholders holding not less than 90% in value of the shares in the
amalgamating Company become shareholders of the amalgamated Company
by virtue of amalgamation.
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(2) Expenditure of equation of patent right / copyright / know-how.
Of the above benefits, the most important is the one relating to the carry
forward of the losses and unabsorbed depreciation of the amalgamating company.
Generally accumulated losses and unabsorbed depreciation of an assessee cannot be
carried and set off by another assesses. However as an exception, carry forward and
set off is available in case of amalgamation, subject to fulfillment of following
conditions : -
(2) The amalgamated Co. continues to hold at least 3/4th of the book value of the
fixed assets of the amalgamating co. for the period of 5 years from the
effective cleat of amalgamation.
(3) The amalgamated co. continues the business of the amalgamating co. for a
minimum period of 5 yrs.
(4) the amalgamated co. achieves a level of protection of at least 50% of the
installed capacity of the said undertaking before the end of 4 years from the
date of amalgamation and continues to maintain the said minimum level of
production till the end of 5 yrs. from the date of amalgamation.
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Cost and Benefits of Merger –
NPV of the merger from the point of view of A is the difference between the
benefit and cost.
NPV of the merger from the point of view of B is simply the cost of the
merger from the point of view of A.
(1) Overvaluation – If the carrying firms stocks are activated relative to required
Co's. Stock – paying in stocks can be less losing than paying the cash.
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Stock compensation – Shareholder of the required Company take parts in the
risk as well as reward of the major.
Takeovers
A takeover generally involves the requisition of a certain block of equity
capital of a company which enables the acquirer exercise control over the officers
of the company.
Through theoretical more than 50% of the paid up equity is required to enjoy
complete control, but in practice effective control can be exercised with a smaller
holding (20% to 40%), because the remaining share-holders are scattered and ill
organised and are not likely to challenge the control of the acquirer.
(1) Open market Purchase: The acquirer buys the shares of the listed Co. in
the stock market. Generally, hostile takeovers are initiated in this manner.
(2) Negotiated Acquisition: Acquirer buys shares of the target company from
one or more existing shareholders in a negotiated transaction.
(3) Preferential Allotment: The acquirer buys the shares of the target company
through preferential allotment of equity shares. Such an acquisition is
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friendly acquisition meant to give the acquirer a strategic stake in the
company and to infuse funds into the company.
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SEBI Takeover Code
2. Trigger Point: Holdings (Existing & Acquired) should not be greater than
15% of the total unless such acquirer makes a public announcement to
acquire shares through a public offer to the extent stipulated in the code
(Currently 20%).
3. Offer Price: The offer price to the public shall not be less than the highest
of the following :-
negotiated price.
average price paid by the acquirer.
professional offer price if made in the last 12 months.
average of the weekly high and low for the last 26 months.
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between 15% and 75%, i.e., such acquire who already has more than 15%
can do a creeping acquisition of upto 5% per year without triggering off the
open offer requirement.
Anti-Takeover Defences:
These are employed by target companies to ward off bidders. These
defences can be divided into two categories viz. Pre-offer defences and
Post offer defences.
Pre-Offer Defences:
3. Person Pills: Existing shareholders are granted the right to buy bends or
preference stocks that get converted into the stock of the acquiring firm, in
the event of a merger, on very favourable terms.
Post-Offer Defence
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1. Green mail: The target company agrees to buy the shares acquired by the
bidder at premium in exchange for bidder's promise to refrain from hostile
takeover.
2. Pacman Defence: The target company makers a counter bid for the stock of
the bidder.
3. Litigation: The target company files a short against the bidding company
for isolating anti-trust or securities laws.
4. Asset Restructuring: The target company sells its most precious assets (the
crown jewels), and/or buys assets the bidder does not want or that may pose
anti-trust problems for it.
5. Search for White Knight: A company under seize may look for support
and help from its friends.
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Joint Ventures: A JV is set up as a independent legal entity in which two or
more separate organisation participate. The JV agreement spells out how
ownership, operational responsibilities and financial risks oval rewards will
be shored. Each member preserves its own corporate identity & autonomy.
Strategic alliances:
Does not result in the creation of a separate legal entity (like JV).
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Cost of accessing new market requires huge outlays, audit,
promotion, warehousing etc.
3. Cost Reduction:
Sharing of cost and facilities.
Divestitures
Mergers, forced purchases and takeover lead to expansion in some way or
the other. They are based on the principle of synergy which says 2+2 = 5.
Important methods of divestitures are partial sell off, demerger (spinoff &
split up) and equity course out.
Partial sell off - also called slump sale, it invites the sale of a business unit or plant
of one firm to another.
Motives :
raising capital
containment of losses.
Strategic realignment
Efficiency gain.
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In split up - a company is split up into two or more independent companies. As a
sequel, the parent company disappears as a company entity and in its place two or
more separate company emerge.
Equity Carve out - a parent company sells a partition of its equity in wholly
owned subsidiary. The sale may be to the general investing public or to strategic
investors.
1. In spinoff the shares of the spun off company are distributed to the existing
shareholders of the parent company.
2. An equity carve out brings cash infusion to the parent company, whereas a
spinoff does not.
Examples:
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2. Reorganisation of the share capital of the company by exchange of the
company's assets for shares of newly formed company.
4. The creditors agreeing to receive cash in part payment of the claims and the
balance in shares and debentures of the company.
The express power to do such things is usually inserted in the objects clause
of the memorandum as one of the standard provisions.
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Such machinery is provided by agreements between the company and the
classes of persons and also under the Companies Act, 1956.
(2) If at the meeting, a majority of the number representing in value 3/4th of the
creditors or members (or any class of them) present in person or by proxy agree to
the compromise or arrangement, then the compromise/arrangement will be binding
on.
(a) all creditors or members (or of any class)
(b) the company or the liquidator (in winding up) or the contributories of the
company.
Scope of Sec. 391: The aid of the section may be invoked when it is not otherwise
possible to make some arrangement or compromise which would be in the interests
of the company the others party or parties to the arrangement. It can be used
whether the company is a going concern or is in the course of winding up.
the court shall not make any order sanctioning the compromise or
arrangement unless it is satisfied that the company or any other party
making the application has disclosed to the court by affidavit or
otherwise, all material facts relating to company, such as -
(a) latest financial position of company
(b) the latest auditors report on the acc. of the company.
(c) whether any investigation or proceeding is 235 to 251 are pending
against the company etc.
at any time.
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statutory majority and not course the minority in order to promote
interests adverse to those of the class whom they passport to represent.
meeting was held properly and not will not sanction the scheme of
meeting was held irregularly.
The court can pierce corp veil and if the scheme is found to be fraudulent
and intended for a purpose other than he purpose started, it may be
rejected even at the outset.
(a) a majority in no. of those members of the class who are present and
voting.
Example: There are 100 member noting - one held 901 shares and the
remainder hold one each. The 99 shareholders holding one share each
cannot force a scheme against the vote of the holder of 901 shares,
because they do not muster 3/4th in value. Conversely, that shareholder
and 49 of the other cannot force a scheme against the votes of the
remaining 50 therefore, there would be no majority in no.
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SC has laid down guidelines for consideration of the count in the matter
of sanction of a scheme L/S 391 and 394 of the Act in -
8. The scheme as a whole is found to be just, fair and reasonable from the
point of view of prudent men of business taking a commercial decision
beneficial to the class represented by them for whom the scheme is
meant.
9. Above thing satisfied, court cannot substitute for the commercial wisdom
of the majority of the class of persons.
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Powers of the Court/Tribunal
6. Power to recall its order (assessed ex-parte) if party affected was able to
satisfy that ex-parte order passed was patently illegal, erroneous or
passed under misconception or misrepresentation.
(i) the transfer of undertaking of an existing Co. to another Co., usually inc. for
the purpose. The old & ceases to exist. However, all the assets might not pass
to the new Co.
(ii) the carrying on of substantially the same business by the same persons.
(iii) the rights of the shareholders in the old co. are satisfied by their being allotted
shares in the new col.
Purpose of reconstruction
Amalgamation
Amalgamation is the blending of two or more undertakings (Cos.) into one
undertaking, the shareholders of each blending undertaking becoming substantially
the shareholders of the other company which holds blended undertakings.
{293}
- Amalgamation involves blending of two or more different entities, and
not merely continuance of one entity.
- In takeover direct or indirect control over the assets of the acquired co.
passed to the acquirer.
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- application made to the Court/Tribunal C/s 391.
- the court may make provisions for all or any of the following matters :
[ICICI Ltd. c/s Financial & Management Services Ltd.] (1998) Bom.
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[Kirloskar Electric Co. Ltd., in re] (2002) Karnataka HC
The views of the Cal. HC proceed on the bans that a power which is
conferred by the statute itself need not to be a derivative of the OC of the
MOA. Also, to amalgamate with another company, is an interest power of
the company and need not to be the object of the Co.
Similar view :
[Elta (I) Ltd. & Others, In re] (1996) Cal HC
- Shares are sold & registered in the name of the purchasing company
based on a contract between the transferee company and the transferor
company for wholesale acquisition of shares.
UNIT 12 Winding Up
Structure
12.0 Introduction
12.6 Summary
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12.0 Introduction
2. Through the removal of its name for the Register of Companies the
Registrar; or
Winding up should not be taken to mean the same thing as dissolution of the
company. Winding up of a company precedes its dissolution. Prior to dissolution
and after winding up the legal entity of the company remains and it can be sued in a
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Court of Law. On dissolution, the company ceases to exist, its name is actually
struck off the Register of Companies by the Registrar and the fact is published in
the Official Gazette.
Modes of Winding up
The Act provides for winding up of a company in any of the following three
ways :
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We shall now discuss the modes of winding up, if brief, one by one.
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Where a company cease to operate its business for more than a year, and
instead becomes a holding company by forming two subsidiary companies which
are engaged in the pursuit of objects of their holding company, it can not be said
that the company has suspended its business so as to justify an order for its winding
up (Re Eastern Telegraph Co. Ltd. (1947) 2 All ER 104).
(i) Where the company fails to pay a creditor to whom its owes a sum
exceeding 500 rupees, within 3 weeks of the demand for payment made by its
creditor or his agent or legal adviser.
The debt, however, must be real, immediately payable and without any bona
fide and reasonable dispute with regard to it. If there is a bona fide dispute as to
liability, there can be no 'neglect to pay' and therefore no order for winding up can
be made on this ground (Re British India General Insurance Co. Ltd. (1970), Comp.
Cas. 554). "Where, however, there is no doubt that the petitioner is a creditor for a
sum which would otherwise entitle him to a winding up order, a dispute as to the
precise amount owed to him by the company would not be a sufficient answer to
the petition and a winding up order would be made."
(ii) Where the company fails to satisfy a court decree in favour of a creditor
– either in whole or in part. Note that there is no condition of any amount in this
case. Unsatisfied execution of a decree for any amount howsoever small will
constitute inability to pay.
(iii) Where its I provide to the satisfaction of the Court that the company is
'unable to pay its debts'. While determining that, the Court shall take into account
the contingent and prospective liabilities of the company. Under this clause, the
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company may be wound up, if the applicant can prove that the company is
'commercially insolvent' even if the debt retired upon in the petition is disputed
(O.P. Mohta vs. Steel Equipment & Construction Co. Pvt. Ltd. (1967), 1 Comp. L.J.
172). A company is deemed to be 'commercially insolvent' when it is unable to
meet its current liabilities. It need not necessarily be due to inadequacy of assets.
The company may be having more than sufficient assets to meet its liabilities but
the assets may not be presently realizable or they may be indispensable for carrying
on the business and therefore the company may be unable to meet its current
liabilities.
If any of these circumstances be proved, the Court in its discretion may (i)
make a winding up order at once, or (ii) postpone the winding up order for
sometime if it is of the opinion that the company shall soon be in position to meet
its current liabilities (Re Brighton Hotel Co. (1967), 1 Comp. L.J. 172) or (iii) refuse
to make a winding up order if the majority in value of the creditors oppose the
petition for good reason and prove to the satisfaction of the Court that in view of
the total assets and liabilities of the company, it must continue to trade (Re. R.W.
Sharman Ltd. (1957), 1 W.L.R. 774.).
(6) Just and equitable. A company may also be ordered to be wound up, if
the Court is of opinion that it is just and equitable that the company should be
wound up. The Court enjoys wide discretionary power under this clause. What is a
'Just and Equitable' cause depends upon the facts of each particular case. On the
basis of judicial decision, the following examples may be given where the Court
may order winding up under the head' just and Equitable' :
(i) When the main object of the company has failed or its substratum is gone
(Re H.C. Insurance Society Ltd (1960), 65, C.W.N. 68).e.g. where the 'patent' under
which the company proposed to manufacture could not be granted to it, or where
the company proposed to acquire some running businesses but the vendor refused
to sell the business to the company, or where the whole or substantially the whole
of the paid-up capital of the company has been lost, or where there is no reasonable
hope of trading at a profit in the business for which the company was formed (Re
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Kaithal Cotton and General Mills Co. Ltd (1951), 31 Comp. Cas. 461.) It is to be
noted that where a company's main object fails its substratum is gone and it may be
would up even though it is carrying on its business in pursuit of a subsidiary object.
(Re German Date Coffee Co. (1882), 20 Ch. D. 169) However, a temporary
difficulty, e.g., on account of litigation the business of the company has come to a
standstill on account of litigation the business of the company has come to
standstill shall not be permitted to become a ground for liquidation because in such
a case the company could always restart the business with the assets it possessed
(Seth Mohan Lal v. Grain Chambers Ltd. (1968), 1 Comp. L.J. 275).
(iv) When the company was conceived to carry out an illegal or fraudulent
business or when the business of the company becomes illegal, e.g. if the main
object of the company is to conducting a lottery.
(v) When the business of the company cannot be carried on expect at losses.
However, where the majority of shareholders are against it, the Court will not order
a company to be wound up merely because it is making a loss (Re Suburban Hotel
Co. (1867), 2 Ch. App. 737).
Under Section 439, the following persons can make a petition to the Court to
get an order for winding up a company :
(1) Petition by the Company. A petition to the Court by a company for its
winding up may be made by its directors (i) when it has passed a special resolution
to this effect, or (ii) when the directors are of the opinion that he circumstances
leading to the insolvent state of affairs of the company ought to be investigated by
the Court (State of Madras vs. Electric Tramways Ltd. (1956) AIR Mad. 131). Note
that in the latter case the directors do not require passing of any resolution by the
shareholders for filing a winding up petition on behalf of the company.
(3) Contributory's petition. The members and the past members (who ceased
to be the members within one year preceding the commencement of winding up),
who are liable to contribute to assets of the company in winding up, are referred to
as contributories. Of course they will be liable only if they have partly paid shares.
Moreover, a contributory is not essentially to contributory or contributories may
present a petition for winding up notwithstanding that he or they may be the holder
of fully paid-up shares that the company may have no assts at all or may have no
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surplus assets left for distribution amongst them after the satisfaction of its
liabilities.[Sec. 439 (3) any provision in the articles which deprives members of
their right to petition for winding up is void.
(4) Petition by all or any two of the aforesaid parties together. The
company, its creditor and / or contributory may also present a petition for winding
up of the company jointly.
(i) When default is made in filing the Statutory Report or in holding the
Statutory Meeting;
(ii) When the company does not commence its business within a year from
its incorporation, or suspends its business for a whole year;
(iii) When the number of member has fallen below the statutory minimum;
(iv) when the company is unable to pay its debts as shown by the financial
condition of the company as disclosed in its Balance Sheet or from the report of a
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special auditor appointed under Section 233-A or an inspector appointed under
section 235 or 237.
(v) When the Court is of the opinion that it is just and equitable that the
company should be wound up.
Section 243 states that if from the report of the inspector who have
investigagted the affairs of the company, it appears to the Government that the
business of the company is being conducted with intent to defraud its creditors,
members or any other person or the management have been guilty of fraud, the
Central Government may authorize any person (usually the Registrar of
Companies) to file a petition for winding up the company.
Jurisdiction to Wind Up
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with the winding up itself, or transfer it to another District Court, (iii) to direct a
District Court to retain and continue the winding up proceeding although it may not
be Court in which they ought to have been commenced.
Winding up commences not from the date of the winding up order of the
Court but it shall be deemed to commence at time of the presentation of the
petition. Where before the presentation of the petition a resolution has been passed
by the company for voluntary winding up, the winding up shall be deemed to have
commenced at the time of the passing of the resolution. Further, if a winding up
order is made on more than one petition, the commencement of winding up dates
from the earliest petition (Sec. 441).
On the specified date, upon hearing all the connected parties and on keeping
in mind all the circumstances of the case, the Court may act in any of the following
ways –
(d) make an order for winding up of the company, with or without costs
(Sec. 443).
In case the Court decides to made an order of winding up, it will fix the
power, duties and remuneration of the Official Liquidator and shall forth with
intimate the Official Liquidator and the Registrar of Companies about the winding
up order (Sec. 444).
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(1) The petitioner and the company are required to file with the Registrar of
Companies, a certified copy of the Court's order, within one month of the
order. The Registrar will then notify in the Official Gazette that such an
order has been made [Sec. 445 (1)(2)].
(2) The order for winding up shall be deemed to be notice of discharge to the
officer and employees of the company, except when the business of the
company is continued for the purpose of beneficial realization of assets
[Sec. 445(3)]. It is worth noting here that where an employee is on a
contract of service for the term which has not expired on the date of winding
up, the order will operate as a wrongful discharge, and damage will be
winding up, the order breach of contract of service (Reigate vs. Union
Manufacturing Co. (1918) 1 KB 592).
(3) The powers of the Board of Directors are terminated and the same will not
be exercised by the Official Liquidator.
(4) The winding up order shall operate in favour of all the creditors and all the
contributories of the company, as if such an order has been made on their
joint petition (Sec. 447).
(5) The Official Liquidator shall by virtue of his office, become the liquidator
of the company (Sec. 449).
(6) Any debts payable at a future date, become immediately payable on the
winding up order.
(7) For computing the period of limitation in respect of the suits and application
on behalf or in the name of a company which is being wound up by the
Court, the period between the date of making the application for winding up
and the date of the order of winding up (both inclusive) and a period of one
year immediately following the date of the winding up order, should be
excluded. This shall hold good irrespective of anything to the contrary
excluded. This shall hold good irrespective of anything to the contrary
{308}
contained in the Indian Limitation Act, 1908, or in any other law (Sec. 458
A).
(8) No suit or legal proceeding can be commenced against the company without
the leave of the Court. Similarly, if a suit is pending against the company at
the date of the winding up order, it shall a suit is pending against the
company at the date of the winding up order, it shall not be proceeded with,
expect with the permission of the Court (Sec. 446). However, in Kondaskar
vs. I.T.O. (Companies Circle) Bombay AIR (1972) SC 878, it has been held
by the Supreme Court that an income-tax officer can commence assessment
proceedings without leave of the Court.
(9) The Court which is winding up the company shall have full powers to
entertain or dispose of any new or pending suit or proceeding by or against
the company. Any suit or proceeding pending in any other Court shall also
be transferred to the Court in which the winding up of the company is
proceeding (Sec. 446).
The Court enjoys wide power after making the winding up order, under
Sections 446-481 and Section 559 of the Companies Act. Some of the more
important powers and enumerated below :
(1) Power to stay winding up proceedings. The Court may, at any time, after
making a winding up order, on the application either of the Official
Liquidator or of any creditor or contributory, make an order staying the
proceedings, either altogether or for a limited time, on such terms and
conditions as it thinks fit, provided it is satisfied that the stay order would be
{309}
in the interest of general public. A copy order shall forthwith be field with
the Registrar (Sec. 466).
(3) To order for the delivery of property to the liquidator. The Court has the
power to require any contributory, any trustees, receiver, banker, agent,
officer or employee of the company to pay, deliver, surrender or transfer
forthwith, to the liquidator any money, property or books and papers in his
custody or under his control, to which the company is prima facie entitled
(Sec. 468).
(4) Power to make calls. If the Court finds that there is deficiency of assets to
meet the company's liabilities and the expenses of winding up, it has the
power to make calls on contributories (such shareholders who hold partly
paid shares) and order them for the payment of the same (Sec. 470). It
should be noted that no statutory liability, e.g. for an unpaid call, can be set
off against a credit. Where a contributory upon whom a call has been made,
also happens to be a creditor of the company is some other respects, he
cannot demand any set off-balancing unpaid call against credit. Of course
the right of set off is available to a limited extent in case of a contractual
debt.
(5) Power to exclude creditors no providing in time. The court may fix a time
within which the creditor will have to prove their claims. The Court has the
power to exclude any creditor who fails to prove his claim within the fixed
time, from the benefit of any distributions made immediately on the expiry
of announced date. Of course such a creditor may prove his claim later and
may share in later distributions (Sec. 474).
{310}
(6) Power to summon persons suspected to having property, etc. of the
company. The Court may summon before it any officer of the company or
person known or suspected to have in his possession any property or books
or papers of the company; or known or suspected to be indebted to the
company; or any person whom the Court deems capable of giving
information concerning the promotion, formation, trade dealing, property,
book or papers or affairs of the company. Any such persons may be
examined an oath. The Court may further require him to produce an books
and papers in his custody relating to the company, without prejudice to his
rights and interests. I the person or officer, so summoned, fails to appear
before the Court without any valid reason, the Court may cause him be
apprehended and brought before it for examination. If on examination, he
admits that he is indebted to the company or has any property in his
possession, the Court may order him to pay the amount or deliver the
property to the liquidator in such manner and on such term as the Court may
seem just (Sec. 477).
{311}
property, for the purpose of evading payment of calls or of avoiding
examination in respect of the affair of the company, cause him to be arrested
and his books, papers and movable property to be sized and safely kept unit
such time as the Court may order.
(9) Power to order for the dissolution of the company. When the affairs of
the company have been completely wound up and the Official Liquidator
has made an application to the Court in that behalf, or when the Court is of
the opinion that the Liquidator cannot proceed with the winding up for want
of funds or for any other just and equitable reason, the Court shall make an
order that the company be dissolved from the date of the order and the
company shall be dissolved accordingly. Within 30 days, the Liquidator
shall file a copy of the order with the Registrar, who shall make in his books
a minute for the dissolution of the company (Sec. 481).
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up, the company and its creditors are left free to settle their affairs without going to
a Court, although they may apply to the Court for directions or orders if and when
necessary (Sec. 518).
a. when the period fixed for the duration of the company as mentioned
in its articles, has expired, or
b. when the event on the happening of which, the articles provide that
the company is to be dissolved has occurred; or
(1) A voluntary winding up shall be deemed to commence from the date of the
passing of the resolution to that effect (Sec. 486).
(2) Form the commencement of voluntary winding up, the company ceases to
carry on its business, except so far as may be required for the beneficial
winding up thereof. (Sec. 487).
(3) The possession of the assets of the company vests in the Liquidator for
realization and distribution among the creditors. The corporate state and
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power of the company shall, however, continue will until it is dissolved
(Secs. 456 and 487).
(5) On the appointment of the Liquidator, all the power of the board of
Directors, Managing Director or Manager, shall come to an end except : (a)
for the purpose of giving notice the Registrar about any vacancy occurring in
the office of the Liquidator and of the name of the Liquidator appointed to
fill such vacancy, or (b) in so far as the company in general meeting or the
Liquidator or the Committee of Inspection of the Creditors in the creditor
voluntary winding up, may sanction the continuance of their power (Secs.
491 and 505).
(6) The company's creditors cannot file suits or continue any pending suits
against the company. They are required to lodge their claims and prove their
debts to Liquidator. In the case of disputed claims, however, a voluntary
winding up does not operate as a stay of any existing proceedings or prevent
the institution of new proceedings.
(7) All transfers of shares or alternations in the status of the members, made
after the commencement of the winding up of the company, shall be void
except when it is made with the permission of the Liquidator (Sec. 536).
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Under the Act voluntary winding up may be of two types (i) Members'
voluntary winding up; and (2) Creditors voluntary winding up.
(b) The passing of an ordinary or special resolution, as the case may be, by
the members at an extraordinary general meeting and filling a copy thereof, with
the Registrar.
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members shall appoint by the same resolution one or more liquidators and shall not
be increased in any circumstances whatsoever, not even with the sanction of the
Court. No liquidator shall take charge of his office, unless his remuneration is so
fixed. Further, if more than one liquidator are appointed and there occurs a vacancy
by death, resignation or otherwise in the office of any liquidator, the other
liquidator or liquidator cannot act until a new liquidator is appointed to fill up the
vacancy so caused by the company in liquidator is appointed to fill up the vacancy
so caused by the company in general meeting (Secs. 490 and 492). Quite often, the
secretary of the company is appointed as liquidator is this mode of winding up.
{316}
has expired without the debts having been paid in full, he shall forthwith summon a
meeting of the creditors and shall lay before the meeting a statement of the assets
and liabilities of the company (Sec. 495). Thereafter, the winding up shall proceed
as if it were creditors' voluntary winding up (Sec. 498).
(7) Duty of liquidator to call the general meeting the end of each year.
In the event of the winding up continuing for more than one year, the liquidator
must call a meeting of the members of the company at the end of the first year and
at the end on each subsequent year, or as soon thereafter as may be convenient
within three months from the end of the year. He must lay before the meeting an
account of his acts and dealings and report the progress of the winding up during
the year (Sec. 496).
(8). Finial meeting and dissolution. When the affairs of the company are
completely would up, the liquidator will call the final general meeting of the
members for the purpose of laying the detailed account of the winding up before it
and giving any explanation therefore. The meeting shall be called by advertisement
published not less than one months before ht emitting in the Official Gazette and
also in one of the local newspapers, specifying the time, place and object of the
meeting.
(8) Final meeting and dissolution. When the affairs of the company are
completely wound up, the liquidator will call the final general meeting of the
members for the purpose of laying the detailed account of the winding up before it
and giving any explanation thereof. The meeting shall be called by advertisement
published not less than one months before the meeting in the Official Gazettee and
{317}
also in one of the local newspapers, specifying the time, place and object of the
meeting.
Within one week after the meeting, the liquidator shall send to the Registrar
and the Official Liquidator a copy of the final accounts of winding up and 'return'
of meeting.
The Registrar on receiving the accounts and the 'return', shall register them.
The Official Liquidator will scrutinize the accounts and 'return' of the meeting and
also the books and papers of the company and will then report to the Court, the
result of his scrutiny. If the report of the Official Liquidator shows that the affairs
of the company have been conducted in a satisfactory manner, then from the date of
the submission of the report to the Court, the company shall be deemed to be
dissolved. In the case of an unfavorable report, the Court shall be directed the
Official Liquidator to make a future investigation of the affairs of the company, and
for the purpose shall invest him with all such powers as it deems fit. On the receipt
of the report of the Official Liquidator on such further investigation, the Court may
either make an order the company stands dissolved with the effect from the date
specified therein or make such other order as the circumstances of the case brought
out in the report permits (Sec. 497).
Where the company is unable to pay its liabilities in full (i.e. is insolvent)
and still wants to undergo voluntary winding, it should naturally be controlled and
supervised by the creditors, so that their interests can be duty protected. It is for this
reason, that creditors have the dominating control over the proceedings under this
mode of winding up.
{318}
Statutory provisions applicable to a creditors' voluntary winding up. Section
500 to 509 contain provisions regarding creditors' voluntary winding up, which are
summarized below:
(3) Filing of copy of the resolution with the Registrar. A copy of the
resolution passed for voluntary winding up the creditors' meeting, must be field
with the Registrar with ten days of the passing thereof (Sec. 501).
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(5) Appointment of Committee of Inspection. The creditors may at the same
or subsequent meeting, appoint a 'Committee of Inspection' consisting of not more
than five members. If such a committee is appointed, the company may also at a
subsequent general meeting, appoint five members to act as members of the
committee. If the creditor object against the persons appointed by the company,
then the matter will be referred to the Court for the final decision. The powers of
such 'Committee of Inspection' are the same, as those of a 'Committee of
Inspection' appointed in a compulsory winding up and these powers have already
been discussed in the present chapter (Sec. 503).
Section 512 provides that the powers and duties of the Liquidator in
voluntary winding up are just the same as those of the Official Liquidator in
compulsory winding up under order of the Court. We saw it the case of
compulsory winding up, that the Official Liquidator can exercise certain powers
with sanction of the Court. Similarly, here, the liquidator can exercise certain
power with the prior sanction and certain power without any sanction; the line of
demarcation being exactly the same as that in compulsory winding up; with one
important difference that here instead of sanction of the Court, the liquidator has to
obtain the sanction of a special resolution of the company is case of members'
voluntary winding up and he shall have to obtain the sanction of the Committee of
Inspection, or in its absence, of the creditors in the case of creditors' voluntary
winding up.
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Further, it is to be noted that : (i) in the exercise of those powers which
require sanction of special resolution, etc., the liquidator shall be subject ot eh
control of the Court and any creditor or contributory may apply to the court with
the respect to any exercise of these powers, (ii) the liquidator or any contributory or
creditor may apply to the Court to determine any question arising in the winding up
of the company or to exercise all or any of the powers which the Court may
exercise in case of compulsory winding up by the court (Sec. 518) (iii) The Court
may order public examination of any such person about whom a report has been
made by the liquidator alleging that in his opinion a fraud has been committed in
the promotion or formation or in conducting the affairs of the company (sec. 519)
and (iv) where several liquidators are appointed, they shall exercise their powers
jointly or by any number of them not being less than two; unless otherwise
expressly determine at the time of their appointment [Sec. 512(4)]. Where one of
several liquidators accepted a bill of exchange without authority of others, it was
held that the company was no liable.
The main difference between the two types of voluntary winding up are also
follows :
(c) The rules relating to winding up are not being observed, e.g. not to give
priority in payment to preferential creators etc.
Under these circumstances, the Court may make an order that the voluntary
winding up shall continue, but subject to the supervision of the court and on the
terms and cogitations specified by the Court (Sec. 522). The most important effect
of such an order is that the Court gets the same power as it has in the case of
Compulsory Winding up under order of the Court. [Sec. 526 (2)]. The court may
also appoint one or more additional liquidators. The Court has also to power to
remove any liquidator and fill any vacancy occasioned by the removal or by death
or resignation [Sec. 524( 1) (2)].
Section 527 further empowers the Court to pass an order for the compulsory
winding up, in case of need, superseding the supervisory winding up.
It will be seen from the above that this kind of winding up combines the
advantages of a voluntary winding up with the advantages of winding up by the
Court.
It will be seen from the above that this kind of winding up combines the
advantages of voluntary winding up with the advantages of winding up the Court.
(1) In the winding up of an insolvent company, the same rules as are in force
for the time being under the law of insolvency with respect to the estates of persons
adjudged insolvent shall prevail with regard to
(b) the valuation of annuities and further and contingent liabilities; and
{324}
Provides that eh security of every secured creditor shall be deemed to be
subject to a pari passu change in favour of the workmen to the extent of the
workmen's partition therein, and where a secured creditor, instead of relinquishing
his security and providing his dept, opts to realize his security; -
(a) the liquidator shall be entitled to represent the workmen and enforce and
such charge;
(c) so much of the debt use to such secured creditors as could not be realized by
him by virtue of the foregoing provisions of this or the amount or the
workmen's portion in his security, whichever is less, shall rank pari passu
with the workmen's dues for the purpose of Section 529 A.
(2) All persons who in any such case would be entitled to prove for and
receive dividends out of the assets the company, may come in under the winding
up, and make such claims against the company as they respectively are entitled to
make by virtue of this Section.
{325}
be liable to pay shall be the whole of the expenses leas an amount which bears to
such expenses the same proportion as the workmen's portion in relation to the
security bears to the value of the security.
(3) For the purposes of this Section, section 529 A and Section 530, -
(i) all wages or salary including wages payable for time or piece work and
salary earned wholly or in part by way of commission of any workman, in respect
of service rendered to the company, and any compensation payable to any
workman under any of the provisions of the industrial disputes Act, 1947;
(iii) unless the company is being wound up voluntarily merely for the
purpose of reconstruction or of amalgamation with another company, or unless the
company has, at the commencement of the winding up, under such a contract with
insures as is mentioned in Section 14 of the Workmen's Compensation Act, 1923,
rights capable of being transferred to and vested in the workman, all amount in due
in respect of any compensation or liability or compensation under the said Act, in
respect of the death or disablement of any workman of the company;
(iv) all sums due to any workman from a provident fund, a pension fund a
gratuity fund or any other fund for the welfare of the workman, mankind by the
company;
The liquidator has to prepare the list of contributories in two parts, i.e. 'List
A' and 'List B'. List A includes the 'present members' of the company whose names
appear in the register of members on the commencement of winding up. 'List B'
contains the names of 'past members', i.e. the members who ceased to be the
members within one year preceding the commencement of the winding up of the
company for any reasons whatever, e.g. because they have transferred or
surrendered their shares or business their shares have been forfeited.
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par with those who have paid the amount partly for their shareholder
[Sec. 426 (1)].
(1) Present Members. They are primarily liable to pay the unpaid amount
on their shares on the demand made by the Court or the liquidator as the case may
be. Their liability is absolute and any person whose name appears on the Register
of Members cannot escape his liability on the plea that the allotment of shares to
him was void (Lakshmi Narsa Reddi vs. The Official Liquidator, Shri Films Ltd.
(1951) AIR Mad 890). In this case of accompany limited by guarantee having a
share capital every member shall be liable (in addition to the amount guaranteed by
him) to contribute to the extent of any sum unpaid on the shares held by him, as if
the company were a company limited by shares.
(2) Past Members. Their liabilities is secondary and they will be liable to
pay only when it appears to the Court that the present members are unable to satisfy
the contributions required to be made by them. Further, a past member is not liable
to contribute in respect of any debt or liability of the company contracted after he
ceased to a member. The extent of liability is same as that present members, i.e. up
to the unpaid amount or up to the amount of that of guarantee in case of a guarantee
limited company, on the shares held by them (Sec. 426).
(a) if he has ceased to hold office for a year or more before the
commencement of winding up; or
(b) if the debt or liability was incurred after he ceased to held office; or
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(c) where the court does not deem it necessary to require further
contribution (Sec. 427).
(4) Any other person to whom the Court may so direct. The Court may,
be its order, impose liability on any person to contribute towards the payment of the
liabilities of the company, to an unlimited extent, on the ground that such a person
was a party to fraudulent trading carried on by the company or was guilty of
misfeasance or breach of trust in connection with the company's affairs (Sec. 542).
Explaining the meaning of 'fraudulent trading', Maugham, J. observed, "if a
company continues to carry on business and incurs debts at a time when there is, to
the knowledge of the directors, no reasonable prospect of the creditors ever
receiving payment of those debts, it is, in general, a proper influence that the
company is carrying on business with intent to defraud". Jenkins Committee of
England in 1962 further enlarged the term 'fraud' for this purpose and
recommended that the Section should be extended besides fraudulent trading, to
reckless trading as well.
{329}
'Register' and disowning liability (Somasundaram Pillai vs. the Official Liquidator
(1967), 2 Comp. L.J. 257, Mad.).
(1) A contributory cannot avoid his liability arising on the winding up of the
company on the ground that he had subscribed to the shares on the faith rescission
of the contract before the company goes into liquidation.
(3) Where a contributory upon whom a call has been made, also happens to
be a creditor of the company in some other respects, he cannot demand any set off
– balancing unpaid call against creditor – for, as a rule a statutory liability (e.g. for
an unpaid call ) cannot be set off against a credit. Of course the right of set off is
available to a limited extent in case of a contractual debt.
(4) Where share have been forfeited more than a year before the
commencement of the winding up, the names of the person concerned cannot be
place don the list of contributories as past members, bust such person shall remain
liable as a debtor to the company for the amount of unpaid calls for a period of
three years from the date of forfeiture, if the articles so provide (Ladies Dress
Association vs. Pullbork (1900) 2 Q.B. 326).
A secured creditor need not prove his debts against the company in winding
up as he has the right to realize his security in satisfaction of his debt. He can,
{330}
however, put his claim for the deficiency, if any, before the liquidator as unsecured,
creditor, and where there is a surplus left on the realization of pledged assets he is
required to hand over the same to the liquidator. The secured creditor has also the
open of relinquishing his security and to proved his debt as if he were an unsecured
creditor.
On the realization of assets and after finalizing the list of claimants, the
liquidator starts making payments of various claimants, subject to the rights of
secured creditors, the following order :
Preferential payments
After retaining the amount necessary for cost and expenses of winding up
proceedings (including the remuneration of the liquidator), certain unsecured
{331}
creditors known as preferential creditors have to be paid in priority to all other
unsecured creditors; including those who are secured by a floating charge.
Preferential creditors will rank equally among themselves and have to be paid in
full, unless the assets are inadequate in which case they shall abate in equal
proportions.
(a) Workmen's dues (as defined under Section 529 discussed earlier under
the heading : "Winding of Insolvent Companies"); and
(b) debts due to secured creditors to the extent such debts ranks pari passu
with the workmen's dues under clause (c) of the proviso to sub-section
(1) of Section 529. The aforestated proviso is reproduced below :
(c) so much of the debt due to such secured creditor as could nto be
realized by him by virtue o the foregoing provisions of this
{332}
proviso or the amount of workmen's portion in his security,
whichever is less shall rank pari passu with the workmen's dues
for the purpose of Section 529 A."
(1) All revenues, taxes, cases and rates due to the Central or a State
Government or to a local authority, which have become due and payable within
twelve months preceding the date of appointment of a provisional liquidator, or
otherwise the date of winding up order in case of compulsory winding up and the
date of the passing of the special resolution for winding up in the case of voluntary
liquidation.
(3) all assured holiday remuneration which has become payable to any
employee or in this case of his death to any other person in his right, on the
termination of his employment before, or by the effect of the winding up.
(4) All amounts due in respect of contributions payable during the said
twelve months under the Employees' State Insurance Act, 1948, or any other law
for the time being in force, except in case where the company being wound up
voluntarily merely for he purpose of reconstruction or amalgamation with another
company.
{333}
company is being wound up voluntarily merely fort he purpose of reconstruction or
amalgamation with another company, or where it has taken out a workmen
compensation insurance policy.
(6) All sums due to an employee from a provident funds, a pension fund, a
gratuity fund, or any other welfare fund maintained by the company.
After paying the preferential creditors enumerated above, the liquidator has
pay creditors secured by a floating charge, and then the unsecured creditors. If still
any surplus is left it will be distributed among contributories.
Any person claiming to be entitled to any money paid into the aforesaid
account may apply to the Court or the Central Government for an order for
payment of money claimed. The Court or Central Government may, if satisfied,
{334}
make an order for the payment to that person to the sum due to him, after taking
such security from him as it thinks fit.
Avoidance of voluntary transfer. Section 531 A lays down that any transfer
of property, movable or immovable, or any delivery of goods made by a company
within a period of one year before the commencement of its winding up, shall be
void against the liquidator unless such transfer or delivery is made in the ordinary
{335}
course of business or in favour of a purchaser or encumbrance in good faith and for
valuable consideration.
(a) If the company immediately after the creation of charge was solvent; or
(b) If the company received cash actually at the time of or after the creation of
charge in consideration thereof. The charge in such a case shall be valid to
the extent of amount of cash actually paid with interest at 5% p.a. or any
other rate notified by the Central Government (Sec. 534).
The disclaimer should be in writing and signed by the liquidator. The Court
may, before granting the disclaimer, require notice to be given to persons interested
and imposes such terms as it think just. The disclaimer release the company from
liability but it does not affect the rights or liabilities of any other person in respect
to that property. Any person injured by the operation of a disclaimer, may apply to
the Courts for award of damages for the non-performance of the contract by the
company, and if the Court passes an order awarding damages payable to any such
person, the amount of damages may be proved by him as a debt, in the winding up.
{336}
allowed to disclaim any property where an application in writing has been made to
him by any person interested in the property, requiring him to decide whether he
will or will not disclaim the property concerned, and the liquidator has not, within
28 days after receipt of the application, given notice to the applicant that he intends
to apply to the Court for leave to disclaim the property concerned [Sec. 535 (4)].
Final disposal of the books and papers of the company. When the affairs
of a company have been completely wound up and it is about to be dissolved, its
books and papers and those of the liquidator, may be disposed of as follows:
(a) in the company of winding up by, or subject to the supervision of, the Court,
in such manner as the Court directs;
(b) in the case of members' voluntary winding up, in such manner as the
company by special resolution directs; and
(c) in the case of creditors' voluntary winding up, in such manner as the
Committee of Inspection or, if there is no such Committee, as the creditors
of the company may direct.
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12.6 Summary
Winding up by the court may be ordered in cases mentioned in section 433. The
court that shall have jurisdiction to wind up a company shall be the High Court
having jurisdiction in relation to the place at which the registered office of the
company is situated except to the extent to which the jurisdiction has been
conferred on any district court or district courts subordinate to the High Court.
However, winding up of a company with a paid up share capital of Rs.1 lakh or
more must take place in the High Court.
According to section 433 a company may be wound up by the Court : (a) if the
company has, by special resolution, so resolved; (b) If a company has made a
default in delivering the statutory report to the registrar or in holding the statutory
meeting; (c) if the company does not commence business within one year or
incorporation or suspending its business for a whole year; (d) if the number of
members is reduced below the legal minimum limit, i.e. below 7 in a public
company and below 2 in a private company; (e) if the company is unable to pay its
debts or honour its monetary commitments; (f) if the Court is of opinion that it is
just and equitable that the company should be wound up.
The Companies (Second Amendment) Act,2002, which is yet to come into force
has added further clauses (g), (h) and (i) to section 433 as:
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(g) if the company has made default in filing with the Registrar its balance
sheet and profit and loss account or annual return for any five consecutive financial
years;
(h) if the company has acted against the interest or sovereignty and integrity
of India, the security of the State, friendly relations with foreign states, public
order, decency and morality; and
(i) if the Tribunal is of the opinion that the company shall be wound up
under the circumstances specified in section 424G.
It is important to note that the workers of the company cannot move petition
for winding up. They shall however have right to appear and be heard on a petition
for winding up of a company.
{339}
Such an order is passed by the court where (i) the resolution for winding up was
obtained by fraud, or (ii) the rules relating to the winding up order have not been
observed, or (iii) the liquidator is prejudicial or is negligent in collecting the
assets.
This category of winding up will not be available when Tribunal appointed under
section 10FB of the Companies Act starts functioning.
2. Discuss:
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Block - IV
Corporation Finance
CONTENTS
{341}
UNIT-13 CORPORATION FINANCE
Structure:
13.0 Introduction
13.1 Meaning
13.5 Capitalization
13.6 Summary
13.0 Introduction
{342}
arranged, from outside or from within the business. Corporation finance is
essentially concerned with issues relating to these aspects of business. To begin our
study of corporation finance, we will address two central issues: First, what is
corporation finance? Second, what is its objective?
The object of the Corporate Finance is the acquisition and allocation of corporate
funds or resources with the aim of maximizing shareholders wealth. In the financial
management of a corporation funds are generated from various sources and
allocated or invested for desired assets. The primary function of corporate finance
is resource acquisition, refers to the generation of funds from both internal and
external sources at the lowest possible cost to the corporation. There are two main
categories of resources are equity (shares) and liability (Borrowings). The equities
are proceeds from the sale of stock, returns from investments and retained earnings.
Liabilities include bank loans or other debts, accounts payable, product warranties
and other types of commitments from which an entity derives value. The second
function of corporate finance is resources allocation and investment of funds with
the intent of increasing share holders wealth over a period of time. There are two
basic categories of investments viz. current assets and fixed assets. Current assets
include cash, inventory and accounts receivable. The fixed assets are buildings, real
estate and machinery. In addition, the resource allocation function is concerned
with intangible assets such as goodwill, patents and brand names.
It is the duty of financial manager of a corporation to conduct the above
functions in a manner that maximizes shareholders wealth or stock price and he
must balance the interests of owners or shareholders and creditors including banks
and bondholders and other parties, such as employees, suppliers and customers.
For example a corporation may choose to invest its resources in risky ventures in an
effort to offer its share holders the potential for large profit. However, risky
investments may reduce the perceived security of the companies bond, thus
decreasing their value in the firm must pay to borrow money in the future.
Conversely, if the corporation invests too conservatively, it could fail to maximize
the value of its equity. If the firm performs better than other companies its stock
price will rise, in theory, enabling it to raise additional funds at a lower cost, among
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other benefits. Practical issues and factors influenced by corporate finance include
employee’s salaries, marketing strategies customer credit and the purchase of new
equipment.
The Financial decision affects both the profitability and risk of a firm’s operation.
An increase in cash holdings, for instance risk, but, because of cash is not an
earning asset, converting other types of assets to cash reduces the other firm’s
profitability. Similarly, the use of additional debt can raise the profitability of a
firm, but more debt means more risk. Striking a balance between risk and
profitability that will maintain the long term value of a firm’s securities in the large
of finance.
13.1 Meaning
To understand what is financial management, imagine that you what to start a new
business. No matter what type of business you choose, you will have to address the
following questions :
(i) What long term investments will you undertake? That is, which line of
business you will like to be in and which machinery, equipment building,
etc. you will buy.
(ii) How will you raise finance to pay for the long term investments? Will
you borrow money for this purpose or share the ownership with others by
issuing equity.
(iii) How will you manage flow of finance in respect of day to day operations
of business, such as collecting cash from debtors, paying the creditors,
maintaining appropriate cash balances so that neither there is excess nor
shortage of liquidity.
(iv) How will you reward the investors who hold equity shares of the
business? You must decide whether the whole or a part of profits shall be
distributed as dividends.
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Thus, corporate finance is concerned with efficient acquisition, allocation and
utilization of funds. In operations terms, it is concerned with management of flow
of funds and involves decisions relating to procurement of funds, investment of
funds in long term and short term assets and distribution of earnings to owners. In
other words, focus of financial management is to address four major financial
decision areas namely, investment, financing, operating and dividend decisions.
(i) The term profit is vogue. It conveys a different meaning to different people
e.g. short term profit, long term profit, total profit or rate of profit etc.
(ii) There is a direct relation between risk and profit. If profit maximization is
the only goal, then risk factor is totally ignored.
(iii) The sole objective of profit maximization does not consider time pattern
of returns.
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(iv) Profit maximization as an objective is too narrow. It does not take into
account the social considerations and obligations to protecting the
interests of society, workers, consumers as well as ethical trade practices.
Ignoring these factors, a company cannot survive for long.
Thus it is clear that for maximizing its profits a company may adopt policies
that may give high profits in the short run but which are unhealthy for the
growth, survival and overall interests of the business. Hence it is commonly
agreed that objective of the firm should be to maximize its value or wealth.
According to Prof. Van Horne, value of a firm is represented by the market
price of the company’s common stock. It takes into account present and future
earnings per share, the timing and risk of these earnings, the dividend policy of
the firm and many other factor that bear upon the market price of the stock. The
market price serves as a performance index of the firm’s progress.
Though, prices in the share market at a given point of time are a result of many
factors like general economic outlook, particular outlook of the companies
under consideration, technical factors and even mass psychology. However
taken on a long term basis, the market prices of a company’s share do reflect the
value which the various parties put on a company. Normally, this value is a
function of two factors:
(i) the likely rate of earnings per share of the company; and
(ii) the capitalization rate.
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The financial manager in a company makes decisions for the owners,
i.e. the shareholders of the firm. He must implement financial decisions
which will ultimately prove gainful from the point of view of
shareholders. The shareholders gain if the value of shares in the market
increases. A financial decision can be considered efficient from the point
of view of shareholders if it increases the price of shares. Poor decisions
are those which result in decline in the share price. Thus, we can clearly
state the objective of financial management as follows:
Normally, share price is expected to increase with the rise in gain available to
shareholder and vice versa. We known that equity owners are the residual owners
in the sense that they get paid only after the claims of all others, such as employees,
suppliers, tenders, creditors and any other legitimate claimants, have been duly
paid. If any of these groups remain unpaid shareholders are not entitled to anything.
Therefore, if shareholders are gaining, it automatically implies that all other
claimants are also gaining.
Thus, the goal of financial management is to maximize the equity share price. The
financial manager must identify those avenues of investment, modes of financing,
ways of handling various components of working capital which ultimately will lead
to an increase in the price of equity share. It must be noted that the objective of
maximizing the price of equity shares does not imply that the financial manger
should have recourse to manipulating the share price.
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The finance function relates to three major decisions which the finance manger has
to take : (i) Investment decision; (ii) Finance decision; (iii) Dividend decision and
(iv) operating decision.
(i) Investment decision: This decision relates to the careful selection of assets in
which funds will be invested by the firm. The decisions may relate to investment in
assets which are long term or short term. Decisions relating to the former are
referred to as capital budgeting, and those relating to the latter are referred to as
working capital decisions. A business needs to invest financial resources for setting
up new business, for expansion and modernization. To expand, it undertakes
investment in different projects. To modernize, it replaces existing plants,
machinery, buildings etc. with new ones.
Investment decisions are crucial for business because of the following reasons:
• They are long term investments and therefore considered irreversible. Once
implemented, they can be scrapped only at huge costs to the company.
• They generally involve commitment of huge funds.
• They have an important bearing to the profitability and future of the company.
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accumulated profits. Borrowings from outsiders include borrowed funds like
debentures and loans from financial institutions.
The business has to decide the ratio of borrowed funds and owned funds. The
borrowed funds have to be paid back with interest and there are delay or default
risks involved if the principal amount and interest is not paid. Ownership securities
such as equity have no fixed commitment regarding payment of dividends of
principal amount and therefore, there is no delay on default risk. However, such
sources of finance dilute the controlling rights of existing investors and may these
pose takeover risk. However, most businesses employ a judicious mix of both
borrowed funds as well as shareholders funds to use a combination of borrowed
and shareholders’ funds, and determination of their precise ratio is called the
financing decision.
(iv) Operating decisions: Such decision relates to the management of flows of funds
arising on account of day to day operations of business.
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One the important decisions relating to financial management is the financing
decision which deals whit the financing pattern of the business. A business has to
decide how to raise resources. There are mainly two major sources of funds –
shareholders funds and borrowed funds. Shareholders’ funds may consist of equity
share capital and preference share capital and reserves and surpluses. Borrowed
funds may consist of debentures and long term debt. The assets of a company can
be financed either by owners’ funds or borrowed funds. The appropriate mix of
long term sources of funds such as equity and preference share capital and reserves
and surpluses and debentures and long term debt is called the capital structure of a
company.
Meaning: The capital structure means the proportion of debt and equity used for
financing the operations of a business. The right proportion of debt and equity is
desired to maximize profit or value of the business firm. A capital structure will be
said to be optimal when the proportion of debt and equity is such that it results in
increase in the shareholders value of the share. What kind of capital structure is
best for a firm is very difficult to define. Basically, the right proportion or the
appropriate mix of debt and equity should increase the market value of share held
by shareholders. This means that all decisions relating to capital structure should
emphasis on increasing the shareholders wealth.
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(iii) Flexibility : The company should be able to change the proportion of
debt and equity in the capital structure, if required depending on
changing conditions.
(iv) Capacity : The company should have the capacity to repay long term
debt and its interest obligation. This will depend on the company's ability
to generate future cash flow.
(v) Control : The capital structure should not involve loss of control of the
shareholders. If there is too much debt then shareholders are likely to
lose control to debenture holders.
Financial leverage :
The capital structure of a company may consist of debt, preference shares or equity
shares. Debt is usually in the form of debentures and long term loans with a fixed
financial change rate of interest. Preference shares also have a fixed rate of
dividend but they are paid only if the company earns profits. Since, money return
on preference shares and debt instruments are fixed which are known as fixed
charge securities. The equity shareholders are entitled to the remaining profits after
paying out interest and taxes. The rate of dividend is not fixed on equity shares and
depends on the dividend policy of the company. Equity is known as variable return
security as dividend on it may vary from year to year.
The use of debt and preference shares which have a fixed financing cost along with
equity shares in the capital structure with a view of increase earnings available to
shareholders (earnings per share) is called financial leverage or capital gearing or
trading on equity. The equity shares are used as a base to raise loans and debentures
i.e. the equity is traded upon, hence, the term trading on equity.
Just as a lever is used to lift something heavy by applying less force than required
otherwise, in the same way fixed return bearing securities like debt and preference
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shares are used to increase the earnings and return to equity owners without
increasing the operation income of the business. That is why, use of debt and
preference capital in the capital structure is known as financial leverage. Having
understood the meaning of financial leverage or gearing, let us understand how
financial gearing works.
(i) Financial leverage : The most important factor in deciding capital structure is
the impact of financial leverage or capital gearing on the owners of the company. A
financial manger must examine in detail how the use of proposed financing mix
will affect the risk and return of the owners.
Loans and debentures have a risk factor attached to them as interest has to be paid
irrespective of profits earned by the company. Preference shares are less risky as
dividends are fixed but only payable out of profits. Equity shares bear not risk at all
from the company's point of view. The financial leverage employed by the
company will depend on the amount of risk the company would like to take. More
debentures and preference shares would mean higher returns of equity shareholders
but at the same time risk increases. Therefore, the composition of capital structure
depends upon the financial leverage employed and the risk factor involved. The
main purpose of using financial leverage is to increases the shareholders return of
earnings per share. This is possible only if the rate of interest on debt is less than
the rate return on investment. The difference between the earnings of the firm and
the cost of debt i.e. interest, is distributed to the shareholders thereby increasing
their earning per shares. The earnings per share also increases when preference
shares are used in the capital structure as dividend on preference shares is fixed.
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When debt and preference capital is used in the capital structure the leverage effect
increases because of two reasons :
(a) The rate of return on investment is more than the rate of interest and
dividend on debt and preference capital respectively.
Companies by using more debt i.e. a high degree of leverage can increase the return
on the shareholders equity. This is possible only when the company has a high level
of earnings before interest and taxes i.e. EBIT. Alternative methods of financing
may be considered by the company and their impact on the earnings per share must
be studied and analyzed before taking a decision.
The only disadvantage of using debt in it's capital structure is the financial risk
involved and the threat of insolvency. Interest on debt has to be paid even when the
company is not making sufficient profits. Debentures usually have a charge on the
assets of the company and sue for recovery of their capital and interest. Thus the
threat of insolvency is also there when too much debt is used in the capital
structure.
But, the financial risk can be avoided by not employing debt and financing the
business with equity capital. There is no financial risk involved as interest does not
have to paid and hence, there is no threat of insolvency. But at the same time the
earnings per share decreases as the same earnings have to be divided amongst a
large number of shares. Therefore, the shareholders are not able to get the benefit of
the expected increases in EPS. These are the two criteria which the company has to
consider i.e. the return and the risk involved. Basically it's a trade off between
return and risk.
(ii) Cash Flow Ability : The decision relating to composition of the capital
structure also depends upon the ability of the business to generate enough cash
flows to meet its fixed commitments. The fixed charges are the interest on debt,
dividend on preference capital and principal amount of loan which have to be paid.
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The company may be making sufficient profits but it may not be generating cash
inflows at the time of payment of interest. The expected future cash flow should be
analyzed and synchronized with the payment of interest.
The company is under a legal obligation to pay interest and return the principal
amount of debt. If the company is not able to meet its fixed commitment it may
have to face insolvency.
A company usually would employ debt in the capital structure if it is sure of its
ability to generate cash inflow to meet its interest obligations. It would be quite
risky to employ too much debt if its cash flow were unstable and unpredictable.
Cash shortages are likely to occur in highly profitable companies also if its working
capital management is poor. The company should analyze its liquidity position and
prepare projected cash flow statements. These statements should give the company
a clear indication of its ability to generate cash flow to meet its fixed financial
obligations.
(iii) Control: The equity shareholders have a say in the management of a company.
The debenture holders do not have a right to manage the affairs of the business. The
preference shareholders have a limited rights to vote in Annual General meeting on
resolutions where their payment of divided is affected. The existence of preference
share capital and debt capital as such do not affect the controlling powers of equity
holders but use of equity dilutes controlling rights of existing shareholders. If the
owners are concerned with maintaining tight control over the company it will prefer
to employ debt and preference capital in its capital structure. The control will be
dilute if additional funds are raised through issue of equity as equity shareholders
have a right to vote.
The equity shareholders elect the directors who constitute the Board of Director and
are entrusted with the responsibility of managing the business. This consideration
of maintaining control of the company become significant in companies which do
not have many shareholders i.e. in closely held companies. If additional shares are
issued then another shareholder or group of shareholders may purchase a major
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chuck and gain control over the company. To avoid the risk of losing control or
interference by other shareholders certain companies prefer to raise capital by
issuing preference shares or debentures.
Debt suppliers do not generally have voting rights but when a company uses a large
amount of debt then there are certain terms and conditions in the loan agreements
specially when financial institutions give loans to companies. These terms and
conditions stipulate that these providers of debt have some say in the management
of the company. These conditions at time require their representative to be on the
board of directors, restrict the payment of dividends, undertaking new long term
investment, maintaining a specific level of liquidity etc.
Types of debentures of the issues also have implication for the degree of control
enjoyed by equity holders. If the company issues convertible debentures which get
converted into equity shares at a predetermined point of time tin future then there is
a dilution of control.
(iv) Flexibility: A company should be able to adapt its capital structure to changing
conditions when required. The capital structure should be flexible enough to raise
additional funds without undue delay and cost. Additional funds may be raised in
the from of debt or share capital. The company should be able to borrow from the
capital market whenever required. But if the capital structure has too much debt
already then lenders may not be willing to give more loans to the company. The
composition of the capital structure should be flexible enough to change as per the
company's requirements and operations. The shares or debt may be substituted
depending upon the conditions in the capital market or the company's need.
The terms and conditions in the loan agreements may restrict the company's
flexibility in dealing with financial matters. The terms may include restrictions on
distributing cash dividends, investing in new projects, or maintaining a particular
liquidity position. These restrictions protect the interest of lenders but at the same
time restrict the company to operate freely. Therefore, while raising debt a
company should ensure there are a minimum of restrictive clauses.
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(v) Market Conditions : The conditions in the capital market to some extent
influence the capital structure decisions. They may not affect the initial capital
structure but when the company requires additional funds then the appropriate time
for issuing shares or debentures is an important consideration. Depending on the
economic conditions, investors may be cautious in their dealings and not be ready
to take unnecessary risks by purchasing shares. At this time a debenture issue may
be appropriate as it assures a fixed rate of interest to the investor.
Depending upon the conditions in the capital market, the mood of the investor and
the internal conditions of the company, the company should decide on the
alternative methods of financing and choose an appropriate mix.
If there is a depression in the market then equity shares should not be issued as they
have a risk element attached to them, and investors may not be in a mood to take
risks. The company should wait till there is a revival of the share market. At this
time it would be advisable for the company to issue debentures. But if there is a
boom period i.e. the market is in a highly volatile state where investors are ready to
purchase and anything sells. During this period the company may be able to issue
shares and that too at a premium. At the same time the company is able to keep its
dept capacity unutilized i.e. it may issue debentures at a later stage, when required.
The company may find it difficult to raise additional debt from the market because
of its internal conditions also. If it is highly levered company, i.e. it has high debt
employed in its capital structure; it may find it difficult to raise funds from the
market. Restrictive clause in loan agreements like dividend payout etc may also
hinder its capacity to raise funds. All these give the company a low rating in the
capital market.
(vi) Floatation costs : Flotation costs are the costs involved in the issue of shares
or debentures. These costs include the costs of advertisement, underwriting
statutory fees, printing prospectus and other miscellaneous expenses. It must be
noted that this is not a major consideration while deciding on the matter of issuing
shares or debentures in case of large companies. In small companies, however this
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may be a major factor while considering a debenture or share issue. Even large
companies cannot afford to make frequent issue of debentures and equity shares.
There are a number of legal formalities to be completed and miscellaneous
expenses can add up substantial amounts. At times a company may decide to raise
capital at one time only to avoid incurring flotation costs again at a later state. it
also depends upon the underwriters willingness and the commission they are likely
to charge. Therefore, while deciding on the size and type of security to be issued
along with the other factors, this factor though relatively less important must be
considered. It may be pointed out here that in view of unprecedented size in these
costs involving huge sums of money extending up to crores of rupees, this factor is
increasingly gaining in importance.
13.5 Capitalization
Capital is the basis of all financial decisions and the term capitalization had been
derived from it. Capital means – the total funds invested in the business and
includes owners' funds, long term loans and other reserves which are represented
by assets. Capitalization is the valuation of this capital and will include owners’
funds, borrowed funds, long terms loans reserves and any surplus earnings. The
surplus earnings are the accumulation of net earnings which are not distributed to
owners and are allowed to remain in the business. Since, these earnings are not
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meant for distribution to shareholders they are in the nature of free reserves and are
included in the valuation of capital.
Suppose the average rate of earnings of an industry is say, 10 per cent per
annum. A company has invested Rs. 10,00,000 in a business and its net earnings
are Rs. 1,00,000. The rate of earnings of this company is 10 per cent per annum.
This means that this company is able to earn what other business firms are earning.
The company can be said to have a normal capitalization. In case this company had
invested Rs. 12,00,000 and its earnings were Rs. 1,00,000 (Same as above) then
the rate of earnings would have been 8.33 per cent which is less than the industry's
average of 10 per cent. On an investment of Rs. 12 lacs its earnings should have
been Rs. 1,20,000. Since the company would be using greater amount of capital
than needed to generate the earnings of Rs. 1,00,000, the company will be regarded
as over capitalized.
Let us take another situation. Suppose the company had invested Rs. 8,00,000 and
1,00,000
its earnings were Rs. 1,00,000 the rate of earnings would be × 100 = 12.5
8,00,000
per cent which is more than the industry's average of 10 per cent. The company is
able to earn more on less capital invested. The company is characterized by under
capitalization.
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Thus, the phenomenon of fair, over and under capitalization is based on rate of
return on capital employed by a company compared to the rate of return of the
industry as a whole to which the company belongs.
It is true that an over capitalized company has more capital than what is justified by
its earnings. But this does not mean that the business has an excess of capital or
abundance of capital. It simply means that capital is not being efficiently utilized
and the earnings are less than what is warranted by the capital employed. The
earning capacity does not justify the amount of capitalization and, therefore, the
company becomes over capitalized. The correct indicator of over capitalization is
the level of earnings of a company. If the earnings of a company are not sufficient
to pay its fixed interest charges and dividends to shareholders over a period of time,
then the company is over capitalized.
(i) High promotion costs : At the time of promotion many companies incur heavy
preliminary expenses such as promoters' fees, brokerage and underwriting
commission, purchases of patents and goodwill. Some of these expenses are not
productive and sometime the purchase of goodwill or patent rights does not
enhance the earning capacity of the business. Therefore, capital becomes excessive
and the earnings are not above to justify the amount of capital employed.
(ii) Unduly high price paid for assets: Sometimes partnerships or private
companies are converted into public limited companies are converted into public
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limited companies and assets are transferred at inflated prices or land and building
are purchased at very high price. These assets do not give commensurate returns or
contribute to the earning capacity of the business.
The inflated asset values are not reflected in the earnings of the company. This
leads the company to become over capitalized.
(v) Liberal dividend policy: Some companies distribute dividends liberally out of
profits instead of being retained and reinvested in the business. As a result, reserves
which enhance the earning capacity of the company are not created. To make up
the deficiency, the company borrows from the external sources and raises capital
through issue of shares. This proves to be costlier affairs in terms of the earnings
not being able to justify the high amount of capital raised. In such a situation the
company finds itself over capitalized.
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These can be studied from the point of view of the company, shareholders and the
society.
On the Company
(i) The market value of the shares of a company falls drastically because
of its reduced earning capacity.
(ii) It becomes difficult for such a company to raise loans since its credit
standing is adversely affected.
(iii) Since earnings are low the company cuts down the expenditure on
maintenance, replacement of assets and adequate provision for
depreciation.
(iv) The company resorts to manipulation of accounts to show profits,
sometimes dividends are paid even if there are no profits.
(v) The reputation of a company is affected and goodwill is lost. The
company has to go in for capital reorganization.
On Shareholders
(i) The market value of share falls and their capital is depreciated. They
incur huge loss at the time of selling the shares.
(ii) Since earnings of the company are reduced, their dividends are also
affected which become uncertain and irregular.
(iii) The shares of such companies are not accepted as security for
advance and loans. These shares instead of being an asset become a
liability.
(iv) In case, reorganization of the company takes place the shareholder
have to bear the brunt because the face value of their shares is
brought down.
On Society
(i) Since, profit are falling, an over capitalized concern resorts to tactics like
increase is prices are reducing the quality of products.
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(ii) Expenditure on wages is curtailed which leads to labour unrest and
strikes.
(iii) Creditors of the company are affected because of irregular payment of
interest.
(iv) Over capitalized companies because of their inability to earn adequate
returns on capital employed become a drain on the resources of society
which are extremely limited and scarce.
Under Capitalization
in the same example, the company had invested Rs. 8,00,000 and was earning Rs.
1,00,000 which was 12.5 per cent on capital. This does not mean that this company
is short of capital of Rs. 2, 00,000. In fact this company has been able to earn more
on a lesser amount of capital invested, hence utilizing its funds more efficiently.
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Causes of under capitalization are mentioned below :
(iii) Conservative dividend policy: The Company might have not distributed
dividends freely in the initial years of its existence. Profits are retained in
the business and reserves are created or reinvested in the business. This
results in higher earnings on the capital employed and hence under
capitalization.
(iv) High efficiency: If assets are used and maintained properly, costs are
reduced. A higher level of vigilance and efficiency leads to improvement
in productivity and profitability which is relates to the amount of capital
employed.
On the Company
(i) The market value of shares goes up since earnings are high.
(ii) Secret reserves are built up.
(iii) Government intervention in the form of higher taxes.
(iv) The high rate of earnings may encourage outsiders to enter the field and
increase competitions.
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(v) The employees demand higher salaries and wages and this may lead to
dissatisfaction and labour tension.
On Society
(ii) Consumers feel exploited since profits are high. They may feel it is due
to higher prices charged for products.
Under capitalization is a condition which cannot exist for long. Higher earnings
attract competition, government intervention in the form of taxation and so
ultimately the profits come down. The economy takes care of an undercapitalized
company and because of its pulls and pressures, the company may have to go in for
a complete reorganisation in which the shareholders and creditors often suffers.
Both under capitalization and over capitalization are evils but under capitalization
is a lesser evil. Therefore, companies should strive to target at fair capitalization.
13.6 Summary
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13.7 Check Your Progress
14.0 Introduction.
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14.1.2 Stock
14.13 Summary
14.0 Introduction:
A share in a company is one of the units into which the total capital of the company
is divided.
Section 2 (46) of the Companies Act defines shares "as a share in the share
capital of company and includes stock except where a distinction between stock
and share is expressed or implied."
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A share is a fractional part of the capital of the company which forms the
basis of ownership of certain rights and interests of a subscriber in the company. It
is not a sum of money but an interest or right measured in a sum of money to
participate in the profits of the company, or in the assets of the company when it is
wound up. The members does not own an identified part of the company's
undertakings. His interest is something he owns. Share holders are not part owners
of the undertaking (in the eye of law). The ownership of the assets rests in the
corporate body and not in the members composing it. A share secures to its owners
certain rights and liabilities e.g. right to dividend, right to vote, and liability to pay
unpaid balance (if any) and to be bound by the provisions of the article and
memorandum.
14.1 Share and share capital. We shall first have a brief understanding of
the concept and nature of shares and stock and the distinction between the two. We
shall also have a brief discussion about share capital and different kinds of share
capital.
Each share in a company having a share capital must have a nominal value.
Each share must bear a distinctive number, but this requirement of distinctive
numbers shall not apply to share held with a depository (as per section 83).
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14.1.2 Stock
Stock in a company means a bundle of fully paid shares put together for
convenience so that it may be divided into any amount and transferred into any
fractions and sub-divisions without regard to the original face value of the shares.
A company cannot issue stock originally and the stock can only be obtained
by conversion by an ordinary resolution by members-
(1) Stock cannot be originally issued but only fully paid shares are converted
to stock.
(2) Shares may be fully paid or partially paid, stock must be fully paid.
(4) Shares have distinct / definite numbers, Stock has no such number.
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14.1.4 Share Capital:
Share capital denotes the amount of capital raised or to be raised by the issue of
shares by a company.
2. Issued Capital : Means nominal value of that part of the authorized capital
which is allotted for cash or for consideration other than cash and includes
shares subscribed by signatories to memorandum.
Called up capital – It is that part of the allotted share capital which has
been called up to the Company.
Uncalled capital : It is that part of the allotted share capital which has not
been called up the Company.
Reserved capital : It is that part of uncalled capital which has been reserved
by the Company to be called in the event of its winding up.
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Section 99 states that a Limited Company many make a provisions for
reserve capital by special resolution.
Reserve capital cannot be charged as security for loans unlike the uncalled
capital.
Reserve capital cannot be turned into ordinary capital without leave of the
Court nor can it be canceled in reduction of capital.
Preference Equity
Cumulative Non-Cumulative
Participating or non-
participating Participating or Non-
participating
Convertible or Non-
convertible Convertible or Non-
convertible
14.3 Redeemable or
Preference Shares Redeemable or
Irredeemable Irredeemable
(a) as to payment of dividend at a fixed rate during the life time of Company,
and
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If any shares carry only one of these two preferential rights, they will be
treated as equity shares.
The holder of preference shares enjoys only a preferential right over the
equity share holder. He will service dividend at a fixed rate e.g. 13% if a dividend
is declassed. He is only entitled to income form his investment if a distributable
prompt is available. His right is not to dividend but to preferential treatment as and
when dividend is distributed.
They do not enjoy normal voting right as equity shares with voting rights do.
ii. When the dividend due on their preference shares has remained unpaid.
In case of cumulative shares – for an aggregate period of not less than 2 years
immediately proceeding the date of meeting.
As per section 90 (2) above provisions relating to voting rights of preference share
holders do not apply to a Private Company. Such a Company can issue preference
shares carrying normal rights or even disproportionate voting rights.
Preference shares may be of various kinds depending upon terms of issue defined
either in Article or in Prospects.
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1. Cumulative – In cumulative preference shares arrears of dividends are
accumulated and shall be paid, if any dividend is declared in subsequent years,
before any dividend is paid to the equity shareholders.
Arrears of undeclared dividend shall be payable out of the surplus left after
returning in full the preference and equity shares capital.
5. Convertible – They bear the right to convert preference shares into equity shares
after certain period of time.
6. Non Convertible - Non-convertible preference shares have not been given right
of conversion into equity shares.
{372}
All preference shares are deemed to be non-convertible unless contrary has
been stated in Article or terms of issue.
(ii) The shares may only be redeemed if they are fully paid up.
(iii) The shares may only be redeemed either out of distributable profits of the
company accumulated for the Purpose into a "Capital Redemption
Reserve A/c" or out of the "proceeds of a fresh, issue of shares"
including the amount of premium received, if any, made for the purpose.
The rationale behind the imposition of above restrictions is that since basic
objective of company law is 'preservation of subscribed share capital' for the
benefits of creditors. The companies Act attempts to keep intact even the
redeemable preference share capital by not allowing its outright redemption. It only
allows the replacement of redeemable preference share capital either by 'fresh share
capital' or by 'Capital Redemption Reserve Account'.
{373}
(iv) If any premiums is payable on redemption the amount must have been
provided for, either out of the profits of the company or out of the
company's "Securities Premium Account' before the shares are redeemed.
"
(b) the issue of new shares for the purpose of redemption should not amount to
'increase of capital' for stamp duty purposes. Provided the redemption takes
place within one month after the making of the fresh issue'.
– Non-participating,
– Non – Convertible
Equity shares mean those shares which are not preference shares [sec.
85(2)]. These shares carry the right to receive the whole of surplus profits after the
{374}
preference shares have received their fixed dividend. If not profits are left after
paying fixed preference dividends, the holders of equity shares get no dividend,
same is the case with regard to return of capital on winding up of the company.
Directors have the sole right of recommending dividends to such shares and,
therefore they may not get any dividends in case the directors so choose, in spite of
huge profits. Therefore Share capital raised through such shares is called 'Risk
Capital'.
{375}
(I) Company limited by shares may issue equity shares with differential
rights (as to voting & dividend) to the extent of 25% of the total share
capital issued provided it has distributable profits in terms of sec. 205
for three financial years preceding year of issue and has not defaulted
in repayment of its deposits or debentures.
(iii) The Company will not be allowed to convert its equity capital with
voting rights into equity share with differential rights and vise-versa.
Therefore, Companies will now be allowed to issue equity shares with differential
voting rights including non-voting rights (but carrying higher rate of dividend). A
large number of small investors, who hardly exercises their voting rights, would
find non- voting equity shares of financially sound companies an alternative
instrument of saving. On the other hand, such non-voting equity shares will be a
boon to existing management of Companies who can raise capital without diluting
or reducing their control over the company.
Section 78 of the Companies Act lays down certain restriction upon the use of
premium amount (in excess of par value) so collected. It says that the premium
amount so collected must be transferred to the Securities Premium Account and this
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account is to be treated as share capital for reduction purpose except when it is to
be used for the following purposes:-
(I)To issue fully paid bonus shares to members. (ii) To write off the
preliminary expenses of the company. (iii) To write off the expenses of
/commission paid/ discount allowed on any issue of shares or debenture of the
company. (iv) To provide premium payable on redemption of redeemable
preference shares or debentures. (v) For buy back of own securities u/s 77A.
When securities are issue at a premium for consideration other than cash, a
sum equal to the amount of premium must be transferred to 'securities premium
account'
When shares are issued for consideration less than their par value, they are
taken to be issued at discount.
1. The shares must be of a class already issued. (i.e. no new class of shares)
{377}
4. Issue must be sanctioned by Company Law Board(CLB). (No sanction if
discount exceeds 10% unless CLB allows such issue considering special
circumstances of the case).
Reasons for prescribing such strict restrictions for issuing shares at discount
is that such a practice actually amounts to reduction of the capital.
Above restrictions don't apply in case of debentures, since they do not from
part of the share capital of the company. However, debentures cannot be issued at
the discount if the ultimate object is to convert them into shares.
Thus, sweat equity shares are not independent class of shares. They are a
kind of equity shares and all provisions relating to equity shares shall be applicable
to such shares.
A company may issue sweat equity shares if the following conditions are
satisfied : -
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(3) Issue must be authorized by special resolution passed by the company in a
general meeting
(4) Resolution must specify number of shares, their current market price,
consideration (if any), and the class or classes of directors or employees for
whom they are issued.
(5) The shares must be issued in accordance with SEBI guidelines [SEBI (Issue
of Sweat Equity) Regulations, 2002] in case of listed shares or Central Govt.
guidelines in case of unlisted shares.
(ii) Rate of commission should not exceed 5% (in case of shares) and 2½%
(in case of debentures) of the price at which they are issued or the rate
specified in the Article whichever is lesser.
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(iii) The rate of commission agreed to be paid should be disclosed in the
prospectus or statement on lieu of prospectus (for public companies) or it
must be filed with the Registrar (for private companies).
Section 402 provides that a company can buy its own shares to relieve an
oppressed part of members with a view of prevention of oppression under the
orders of CLB.
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will push up the market price of shares. Thus, there is enhancement of
shareholders value as a result of buyback.
A cash rich company may buy back its own shares at the market rate as a means
of better investment.
The buyback strategy may be used to reduce the floating stock from the market
to prevent the hostile take over bid and thereby enabling the existing
management to maintain the controlling interest using the company's money.
Buyback of shares should only be attempted when the future earnings are
forecasted to be strong otherwise it may damage the shareholders’ interest.
A company may purchase its own shares or other specified securities out of
–
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(a) 'Specified securities’ includes employees stock option or other securities
as may be notified by central govt. from time to time.
(b) 'Free reserves' means those reserves which are free for distribution as
dividend and shall include balance to the credit of the securities premium
account but shall not include share application money (which is due for
refund but has not been encashed).
Where a company purchases its owns shares out of 'free reserves', then a
sum equal to the nominal value of the shares so purchased must be transferred to
the 'Capital Redemption Reserve Account' and its details must be disclosed in
balance sheet.
As per Sec. 80 (1) the 'Capital Redemption Reserve Account' is special type
of reserve account and it is to be treated as share capital for reduction purposes.
This reserve may be utilized for the issue of fully paid bonus shares.
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Companies are now permitted to buyback shares & securities up to 10% of the total
paid up equity capital and free reserves with the approval of BOD by resolution
passed at Board's meeting, but only one buyback is permitted in one year).
4. Amount involved in buyback should not exceed 25% of the total paid up capital
and free reserves of the company.
Strict norm for Equity shares – But if the equity shares are to be bought back, the
amount involved should not exceed 25% of the Companies total paid up capital in
that financial year.
5. After the buyback - the ratio of Debt to Capital and free reserves should not
be more than 2:1 (Central Government may provide higher ratio).
6. The shares or securities brought to be buy back should be fully paid up. 7.
Buyback of shares must be completed within 12 months from the date of
passing of resolution by board of directors.
Bonus issue occurs when the company does not distribute its profits and
reserves by way of dividend but retain them and uses them to pay for the issue of
new fully paid shares. These shares are called Bonus shares. Thus issue of bonus
shares implies the payment of dividend in the form of shares instead of cash.
According to section 205(3), a company may, if its Articles so provide, capitalize
profits by issuing fully paid up shares to the members thereby transferring the sums
capitalized from the profit and loss account or Reserve Account to the Share
Capital.
6. SEBI guidelines for issue of bonus shares must be complied with (in case of
listed Companies.).
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14.12 SHARE CERTIFICATE AND SHARE WARRANT
Share Certificate :
A shares certificate is not a document of title of the rights under it are not
transferable by a more endorsement and /or delivery of the certificate. In order to
transfer shares evidenced by a share certificate on 'instrument of transfer' duly
competed must be logged with the Co. for approval by the BOD.
In case of joint holder of shares – Co. shall issue only one share certificate to
the hinder first named in the register of members. the name of every holder of a
shares certificate shall appear in the register of member of the Co.
1. Name of persons
6. Certificate no.
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As per Sec. 113 (amend. 1988) – A share certificate must be issued/ despotized
to the allotted within three months after the date of allotment or within two months
after the application for the registration of the transfer.
CLB can extend the aforesaid period not exceeding 9 months. The Penalty for
non-compliance is fine up to 5000/- per day till default continues.
Under 'Depository System' there is not need to issue share certificate for the
shares registered in the name of the depository. Instead the Co. slowed intimates
the details of allotment of shares to the depository immediately on the allotment of
such shares. [New sub-Sec. (4) to sec. 113 inserted by the Depositories Act, 1996].
{386}
against a bona-fide purchaser of shares for value, from alleging that the
shares over not fully paid up.
As per section 84(3) ,if a company with intent to defraud renews a certificate or
issue a duplicate thereof, the company shall be punishable with fine which may
extend to Rs.10,000/- and every defaulting officer shall be punishable with
imprisonment up to 6 months or fine up to one lakh rupees or both.
Share Warrant
(1) Only a Public Co. Ltd. by shares can issue share warrants.
(2) The articles of association must authorize the issue of the share
warrants
(4) Approval of central govt. must be obtained for issuing share warrants.
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Effect of Issue of Share Warrants –
1. Company shall strike out the names of the members from the register of member
as holding the shares specified in the warrant, just as if he had ceased to be a
member and shall enter in that register the following particulars--
(b) a statement of the shares specified in the warrant distinguishing each shares by
the number;
2. As per section 115(5) the bearer of a share warrant may not be granted all the
rights of membership.
3. The share warrant will not constitute the qualification shares for the directors, i.e.
holders of a shares warrant cannot qualify himself for the appointment of a director.
1 Both public as well as private Cos. Can be issued by public ltd. Cos. only
can issue
2 Can be issued originally and were with Cannot be issued originally, only
respect to partly pond up shares shares certificate for fully paid shares
can be converted into shares warrant.
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4 Name / Address of shares certificate No such details are entered in case of
holder is entered into Register of bearer share warrant.
member
8 Holder has all normal rights of May or may not have normal rights of
membership membership
14.13 Summary
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A share is a fractional part of the capital of the company which forms the basis of
ownership of certain rights and interests of a subscriber in the company. A share
secures to its owners certain rights and liabilities e.g. right to dividend, right to
vote, and liability to pay unpaid balance (if any) and to be bound by the provisions
of the article and memorandum. A share is regarded as 'goods' in India. According
to section 82 the shares of any members or debentures in a company shall be
movable property, transferable in the manners provided by the Article of the
company. Stock in a company means a bundle of fully paid shares put together for
convenience so that it may be divided into any amount and transferred into any
fractions and sub-divisions without regard to the original face value of the shares.
Share capital denotes the amount of capital raised or to be raised by the issue of
shares by a company. The share capital may be of various kinds viz. authorized
capital, issued capital, subscribed capital, called up capital, uncalled capital, paid
up capital and reserved capital.
Shares may be classified as preference shares and equity shares. Preference shares
may further be cumulative or non cumulative, participating and non-participating
and redeemable and non-redeemable.
Equity shares mean those shares which are not preference shares. These shares
carry the right to receive the whole of surplus profits after the preference shares
have received their fixed dividend. Equity shares may be of two types- equity
shares with voting rights and equity shares with differential rights as to voting and
dividend.
Normally securities are issued at 'par value' or 'face value'. But sometimes
companies with good prospects issues securities at price above par value i.e. at
premium. When shares are issued for consideration less than their par value, they
are taken to be issued at discount.
{390}
price) or for consideration other than cash for providing know-how or making
available rights in the nature of Intellectual Property Rights or value additions etc.
A share warrant is a bearer ‘document of title’ to the shares. A share warrant is just
like a negotiable instrument. The shares specified therein may be transferred by
delivery of the warrant only and any bona-fide holder for value will obtain a perfect
title to the share.
3. When a company can issue shares at premium and at discount and how?
5. What are the provisions of Companies Act regarding ‘buy back’ of shares?
{391}
UNIT 15: DEBT FINANCE
Structure
15.0 Introduction
15.1 Borrowings
15.2 Ultra Vires Borrowings
15.3 Security for Borrowings
15.3.1 Fixed Charge
15.3.2 Floating Charge
15.3.3 Registration of Charges
15.4 Debentures
15.5 Issue of Debentures
15.6 Classes of Debentures
15.7 Debenture holders Protection
15.8 Public Deposits
15.9 Protection of Small Depositors
15.10 Investments
15.11 Inter Corporate Loans
15.12 Summary
15.13 Check Your Progress
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15.0 Introduction
When the company management does not wish to dilute its control over the affairs
of the company, it resorts to debt financing rather than issuing equity shares. It may
take the shape of borrowings, issue of debentures, public deposits, investments,
inter corporate loans or any other instrument devised for the purpose. Though it
contains more risk than equity as it carries a fixed cost in the form of interest on
capital, but is preferred when the company is able to pay the interest irrespective of
its own profit and does not wish to dilute its holding on the company.
15.1 Borrowings
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meeting, borrow moneys which together with those already borrowed (apart from
temporary loans obtained from the company’s bankers in the ordinary course of
business) will exceed the aggregate of the paid-up capital of the company and its
free reserves.
(1) borrowings which are ultra vires the company, i.e., beyond the authority given
to the company by its memorandum and articles, or
(2) borrowings ultra vires the directors, i.e., beyond the authority of the directors.
We shall now see the legal effect of ultra vires borrowings in each of the
above cases.
(1) Borrowings which are ultra vires the company. The basic principle of
Company Law is that any act which is ultra vires the company is void. Therefore,
in the eyes of law borrowings which are ultra vires the company, are not recognised
as a debt against the company and the lender of money cannot sue the company for
the excess credit in case of default, nor he can enforce any security given for such
loan. But the following remedies shall be available to such a lender:
(i) If the company has not applied the money so advanced to any transaction so
far, he may obtain an injunction order against the company restraining it from
spending the amount and may recover the money as actually existing.
(ii) If the money has been expended in purchasing some particular asset which
can be traced into the company’s possession, he can obtain a tracing order
and may claim that asset. Even if no specific asset could be earmarked, the
lender is still entitled to have restored to him any increase in the assets which
is shown to be due to the ultra vires borrowings, in the event of winding up of
the company. In Sinclair vs. Brougham[(1914), A.C. 398], Lord Parker has
observed that- “Neither creditors nor contributories ought in equity be allowed
{394}
to retain an advantage derived by reason of the misapplication by the
company’s agents of moneys which were in the position of trust moneys.”
(iii) If the money so borrowed is applied in paying off lawful debts of the
company, the lender is entitled to step into the shoes of the creditors who have
been paid off and subrogate to their rights. He can thus rank as a creditor of
the company to the extent to which the money has been so applied, for the
simple reason that by treating him as a creditor in place of that who has been
paid off the total indebtedness of the company remains the same. But the
lender has no right to any securities held by such creditors (Re Wrexham,
Mold and Cannah’s Quay Rly. (1899), 1 Ch. 440).
The reasoning behind the above remedies is, as the ultra vires lending is
void ab initio, the lender continues to be the owner of that money and he has
the right to recover it under the equitable doctrine of restitution.
(iv) Finally, the lender may claim damages from the directors and sue them
personally for a breach of implied warranty of authority, provided at the time
of advancing the money he acted in good faith without knowledge of the fact
that directors were borrowing in excess of maximum limits fixed by the
Memorandum of Association (Weeks vs. Propert (1873), 42 L.J. (C.P.) 149).
But if the fact that the company has no powers to borrow was apparent upon
reference to the company's memorandum and articles, the lender cannot claim
damages from directors upon this ground as he was not misled because he will
be deemed to have knowledge of these public documents (Rashdall vs.
Ford(1866), L.R. 2Eq. Cas. 750):
It has been held in Ashbury Railway Carriage Co. vs Riche (1875), L.R.
7, H.L. 653, that if the borrowing is ultra vires the memorandum it is
incapable of ratification by the company even with the assent of every
shareholder but if the borrowing is ultra vires the articles only, members in
the general meeting may ratify it by altering the articles.
(2) Borrowings which are ultra vires the directors. In case of borrowings ultra
vires the directors but intra vires the company, the legal position is simple. The
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company may, if it wishes, in general meeting ratify such act of the directors, in
which case the loan shall become perfectly valid and binding upon the company.
Even if the company decides otherwise (i.e., not to ratify the directors’ act) the
doctrine of “Indoor management” (as was laid in the case of Royal British Bank vs.
Turquand (1856), 6 E & B. 327.) and the normal principles of agency will protect a
lender who has lent money to the company provided he proves that he advanced the
money in good faith and had no knowledge of the fact that the limit had been
exceeded. Of course the company can claim an indemnity from the directors.
Alternatively, the lender may sue the directors directly for breach of implied
warranty to authority and make them personally liable. It is to be noted that if the
lender knew at the time of lending that the loan shall be used for an unauthorised
activity, he cannot recover the money lent from the company.
{396}
The security given to debenture-holders may create either a fixed or specific
charge or a floating charge.
(A) Legal mortgage, Here the full legal ownership of the property is
transferred to the creditor (i.e., the mortgagee) without delivering possession of the
mortgaged property and the borrower (i.e., the mortgagor) reserves his right to
regain the full legal ownership upon payment of the loan with interest. Such a
mortgage is effected by executing a ‘mortgage deed’, and requires registration with
the Registrar of Companies. When the amount secured is Rs. 100 or more a
‘mortgage deed’ is also to be registered under the Transfer of Property Act. In case
of default the creditor is entitled to take possession and dispose of the mortgaged
property without the intervention of the court. This type of mortgage is also known
as English Mortgage.
A company will not possibly like to create a fixed mortgage upon its circulating
capital, e.g., stock-in-trade. For, under the terms of fixed mortgage the company
can only deal with the asset subject to the charge. It was for this reason that a new
type of charge known as ‘floating charge’ was invented.
A floating charge is an equitable charge on the assets for the time being of a
going concern. It is a charge on the assets of the company in general. It covers all
the assets whether subject to a fixed charge or not and keeps on floating with the
property which it is intended to cover. in Illingworth vs. Houldsworth (1904), A.C.
355 Lord McNaughton has observed that- “a floating charge is ambulatory and
shifting in its nature, hovering over and so to speak floating with the property
which it is intended to affect until some event occurs or some act is done which
causes is to settle and fasten on the subject of the charge within its reach and
grasp.” A floating charge does not attach to any specific property till the event on
which it is to get fixed occurs. Neither ownership nor possession is passed to the
lender under this type of charge.
The main merit of a floating charge is that the company can deal with its
assets so charged in a way it thinks best until the charge crystallizes. It can even
mortgage the assets charged so as to give a registered mortgagee priority over the
floating charge holder. A floating charge can be created only by an
incorporated body. It is created by a “deed” and requires registration with the
Registrar of Companies under Section 125 of the Companies Act.
{398}
15.3.3 Crystallization of Charges.
Once a floating charge crystallises the creditors covered under the charge
become entitled to be paid out of the assets comprised in the charge in priority to all
other liabilities, except the following: (i) The preferential payments as detailed in
Section 530, e.g., rates, taxes, wages, etc., and (ii) A hire purchase Vendor until
goods are paid for in full, even though the hire purchase agreement may have been
entered into after the creation of the floating charge (Morrison Jones vs. Taylor Ltd.
(1914), 1 Ch. 50).
Section 534 imposes an important condition for the validity of the floating
charge created within 12 months immediately preceding the commencement of
winding up. It provides that such a charge shall be invalid, except in the following
cases -
(a) if the company immediately after the creation of the charge was solvent;
or
(b) if the company received cash actually, at the time of grafter the creation
recharge in consideration thereof The charge in this case shall he valid to the extent
of amount of cash actually paid to the company with interest at 5 per cent per
annum or any other rate notified by the rental Government.
{399}
It may be interesting to note that under a floating charge the interests of the
creditors are tied up with the prosperity of the company almost to the same extent
as those of shareholders - for, if the company trades unprofitably, creditors' security
will be placed in jeopardy, whereas, if it flourishes, their security will normally be
enhanced.
{400}
however, extend the period of 30 days by another 30 days on payment of additional
fee, if the company satisfies him that it had sufficient cause for delay [Sec. 125(1)].
It is the duty of the company to send the above particulars to the Registrar, but
registration may also be affected on the application of the creditor who may recover
the registration fee from the company (Sec. 134).
(iv) The charge would be void against the liquidator and any creditor of the
company [Sec. 125(1)].
(ii) The debt, in respect of which the charge was given remains valid as an
unsecured debt [Sec. 125(2)].
(iii) The money which the charge purports to secure becomes immediately
payable [See. 125(3)].
(iv) A penalty up to Rs. 5,000 for every day during which the default
continues may be imposed on the company and its every officer who is
knowingly in default [Sec. 142(1)].
{401}
registration. Every company shall forward to the Registrar for being entered in the
register the particulars of all the charges requiring registration in the prescribed
form with a fee of rupees ten. The Companies (Amendment) Act, 1988, has
dispensed with the time consuming procedure of entering by hand the particulars of
charges by providing that companies will henceforth file particulars of charges in
the prescribed form and manner. The particulars of charges shall relate to - (i) the
date of creation of each mortgage or charge, (ii) the amount secured by the charge,
(iii) short particulars of the property charged, and (iv) the names of the persons
entitled to the charge. If the charge is one to which the holders of a series of
debentures are entitled, then the particulars (as set out in Sections 128 and 129) of
charges shall relate to - (a) the total amount secured by the whole series, (b) the
dates of the resolutions authorising the issue of the series, (c) the date of the
covering deed, if any, by which the security is created or defined, (d) a general
description of the property charged, (e) the names of the trustees, if any, for the
debenture-holders, and (f) the amount or rate per cent of the commission or
discount, if any, paid to any person subscribing or procuring subscriptions for any
debentures of the company. The pages of the register shall be consecutively
numbered and the Registrar shall sign or initial every page of the register. Such a
register shall be open to inspection to the public on payment of a fee of rupees ten
for each inspection.
The Registrar is also required to keep a chronological index, in the
prescribed form, of the mortgages and charges registered with him (Sec. 131).
The Registrar gives a certificate of the registration of any charge, and this
certificate is conclusive evidence that the requirements of law as to the registration
have been complied with (Sec. 132). The company must cause a copy of this
certificate to be endorsed on every debenture or debenture stock certificate issued
by it and the payment of which is secured by the charge so registered. A person
who knowingly permits the delivery of any debenture without the required
certificate endorsed upon it shall be punishable with fine which may extend to Rs.
10,000 (Sec. 133).
{402}
If any person gets a “receiver” appointed, he must give notice of the fact to
the Registrar within 30 days of such appointment, and the Registrar shall enter the
fact in the register of charges. Similarly, the receiver so appointed is required to
give notice to the Registrar upon his ceasing to act as such and the Registrar shall
enter the notice in the register of charges (Sec. 137).
The Company Law Board is empowered to extend time for the registration
of the charge or to order that the omission or misstatement in the register of charges
be rectified, if it is satisfied that the default was accidental or due to inadvertence or
to some other sufficient cause or is not of a nature to prejudice the position of
creditors or shareholders of the company, or that on other grounds it is just and
equitable to grant relief. The company or any interested person may apply to the
Company Law Board for such an order. It may be noted that where the Company
Law Board extends the time for the registration of a charge, the order shall not
prejudice any rights acquired in respect of the property concerned before the charge
is actually registered.
The above register and a copy of every instrument creating any charge
requiring registration must be kept at the registered office of the company (Sec.
136). The register and the copies of instruments shall be open to inspection of any
creditor or member of the company without fee for at least two hours on each
working day. To any other person it shall be open to inspection on payment of a fee
of rupees ten for each inspection. If inspection is refused, the company and every
defaulting officer shall be punishable with fine and the Company Law Board may
also by order compel an immediate inspection of the said copies or register [Sec.
144, as amended by the Companies (Amendment) Act, 1988].
15.4 Debentures
It is difficult to give any precise legal definition of the term ‘debenture’
(Levy vs. Abercorris Co. (1887) 37 Ch. 260). In practice the use of the term
‘debenture’ is restricted to loans of some permanence generally secured by a
mortgage on the property of the company. The issuance of the debentures by the
company is perhaps the most convenient method of long term borrowings.
Section 2(12) defines, “debenture includes debenture stock, bonds and other
securities of a company, whether constituting a charge on the assets of the company
or not.” The definition does not explain the nature of a debenture exactly. In simple
language a debenture means ‘a document containing an acknowledgement of
indebtedness, issued by the company under its common seal, and giving an
undertaking to repay the debt at a specified date or at the option of the company
and in the meantime to pay interest thereon at a fixed rate and at intervals stated in
the debenture’. In brief, a debenture is a certificate of loan issued by a company
and it has nothing to do with security or lack of it.
Denomination of Debentures
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It has been decided-by the Government that henceforth the standard
denomination or face value of debentures should be Rs. 100. Debentures which are
not in denomination of Rs. 100 or of multiples of Rs. 100 should be converted into
those of Rs. 100 latest by 31st December 1984. However, exemption may be
granted to those companies which fulfill any of the following conditions :
(i) more than 50 per cent of the paid up value of the debentures is held by
public financial institutions;
(ii) the debentures are redeemable before the close of the calendar year 1989.
The exemption will be subject to the condition that the company shall
convert the debentures into those of prescribed denomination if such a request is
made by any debenture holder.
As regards convertible debentures the face value should be such that in the
case of those debentures having single point conversion, the non-convertible
portion should result in the face value of Rs. 100. If the convertible debentures
have, however, two points of conversion, the portion after the first point of
conversion should have a face value of Rs. 100.
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The company is required to complete and despatch the debenture certificates
within three months of allotment. However, the Company Law Board may grant
extension for a period not exceeding nine months in appropriate cases (Sec. 113, an
amendment by the Amendment Act, 1988). Further, in case of registered
debentures, the company must prepare a “Register of debenture holders”
containing the following particulars:
(i) the name and address, and the occupation, if any, of each debenture-
holder;
(ii) the debentures held by each holder, distinguishing each debenture by its
number, except where such debentures are held with a debenture, and the amount
paid or agreed to be considered as paid on those debentures;
(iii) the date on which each person was entered in the register as a
debenture-holder; and
(iv) the date at which any person ceased to be a debenture-holder.
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(2) Nature of security: A share is an ownership security non-repayable
during the life time of the company but a debenture is a creditorship security
repayable during the life time of the company, or at its winding up if it occurs
before the maturity date.
(3) Income: Income on debentures-is fixed and certain whether or not the
company has made a profit, whereas income on shares is uncertain depending upon
the profits and the discretion of the directors.
(4) Rights: A shareholder has normal rights of a member, e.g., right to
receive notices of general meetings, right to vote at general meetings, etc. A
debenture-holder does not have any right to vote in the company meetings (Sec.
117).
(5) Re-purchase: A company may repurchase its own debentures, thus in
effect redeeming them, whereas it is not open to a company to purchase its own
shares as per Section 77. However; the Companies (Amendment) Act, 1999 has
permitted companies to buyback their own shares after complying with the
stringent conditions laid down, in newly introduced Sections 77A, 77AA and 77B.
(6) Position at winding up: In case of winding up debenture-holders have
prior claim for the repayment, whereas shareholders can only obtain anything after
all the outside creditors have been paid in full. Moreover, debentures are generally
covered by a charge on the assets of the company. Hence debentures are more
secured.
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between ‘stock’ and ‘debenture stock’. Whereas ‘stock’ cannot be issued originally
(only fully paid shares can be converted into stock later), ‘debenture stock’ can be
so issued.
(1) Secured debentures: They are those which are secured by some charge
on the property of the company. The charge or mortgage may be 'fixed' or
‘floating’. Hence there may be 'fixed mortgage debentures' or 'floating mortgage
debentures' depending upon the nature of charge, under the category of secured
debentures. From the commencement of the Companies (Amendment) Act, 2000
(i.e., w.e.f. 13th December, 2000), it is mandatory for any company making a public
issue of debentures to issue only secured debentures.
(2) Unsecured or naked debentures: They are those that are not secured by
any charge on the assets of the company. The holders of such debentures are just
like ordinary unsecured creditors of the company. Such debentures are not
common.
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(5) Redeemable debentures: They provide for the payment of the principal
sum on a specified date or on demand or notice.
(6) Irredeemable debentures: In this case the issuing company does not fix
any date by which they should be redeemed and the holders of such debentures
cannot demand payment from the company so long as it is a going concern. Such
debentures are also called perpetual debentures because usually they are repayable
after a long period of time on the happening of a contingency, however remote, or
on winding up (Sec. 120).
The terms and conditions on which debentures are issued are endorsed on
their back. It may be noted that the two words 'Bonds' and 'Debentures' are used
interchangeably in relation to company finance,
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company mortgages property with the ‘trustees’ through a ‘debenture trust deed’,
for, it cannot possibly create a separate charge in favour of thousands of debenture-
holders. Thus, trustees are interposed between the company and the debenture-
holders who hold the mortgaged property on trust for the benefit of the debenture-
holders. The trust deed contains detailed conditions and stipulations safeguarding
the interests of debenture-holders. It usually empowers the trustees to appoint a
“receiver”, for enforcing the security in case the company makes a default in
payment of the principal or interest.
Section 117A stipulates that debenture trust deed shall be in such form and
shall be executed within such period as may be prescribed. It also empowers any
member or debenture-holder of the company to inspect the trust deed and obtain
copies of the same on payment of the prescribed amount. In fact this provision shall
run concurrently with Section 118 as per which the company is required to send a
copy of the trust deed to any debenture-holder or member of the company within
seven days of the request.
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(a) beneficially holds shares in the company;
(b) is beneficially entitled to moneys which are to be paid by the company to
the debenture trustee;
(c) has entered into any guarantee in respect of principal debts secured by
the debentures or interest thereon.
The Section further states that duties and functions of the debenture trustees
shall generally be as follows:
(i) to protect the interests of debenture-holders which would include creation
of securities within the stipulated time;
(ii) to redress the grievances of debenture-holders effectively;
(iii) to ensure that the assets of the company and each of the guarantors are
sufficient to discharge the principal amount of the debentures at all times;
(iv) to ensure that the company does not commit a breach of terms of the
Trust Deed, and
(v) to file a petition before the Company Law Board and obtain an
appropriate order there from in the interest of the debenture-holders, if he is of the
opinion that the assets of the company are insufficient or are likely to become
insufficient to discharge the principal amount as and when it becomes due.
There exists a fiduciary relationship between the trustees and the debenture-
holders. Therefore trustees must act with reasonable care and diligence in respect of
their powers and duties as provided in the trust deed and the Act (discussed above).
Any provision in the trust deed exempting them from, or indemnifying them
against, liability for breach of trust shall be void (Sec. 119).
In exercising the above right the company may either re-issue the same
debentures or issue others in their place. Upon such re-issue, the persons entitled to
debentures will have the same rights and priorities as if the debentures had never
been redeemed. To put it differently, the company is not allowed to change the
terms and conditions as governing the redeemed debentures while making a re-
issue of such debentures. The re-issue will, however, be treated as a new issue for
the purposes of stamp duty.
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Remedies of Debenture-holders
If the company makes a default in payment of the interest or in repayment of
the principal sum, the unsecured debenture-holders, like any other unsecured
creditor, may sue the company for breach of contract or they may present a petition
under Section 439, for the winding up of the company by the Court and may prove
in the winding up for the amount due.
(1) They may exercise the powers which are conferred upon them by the
terms of issue or the trust deed without applying lo the Court. Usually these include
a power to appoint a 'receiver' of the company's profits and rents, to appoint a
manager to manage the business and a power to take possession of the mortgaged
property and through the trustees enforce its sales and distribute i lie proceeds
among themselves.
(2) They may apply to the Court for the appointment of a 'receiver' or for an
order for sale of the property charged or for an order for foreclosure. The order for
foreclosure debars the mortgagor of his right to redeem the mortgaged property.
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with the orders of Company Law Board shall make every defaulting officer
punishable with imprisonment up to three years and with fine of at least Rs. 500 for
every day during which such default continues.
Section 58 A(2) lays down that a company could invite or accept or allow
any other person to invite or accept on its behalf deposits only in accordance with
the Rules to be framed by the Government and by issuing an advertisement in the
prescribed form, including therein a statement showing the financial position of the
company. The Central Government has notified the Rules called “The Companies
(Acceptance of Deposits) Rules, 1975. As per Section 58B, all the provisions of the
Act relating to a Prospectus will also, as far as practicable, apply to the said
advertisement.
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The Section also provides that where any deposit is accepted by a company
after the commencement of the Companies (Amendment) Act, 1974, in
contravention of the Rules made by the Central Government, the deposit must be
refunded within thirty days from the date of acceptance of such deposit or within
such further time, not exceeding thirty days, as the Central Government may allow.
It has further been provided that if a company fails to refund any deposit in
accordance with the provisions indicated above, the company shall be punishable
with a fine which shall not be less than twice the amount of such deposit and every
officer of the company who is in default shall also be punishable with
imprisonment for a term which may extend to five years and shall also be liable to
fine. The depositor shall, however, be paid by the Court trying the offence out of
fine, if realised. Penal provisions have also been provided for companies and their
defaulting officers in case they accept deposits in contravention of the conditions
prescribed under this Section. The Companies (Amendment) Act, 2000 has
increased the quantum of fines. Accordingly, where contravention relates to the
invitation of any deposit, the company shall be punishable with fine which may
extend to Rs. 10 lakhs (as against Rs. 1 lakh earlier) but shall not be less than Rs.
50,000 (as against Rs. 5,000 earlier).
The Section also empowers the Central Government to give total exemption
to any company or class of companies from the provisions of the Section, or to
grant partial relaxation like extension of time in deserving cases for the repayment
of deposits, after consulting the Reserve Bank of India.
Section 58A has been amended by the Companies (Amendment) Act, 1988
to provide that in the event of the failure of a company to repay any deposits or part
thereof in accordance with the terms and conditions of such deposit, the Company
Law Board may either on its own motion or on the application of the depositor, by
order direct the company to make repayment of such deposit subject to such
conditions as may be prescribed in the order. Whoever fails to comply with any
order made by the Company Law Board shall be punishable with imprisonment up
to three years and shall also be liable to a fine of at least Rs. 500 for every day
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during which such non- compliance continues [Sub-sections (9) and (10) added by
the Amendment Act, 1988], Accordingly, the Government has now set-up four
offices in the four metropolises of New Delhi, Kolkata, Chennai and Mumbai to
entertain complaints from aggrieved depositors.
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(1) Every company which accepts deposits from ‘small depositors’ shall
give an intimation on monthly basis to the Company Law Board (CLB) of any
default made by it in repayment of any such deposits or part thereof or any interest
thereupon. Such intimation shall be given within 60 days from the date of default
and shall include the particulars in respect of names and addresses of each small
depositor, the principal sum of deposit due to them and the interest accrued thereon.
The Company Law Board shall, on its own, pass an appropriate order within 30
days from the date of receipt of intimation. It shall not be necessary for a small
depositor to be present at the hearing of CLB proceedings.
(2) A company shall not accept further deposits from 'small depositors'
unless each small depositor, whose deposit has matured, had been paid the amount
of the deposit and the interest accrued thereon.
(4) Where a company has accepted deposits from small depositors and
subsequent to this obtains funds by way of loan for working capital from any bank,
it shall first utilise such funds for the repayment of any deposit or interest thereon
to the small depositor before applying such funds for any other purpose.
(5) Any person who knowingly fails to comply with the provisions of this
Section or with any order of the Company Law Board shall be punishable with
imprisonment upto three years and shall also be liable to fine of at least Rs. 500 for
every day during which such non-compliance continues. In case of the defaulter
being a company, every person who was a director at the time the contravention
was committed as well as the company shall be deemed to be guilty of the offence
and shall be liable to be proceeded against and punished accordingly.
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connected with or arising out of acceptance of deposits under Section 58A or 58AA
(discussed, above) shall be a cognizable offence under the Criminal Procedure
Code 1973. With a view to avoid any misuse of power, it has further been provided
that no court shall take cognizance of the offence except on a complaint made by
the Central Government or any officer authorised by it in that behalf. The Central
Government has notified [Vide the Companies (Acceptance of Deposits)
Amendment Rules, 2001], that the Regional Director of the Department of
Company Affairs shall be the authorised officer to make complaints relating to
offence connected with acceptance of deposits. Cognizable offence is an offence in
respect of which a police officer may arrest a person without an arrest warrant from
a criminal court. Thus, if a complaint is made by the Regional Director of the
Department of Company Affairs in this regard, the Inspector of Police can arrest
without a warrant the directors of the company who have committed a default in the
repayment of deposits or payment of interest thereon.
Certain loans, deposits, etc., excluded: Under these Rules, for calculating
whether the deposits exceed the prescribed limits, ‘deposit’ means any deposit of
money with, and including any money borrowed by, a company, but the following
types of loans, advances and deposits have, been excluded from the definition of
‘deposits’:
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(i) Any loan received from or guaranteed by the Central or State
Government and any amount received from a local authority or a foreign
Government or foreign citizen or authority, or foreign person.
(ii) Any amount received as a loan from any banking company or the State
Bank or its subsidiary banks or a nationalised bank or a cooperative bank.
(ix) Any amount received by a private company from its directors, relatives
of its directors or members.
(x) Amounts raised by the issue of bonds and debentures secured by the
mortgage of immovable property provided the amount of such bonds or debentures
does not exceed the market value of the immovable property; and amounts raised
by the issue of unsecured bonds and debentures with an option to convert them into
shares of the company.
(a) the loans are brought in pursuance of the stipulation imposed by the
financial institutions in fulfillment of the obligation of the promoters to contribute
such finance;
(b) the loans are provided by the promoters themselves and/or by their
relatives, and not from their friends and business associates; and
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(c) the exemption under this sub-clause shall be available only till the loans
of financial institutions are repaid and not thereafter.
(xii) Any amount received as loan from the National Dairy Development
Board by the companies owned by it directly or through its subsidiary companies.
(i) 25% of the aggregate of the paid up capital and free reserves from the
public.
(ii) 10% of the aggregate of the paid up capital and free reserves as deposits
against unsecured debentures, or any deposits from its shareholders (in case of a
public company) or any deposits guaranteed by any director.
These two separate limits have been merged for the Government companies
and such companies can accept deposits from the public upto 35% of the aggregate
of the paid-up capital and free reserves.
For arriving at the aggregate of the paid up capital and free reserves for the
purpose of computing the amount which can be accepted by a company as deposit
under the above categories, the amount of the accumulated balance of loss, balance
of deferred revenue expenditure and other intangible assets should, as disclosed in
the latest audited balance sheet, be deducted from the aggregate of the paid up
capital and free reserves. Further, for this purpose 'free reserves' will include the
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balance of share premium account, capital and debenture redemption reserve and
any other reserves shown or published in the balance sheet and created out of the
profits of the company, but does not include any reserve created for repayment of
any future liability or for depreciation in assets or for bad debts, or created by
revaluation of assets.
Thus under the Deposit Rules, any company can accept deposits under
different categories up to a maximum of 35 percent of the aggregate of paid up
share capital plus free reserves as reduced by the value of intangible assets,
deferred revenue expenditure and accumulated losses. It has been further provided
that after the commencement of these Rules no company can accept or renew
deposits repayable on demand or on notice. The minimum period for which
deposits could be accepted is normally six months but for meeting short-term
requirements deposits repayable not earlier than three months from the date of such
deposit or renewal may also be accepted in accordance with the limits stated above.
The maximum period for which deposits can be accepted or renewed has been
fixed at thirty-six months and the maximum rate of interest payable on any deposits
has been fixed at 11% per annum. Once a deposit is taken for a specified period, it
cannot be repaid before the expiry of the period of six months. After the said six
months, it can be repaid earlier at the discretion of the company, but the rate of
interest payable by the company must be reduced by one per cent from the rate
which the company would have paid had the deposit been accepted for the period
which it had run.
Maintenance of liquid assets: Under the Deposit Rules, every such company
will also be under an obligation to maintain liquid assets, before 30 April, each
year, to the tune of at least fifteen per cent of the deposits which mature for
repayment within a year (between 1 April and 31 March next) in the form of
current or other deposit account with any scheduled bank free from any charge or
lien or investment in any unencumbered securities of Central or State Government
or any Trust securities. Further, the amount deposited or invested, as the case may
be, must not be utilised for any purpose other than for the repayment of deposits
maturing during the year, provided that the amount remaining deposited or invested
must not at any time fall below ten per cent of the amount of deposits maturing
until the 31st day of March of that year.
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also contain a statement that the company is not in default in the repayment of any
deposit or part thereof and any interest thereupon in accordance with the terms and
conditions of such deposits. The advertisement has to be signed by a majority of the
directors. The advertisement, once issued, is valid until the expiry of six months
from the date of closure of the financial year in which it is issued or until the date
on which the Balance Sheet is laid before the company in the Annual General
Meeting or when the Annual General Meeting of any year has not been held, the
latest day on which that meeting should have been held, whichever is earlier. After
the expiry of this period, the companies have to issue a fresh advertisement for
inviting further deposits. Where a company intends to accept deposits without
issuing an advertisement for the same, it will have to file a ‘statement in lieu of
advertisement’ with the Registrar before accepting any deposits. This document
contains information similar to an ‘advertisement inviting deposits’ and is required
to be delivered afresh likewise to the Registrar.
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for the advertisement referred to above. In the application form the depositor inter
alia should make a declaration that he has not borrowed, or accepted deposits from
any other person for making the deposit in question. On the acceptance or renewal
of the deposit the companies should issue within a period of eight weeks from the
date of realisation of cheques an official receipt to each depositor containing name
and address of the depositor, the date and amount of deposit received, the rate of
interest payable and the date on which deposit is repayable. The Deposit Rules also
state that the company cannot reserve to itself either directly or indirectly a right to-
alter, to the prejudice or disadvantage of the depositor, the terms and conditions of
the deposit after it is accepted.
Companies which are Small Scale Industrial Units and fulfil the following
conditions, namely:
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(a) paid-up capital of the company does not exceed Rs. 25 lakh; (b) the
company accepts deposits from not more than 100 person^; (c) there is no
invitation to public for deposits; and (d) the amount of deposits accepted by the
company does not exceed Rs. 20 lakhs or the amount of its paid-up capital,
whichever is less.
15.10 Investments
For the purposes of Companies Act the term ‘investment’ has been used in a
restricted sense to mean the investing of money in shares, stock, debentures or
other securities rather than including any property or right in which capital is
invested.
Section 372A, inserted by the Companies (Amendment) Act, 1999, contains the
consolidated provisions with respect to inter corporate loans. It provides as:
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Exceeding 60% of its paid up share capital and free reserves , or 100% of
its free reserves, whichever is more.
ii. Rate of interest: No loan to any body corporate shall be made at the rate
of interest lower than the prevailing ‘bank rate’ i.e. at the rate at which
the RBI lends to the Commercial banks.
iii. Unanimous resolution of the board and approval of the public financial
institutions: No loan or investment shall be made unless the resolution
sanctioning it is passed at the meeting of the Board with the consent of
all the directors present at the meeting and where any term loan is
subsisting, the prior approval of the public financial institution is
obtained. Though, no approval of the public financial institution shall be
obtained when loan etc. is within the alternative limit of 60% of the paid
up capital or free reserves.
iv. Register of Investments and Loans: every company shall keep a register
showing the particular in respect of every investment or loan made by it
in relation to any body corporate as to the name of the body corporate,
the amount, term and purpose of the loan and the date on which the loan
has been made.
v. Defaults in repayment of Deposits etc.: No company which has defaulted
in complying with the provisions of section 58A shall, directly or
indirectly, make any loan as above if the default is subsisting.
vi. Exemptions: Nothing contained in section 372A shall apply to any loan
made by-
a. a banking company, or an insurance company, or a housing finance
company, or a company established with the objective of financing
industrial enterprises, or of providing infrastructural facilities;
b. accompany whose principal business is the acquisition of shares,
stock, debentures or other securiries;
c. a private company, unless it is a subsidiary of a public company;
d. the company allotting shares pursuant to section 81(1)(a) i.e. rights
issues;
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e. to any loan made by a holding company to its wholly owned
subsidiary;
vii. Penalty: If default is made in complying with these provisions, the
company and every officer of the company, who is in default, shall be
punishable with imprisonment which may extend to two years or with
fine which may extend to fifty thousand rupees.
15.12 Summary
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certificate of loan issued by a company and it has nothing to do with security
or lack of it. Debenture may be classified as secured debentures or unsecured
or naked debentures, registered debentures, bearer debentures, redeemable or
irredeemable debentures, convertible or non-convertible debentures. In the
case of secured debentures, the issuing company mortgages property with
the ‘trustees’ through a ‘debenture trust deed’, for, it cannot possibly create a
separate charge in favour of thousands of debenture-holders.
For the purposes of Companies Act the term ‘investment’ has been used in a
restricted sense to mean the investing of money in shares, stock, debentures
or other securities rather than including any property or right in which
capital is invested.
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UNIT 16 Corporate Fund Raising
Structure:
16.0 Introduction
16.1 Objectives
16.2 Financial Needs and Sources of Finance
16.3 Long Term Sources
16.3.1 Equity Capital
16.3.2 Preference Share Capital
16.3.3 Debenture or Bonds
16.3.4 Retained Earnings
16.3.5 Loans from Commercial Banks
16.3.6 Loans from Financial Institutions
16.4 Short Term Sources
16.4.1 Commercial Papers
16.4.2 Trade Credit
16.4.3 Advances from Customers
16.4.4 Accrued expenses and Deferred Income
16.4.5 Bank Advances
16.4.6 Inter Corporate Loans
16.4.7 Public Deposits
16.4.8 Certificate of Deposits
16.0 INTRODUCTION
Ascertainment of the cost of project and means of finance is one of the most
important considerations for an entrepreneur-company in implementing a new
project or undertaking expansion, diversification, and modernization and
rehabilitation scheme. There are several sources of finance/funds available to any
company. An effective appraisal mechanism of various sources of funds available
to a company must be instituted in the company to achieve its main objectives.
Such a mechanism is required to evaluate risk, tenure and cost of each and every
source of fund. The selection of the fund source is dependent on the financial
strategy pursued by the company; the leverage planned by the company, the
financial conditions prevalent in the economy and the risk profile of both the
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company as well as -the industry in which the company operates. Each and every
source of fund has some advantages as well as disadvantages.
16.1 Objectives
After studying this chapter, you will be able to understand the different sources
of finance available to a business;
Differentiate between the various long term and short term sources of finance;
Understand the concept of Venture Capital financing;
Understand the meaning and purpose of securitization and debt securitization;
Understand the concept of lease financing;
Understand the various financial instruments dealt with in the International
market.
Business organisations need funds to meet their different types of requirements. All
the financial needs of a business may be grouped into the following three
categories:
(i) Long term financial needs: Such needs generally refer to those requirements
of funds which are for a period exceeding 5-10 years. All investments in plant,
machinery, land, buildings, etc., are considered as long term financial needs.
Funds required to finance permanent or fixed working capital should also be
procured from long term sources.
(ii) Medium term financial needs: Such requirements refer to those funds which
are required for a period exceeding one year but not exceeding 5 years e.g. if a
company resorts to extensive publicity and advertisement campaign then such
type of expenses may be written off over a period of 3 to 5 years. These are
called deferred revenue expenses and funds required for them are classified in
the category of medium term financial needs. Sometimes long term
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requirements, for which long term funds cannot be arranged immediately may
be met from medium term sources and thus the demand of medium term
financial needs, are generated. As and when the desired long term funds are
made available, medium term loans taken earlier may be paid off.
(iii) Short term financial needs: Such type of financial needs arise to finance in
current assets such as stock, debtors, cash, etc. Investment in these assets is
known as meeting of working capital requirements of the concern. Firms
require working capital to employ fixed assets gainfully. The requirement of
working capital depends upon a number of factors which may differ from
industry to industry and from company to company in the same industry. The
main characteristic of short term financial needs is that they arise for a short
period of time not exceeding the accounting period, i.e., one year.
The basic principle for meeting the short term financial needs of a concern is
that such needs should be met from short term sources, and for medium term
financial needs from medium term sources and long term financial needs from
long term sources. Accordingly, the method of raising funds is to be decided
with reference to the period for which funds are required. Basically, there are
two sources of raising funds for any business enterprise viz. owner's capital
and borrowed capital. The owner’s capital is used for meeting long term
financial needs and it primarily comes from share capital and retained
earnings. Borrowed capital for all the other types of requirement can be raised
from different sources such as debentures, public deposits, loans from
financial institutions and commercial banks, etc.
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4. Retained earnings
5. Loans from commercial banks
6. Loans from financial institutions
7. Venture capital funding
8. Asset securitization
9. International financing like Euro-issues, foreign currency loans
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16.3 LONG TERM SOURCES OF FINANCE
There are different sources of funds available to meet long term financial needs of
the business. These sources may be broadly classified into share capital (both
equity and preference) and debt (including debentures, long term borrowings or
other debt instruments).
In recent times in India, many companies have raised long term finance by offering
various instruments to public like deep discount bonds, fully convertible debentures
etc. These new instruments have characteristics of both equity and debt and it is
difficult to categorised these either as debt or equity.
16.3.1 Equity Capital : A public limited company may raise funds from
promoters or from the investing public by way of owners capital or equity capital
by issuing ordinary equity shares. Ordinary equity shares are a source of permanent
capital. Ordinary shareholders are owners of the company and they undertake the
risks of-business. They are entitled to dividends after the income claims of other
stakeholders are satisfied. Similarly, in the event of winding up, ordinary
shareholders can exercise their claim on assets after the claims of the other
suppliers of capital have been met. They elect the directors to run the company and
have the optimum control over the management of the company. Since equity
shares can be paid off only in the event of liquidation,, this source has the least risk
involved. This is more so due to the fact that equity shareholders can be paid
dividends only when there are distributable profits. However, the cost of ordinary
shares is usually the highest. This is due to the fact that such shareholders expect a
higher rate of return on their investment as compared to other suppliers of long-
term funds. Such behaviour is directly related to the risk undertaken by ordinary
shareholders when compared to the providers of other forms of capital e.g. debt.
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Whereas, an ordinary shareholder shall take responsibility of losses incurred by the
company by foregoing dividend or accepting a lesser amount, a debt holder shall be
statutorily entitled to get regular payments as per the contract. Hence, when
compared to those who have provided loan capital to the company, ordinary
shareholders carry a higher amount of risk and so expect a higher return. Further,
the dividend payable on shares is an appropriation of profits and not a charge
against profits. This means that unlike debt, ordinary equity shares do not provide
any tax shield to the company, thereby resulting in a higher cost.
Ordinary share capital also provides a security to other suppliers of funds. Thus, a
company having substantial ordinary share capital may find it easier to raise further
funds, in view of-the fact that share capital provides a security to other suppliers of
funds.
The Companies Act, 1956 and SEBI Guidelines for disclosure and investors'
protections and the clarifications thereto lay down a number of provisions
regarding the issue and management of equity shares capital.
(i) It is a permanent source of finance. Since such shares are not redeemable, the
company has no liability for cash outflows associated with its redemption.
(ii) Equity capital increases the company's financial base and thus helps further
the borrowing powers of the company.
(iii) The company is not obliged legally to pay dividends. Hence in times of
uncertainties or when the company is not performing well, dividend payments
can be reduced or even suspended.
(iv) The company can make further issue of share capital by making a right issue.
Apart from the above mentioned advantages, equity capital has some disadvantages
to the company when compared with other sources of finance. These are as follows:
(i) The cost of ordinary shares is higher because dividends are not tax deductible
and also the floatation costs of such issues are higher.
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(ii) Investors find ordinary shares riskier because of uncertain dividend payments
and capital gains.
(iii) The issue of new equity shares reduces the earning per share of the existing
shareholders until and unless the profits are proportionately increased.
(iv) The issue of new equity shares can also reduce the ownership and control of
the existing shareholders.
16.3.2 Preference Share Capital: These are a special kind of shares; the
holders of such shares enjoy priority, both as regards to the payment of a fixed
amount of dividend and repayment of capital on winding up of the company.
Long-term funds from preference shares can be raised through a public issue of
shares. Such shares are normally cumulative, i.e., the dividend payable in a year of
loss gets carried over-to the next year till there are adequate profits to pay the
cumulative dividends. The rate of dividend on preference shares is normally higher
than the rate of interest on debentures, loans etc. Most of preference shares these
days carry a stipulation of period and the funds have to be repaid at the end of a
stipulated period.
Preference share capital is a hybrid form of financing which imbibes within itself
some characteristics of equity capital and some attributes of debt capital. It is
similar to equity because preference dividend, like equity dividend is not a tax
deductible payment. It resembles debt capital because the rate of preference
dividend is fixed. Typically, when preference dividend is skipped it is payable in
future because of the cumulative feature associated with most of preference shares.
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withdrawn capital may be reinvested in other profitable ventures. It may be
mentioned that irredeemable preference shares cannot be issued by any company.
Preference shares have gained importance after the Finance bill 1997 as dividends
became tax exempted in the hands of the individual investor and are taxable in the
hands of the company as tax is imposed on distributed profits at a flat rate. At
present, a domestic company paying dividend will have to pay dividend distribution
tax @ 12.5% plus surcharge of 10% plus an education cess equal to 2% (total
14.025%).
(iii) There is no risk of takeover as the preference shareholders do not have voting
rights except in case where dividend-arrears exist.
(iv) The preference dividends are fixed and pre decided. Hence Preference
shareholders do not participate in surplus profits as the ordinary shareholders.
(ii) Preference dividends are cumulative in nature. This means that although these
dividends may be omitted, they shall need to be paid later. Also, if these
dividends are not paid, no dividend can be paid to ordinary shareholders. The
non-payment of dividend to ordinary shareholders could seriously impair the
reputation of the company concerned.
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16.3.3 Debentures or Bonds: Loans can be raised from public by issuing
debentures or bonds by public limited companies. Debentures are normally issued
in different denominations ranging from Rs. 100 to Rs. 1,000 and carry different
rates of interest. By issuing debentures, a company can raise long term loans from
public. Normally, debentures are issued on the basis of a debenture trust deed
which lists the terms and conditions on which the debentures are floated.
Debentures are either secured or unsecured.
Debentures are thus instruments for raising long-term debt capital. Secured
debentures are protected by a charge on the assets of the company. While the
secured debentures of a well-established company may be attractive to investors,
secured debentures of a new company do not normally evoke same interest in the
investing public.
(i) Non convertible debentures - These types of debentures do not have any
feature of conversion and are repayable on maturity.
(ii) Fully convertible debentures - Such debentures are converted into equity
shares as per the terms of issue in relation to price and the time of conversion.
Interest rates on such debentures are generally less than the non convertible
debentures because of their carrying the attractive feature of getting
themselves converted into shares.
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(iii) Partly convertible debentures - Those debentures which carry features of a
convertible and a non convertible debenture belong to this category. The
investor has the advantage of having both the features in one debenture.
(i) The cost of debentures is much lower than the cost of preference or equity
capital as the interest is tax-deductible. Also, investors consider debenture
investment safer than equity or preferred investment and, hence, may require a
lower return on debenture investment.
(ii) The protective covenants associated with a debenture issue may be restrictive.
(iii) Debenture financing enhances the financial risk associated with the firm.
(iv) Since debentures need to be paid during maturity, a large amount of cash
outflow is needed at that time.
These days many companies are issuing convertible debentures or bonds with a
number of schemes/incentives like warrants/options etc. These bonds or debentures
are exchangeable at the option of the holder for ordinary shares under specified
terms and conditions. Thus for the first few years these securities remain as
debentures and later they can be converted into equity shares at a pre-determined
conversion price. The issue of convertible debentures has distinct advantages from
the point of view of the issuing company. Firstly, such an-issue enables the
management to raise equity capital indirectly without-diluting the equity holding,
until the capital raised has started earning an added return to support the additional
shares. Secondly, such securities can be issued even when the equity market is not
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very good. Thirdly, convertible bonds are normally unsecured and, therefore, their
issuance may ordinarily not impair the borrowing capacity. These debentures/bonds
are issued subject to the SEBI guidelines notified from time to time.
Public issue of debentures and private placement to mutual funds now require that
the issue be rated by a credit rating agency like CRISIL (Credit Rating and
information Services of India Ltd.). The credit rating is given after evaluating
factors like track record of the company, profitability, debt servicing capacity,
credit worthiness and the perceived risk of lending.
Term lending by banks has become a controversial issue these days. It has been
argued that term loans do not satisfy the canon of liquidity which is a major
consideration in all bank operations. According to the traditional values, banks
should provide loans only for short periods and for operations which result in the
automatic liquidation of such credits over short periods. On the other hand, it is
contended that the traditional concept of liquidity requires to be modified. The
proceeds of the term loan are generally used for what are broadly known as fixed
assets or for expansion in plant capacity. Their repayment is usually scheduled over
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a long period of time. The liquidity of such loans is said to depend on the
anticipated income of the borrowers.
As a matter of fact, a working capital loan is more permanent and long term than a
term loan. The reason for making this statement is that a term loan is always
repayable on a fixed date and ultimately, a day will come when the account will be
totally adjusted. However, in the case of working capital finance, though it is
payable on demand, yet in actual practice it is noticed that the account is never
adjusted as such; and, if at all the payment is asked back, it is with a clear purpose
and intention of refinance being provided at the beginning of the next year or half
year.
This technique of providing long term finance can be technically called as “rolled
over for periods exceeding more than one year”. Therefore, instead of indulging in
term financing by the rolled over method, banks can and should extend credit term
after a proper appraisal of applications for terms loans. In fact, as stated above, the
degree of liquidity in the provision for regular amortization of term loans is more,
than in some of these so called demand loans which are renewed from year to year.
Actually, term financing disciplines both the banker and the borrower as long term
planning is required to ensure that cash inflows would be adequate to meet the
instruments of repayments and allow an active turnover of bank loans. The
adoption of the formal term loan lending by commercial banks will not in any way
hamper the criteria of liquidity and as a matter of fact, it will introduce flexibility in
the operations of tile banking system.
The real limitation to the scope of bank activities in this field is that all banks are
not well equipped to make appraisal of such loan proposals. Term loan proposals
involve an element of risk because of changes in the conditions affecting the
borrower. The bank making such a loan, therefore, has to assess the situation to
make a proper appraisal. The decision in such cases would depend on various-
factors affecting the conditions of the industry concerned and the earning potential
of the borrower.
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Bridge Finance: Bridge finance refers to loans taken by a company normally from
commercial banks for a short period, pending disbursement of loans sanctioned by
financial institutions. Normally, it takes time for financial institutions to disburse
loans to companies. However, once the loans are approved by the term lending
institutions, companies, in order not to lose further time in starting their projects,
arrange short term loans from commercial banks. Bridge loans are also provided by
financial institutions pending the signing of regular term loan agreement, which
may be delayed due to non-compliance of conditions stipulated by the institutions
while sanctioning the loan. The bridge loans are repaid/ adjusted out of the term
loans as and when disbursed by the concerned institutions. Bridge loans are
normally secured by hypothecating movable assets, personal guarantees and
demand promissory notes. Generally, the rate of interest on bridge finance is higher
as com- pared with that on term loans.
Term loans represent secured borrowings and at present it is the most important
source of finance for new projects. They generally carry a rate of interest inclusive
of interest tax, depending on the credit rating of the borrower, the perceived risk of
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lending and the cost of funds. These loans are generally repayable over a period of
6 to 10 years in annual, semiannual or quarterly installments.
Term loans are also provided by banks, State financial/development institutions and
all- India term lending financial institutions. Banks and State Financial
Corporations normally provide term loans to projects in the small scale sector while
for the medium and large industries term loans are provided by State developmental
institutions alone or in consortium with banks and State financial corporations. For
large scale projects All India financial institutions provide the bulk of term finance
either singly or in consortium with other A1I India financial institutions, State level
institutions and/or banks.
After Independence, the institutional set up in India for the provision of medium
and long term credit for industry has been broadened. The assistance sanctioned
and disbursed by these specialized institutions has increased impressively during
the years. A number of such specialized institutions have been established all over
the-country.
There are various sources available to meet short term needs of finance. The
different sources are discussed below:
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allowed to issue Commercial Papers. Commercial Papers can be issued for
maturities between 15 days and a maximum up to one year from the date of issue.
These can be issued in denominations of Rs 5 lakhs or multiples thereof. All
eligible issuers are required to get the credit rating from Credit Rating Information
Services of India Ltd, (CRISlL), or the Investment Information and Credit Rating
Agency of India Ltd (ICRA) or the Credit Analysis and Research Ltd (CARE) or
the FITCH Ratings India Pvt Ltd or any such other credit rating agency as is
specified by the Reserve Bank of India. Individuals, banking companies, corporate
bodies incorporated in India, Non Resident Indians, and Foreign Institutional
Investors etc. are allowed to invest in Commercial Paper, the minimum amount of
such investment being Rs 5 lakhs.
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Deferred income, on the other hand, reflects the amount of funds received by a
company in lieu of goods and services to be provided in the future. Since these
receipts increase a company's liquidity, they are also considered to be an important
source of spontaneous finance.
16.4.5 Bank Advances: Banks receive deposits from public for different periods at
varying rates of interest. These funds are invested and lent in such a manner that
when required, they may be called back. Lending results in gross revenues out of
which costs, such as interest on deposits, administrative costs, etc., are met and a
reasonable profit is made. A bank's lending policy is not merely profit motivated
but has to also keep in mind the socio- economic development of the country.
Bank advances are in the form of loan, overdraft, cash credit and bills
purchased/discounted etc. Banks do not sanction advances on a long term basis
beyond a small proportion of their demand and time liabilities. Advances are
granted against tangible securities such as goods, shares, government promissory
notes, Bills etc. In very rare cases, clean advances may also be allowed.
(i) Loans: In a loan account, the entire advance is disbursed at one time either in
cash or by transfer to the current account of the borrower. It is a single advance.
Except by way of interest and other charges no further adjustments are made in this
account. Loan accounts are not running accounts like overdraft and cash credit
accounts, repayment under the loan account may be the full amounts or by way of
schedule of repayments agreed upon as in case of term loans. The securities may be
shares, government securities, life insurance policies and fixed deposit receipts, etc.
(ii) Overdraft: Under this facility, customers are allowed to withdraw in excess of
credit balance standing in their Current Deposit Account. A fixed limit is therefore
granted to the borrower within which the borrower is allowed to overdraw his
account. Opening -of an overdraft account requires that a current account will have
to be formally opened. Though overdrafts are repayable on demand, they generally
continue for long periods by annual renewals of the limits. This is a convenient
arrangement for the borrower as he is in a position to avail of the limit sanctioned,
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according to his requirements. Interest is charged on-daily balances. Since these
accounts are operative like cash credit and current accounts, cheque books are
provided. As in the case of a loan account the security in an overdraft account may
be shares, debentures and Government securities. In special cases, life insurance
policies and fixed deposit receipts are also accepted.
(iii) Clean Overdrafts: Request for clean advances are entertained only from parties
which are financially sound and reputed for their integrity. The bank has to rely
upon the personal security of the borrowers. Therefore, while entertaining
proposals for clean advances; banks exercise a good deal of restraint since they
have no backing of any tangible security. If the parties are already enjoying secured
advance facilities, this may be a point in favour and may be taken into account
while screening such proposals. The turnover in the account, satisfactory dealings
for considerable period and reputation in the market are some of the factors which
the bank will normally see. As a safeguard, banks take guarantees from other
persons who are credit worthy before granting this facility. A clean advance is
generally granted for a short period and must not be continued for long.
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of emergency he can fall back on the goods for realisation of his advance under
proper notice to the borrower.
(v) Advances against goods : Advances against goods occupy an important place in
total bank credit. Goods are security have certain distinct advantages. They provide
a reliable source of repayment. Advances against them are safe and liquid. Also,
there is a quick turnover in goods, as they are in constant demand. So a banker
accepts them as security. Generally goods are charged to the bank either by way of
pledge or by way of hypothecation. The term ‘goods’ includes all forms of
movables which are offered to the bank as security. They may be agricultural
commodities or industrial raw materials or partly finished goods.
For the purpose of calculation of the drawing limits, valuation of the goods is made
from time to time. In case of hypothecation advance, an undertaking is obtained
from the borrower that the goods are not charged to some other bank. The bank also
takes periodical statements of stocks regarding quantity valuation etc.
The Reserve Bank of India issues directives from time to time, imposing
restrictions on advances against certain commodities. It is obligatory on banks to
follow these directives in letter and spirit. The directives also sometimes stipulate
changes in the margin.
(vi) Bills Purchased/Discounted : These advances are allowed against the security
of bills which may be clean or documentary. Bills are sometimes purchased from
approved customers in whose favour limits are sanctioned. Before granting a limit
the banker satisfies himself as to the credit worthiness of the drawer. Although the
term 'bills purchased' gives the impression that the bank becomes the owner or
purchaser of such -bills, in actual practice the bank holds the bills only as security
for the advance. The bank, in addition to the rights against the parties liable on the
bills, can also exercise a pledge's rights over the goods covered by the documents.
Issuance bills maturing at a future date or sight are discounted by the banks for
approved parties. When a bill is discounted, the borrower is paid the present worth.
The bankers, however, collect the full amounts on maturity. The difference between
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these two amounts represents earnings of the bankers for the period. This item of
income is called ‘discount’.
Sometimes, overdraft or cash credit limits are allowed against the security of bills.
A suitable margin is usually maintained. Here the bill is not a primary security but
only a collateral security. The banker in the case, does not become a party to the
bill, but merely collects it as an agent for its customer.
When a banker purchases or discounts a bill, he advances against the bill; he has
therefore to be very cautious and grant such facilities only to those customers who
are creditworthy and have established a steady relationship with the bank. Credit
reports are also compiled on the drawees.
(viii) Advance against supply of bills: Advances against bills for supply of goods to
government or semi-government departments against firm orders after acceptance
of tender fall under this category. The other type of bills which also come under
this category are bills from contractors for work executed either wholly or partially
under firm contracts entered into, with the above mentioned Government agencies.
These bills are clean bills without being accompanied by any document of title of
goods. But they evidence supply of goods directly to Governmental agencies.
Sometimes these bills may be accompanied by inspection notes from
representatives of government agencies for having inspected the goods before they
are dispatched. If bills are without the inspection report, banks like to examine
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them with the accepted tender or contract for verifying that the goods supplied
under the bills strictly conform to the terms and conditions in the acceptance tender.
These supply bills represent debt in favour of suppliers/contractors, for the goods
supplied to the government bodies or work executed under contract from the
Government bodies. \i is this debt that is assigned to the bank by endorsement of
supply bills and executing irrevocable power of attorney in favour of the banks for
receiving the amount of supply bills from the Government departments. The power
of attorney has got to be registered with the Government department concerned.
The banks also take separate letter from the suppliers / contractors instructing the
Government body to pay the amount of bills direct to the bank.
Supply bills do not enjoy the legal status of negotiable instruments because they are
not bills of exchange. The security available to a banker is by way of assignment of
debts represented by the supply bills.
(ix) Term Loans by banks: Term loans are an installment credit repayable over a
period of time in monthly/quarterly/half-yearly or yearly installment. Banks grant
term loans for small projects falling under priority sector, small scale sector and big
units. Banks have now been permitted to sanction term loan for projects as well
without association of financial institutions. The banks grant loans for periods
which normally range from 3 to 7 years and some- times even more. These loans
are granted on the security of fixed assets.
16.4.6 Inter Corporate Loans: The companies can borrow funds for a short period
say 6 months from other companies which have surplus liquidity. The rate of
interest on inter corporate deposits varies depending upon the amount involved and
time period.
16.4.7 Public Deposits: Public deposits are very important source of short-term
and medium term finances particularly due to credit squeeze by the Reserve Bank
of India. A company can accept public deposits subject to the stipulations of
Reserve Bank of India from time to time maximum up to 35 per cent of its paid up
capital and reserves, from the public and shareholders. These deposits may be
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accepted for a period of six months to three years. Public deposits are unsecured
loans; they should not be used for acquiring fixed assets since they are to be repaid
within a period of 3 years. These are mainly used to finance working capital
requirements.
The main advantage of certificate of deposit is that banker is not required to encash
the deposit before maturity period and the investor is assured of liquidity because
he can sell the certificate of deposit in secondary market.
A finance company has issued a large number of car loans. It desires to raise further
cash so as to be in a position to issue more loans. One way to achieve this goal is by
selling all the existing loans, however, in the absence of a liquid secondary market
for individual car loans, this may not be feasible. Instead, the company pools a
large number of these loans and sells interest in the pool to investors. This process
helps the company to raise finances and get the loans off its Balance Sheet. These
finances shall help the company disburse further loans. Similarly, the process is
beneficial to the investors as it creates a liquid investment in a diversified pool of
auto loans, which may be an attractive option to other fixed income instruments.
The whole process is carried out in such a way, that the ultimate debtors- the car
owners - may not be aware of the transaction. They shall continue making
payments the way they were doing before, however, these payments shall reach the
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new investors instead of the company they (the car owners) had financed their car
from.
The company to which the underlying pool of assets or asset is sold is known, as a
‘Special Purpose Vehicle’ (SPV) and the company which sells the underlying pool
of assets or asset is known as the originator.
The process of securitisation is generally without recourse i.e. the investor bears the
credit risk or risk of default and the issuer is under an obligation to pay to investors
only if the cash flows are received by him from the collateral. The issuer however,
has a right to legal recourse in the event of default. The risk run by the investor can
be further reduced through credit enhancement facilities like insurance, letters of
credit and guarantees.
In a simple pass through structure, the investor owns a proportionate share of the
asset pool and cash flows when generated are passed on directly to the investor.
This is done by issuing pass through certificates. In mortgage or asset backed
bonds, the investor has a lien on the underlying asset pool. The SPV accumulates
payments from the original borrowers from time to time and makes payments to
investors at regular predetermined intervals. The SPV can invest the funds received
in short term instruments and improve yield when there is time lag between receipt
and payment.
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In India, the Reserve Bank of India had issued draft guidelines on securitisation of
standard assets in April’2005. These guidelines were applicable to banks, financial
institutions and non banking financial companies. The guidelines were suitably
modified and brought into effect from February 2006.
For the investor securitisation opens up new investment avenues. Though the
investor bears the credit risk, the securities are tied up to definite assets.
The venture capital financing refers to financing of new high risky venture
promoted -by qualified entrepreneurs who lack experience and funds to give shape
to their ideas. In broad sense, under venture capital financing venture capitalist
make investment to -purchase equity or debt securities from inexperienced
entrepreneurs who undertake highly risky ventures with a potential of success.
The guidelines mentioned above restricted the setting up of Venture Capital Funds
by banks and financial institutions only. Subsequently guidelines were issued in the
month of September 1995, for overseas investment in Venture Capital in India.
A major development in venture capital financing in India was in the year 1996
when the Securities and Exchange Board of India (SEBI) issued guidelines for
venture capital funds to follow. These guidelines described a venture capital fund
as a fund established in the form of a company or trust, which raises money through
loans, donations, issue of securities or units and makes or proposes to make
investments in accordance with the regulations. This move was instrumental in the
entry of various foreign venture capital funds to enter India.. The guidelines were
further amended in April 2000 with the objective of fuelling the growth of Venture
Capital activities in India. A few venture capital companies operate as both
investment and fund management companies; others set up funds and function as
asset management companies.
It is hoped that the changes in the guidelines for the implementation of venture
capital schemes in the country would encourage more funds to be set up to give the
required momentum for venture capital investment in India.
(i) Equity financing : The venture capital undertakings generally requires funds
for a longer period but may not be able to provide returns to the investors
during the initial stages. Therefore, the venture capital finance is generally
provided by way of equity share capital. The equity contribution of venture
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capital firm does not exceed 49% of the total equity capital of venture capital
undertakings so that the effective control and ownership remains with the
entrepreneur.
(ii) Conditional ban: A conditional loan is repayable in the form of a royalty .after
the venture is able to generate sales. No interest is paid on such loans. In India
venture capital financiers charge royalty ranging between 2 and 15 per cent;
actual rate depends on other factors of the venture such as gestation period,
cash flow patterns, risk and other factors of the enterprise. Some Venture
capital financiers give a choice to the enterprise of paying a high rate of
interest (which could be well above 20 per cent) instead of royalty on sales
once it becomes commercially sounds.
(iii) Income note: It is a hybrid security which combines the features of both
conventional loan and conditional loan. The entrepreneur has to pay both
interest and royalty on sales but at substantially low rates. IDBPs VCF
provides funding equal to 80 - 87.50% of the projects cost for commercial
application of indigenous technology.
(iv) Participating debenture: Such security carries charges in three phases - in the
start up phase no interest is charged, next stage a low rate of interest is
charged up to a particular level of operation, after that, a high rate of interest is
required to be paid.
Factors that a venture capitalist should consider before financing any risky project
are as follows:
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(ii) Level of expertise in production: Venture capital should ensure that
entrepreneur and his team should have necessary technical ability to be able to
develop and produce new product/service.
(iii) Nature of new product / service: The venture capitalist should consider
whether the development and production of new product / service should be
technically feasible. They should employ experts in their respective fields to
examine idea proposed by the entrepreneur.
(iv) Future Prospects: Since the degree of risk involved in investing in the
company is quite fairly high, venture capitalists should seek to ensure that the
prospects for future profits compensate for the risk. Therefore, they should see
a detailed business plan setting out the future business strategy.
(v) Competition: The venture capitalist should seek assurance that there is
actually a market for a new product. Further venture capitalists should see the
research carried on by the entrepreneur.
(vi) Risk borne by entrepreneur: The venture capitalist is expected to see that the
entrepreneur bears a high degree of risk. This will assure them that the
entrepreneur have the sufficient level of the commitments to project as they
themselves will have a lot of loss, should the project fail.
(vii) Exit Route: The venture capitalist should try to establish a number of exist
routes. These may include a sale of shares to the public, sale of shares to
another business, or sale of shares to original owners.
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Leasing is a general contract between the owner and user of the asset over a
specified period of time. The asset is purchased initially by the lesser (leasing
company) and thereafter leased to the user (lessee company) which pays a specified
rent at periodical intervals. Thus, leasing is an alternative to the purchase of an
asset out of own or borrowed funds. Moreover, lease finance can be arranged much
faster as compared to term loans from financial institutions.
The term of this type of lease is shorter than the asset's economic life. The lessee is
obliged to make payment until the lease expiration, which approaches useful life of
the asset.
An operating lease is particularly attractive to companies that continually update or
replace equipment and want to use equipment without ownership, but also want to
return equipment at lease end and avoid technological obsolescence.
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Other types of Leases
(1) Sales and Lease Back
Under this type of lease, the owner of an asset sells the asset to a party (the buyer),
who in turn leases back the same asset to the owner in consideration of a lease
rentals. Under this arrangement, the assets are not physically exchanged but it
happens in records only. The main advantage of this method is that the lessee can
satisfy himself completely regarding the quality of an asset and after possession of
the asset convert the sale into a lease agreement.
Under this transaction, the seller assumes the role of lessee and the buyer assumes
the role of a lesser. The seller gets the agreed selling price and the buyer-gets the
lease rentals.
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owner of the asset. In the open-ended lease, the lessee has the option of purchasing
the asset at the end of the lease period.
In recent years, leasing has become a popular source of financing in India. From the
lessee's point of view, leasing has the attraction of eliminating immediate cash
outflow, and the lease rentals can be deducted for computing the total income under
the Income tax Act. As against this, buying has the advantages of depreciation
allowance (including additional depreciation) and interest on borrowed capital
being tax-deductible. Thus, an evaluation of the two alternatives is to be made in
order to take a decision.
The new instruments that have been introduced since early 90's as a source of -
finance is staggering in their nature and diversity. Few of these new instruments
are:
IDBI was the first to issue a deep discount bond in India in January, 1992.
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16.8.3 Zero interest fully convertible debentures: These are fully
convertible debentures which do not carry any interest. The debentures are
compulsorily and automatically converted after a specified period of time and
holders thereof are entitled to new equity shares of the company at predetermined
price. From the point of view of company this kind of instrument is beneficial in
the sense that no interest is to be paid on it, if the share price of the company in the
market is very high than the investors tends to get equity shares of the company at
the lower rate.
16.8.4 Zero Coupon Bonds: A Zero Coupon Bonds does not carry any
interest but it is sold by the issuing company at a discount. The difference between
the discounted value and maturing or face value represents the interest to be earned
by the investor on such bonds.
16.8.5 Double Option Bonds: These have also been recently issued by the
IDBI. The face value of each bond is Rs. 5,000. The bond carries interest at 15%
per annum compounded half yearly from the date of allotment. The bond has
maturity period of 10 years. Each bond has two parts in the form of two separate
certificates, one for principal of Rs. 5,000 and other for interest (including
redemption premium) of Rs. 16,500. Both these certificates are listed on all major
stock exchanges. The investor has the facility of selling either one or both parts
anytime he likes.
16.8.6 Inflation Bonds: Inflation Bonds are the bonds in which interest rate
is adjusted for inflation. Thus, the investor gets interest which is free from the
effects of inflation. For example, if the interest rate is 11 per cent and the inflation
is 5 per cent, the investor will earn 16 per cent meaning thereby that the investor is
protected against inflation.
16.8.7 Floating Rate Bonds: This as the name suggests is bond where the
interest rate is not fixed and is allowed to float depending upon the market
conditions. This is an ideal instrument which can be resorted to by the issuer to
hedge themselves against the volatility in the interest rates. This has become more
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popular as a money market instrument and has been successfully issued by
financial institutions like IDBI, ICICI etc.
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16.9 INTERNATIONAL FINANCING
The essence of financial management is to raise and utilise the funds raised
effectively. There are various avenues for organisations to raise funds either
through internal or external sources. The sources of external sources include:
16.9.1 Commercial Banks: Like domestic loans, commercial banks all over
the world extend Foreign Currency (FC) loans also for international operations.
These banks also provide to overdraw over and above the loan amount.
16.9.2 Development Banks; Development banks offer long & medium term
loans including FC loans. Many agencies at the national level offer a number of
concessions to foreign companies to invest within their country and to finance
exports from their countries. e.g. EXIM Bank of USA.
In international capital market, the availability of FC is assured under the four main
systems viz:
Euro-currency market
Export credit facilities
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Bonds issues
Financial Institutions.
The origin of the Euro-currency market was with the dollar denominated bank
deposits & loans in Europe particularly in London. Euro-dollar deposits are dollar
denominated time deposits available at foreign branches of US banks & at some
foreign banks. Banks based in Europe accept dollar denominated deposits & make
dollar denominated deposits to the clients. This forms the backbone of the Euro-
currency market all over the globe, in this market, funds are made available as
loans through syndicated Euro-credit of instruments such as FRN’s. FR certificates
of deposits.
External Commercial Borrowings can be accessed under two routes viz (i)
Automatic route and (ii) Approval route. Under the Automatic route there is no
need to take the RBI/Government approval whereas such approval is necessary
under the Approval route. Company's registered under the Companies Act and
NGOs engaged in micro finance activities are eligible for the Automatic Route
where as Financial Institutions and Banks dealing exclusively in infrastructure or
export finance and the ones which had participated in the textile and steel sector
restructuring packages as approved by the government are required to take the
Approval Route.
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(b) Euro Bonds: Euro bonds are debt instruments which are not denominated in
the currency of the country in which they are issued. e.g. a Yen note floated in
Germany. Such bonds are generally issued in a bearer form rather than as registered
bonds and in such cases they do not contain the investor's names or the country of
their origin. These bonds are an attractive proposition to investors seeking privacy.
(c) Foreign Bonds: These are debt instruments issued by foreign corporations or
foreign governments. Such bonds are exposed to default risk, especially the
corporate bonds. These bonds are denominated in the currency of the country
where they are issued, however, in case these bonds are issued in a currency other
than the investors home currency, they are exposed to exchange rate risks. An
example of a foreign bond ‘A British firm placing Dollar denominated bonds in
USA’.
(d) Fully Hedged Bonds: As mentioned above, in foreign bonds, the risk of
currency fluctuations exists. Fully hedged bonds eliminate the risk by selling in
forward markets the entire stream of principal and interest payments.
(e) Medium Term Notes: Certain issuers need frequent financing through the
Bond route including that of the Euro bond. However it may be costly and
ineffective to go in for frequent issues. Instead, investors can follow the MTN
programme. Under this programme, several lots of bonds can be issued, all having
different features e.g. different coupon rates, different currencies etc. The timing of
each lot can be decided keeping in mind the future market opportunities. The entire
documentation and various regulatory approvals can be taken at one point of time
(f) Floating Rate Notes: These are issued up to seven years maturity. Interest
rates are adjusted to reflect the prevailing exchange rates. They provide cheaper
money than foreign loans.
(g) Euro Commercial Papers (ECP): ECPs are short term money market
instruments. They are for maturities less than one year. They are usually designated
in US Dollars.
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(h) Foreign Currency Option: A FC Option is the right to buy or sell, spot,
future or forward, a specified foreign currency. It provides a hedge against financial
and economic risks.
(a) American Depository Deposits (ADR) : These are securities offered by non-
US companies who want to list on any of the US exchange. Each ADR represents a
certain number of a company's regular shares. ADRs allow US investors to buy
shares of these companies without the costs of investing directly in a foreign stock
exchange. ADRs are issued by an approved New York bank or trust company
against the deposit of the original shares. These are deposited in a custodial account
in the US. Such receipts have to be issued in accordance with the provisions
stipulated by the SEC. USA which are very stringent.
ADRs can be traded either by trading existing ADRs or purchasing the shares in the
issuer’s home market and having new ADRs created, based upon availability and
market conditions. When trading in existing ADRs, the trade is executed on the
secondary market on the New York Stock Exchange (NYSE) through Depository
Trust Company (DTC) without involvement from foreign brokers or custodians.
The process of buying new, issued ADRs goes through US brokers, Helsinki
Exchanges and DTC as well as Deutsche Bank. When transactions are made, the
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ADRs change hands, not the certificates. This eliminates the actual transfer of stock
certificates between the US and foreign countries.
In a bid to bypass the stringent disclosure norms mandated by the SEC for equity
shares, the Indian companies have however, chosen the indirect route to tap the vast
American financial market through private debt placement of GDRs listed in
London and Luxemburg Stock Exchanges.
The Indian companies have preferred the GDRs to ADRs because the US market
exposes them to a higher level or responsibility than a European listing in the areas
of disclosure, costs, liabilities and timing. The SECs regulations set up to protect
the retail investor base are somewhat more stringent and onerous, even for
companies already listed and held by retail investors, in their home country. The
most onerous aspect of a US listing for the companies is to provide full, half yearly
and quarterly accounts in accordance with, or at least reconciled with US GAAPs.
(b) Global Depository Receipt (GDRs): These are negotiable certificate held in
the bank of one country representing a specific number of shares of a stock traded
on the exchange of another country. These financial instruments are used by
companies to raise capital in either dollars or Euros. These are mainly traded in
European countries and particularly in London.
ADRs/GDRs and the Indian Scenario: Indian companies are shedding their
reluctance to tap the US markets. Infosys Technologies was the first Indian
company to be listed on Nasdaq in 1999. However, the first Indian firm to issue
sponsored GDR or ADR was Reliance industries Limited. Beside, these two
companies there are several other Indian firms are also listed in the overseas
bourses. These are Satyam Computer, Wipro, MTNL, VSNL, State Bank of India,
Tata Motors, Dr Reddy's Lab, Ranbaxy, Larsen & Toubro, ITC, ICICI Bank,
Hindalco, HDFC Bank and Bajaj Auto.
(c) Indian Depository Receipts (IDRs): The concept of the depository receipt
mechanism which is used to raise funds in foreign currency has been applied in the
Indian Capital Market through the issue of Indian Depository Receipts (IDRs).
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IDRs are similar to ADRs/GDRs in the sense that foreign companies can issue
IDRs to raise funds from the Indian Capital Market in the same lines as an Indian
company uses ADRs/GDRs to raise foreign capital. The IDRs are listed and traded
in India in the same way as other Indian securities are traded.
(c) Euro Bonds: Plain Euro Bonds are nothing but debt Instruments. These are
not very at-attractive for an investor who desires to have valuable additions to his
investments.
(d) Euro Convertible Zero Bonds: These bonds are structured as a convertible
bond. No interest is payable on the bonds. But conversion of bonds takes place on
maturity at a predetermined price. Usually there is a five years maturity period and
they are treated as a deferred equity issue.
(e) Euro Bonds with Equity Warrants: These bonds carry a coupon rate
determined by market rates. The warrants are detachable. Pure bonds are traded at a
discount. Fixed Income Funds Management may like to invest for the purposes of
regular income.
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16.10 Summary
1. What are the long term and short term sources of finance of a business
enterprise?
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Block - V
Corporate Governance
CONTENTS
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UNIT 17: Protection of Investors
Structure
17.0 Introduction
17.1 Protection of Investor
17.2 Regulatory Measures for Protection of Investors’ Interest
17.3 SEBI Guidelines on Disclosure Requirements
17.4 Provisions in Listing Agreement for Investors Protection
17.5 Investors Education
17.6 Investors Education and Protection Fund
17.7 Ombudsman
17.8 Summary
17.9 Check Your Progress
17.0 INTRODUCTION
The concept of joint stock companies had its origin in the middle of 19th
Century, enabling the pooling of small savings from the general public into the
companies' treasury and issuing shares to the investors in lieu thereof. Initially the
benefit of limited liability did not attach to these corporate securities called
company shares. In other words, investments in companies carried the same
unlimited liability for the investors as was the case with investments in
proprietorship concerns and partnership firms. The investors control the
management group through their representatives at the Board meetings and other
company meetings, where the affairs of the company are managed by professionals.
Thus, the privity and close association which are noticed in a partnership firm
amongst the investing partners do not exist in a joint stock company between the
management and the investing public. Soon after the concept of joint stock
companies came into being a number of companies mismanaged and lost their
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capital and worse still, the creditors chased the investors of the joint stock
companies and attached their private properties also, to satisfy their claims on the
basis of unlimited liability. At this juncture, the joint stock concept itself received a
rude shock and was about to become defunct. It was at this stage that the protection
of limited liability was conceived and added as a feature of the investments in the
shares of joint stock companies. In fact, -this innovation was a remarkable one
which paved the way for large sized joint stock companies to emerge and mop up
private savings for being channelised into productive purposes. It is therefore often
held that after the invention of the Rail Road Engine, the most spectacular
innovation of the 19th Century was the creation of joint stock companies with
limited liability for the investors and with separation of ownership from
management in the conduct of trade and commerce.
With the growth in corporate activities, collection of funds towards shares in joint
stock companies became common. However this involved detailed legal provisions
in different enactments compelling issuers of capital to disclose all relevant
information fully and fairly and to follow the laid down procedures for protecting
the interest of investors, and consulting and obtaining approval from them on
matters of relevance to them. The practice of circulating annual accounts prepared
by the Board of Directors, to the members along with the directors report and
seeking their approval for appointment of directors and auditors and obtaining their
consent on other statutorily prescribed matters had its origin from the above
considerations. The principle of corporate democracy was embedded in the
corporate legislations from the inception so that the managements even while
possessing majority voting power in their hands were obliged to consult and give
an opportunity to the minority shareholders also, to have a say in passing
resolutions at the general meetings. The system of statutory audit by duly-qualified
accountants holding certificate of practice and observing standard accounting
procedure and disclosure norms followed in due course.
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In the case of purchase of goods, the dictum of buyer beware (caveat emptor)
applies. Whereas this has limited application in respect of securities, Investors
decide to buy securities on the basis of information provided to them. If the
information is incomplete or contains misrepresentation or is fraudulent, the
investor stands to lose. In such a setting, it is almost impossible to sustain investor
confidence for the healthy growth and development of the capital market in a
country. It is thus essential to ensure that companies provide adequate, accurate and
authentic information to the investors and to safeguard them against unscrupulous
promoters trying to hoodwink them. Besides, the investors need to be protected
from delays in listing of securities with the stock exchanges, dispatch of allotment
letters and refund orders, transfer of securities, non-payment of interest and
dividend, issue of notices regarding meetings and issue of copies of the audited
accounts, directors report and other relevant information which help them to take
considered decisions in keeping or disposing of their shares.
India has a comparatively higher rate of savings in the World but the investment of
this savings in productive channels and in corporate securities is remarkably low.
While in UK and USA 25% of the population invests in corporate securities, a very
small proportion of the Indian population invests in such securities. Investment in
corporate securities essentially comes from metropolitan cities, urban and semi-
urban centres in India, information on risks involved and view points on the merits
and demerits of the investment should be disseminated widely and reliably. Thus
adequate, accurate, relevant and authentic information forms the core of decision
making by the investors. Such information should be available on a continuous
basis so that the investor is able to make disinvestment decisions also at the right
time.
For example when the great crash in the US market (Black Thursday - October
29,1929) occurred it led to the enactment of Securities Act, 1933 and the Securities
Exchange Act, 1934. A far more severe crash of Thursday - October, 19, 1987
further led to the tightening of stock market controls and regulations. In the UK in
February, 1997, the Director General of Fair Trading advised the London Stock
Exchange of his intention to appeal before the Restrictive Practices Court because
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the rules of the London Stock Exchange regarding fixed minimum commission and
membership were unfair to the investors. The Government offered the Exchange an
opportunity to amend these rules. The rules were amended but still could not
prevent the Big Bang of October 27,1986. Therefore, the Financial Services Act,
1986 had to be brought into effect to secure fair play in the securities business. The
legislative developments in the US and UK are a pointer in determining the sort of
structural changes needed in regulating the Indian stock market.
COMMON GRIEVANCES OF INVESTORS
The general grievances the investors have against companies can be listed as under:
1. Furnishing inadequate information or making misrepresentation in prospectus,
application forms, advertisements and rights offer documents.
2. Delay/non-receipt of refund orders, allotment letters and share certificates/
debenture certificates/bonds.
3. Delay/non-receipt of share certificates/debenture certificates after transfer.
4. Delay in listing of securities with stock exchanges.
5. Delay/non-receipt of share certificates/bonds/debentures after endorsement of
part payment/call money.
6. Delay/non-receipt of share certificates/bonds/debentures after sub division or
consolidation.
7. Delay/non-receipt of letter of offer of rights issue.
8. Delay/non-receipt of bonus shares/right shares.
9. Delay/non-receipt of notices for meetings/annual reports.
10. Delay/non-receipt of interest warrants and dividend warrants.
11. Fixing unduly high premium on shares.
12. Difficulties in sending odd lots.
13. Obtaining undue benefits by company insiders.
14. Delay/default in payment of interest and repayment of deposits.
In respect of each of the above grievances complaints can be lodged with the
Registrar of Companies, stock exchanges or SEBI as the case may be and in certain
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cases, they can be pursued with the Company Law Board also to obtain remedies
and relief.
Investor Information Centres have been set up in every recognised stock exchange
which take up all complaints regarding the trades effected in the exchange and the
relevant member of the exchange.
Moreover two other avenues are always available to the investors to seek redressal
of their complaints:
But considering the cost and time involved, the investor should better opt for these
methods only as a last resort, after exhausting other simpler and direct methods of
redressal of their grievances.
SEBI has issued rules, regulations and guidelines to monitor the working of various
players both in the primary market and secondary market including stock
exchanges and mutual funds. In particular, SEBI guidelines provide for due -
diligence to be carried out by each intermediary in the performance of his work.
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companies, the clauses in the listing agreement contain provisions for prompt issue
of certificates after effecting transfers.
Failure to comply with the provisions of Companies Act can be brought before the
Company Law Board through an appeal under Section 111 and 111 A. After
hearing the parties Company Law Board may by order direct the company to
register the transfer.
In the case of listed companies investors are entitled to forward their complaints to
the company and SEBI and the latter takes up the matter with the companies. SEBI
has the power to take action including criminal proceeding where necessary against
persons responsible for delay.
Besides, Section 621 of the Companies Act, 1956 permits the shareholder to
proceed against the company and its officers in a court of law generally for
offences committed under the Companies Act including prospectus, abridged
prospectus, allotment, listing, transfer of shares, dividend payment etc. committed
by the company as well as its officers under various provisions in the Act.
Another notable feature of the Companies (Amendment) Act, 2000 is that SEBI has
been delegated powers to take action against listed companies under 45 Sections of
the Companies Act in relation to issue and transfer of securities and nonpayment of
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dividend. In the past SEBI felt handicapped in proceeding against violations and
defaults for want of powers. This has now been set right and SEBI is empowered to
deal with violations and defaults under Sections 55 to 58, 59 to 84, 108 to 110, 112
& 113, 116 to 122, 206 and 206A & 207, committed by listed companies as well as
public companies which intend to make public issues and get their securities listed
on any recognised stock exchange. Under Section 209A, officers of SEBI are also
authorised to undertake inspection of books of-the company in regard to matters
covered under Section 55A, and SEBI need not give previous notice to the
company in this regard.
Protection to Depositors
Section ,58AA has been inserted in the Companies (Amendment) Act, 2000
affording special protection to small depositors and prescribing punishments for
violations. Small depositor means a depositor who has deposited in a financial year
a sum not exceeding Rs. 20,000/- in a company under Section 58.
Section 117A to 117C has been inserted in the Act to protect the debenture holders,
and the new sections contains stringent punishments for default.
Section 205 has been amended to include interim dividend under the term dividend.
It is now provided that the total amount payable as dividend shall be deposited in a
separate bank account within five days from the date of declaration of dividend and
that the dividend warrants should be posted within 30 days from the date of
declaration (and not 42 days as provided earlier). Punishment for default will
consist of simple imprisonment upto 3 years and fine upto Rs.1000/- per day of
default. Delayed payments will also carry simple interest @ 18% per annum for the
period of default.
In the preamble to the SEBI Act, 1992 two objectives are mentioned. The first
objective is protecting the interest of the investors in securities and the second is to
promote the development of and to regulate the securities market and for matters
connected therewith or incidental thereto. Thus priority is accorded to investor
protection in the SEBI Act.
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Section 11 in Chapter IV of the SEBI Act lists out the functions of the SEBI. There
are 15 functions provided for SEBI in this section. Section 11(2)(e) stipulates
prohibition of fraudulent and unfair practices relating to securities markets as one
of these functions and Section 11 (2)(g) provides for prohibition of insider trading
in securities. In pursuance of this provision the Board had notified the SEBI
(Prohibition of fraudulent and unfair practices relating to securities markets)
Regulations, 1995 on 25th October, 1995 in exercise of Section 30 of SEBI Act
which empowers SEBI to make regulations for different purposes of the Act. These
regulations have now been replaced with SEBI (Prohibition of Fraudulent and
Unfair Trade Practices relating to Securities Market) Regulations, 2003 w.e.f.
177.2003.
SEBI Regulations prohibiting the Fraudulent and Unfair Trade Practices relating to
Securities Market have been divided into 3 chapters. While Chapter I deals with
preliminary matters, Chapter II provides for prohibition of fraudulent and unfair
trade practices relating to securities markets and Chapter III prescribes the powers
and procedure for investigating into alleged contraventions and issuing directions
and orders including suspension or cancellation of registration of an intermediary
guilty of such contraventions.
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(i) a knowing misrepresentation of the truth or concealment of material
fact in order that another person may act to his detriment;
(ii) a suggestion as to a fact which is not true by one who does not -believe
it to be true;
(iii) an active concealment of a fact by a person having knowledge or belief
of the fact;
(iv) a promise made without any intention of performing it;
(v) a representation made in a reckless and careless manner whether it be
true or false;
(vi) any such act or omission as any other law specifically declares to be
fraudulent;
(vii) deceptive behaviour by a person depriving another of informed consent
or full participation;
(viii) a false statement made without reasonable ground for believing it to be
true;
(ix) the act of an issuer of securities giving out misinformation that affects
the market price of the security, resulting in investors being effectively
misled even though they did not rely on the statement itself or anything
derived from it other than the market price.
And “fraudulent” shall be construed accordingly.
Nothing contained in this clause shall apply to any general comments made in good
faith in regard to -
(a) the economic policy of the government
(b) the economic situation of the country
(c) trends in the securities marketer
(d) any other matter of a like nature
whether such comments are made in public or in private.
(d) engage in any act, practice, course of business which operates or would
operate as fraud or deceit upon any person in connection with any
dealing in or issue of securities which are listed or proposed to be listed
on a recognized stock exchange in contravention of the provisions of the
Act or the rules and the regulations made there under.
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(d) paying, offering or agreeing to pay or offer, directly or indirectly, to any
person any money or money's worth for inducing such person for dealing
in any security with the object of inflating, depressing, maintaining or
causing fluctuation in the price of such security;
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appearance of trading in such security or to inflate, depress or cause
fluctuations in the price of such security;
(r) planting false or misleading news which may induce sale or purchase of
securities.
it may, at any time by order in writing, direct any officer not below the rank of
Division Chief (hereinafter referred to as the “Investigating Authority”) specified in
the order to investigate the affairs of such intermediary or persons associated with
the securities market or any other person and to report thereon to the Board in the
manner provided in Section 11C of the Act.
(1) to call for information or records from any person specified in Section 11
(2)(i) of the Act;
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(2) to undertake inspection of any book, or register, or other document or record
of any listed public company or a public company which intends to get its
securities listed on any recognized stock exchange where the Investigating
Authority has reasonable grounds to believe that such company has been
conducting in violation of these regulations;
(3) to require any intermediary or any person associated with securities market in
any manner to furnish such information to, or produce such books, or
registers, or other documents, or record before him or any person authorized
by him in this behalf as he may consider necessary if the furnishing of such
information or the production of such books, or registers, or other documents,
or record is relevant or necessary for the purposes of the investigation;
(4) to keep in his custody any books, registers, other documents and record
produced under this regulation for a maximum period of one month which
may be extended upto a period of six months by the Board.
The Investigating Authority may call for any book, register, other document or
record if the same is needed again. However if the person on whose behalf the
books, registers, other documents and record are produced requires certified
copies of the books, registers, other documents and record produced, the
Investigating Authority has been put under obligation to give certified copies
of such books, registers, other documents and record to such person on whose
behalf the books, registers, other documents and record were produced;
(5) to examine orally and to record the statement of the person concerned or any
director, partner, member or employee of such person and to take notes of
such oral examination to be used as an evidence against such person. However
the said notes are required to be read over to, or by, and signed by, the person
so examined;
(6) to examine on oath any manager, managing director, officer or other employee
of any intermediary or any person associated with securities market in any
manner in relation to the affairs of his business and may administer an oath
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accordingly and for that purpose may require any of those persons to appear
before him personally.
The Investigating Authority have also been vested with the following powers
subject to the specific approval from the Chairman or Member, namely:
(a) to call 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
are under investigation;
(b) to make an application to the Judicial Magistrate of the first class having
jurisdiction for an order for the seizure of any books, registers, other
documents and record, if in the course of investigation, 'the Investigating
Authority has reasonable ground to believe that such books, registers,
other documents and record of, or relating to, any intermediary or any
person associated with securities market in any manner may be
destroyed, mutilated, altered, falsified or secreted;
(c) to keep in his custody the books, registers, other documents and record
seized under these regulations for such period not later than the
conclusion of the investigation as he considers necessary and thereafter
to return the same to the person, the company or the other body
corporate, or, as the case may be, to the managing director or the
manager or any other person from whose custody or power they were
seized. However, the. Investigating Authority may, before returning such
books, registers, other documents and record as aforesaid, place
identification marks on them or any part thereof.
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After the completion of investigation, the Investigating Authority takes into
account all relevant facts and submit a report to the appointing authority:
However, it has been provided that the Investigating Authority may submit an
interim report pending completion of investigations if he considers necessary in the
interest of investors and the securities market or as directed by the appointing
authority.
(b) restrain persons from accessing the securities market and prohibit any
person associated with securities market to buy, sell or deal in securities;
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(e) direct any intermediary or any person associated with the securities
market in any manner not to dispose of or alienate an asset forming part
of a fraudulent and unfair transaction;
(f) require the person concerned to call upon any of its officers, other
employees or representatives to refrain from dealing in securities in any
particular manner;
(g) prohibit the person concerned from disposing of any of the securities
acquired in contravention of these regulations;
(h) direct the person concerned to dispose of any such securities acquired in
contravention of these regulations, in such manner as *he Board may
deem fit, for restoring the status-quo ante;
(2) SEBI has been put under an obligation to issue a press release in respect of
any final order passed in atleast two newspapers of which one shall have
nationwide circulation and also put the order on the website of the Board.
SEBI may in the interests of investors-and securities market take the following
action against an intermediary:
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and has been amending and improving them from time to time to meet and deal
with contraventions of the Act and distortions and malpractices in the market.
These guidelines have been revised and consolidated in early 2000 as a
compendium on SEBI (Disclosure & Investor Protection) Guidelines, 2000.
These guidelines besides providing for procedures for operation of different
intermediaries, also have the basic purpose of protecting the interests of investors.
SEBI has been emphasising on the importance of disclosure standards for
corporates in disseminating relevant and correct information to the investors. With
this view SEBI had appointed a committee under the chairmanship of Shri C B
Bhave to suggest measures for improving the continuing disclosure standards by
corporates and timely dissemination of price sensitive information to the public.
The committee submitted its report to the SEBI.
17.4 PROVISIONS IN LISTING AGREEMENT FOR INVESTOR
PROTECTION
Listing of Securities on Indian Stock Exchanges is essentially governed by the
provisions in the Companies Act, 1956, the Securities Contracts {Regulation) Act,
1956, the Securities Contracts (Regulation) Rules, 1957, Rules, bye laws,
regulations of concerned stock exchange, the listing agreement entered into by the
issuer and stock exchange and circulars/guidelines issued by the Central
Government and SEBI.
Major Compliances ought to be followed pursuant to the Listing Agreement are
given hereunder:
1. Share allotment, Regret letters, and notification in press.
2. Notification of any attachment of prohibiting orders against transfer of
securities, to the exchange.
3. Books closure/Record Date.
4. Convening of a Board Meeting for Declaration/Decision regarding:
(a) Dividend.
(b) Bonus shares if forming part of Agenda.
(c) Issue of rights shares.
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(d) Issue of convertible debentures
(e) Issue of debentures carrying a right to subscribe to equity shares.
(f) Passing over of dividend.
(g) Buy-back of securities.
5. Decision regarding declaration of dividend, bonus, interest payment, buy-
back of securities, rights, re-issue of forfeited shares, calls to be made.
6. Payment of dividend oh shares, interest on debentures/bonds, redemption
amount of redeemable shares or debentures/bonds and interest warrants and
cheques for redemption money of redeemable shares or of debentures and
bonds.
7. Granting options to purchase any shares of the company.
8. Any action resulting in redemption, cancellation or retirement in whole or in
part of listed securities, or intention to make withdrawal of such securities.
9. Change in the form or nature of listed securities or change in the rights/
privileges thereof.
10. Further issue of Securities.
11. Cash Flow Statement in the Annual Report, Consolidated Financial
Statement and related party disclosures.
12. Shareholding pattern containing details of promoters holding and non-
promoters holding.
13. Decision regarding issue of shares, forfeiture of shares, alteration of shares,
cancellation of declared dividend, merger, amalgamation, de-merger, hiving
off, voluntary delisting and other material decisions.
14. Conditions for continued listing and Takeover offer.
15. Un-audited financial results.
16. Half-yearly results and Limited review Report by auditors.
17. Auditors Qualification.
18. Quarterly reporting of Segment wise Revenue, results and Capital
Employed.
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19. Consolidated Quarterly Financial results of parent company.
20. Annual Results.
21. Change of name due to new activity.
22. Explanation regarding variations in utilisation of funds and profitability.
23. Appointment of Company Secretary as Compliance Officer.
24. Registration of share Transfer.
25. Corporate Governance.
26. Accounting Standards.
27. EDIFAR (Electronic Data Information Filing and Retrieval).
EDIFAR is the Electronic Data Information Filing and Retrieval system. This is an
automated system for filing, retrieval and dissemination of time sensitive corporate
information which till now were being filed physically by the listed companies with
the stock exchanges in India. By centralising the information through on-line filing,
EDIFAR’s primary objective is to centralise the information and accelerate its
dissemination and by doing so enhance the transparency and efficiency for the
benefit of all the stakeholders in the securities market.
EDIFAR is being implemented in a phased manner. As of date, all the listed
companies are required to file disclosure statements and other information with the
stock exchanges where they are listed. The stock exchanges disseminate this
information through trading terminals, their website etc.
In the first phase, a select list of such disclosure statements viz. financial statements
comprising of balance sheet, profit and loss account and full version of annual
report; half yearly financial statements including cash flow statements and quarterly
financial statements; corporate governance reports; shareholding pattern statement;
action taken against any company by any regulatory agency are required to be filed
electronically-by about 200 companies included in BSE Sensex, S&P CNX Nifty
and BSE-200 indices. These companies are also required to file this information in
the physical form with the stock exchanges. Gradually the physical filing will be
discontinued and both the number of companies as well as the disclosure statements
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will be expanded to cover all the actively traded companies for ail the disclosure
statements. All physical filing would thereby discontinued.
17.5 INVESTORS EDUCATION AND PROTECTION FUND
Pursuant to Section 2-05C of the Companies Act, 1956, as inserted by the
Amendment Act of 1999, an Investors Education and Protection Fund (IEPF) (the
Fund) has been established by the Central Government. To the IEPF, the amounts
in unpaid dividend accounts, unpaid refund of application money received by
companies for allotment of securities, unpaid matured deposits and debentures,
interest accrued thereon, grants and donations of the Government to the Fund and
the interest/income thereon, shall not form part of the IEPF unless such amounts
have remained unclaimed and unpaid for a period of seven years from the date they
became due for payment. The IEPF shall be used in accordance with the Investors
Education and Protection Fund (Awareness and Protection of Investors) Rules,
2001 and the amounts therein shall be utilised for conducting investors education
and awareness programmes, seminars etc. and protection of the interests of
investors.
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This is further supplemented by the journals and magazines in the field of corporate
investment as well as newspaper articles which highlight the newly emerging
problems, pitfalls and the methods to protect.
Basic Points on Investing in Corporate Securities
It is to be noted that the best protection is self protection. The investors who choose
to lay out their money on corporate securities must necessarily educate themselves
continuously on the developments in the law, regulations of different instruments
and different players in the market. Investors should remember the dictum investor
beware and ignorance of law is no excuse. They should also be guided by the
cardinal principle of safety, liquidity and profitability at all times. They must keep
their eyes and ears open to new developments in the market and make a proper
assessment of the type of instrument, organisations and intermediaries they are
dealing with before venturing into investment.
1. The stock markets have been made broad based and well integrated.
2. The system of trading has been improved and settlement period shortened.
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3. Brokers and sub-brokers are better regulated to offer prompt services.
4. Greater transparency has been brought into the trading activities of the brokers
and their associates.
5. Insider trading is prohibited through new regulations.
6. Registration of brokers has been tightened by prescribing norms for capital
adequacy and eligibility.
7. Grievance ceils have been set up in stock exchanges for expeditious
settlements of complaints of investors. These cells are required to monitor and
remedy the complaints and also furnish monthly progress report to the
governing bodies of the stock exchanges. The presidents of stock exchanges
have been advised to hold open house session or arrange investor service
week periodically with the investors and redress their grievances.
17.7 OMBUDSMAN
Ombudsman in its literal sense is an independent person appointed to hear and act
upon citizen’s complaint about government services. This concept was invented in
Sweden and the idea has been widely adopted. For example, various banks,
insurance companies have appointed Ombudsmen to attend to the complaints of
their customers.
SEBI vide its Notification SO(953)E dated 21.8.2003 has issued SEBI
(Ombudsman) Regulations, 2003. Regulation 2(l) of the Regulations defines
Ombudsman as under:
“Ombudsman” means any person appointed under regulation 3 of these regulations
and unless the context otherwise requires, includes stipendiary Ombudsman.
Regulation 2(n) of the Regulations defines stipendiary Ombudsman as a person
appointed under regulation 9 for the purpose of acting as Ombudsman in respect of
a specific matter or matters in a specific territorial jurisdiction and for which he
may be paid such expenses, honorarium, sitting fees as may be determined by the
Board from time to time.
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The regulations further deal with establishment of office of Ombudsman, powers
and functions of Ombudsman, procedure for redressal of Grievances and
implementation of the award.
The term “complaint” under the Regulation means a representation in writing
containing a grievance as specified in regulation 13 of these regulations; and
“complainant” means any investor who lodges complaint with the Ombudsman and
includes an investors association recognised by the Board.
An “investor” means a person who invests or buys or sells or deals in securities.
“Listed-company” has been defined in the Regulations to mean a company whose
securities are listed on a recognised stock exchange and includes a public company
which intends to get its securities listed on a recognised stock exchange.
Establishment of Office of Ombudsman
SEBI has been empowered to appoint, on recommendation of a Selection
Committee, one or more Ombudsmen for such territorial jurisdiction as may be
specified from time to time by an order. The Selection Committee referred in sub-
regulation(2)should consist of the following members, namely:
(a) an expert in the areas relating to financial market operations to be nominated
by the Chairman;
(b) a person having a special knowledge and experience of law, finance or
economics, to be nominated by the Chairman.
(c) a representative-of the-Board not below the rank of Executive Director who
shall be Secretary of the Selection Committee, to be nominated by the
Chairman.
At the request of SEBI, the Selection Committee may also prepare a panel of
persons out of which a person may be appointed as Stipendiary Ombudsman. The
panel so constituted can remain in force for a maximum period of two years and
shall be reconstituted from time to time. It has also been provided that any person
in the existing panel shall be eligible to be included in the reconstituted panel.
The regulations provide that the office of the Ombudsman shall be located at the
Head Office of the Board and if more than one Ombudsman are appointed then the
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office of any such Ombudsman may be located at any other office of the Board or
any other place as may be specified by the Board from time to time. The
Regulations further provide that the Stipendiary Ombudsman when appointed for
any specific complaint or complaints shall be located at such place as may be
specified. In order to expedite disposal of complaints, the Ombudsman or
Stipendiary Ombudsman, as the case may be, may hold sittings at such places
within his area of jurisdiction as may be considered necessary and proper by him.
SEBI may provide the premises and other infrastructure including staff or
secretarial assistance for the office of Ombudsman or Stipendiary Ombudsman, as
the case may be.
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Tenure
A person appointed as an Ombudsman will hold office for a term of-three years and
shall be eligible for reappointment for another period of two years. No person can
hold the office of Ombudsman after attaining the age of sixty-five years. However
the Board, at any time, before the expiry of the period specified may terminate the
services of the Ombudsman by giving him notice of not less than three months in
writing or three months salary and allowances in lieu thereof. Ombudsman also has
the right to relinquish his office, at any time, before the expiry of period specified
by giving to the Board notice of not less than three months in writing.
Remuneration
The salary, allowances, honorarium or fee payable, to, and other terms and
conditions of service of, an Ombudsman will be determined by the Board from time
to time.
Stipendiary Ombudsman
The Board may appoint a person as a Stipendiary Ombudsman out of the panel
prepared for the purpose of acting as an Ombudsman in respect of a specific matter
or matters in a specific territorial jurisdiction, as may be specified in the order of
appointment. A person is eligible to be appointed as Stipendiary Ombudsman if he
-
(a) has held a judicial post or an executive office under the Central or State
Government for at least ten years; or
(b) is having experience of at least ten years in matters relating to consumer or
investor protection; or
(c) has been a legal practitioner in corporate matters for at least 10 years; or
(d) has served for a minimum period of ten years in any public financial
institution.
The Stipendiary Ombudsman is entitled to exercise ail powers and functions as are
vested in a Ombudsman. The Stipendiary Ombudsman is also entitled to be paid
such fees or honorarium and allowances for the services rendered by him, as may
be determined by the Board from time to time.
{493}
Territorial Jurisdiction
Every Ombudsman or Stipendiary Ombudsman exercises jurisdiction in relation to
an area as may be specified by the Board by an order.
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(ii) Non-receipt of share certificates, unit certificates, debenture certificates,
bonus shares;
(iii) Non-receipt of dividend by shareholders or unit-holders;
(iv) Non-receipt of interest on debentures, redemption amount of debentures or
interest on delayed payment of interest on debentures;
(v) Non-receipt of interest on delayed refund of application monies;
(vi) Non-receipt of annual reports or statements pertaining to the portfolios;
(vii) Non-receipt of redemption amount from a mutual fund or returns from
collective investment scheme;
(viii) Non-transfer of securities by an issuer company, mutual fund, Collective
Investment Management Company or depository within the stipulated time;
(ix) Non-receipt of letter of offer or consideration in takeover or buy-back offer
or delisting;
(x) Non-receipt of statement of holding corporate benefits or any grievances in
respect of corporate benefits, etc;
(xi) Any grievance in respect of public, rights or bonus issue of a listed
company;
(xii) Any of the matters covered under Section 55A of the Companies Act, 1956;
(xiii) Any grievance in respect of issue or dealing in securities against an
intermediary or a listed company.
Power to call for information
An Ombudsman may require the listed company or the intermediary named in the
complaint or any other person, institution or authority to provide any information or
furnish certified copy of any document relating to the subject matter of the
complaint which is or is alleged to be in its or his possession. In the event of the
failure of a listed company or the intermediary to comply with the requisition made
without any sufficient cause, the Ombudsman may, if he deems fit, draw the
inference that the information, if provided or copies if furnished, would be
unfavourable to the listed company or intermediary. The Ombudsman is required to
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maintain confidentiality of any information or document coming to his knowledge
or possession in the course of discharging his duties and shall not disclose such
information or document to any person except and as otherwise required by law or
with the consent of the person furnishing such information or document. The
Ombudsman has been empowered to disclose information or document furnished
by a party in a complaint to the other party or parties, to the extent considered by
him to be reasonably required to comply with the principles of natural justice and
fair play in the proceedings. However these provisions shall not apply in relation to
the disclosures made or information furnished by the Ombudsman to the Board or
to the publication of Ombudsman's award in any journal or newspaper or filing
thereof before any Court, Forum or Authority.
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adjudication shall be made by Ombudsman within a period of three months from
the date of the filing of the complaint. No award shall however be invalidated by
reason alone of the fact that the award was made beyond the said period of three
months. The Ombudsman should send his award to the parties to the adjudication to
perform their obligations under the award.
Finality of Award
An award given by the Ombudsman shall be final and binding on the parties and
persons claiming under them respectively. Any party aggrieved-by the award on
adjudication may within one month from the receipt of the-award or corrected
award may file a petition before the Board setting out the grounds for review of the
award.
Review of Award
An award may be reviewed by the SEBI only if there is substantial mis-carriage of
justice, or there is an error apparent on the face of the award.
Where a petition for review of the award is filed by a party from whom the amount
mentioned in the award is to be paid to the other party in terms of the award, such
petition shall not be entertained by the Board unless the party filing the petition has
deposited with the Board seventy-five percent of the amount mentioned in the
award. However SEBI may, for reasons to be recorded in writing, waive or reduce
the amount to be deposited.
SEBI may review the award and pass such order as it may deem appropriate, within
a period of forty five days of the filing of the petition for review. The award passed
by the Ombudsman shall remain suspended till the expiry of period of one month
for filing review petition or till the review petition is disposed off by the Board, as
the case may be.
The Board may determine its own procedure consistent with principles of natural
justice in the matter of- disposing of review petition and may dismiss the petition in
limine if it does not satisfy any of the grounds specified in the Regulations.
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Implementation of the Award
The award will be implemented by the party so directed within one month of
receipt of the award from the Ombudsman or an order of the Board passed in
review petition or within such period as specified in the award or order of the
Board. If any person fails to implement the award or order of the Board passed in
the review petition, without reasonable cause —
(1) he shall be deemed to have failed to redress investors' grievances and shall be
liable to a penalty under Section 15C of the Act;
(2) he shall also be liable for —
(a) an action under Section 11 (4) of the Act; or
(b) suspension or delisting of securities; or
(c) being debarred from accessing the securities market; or
(d) being debarred from dealing in securities; or dealing in securities; or
(e) an action for suspension or cancellation of certificate of registration; or
(f) such other action permissible which may be deemed appropriate in the
facts and circumstances of the case.
Among other things SEBI has brought out an information pamphlet caption "a
quick reference guide for investors" for the benefit of the public who hold
securities.
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The pamphlet highlights the following:
Rights of Members
To receive share certificates on allotment or transfer, as the case may be, in due
time.
To receive copies of notices for various general meetings and attend them either
personally or through proxies and to participate and vote.
To receive copies of abridged annual report, balance sheet, profit and loss
account and auditor’s report.
To receive dividends declared (including interim dividends) in time.
To receive other corporate benefits such as rights issues, bonus issues as and
when approved.
To apply to the Company Law Board to call or direct -the calling of annual
general meeting of the company.
To inspect minute books of the general meetings and to take copies thereof.
To proceed against the company by way of civil or criminal proceedings
wherever justified.
To apply for the winding up of the company.
To receive the residual proceeds on winding up.
Besides the above rights enjoyed as individual shareholder, the following rights can
also be claimed as a group:
To requisition an extraordinary general meeting.
To demand a poll on any resolution.
To apply to Company Law Board to investigate the affairs of the company.
To apply to Company Law Board for relief in cases of oppression and
mismanagement.
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To approach debenture trustee with a grievance petition.
To apply for winding up if the company fails to pay its dues.
Responsibilities of Members
Besides the above rights members also have certain responsibilities to be
discharged. They are:
To remain informed.
To be vigilant.
To participate and vote in general meetings.
To exercise rights as an individual and also as a group.
Trading of Securities
A shareholder has the right to sell the securities which he holds at a price and time
he chooses. He can do so personally or through a recognised stock exchange.
Similarly, he has the right to buy securities from any one directly or through a
recognised stock exchange at a price and time he chooses. Alt such trading (buying
or selling) should be executed by a valid, duly completed and stamped transfer
deed. If one deals directly with another person, one is exposed to counterparty risk
i.e. the risk of non performance by that party but if you deal through a stock
exchange namely - a broker or sub-broker, this counterparty risk is reduced due to
trade/ settlement guarantee offered by the stock exchange mechanism. Further a
share holder also has certain protection against the defaults by the broker.
When one operates through the stock exchange he has the right to receive the best
price prevailing at that time and the right to receive the money (on sale of
shares/securities) or the shares/securities {purchased) in time. The member has the
right to receive a contract note from the broker confirming the trade and indicating
the necessary details thereof. There is also the right to receive good delivery and
the right to insist on rectification of bad delivery. If one has a dispute with one’s
broker it can be resolved through arbitration under the auspices of the exchange.
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filing a client registration form. Since the contract note is a legally enforceable
document, one should insist on receiving it. If one is selling, he has the obligation
to deliver the shares and if one is buying, he -has the obligation to pay the money.
In case of bad delivery of securities by a person he has the responsibility to rectify
it or replace the bad securities with good securities.
Transfer of Securities
When transfer is affected it means that the company has recorded in its books and
on the securities a change in the title of ownership. To affect a transfer, the security
should be sent to the company along with a valid, duly executed and stamped
transfer deed signed by and on behalf of the transferor (seller) and transferee
(buyer). It will be useful to have photocopies of the securities and transfer deed
when they are sent to the companies for transfer. It is advisable to send them by
Registered Post with' acknowledgement due and watch for the receipt of the
acknowledgement card duly signed. If confirmation of receipt is not-received
within a reasonable period (say 2 months) the post office should be approached for
confirmation. Post Office will respond only if inquiries are made within three
months from the date of booking the registered article.
In case the shareholder who has purchased it wants to sell it for a good price
quickly, he may not fill up the transferee's name and forward it to the company for
effecting transfer, but in such a case he will not be getting dividends, bonus or
rights from the company and these will be sent by the company to the original
holder (transferor). In case the transfer is not valid, the company returns back the
securities giving reasons for not affecting the transfer. This is known as company
objection. Then the errors/discrepancies should be corrected and the papers
resubmitted to the company again. In case of bad delivery one should ask the
transferor to replace with good deliveries. Where one is unable to get the errors
rectify or obtain replacement the recourse will be to the seller and his broker
through the stock exchange to get back the money. Where the transaction was
directly with the original seller and not through the broker, the matter has to be
settled with the seller directly.
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In case of loss or misplacement of securities one should immediately request the
company to record a stop transfer and simultaneously apply for issue of duplicate
securities. For affecting stop transfer, the company requires production of a court
order or the copy of FIR filed with the Police. The company may also require
submission of indemnity bond, affidavit, sureties etc. besides publishing a notice in
the newspaper, for issue of duplicate securities.
One has to watch the receipt of the securities or delivery of the securities sent
through post or courier, so that loss in transit is immediately noticed, in transfer
procedure.
Depository and Dematerialisation - Special Advantages
Shares are traditionally held in physical or paper form. This can involve loss or
theft, forged or fake securities being issued etc. Transfer of securities in physical
form involves time and expenditure. Therefore to eliminate these difficulties a new
system called ‘depository system’ was established, whereby the securities are held
in the form of electronic accounts just as a bank holds our money in a savings
account. The National Depository Organisation is gradually prevailing upon
making large companies to switch over to the new system. If one wants to keep the
shares in their original form without transferring it is allowed but for transfer, they
must be dematerialised.
In the depository system securities cannot be lost, stolen or mutilated and there is
no fear of forgery and fake securities. Physical movement of securities and the cost
involved is avoided, and there is no risk of bad delivery. Bonus/right issues by the
company will be immediately credited to the investors account and he will receive
the statement of accounts of the transactions and the holdings periodically. For this
purpose one has to approach a depository participant who is an agent of the
depository and open an account. The original share certificates need to be
surrendered to the depository .through the Depository Participant (DP) and on
confirmation the investors account will be credited with the equivalent number of
securities. This is known as dematerialisation. If one chooses he can seek
materialisation and get the conversion into paper securities. On sale or purchase the
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DP will debit/credit client's account and the transfer is not dealt with in the books
of the company.
17.8 Summary
All over the world the twin objectives of securities legislations are
adequate protection of investors and proper regulation of stock exchanges and the
intermediaries. In respect of the grievances complaints can be lodged with the
Registrar of Companies, stock exchanges or SEBI as the case may be and in certain
cases, they can be pursued with the Company Law Board also to obtain remedies
and relief.
Investor Information Centers have been set up in every recognised stock exchange
which takes up all complaints regarding the trades affected in the exchange and the
relevant member of the exchange. In order to afford adequate protection to the
investors, provisions have been incorporated in different legislations such as the
Companies Act, Securities Contracts (Regulation) Act, Consumer Protection Act,
Depositories Act, and Listing Agreement of the Stock Exchanges supplemented by
many guidelines, circulars and press notes issued by the Ministry of Finance,
Ministry of Company Affairs and SEBl from time to time. Pursuant to Section 2-
05C of the Companies Act, 1956, as inserted by the Amendment Act of 1999, an
Investors Education and Protection Fund (IEPF) (the Fund) has been established by
the Central Government. It is to be noted that the best protection is self protection.
The investors who choose to lay out their money on corporate securities must
necessarily educate themselves continuously on the developments in the law,
regulations of different instruments and different players in the market. Investors
should remember the dictum investors beware and ignorance of law is no excuse.
They should also be guided by the cardinal principle of safety, liquidity and
profitability at all times.
Ombudsman in its literal sense is an independent person appointed to hear and act
upon citizen’s complaint about government services. This concept was invented in
Sweden and the idea has been widely adopted. SEBI has been empowered to
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appoint, on recommendation of a Selection Committee, one or more Ombudsmen
for such territorial jurisdiction as may be specified from time to time by an order.
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UNIT 18 Creditors Protection
Structure
18.0 Introduction
18.1 Creditors
18.2 Mechanisms to Secure the Interest of creditors
18.3 Legislating Creditor Protection
18.0 Introduction
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corporate world. Were this to happen, not only would the corporate world suffer a
great and irreversible setback, but also it would be a great setback to the Indian
economy and its development itself. Thus the need to protect the legitimate rights
and interests of the creditors if extremely urgent, and indeed as the following
discussion will reveal, measures have indeed been taken in the Indian context to do
so in recognition of the same.
18.1 Creditors
CREDITORS: person or body to whom one owes any money; one who has a right
to require of another the fulfillment of a contract; one to whom another owes the
performance of an obligation; one in whose favour an obligation exists, by reason
of which he is or may become entitled to the payment of money. Creditor signifies
him that trusts another with any debt, be it money, wares or other things (Aiyer’s
Law Lexicon, Wadhwa Publications).
The term creditor postulates indebtedness. There should be a debt and an existing
debt, which falls due at present or in future.
In the corporate world there may be a variety of classes of creditors. Besides the
statutorily recognized Debenture holders, there are also the following important
classes who have briefly been described and their status and position in the
corporate world noted herein below.
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supervision. If after exhausting the security, anything more remains due to him, he
may prove for the deficiency in the winding up. Or he may value the security
without instituting a suit and prove for the balance of the debt after giving credit to
the assessed value. But then the liquidator may redeem the security at his valuation.
Or he may surrender the security and tender proof of his whole debt.
A secured creditor can recover the possession of the security from the official
liquidator by filing a regular suit and not be a petition under the Companies Act.
After a secured creditor has realized such amounts as may be possible by the
proceeding against security, it is open to him to prove for the balance due as an
ordinary creditor in the winding up proceedings. He will be entitled to payment of
interest only if there is a surplus available after all the creditors have been paid off.
“Any person who has been granted financial assistance by any bank or
financial institution or who has given any guarantee or created any mortgage
or pledge as a security for the financial assistance granted by any bank or
financial institution and includes a person who becomes borrower of a
Securitisation company or reconstruction company consequent upon
acquisition by it of any rights or interest of any bank or financial institution
in relation to such financial assistance” (Section 2(f) of the Act.).
The term “borrower” has been made to include a person who has given any
guarantee or created any mortgage or pledge as security for the financial assistance
granted by any bank or financial institution merely to signify the concept of the
liability of the surety or the guarantor being company- extensive with that of the
principal debtor, vide section 128 of the contract act, 1872 and provision has
further been made in sub- section 11 of section 13 of The Securitisation And
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
as an extra abundant caution, to clarify the same by providing that without
prejudice to the rights conferred on the secured creditor under or by section 13 of
The Securitisation And Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002, the secured creditor shall be entitled to proceed against
the guarantors or sell the pledged assets without first taking any other measures
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specified in clauses (a) to (d) of sub- section (4) of section 13 of the said act in
relation to the secured assets under The Securitisation And Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002.
The moot question that must be raised in respect of the protection of the interest of
creditors is: does secured credit confer upon the secured creditor some great and
unfailing advantage? Indeed why is secured credit rated so highly? Is unsecured
creditors at any disadvantage compared to their secured counterparts? Assuming
that secured credit is indeed better than unsecured credit, do the principles of
secured credit teach us anything that may actually contribute in securing better
bargains for the unsecured creditors? Or is it indeed a zero sum game? Do secured
creditors enjoy such advantages as they do at the cost of like advantages forgone by
their unsecured counterparts? These questions cannot, for a moment, be considered
irrelevant for the purposes of out discussion and the broader context thereof, and
must indeed be dealt with to find out if indeed any measure of protection of
creditors can be evolved by a resolution of these questions abovementioned. To try
to confine such questions to the periodisation that otherwise runs through the
scheme of this discussion would be foolhardy and would indeed be a grave
injustice to our enquiry. As such for a brief while, it would serve this discussion to
abandon the artificial dividing line of pre- economic and post- economic reforms
and concentrate solely on resolving the questions abovementioned.
In 1982 the Cork Committee Report on insolvency laws and practice recommended
that ten percent of floating charge realizations should be set aside for distribution to
unsecured creditors. The proposal was one of many, as the chairman of the
committee, Sir Kenneth Cork, an eminent insolvency practitioner, himself
explained:
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from realizing their security for 12 months after the appointment of a
receiver…therefore it seems fair to some of us…to give the unsecured
creditors a stake, say 10 per cent, in the net realizations of the receiver.”
The recommendations however raised a great storm and the banks saw the so-
called 10 per cent fund as a prelude to further diminution of the funds available to
them to recover their just claims from the borrowers. They were also apprehensive
that the 10 per cent figure would be increased substantially in times to come. There
was also the fear that, on implementation of the proposal, banks would be willing to
advance diminished funds and on more stringent terms. This would in its turn lead
to catastrophic consequences for the macro economy in general due to the lack of
substantial funds in hands of the corporates to invest in their businesses. It thus
happened that the government was moved by the apprehensions expressed by the
banking community and assured that it would not take steps as would lead to a
reduction of the operating flexibility of the banks.
On the other hand though, those seconding the 10 per cent proposal had primarily
two lines of reasoning. The first bore relation to the re- distributive function of the
fund and was seen as a compensation measure for the benefit of the economically
weak unsecured creditors. The second saw the fund as a fighting fund used to meet
the expenses of insolvency practitioners who were contemplating the institution of
proceedings, such as improper preference or wrongful trading actions, to recover
misdirected company moneys. Indeed as stated by one of the opposition members:
“There have been too many scandals…we are trying to stop people
hiding behind limited liability and carrying on nefarious activities that
no decent businessman would countenance.”
It may also seem that banks feared the loss of control that a ten per cent “fighting
fund” would entail. Insolvency practitioners would move out of the ambit of the
banks and not only would the banks lose 10 per cent, the insolvency practitioners
could indeed use this money to take away even more of what the banks perceived
to be “their” money. Likewise the government saw the proposal as hindering rather
than hampering business. Lord Denning however, as usual, had a different
perspective and observed:
It is clear that the 10 per cent fund proposal would have operated to reduce some of
the priority that secured creditors otherwise enjoyed. It was opposed by the bankers
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for this very reason as also on the more general ground that it would cause a
diminution in the supply of credit offered.
What happens to the interest of creditors when a company declines into insolvency
and is consequently wound up? It may generally be stated at the outset that
companies registered under the Companies Act, 1956, can be put an end to only in
one of two ways, viz., either through the machinery of winding up or by their
names being struck off the register by the registrar as defunct under section 56.
{511}
The provisions in regard to the liability of contributories are important in so much
as they are called upon to account for their liabilities and obligations owing to the
companies. This means that such persons as are deemed to be contributories cannot
get away without accounting for their liabilities. This in effect further implies that
the funds available to satisfy the debts of the company are enhanced by virtue of
the contributories being called upon to account for their liabilities.(See for instance,
Section 429)
Section 433 of the Companies Act, 1956 provides certain grounds on which a
company may be ordered to be wound up. Some of these grounds indicate that the
interests of the creditors are sought to be well protected herein. One such ground is
available when after notice being served in that regard by the creditor, the company
neglects or fails to pay its debts. Section 434 elaborates this point.
Section 434 describes when a company is deemed unable to pay its debts. It states
that: a company shall be deemed to be unable to pay its debts-
(a) if a creditor, by assignment or otherwise, to whom the
company is indebted for a sum exceeding one lakh rupees then
due, has served on the company, by causing to be delivered by
registered post or otherwise, a demand under his hand
requiring the company to pay the sum so due and the company
has for three weeks thereafter neglected to pay the sum, or to
secure or compound for it to the reasonable satisfaction of the
creditor;
(b) if execution or other process issued on a decree or order of any
court or tribunal in favour of a creditor of the company is
returned unsatisfied in whole or in part; or
(c) If it is proved to the satisfaction of the tribunal that the
company is unable to pay its debts, and in determining whether
a company is unable to pay its debts, the tribunal shall take
into account the contingent liabilities of the company.
Section 439A, which was Inserted by the Companies (Second Amendment) Act,
2002 is also important in as much as the filing of the statement of affairs in the
tribunal will mean that not only will the company be held bound to the truth of the
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statement filed, but indeed, and more importantly, its assets and liabilities will be
subject to the scrutiny of the tribunal. This implies that a kind of transparency will
come in when the availability of assets are determined for paying off the creditors.
Section 446A, which was inserted by the Companies (Second Amendment) Act,
2002, introduces the liability of directors and officers of the company in case of
failure to fulfill their responsibility in regard to the submission of proper and
accurate accounts to the tribunal. This also ensures transparency in the availability
of assets for payment to the creditors.
“An order for winding up a company shall operate in favour of all the
creditors and of all the contributories of the company as if it had been made out
on the joint petition of a creditor and of a contributory.”
Section 454 relates to the statement of affairs required to be made to the official
liquidator. This also brings in transparency in the transaction relating to winding up
and the consequent payment of creditors of the company.
Section 456 pertains to the custody of the company’s properties once the winding
up order is made. This is also a crucial provision and seeks to ensure that assets are
not disposed of or lost or destroyed or siphoned of once the winding up has
commenced. Were this not so, the creditors would have in most cases been
deprived of their dues by unscrupulous promoters or officers of the companies.
It must however, also be observed that the tribunal has the power to stay the
winding up of the company in certain cases. The operative portion of the section
466 for our purposes, relating to the power of the tribunal to stay winding up, reads
as hereunder:
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“(1) The tribunal may at any time after making a winding up order, on the
application either of the official liquidator or of any creditor or
contributory, and on proof to the satisfaction of the tribunal that all
proceedings in relation to the winding up ought to be stayed, make an
order staying the proceedings, either altogether or for a limited time, on
such terms and conditions as the tribunal thinks fit.
(2)On an application under this section, the tribunal may, before making an
order, require the official liquidator to furnish to the tribunal a report
with respect to any facts or matters which are in his opinion relevant to
the application.”
Section 474 relates to the power of the tribunal to exclude creditors not proving in
time. This section actually encapsulates the principle that the law favors the alert
and the vigilant and not those who are not prompt in protecting heir rights. This
section in fact furthers the cause of the creditors themselves in so far as it can be
used to ensure that creditors are paid of in a time bound manner, and that the
sanctity of the transaction is not disturbed at a later stage by a creditor who wakes
up belatedly to his rights.
Section 477 is another important provision that helps in ensuring that the properties
available for payment of dues of the company are not misappropriated and that the
relevant books are not put away to defeat a proper accounting for of the properties.
“(1) when an order has been made for winding up a company by the
tribunal, and the official liquidator has made a report to the tribunal
under this act, stating that in his opinion a fraud has been committed by
any person in the promotion or formation of the company, or by any
officer of the company in relation to the company since its formation, the
tribunal may, after considering the report, direct that that person or
officer shall attend before the tribunal on a day appointed by it for that
purpose, and be publicly examined as to the promotion or formation or
the conduct of the business of the company, or as to his conduct and
dealings as an officer thereof.
(2)Any creditor or contributory may also take part in the examination either
personally or by any chartered accountants or company secretaries or
cost accountants or legal practitioners entitled to appear before the
tribunal under Section 10GD.”
{514}
Section 482 is a vital provision relating to enforceability of the order made by any
court in the course of winding up proceedings, and a cursory glance at the section
will reveal its utmost importance:
“Any order made by a court for, or in the course of, winding up a company
shall be enforceable at any place in India, other than that over which such court
has jurisdiction, by the court which would have had jurisdiction in respect of the
company if its registered office had been situate at such other place, and in the
same manner in all respects as if the order had been made by that court.”
VOLUNTARY WINDING UP
It has already been observed earlier that there are two modes of winding up.
Section 487 declares the effect of winding up on the status of the company. Section
488 is another crucial provision directed at securing the protection of the interest of
creditors in as much as it compels a company to declare its solvency.
Section 490 relates to the power of the company to appoint a liquidator for the
purposes of conducting the winding up proceedings. This is an important provision
as much depends on the conduct of the liquidator in managing the winding up
proceedings. Section 491 further declares that the powers of the board shall cease
on the appointment of a liquidator.This means that the board cannot have any
powers remaining which could be exercised in a manner detrimental to the interests
of the creditors. Section 495 takes the securing of the interest of creditors a step
further by providing that the liquidator shall call a meting of the creditors in case of
insolvency of the company.
“(1) the company shall cause a meeting of the creditors of the company to be
called for the day, or the day next following the day, on which there is to be
held the general meeting of the company at which the resolution for
voluntary winding up is to be proposed, and shall cause notices of the
meeting of creditors to be sent by post to the creditors simultaneously with
the sending of the notices of the meeting of the company.
(3)The board of directors of the company shall-
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(a)cause a full statement of the position of the company’s affairs together
with a list of the creditors of the company and the estimated amount
of their claims to be laid before the meeting of the creditors to be held
as aforesaid; and
(b)Appoint one of their number to preside at the said meeting.”
Section 509 further relates to the final meeting and dissolution of the company.
Section 510 declares that sections 511 to 521 shall apply to every mode of winding
up.
Section 511 is extremely vital as it relates to the distribution of the property of the
company. Section 517 is again a critical provision that seeks to ensure that the
arrangement between the company and its creditors is made binding upon them in
certain circumstances.
Chapter V of Part VII of the Companies Act, 1956 relates to provisions applicable
to ever winding up. As regards the provisions relating to the proof and ranking of
claims, Section 528 thereof states that debts of all descriptions are to be admitted to
proof
Section 530 makes provision for preferential payments but is made subject to
Section 529A. This secures the preferential position of the secured creditors.
Section 531 is an equally important provision that seeks to guard against fraudulent
preference, and declares such preference invalid against the creditors of the
company. The Section declares that:
{516}
being wound up, be deemed a fraudulent preference of its creditors and
be invalid accordingly.”
Section 532 declares that “Any transfer or assignment by a company of all its
property to trustees for the benefit of all its creditors shall be void.” Section 533
logically succeeds the aforementioned provisions in relation to fraudulent
preferences and declares he rights and liabilities of fraudulently preferred persons.
Section 534 declares the invalidity of floating charge in certain cases where it has
been created under circumstances that raise the presumption of fraud and mischief.
The Section declares that:
Section 557 contains provisions crucial to the securing of the protection of the
interest of the creditors. It provides for the calling of meetings to ascertain the
wishes of creditors.
Section 559 relates to the power of tribunal to declare dissolution of company void.
It declares, in effect, that:
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“(1) Where a company has been dissolved, whether in pursuance of this part
or of section 394 or otherwise, the tribunal may at any time within two
years of the date of dissolution, on application by the liquidator of the
company or by any other person who appears to the tribunal to be
interested, make an order, upon such terms as the tribunal thinks fit,
declaring the dissolution to have been void; and thereupon such
proceedings may be taken as might have been taken if the company had
not been dissolved.”
Section 101 also tries to secure the interests of the creditors of the company. The
pertinent provisions thereof declare that:
“(1) …
(2)where the proposed reduction of share capital involves either the
diminution of liability in respect of unpaid share capital or the payment to
any shareholder of any paid- up share capital, and in any other case if the
tribunal so directs, the following provisions shall have effect, subject to the
provisions of sub- section (3)-
(a)every creditor of the company who at the date fixed by the tribunal is
entitled to any debt or claim which, if that date were the
commencement of the winding up of the company, shall be entitled to
object to the reduction;
(b)the tribunal shall settle a list of creditors so entitled to object, and for
that purpose shall ascertain, as far as possible without requiring an
application from any creditor, the names of those creditors and the
nature and amount of their debts or claims, and may publish notices
fixing a day or days within which creditors not entered on the list are
to claim to be so entered or are to be excluded from the right of
objecting to the reduction;
(c)where a creditor entered on the list whose debt or claim is not
discharged or has not determined does not consent to the reduction,
the tribunal may, if it thinks fit, dispense with the consent of that
creditor, on the company securing payment of his debt or claim by
appropriating, as the tribunal may direct, the following amount-
(i)if the company admits the full amount of the debt or claim, or,
though not admitting it, is willing to provide for it, hen, the full
amount of the debt;
(ii) If the company does not admit and is not willing to provide for
the full amount of the debt or claim, or if the amount is contingent
or not ascertained, then, an amount fixed by the tribunal after the
like enquiry and adjudication as if the company were being wound
up by the tribunal.”
{518}
“(1) a company may, by special resolution, alter the provisions of its
memorandum so as to change the place of its registered office from one state
to another, or with respect to the objects of the company so far as may be
required to enable it-
…
before confirming the alteration, the central government must be satisfied-
(a)that sufficient notice has been given to every holder of the debentures
of the company, and to every other person or class of persons whose
interests will, in the opinion of the central government be affected by the
alteration; and
That with respect to every creditor who, in the opinion of the central
government, is entitled to object to the alteration, and who signifies
his objection in the manner directed by the central government, either
his consent to the alteration has been obtained or his debt or claim has
been discharged or has been determined, or has been secured.
(6)The central government shall, in exercising its powers under this section,
have regard to the rights and interests of the members of the company
and of every class of them, as well as to the rights and interests of the
creditors of the company and of every class of them.”
Section 187 of the Companies Act, 1956 also contains certain provisions for the
nomination of directors by the creditors on the board of the Borrower Company. It
declares that:
Section 391 makes the following provisions for the protection of creditors’
interests:
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18.4 PRE- REFORM LEGISLATIONS
Transfer of Property Act, 1882 is more than a century old. No wonder then that it
has had its fair share of criticism. Indeed most recently the Narasimham Committee
observed in their second report that the NPA’s in 1992 were uncomfortably high
for most of the public sector banks. The report, in its Chapter VIII makes certain
pertinent observation about the legal and legislative framework:
“8.1. A legal framework that clearly defines the rights and liabilities
of parties to contracts and provides for speedy resolution of disputes
is a sine qua non for efficient trade and commerce, especially for
financial intermediation. In our system, the evolution of the legal
framework has not kept pace with changing commercial practice and
with the financial sector reforms. As a result, the economy has not
been able to reap the full benefits of the reform process. As an
illustration, we could look at the scheme of mortgage in the transfer
of property act, which is critical to the work of financial
intermediaries…”
It may be observed herein that Transfer of Property Act, 1882 has served as the
relevant legislation governing the law of mortgages. The world of trade and
commerce and practices of doing business, advancing loans and creating securities
has come a long way from the days when the industrial revolution was in its
infancy. Yet the Transfer of Property Act, 1882, barring a few amendments
continues to serve the commercial world. Before a slew of legislations in the late
decades of the twentieth century, it was indeed the Transfer of Property Act, 1882
read with Civil Procedure Code, 1908 (V of 1908) that was employed to enforce
securities and foreclose mortgages. Certain provisions of Transfer of Property Act,
1882, are mentioned in the context of instant work.
Section 48 lays down the general rule regarding priority of rights created by
transfer by a person at different times in or over the same immovable property and
provides that as between such rights each later right is subject to the rights
previously created. This Section applies only where rights are purported to be
created “by transfer” in or over the same immovable property. The creation of
charge is not transfer of any interest in immovable property and consequently
where a person first creates a charge and then executes a mortgage over the same
immovable property the charge will not prevail against the mortgage unless the
mortgagee has taken his mortgage with notice of the charge. As regards more than
one charge on the same immovable property, where a specific charge is created, an
equitable charge or a floating charge will not have priority regardless of point of
times. But where another specific charge is created on the same property, the
specific charge which is first in point of time will have priority over the second.
{520}
Section 52 relates to transfer of property pending suit relating thereto. This Section
is an expression of the principle of the maxim pendent elite nihil innovetur
(pending a litigation nothing new should be introduced) and provides that pendente
lite, neither party to the litigation, in which any right to immovable property is in
question, can alienate or otherwise deal with such property so as to affect his
opponent. The Section declares:
“During the pendency in any court having authority within the limits
of India excluding the state of Jammu and Kashmir or established
beyond such limits by the central government of any suit or
proceedings which is not collusive and in which any right to
immovable property is directly and specifically in question, the
property cannot be transferred or otherwise dealt with by any party to
the suit or proceeding so as to effect the rights of any other party
thereto under any decree or order which may be made therein, except
under the authority of the court and on such terms as it may impose.
The law of lis pendens is an extension of the law of res judicata and makes the
adjudication of suit binding on alienees from parties pending suit, just as much as
the law of res judicata makes the adjudication binding on the parties themselves
and on alienees from them after the decree.
“no man has so absolute a power over his own property as that he can
alienate the same, when such alienation directly tends to delay, hinder
or defraud his creditors unless it is made upon good consideration and
bona fide,”
{521}
Section 58 relates to mortgages. It defines the various terms relevant to the
understanding of the law of mortgages. Furthermore it defines the various kinds of
mortgages
Section 60 of Transfer of Property Act, 1882 deals with the right of redemption,
when it arises, how it is to be exercised and what are the rights of the mortgagor on
redemption. The right of redemption is often referred to as the “equity of
redemption”, an expression borrowed from English law but which is strictly
inapplicable in this country. In England, an English mortgagee became ‘at law’ the
absolute owner of the property conveyed after the time fixed for payment of the
mortgage- amount. But the courts of equity regarded the transaction as morel a
borrowing transaction and held that “time was not of the essence of the contract.”
The mortgagor was accordingly allowed to redeem even after the expiry of the
period for payment. The English doctrine of the equity of redemption was unknown
to the ancient law of India. Accordingly in a mortgage by conditional sale, and in
all other mortgages containing a stipulation that on default of payment within the
time fixed, the mortgagee was to become the owner, the rule was that after the time
fixed for redemption had passed, the mortgagee became the full owner and he
mortgagor lost his property.
Section 67contains a vital provision for securing the interest of creditors. The
Section deals with the enforcement of a mortgage. It defines the rights of a
mortgagee as against the mortgagor, so far as the right to maintain a suit for
foreclosure or sale is concerned. Also, by virtue of Section 100, the provisions of
the Act, which apply to simple mortgages, are also applicable to a charge. This
Section being applicable to all kinds of mortgages including a simple mortgage,
applies also to a charge holder and he is entitled to obtain a decree for sale of the
charged property
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the subsequent mortgagee is, in the absence of a contract to the
contrary, entitled to have the prior mortgage- debt satisfied out of the
property or properties not mortgaged to him, so far as the same will
extend, but not so as to prejudice the rights of the prior mortgagee of
any other person who has for consideration acquired an interest in any
of the properties.
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provisions of that act shall apply in respect of the dispute so
referred to the Lok Adalat;
(c) for judicial settlement, the court shall refer the same to a suitable
institution of person and such institution or person shall be
deemed to be a Lok Adalat and all the provisions of the legal
services authority act, 1987 (39 of 1987) shall apply as if the
dispute were referred to a Lok Adalat under the provisions of that
act;
(d) For mediation, the court shall effect a compromise between the
parties and shall follow such procedure as may be prescribed.
The Civil Procedure Code, 1908 (V of 1908) is the general law of the land
governing the procedure for the filing and disposal of civil suits. Even when the
mortgagees had to exercise their rights and claims in courts, they had to follow the
procedure as prescribed by the Civil Procedure Code, 1908 (V of 1908), unless the
Transfer of Property Act, 1882 said something to the contrary. But the chief
problem with Civil Procedure Code, 1908 (V of 1908) was that its processes had
become very time consuming and winding. Crores of cases are pending disposal in
the civil courts of India. The time consuming processes hurt the interests of the
creditors as a large portion of their money was locked up I such civil suits. Recent
amendments (passed in1999 and 2002) have tried to address and remedy this
problem.
Yet it was precisely the above mentioned lacunae of delays in the processes of civil
courts, and the consequent costs to the banks and financial institutions that he
parliament stepped in to enact special provisions whereby special tribunals (The
Debt Recovery Tribunals under the Recovery of Debts Due to Banks and Financial
Institutions Act, 1993) were set up so that the creditors could achieve a speedier and
a kind of summary relief under hose special acts that catered primarily to their
interests. But even after special legislations to the above effect, the provisions of
the Civil Procedure Code, 1908 (V of 1908) have not entirely lost their relevance in
regard thereto. The provisions of the Civil Procedure Code, 1908 (V of 1908)
continue to govern the procedure relating to enforcing of mortgages and recovery
of money etc. owing to the creditors. It would be beyond the scope of this
dissertation to deal with each and every provision of the Civil Procedure Code,
1908 (V of 1908) Act, but some of the most pertinent ones and relating distinctly to
enforcement of mortgages and for recovery of debts are being mentioned
hereinafter.
Order 34 of the Civil Procedure Code, 1908 (V of 1908) relates to “suits relating to
mortgages of immovable property”. It lays down the procedure with regard to the
same. It provides for the frame of suits relating to sale, foreclosure and redemption
of the mortgaged property and also to enforce charges. Some of the more
significant rules made thereunder are as follows:
Rule 2 of order 34 relates to preliminary decree in a foreclosure suit.
Rule 3 of the order relates to a final decree in foreclosure suit. It declares that:
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“(1) Where, before a final decree debarring the defendant from all
right to redeem the mortgaged property has been passed, the
defendant makes payment into court of all amount due from him
under sub- rule (1) of rule 2, the court shall, on application made
by the defendant in this behalf, pass a final decree-
Ordering the plaintiff to deliver up the documents referred to
in the preliminary decree, and if necessary,-
ordering him to re- transfer at the cost of the defendant the
mortgaged property as directed in the said decree, and also,
if necessary,-
Ordering him to put the defendant in possession of the
property.
(2)where the payment in accordance with sub- rule (1) has not been
made, the court shall, on application made by the plaintiff in this
behalf, pass a final decree declaring that the defendant and all
persons claiming through or under him are debarred from all right
to redeem the mortgaged property and also, if necessary, ordering
the defendant to put the plaintiff in possession of the property.
(3)On the passing of a final decree under sub- rule (2), all liabilities to
which the defendant is subject in respect of the mortgage or on
account of the suit shall be deemed to have been discharged.”
Rule 4is as regards a preliminary decree in a suit for sale. Rule 5 relates to a final
decree for sale of the immovable property. It declares that:
“(1) where, on or before the day fixed or at any time before the confirmation
of a sale made in pursuance of a final decree passed under sub- rule (3)
of this rule, the defendant makes payment into court of all the amounts
due from him under sub- rule (1) of rule 4, the court shall, on application
made by the defendant in this behalf, pass a final decree or, if such
decree has been passed, an order-
(a) ordering the plaintiff to deliver up the documents referred
to in the preliminary decree, and if necessary,-
(b) ordering him to re- transfer at the cost of the defendant the
mortgaged property as directed in the said decree, and also,
if necessary,-
(c) Ordering him to put the defendant in possession of the
property.
(2) where the mortgaged property or part thereof has been sold in
pursuance of a decree passed under sub- rule (3) of this rule, the
court shall not pass as order under sub- rule (1) of this rule,
unless the defendant, in addition to the amount mentioned I sub-
rule (1), deposits in court for payment to the purchaser a sum
equal to five per cent of the amount of the purchase- money paid
into court by the purchaser.
Where such deposits have been made, the purchaser shall be
entitled to an order for repayment of the amount of the purchase-
{525}
money paid into court by him, together with a sum equal to five
per cent thereof.
(3) where payment in accordance with sub- rule (1) has not been
made, the court shall, on application made by the plaintiff in this
behalf, pass a final decree directing that the mortgaged property
or a sufficient part thereof be sold, and that the proceeds of the
sale be dealt with in the manner provided in sub- rule (1) of rule
4.”
Rule 6 makes provision in respect of recovery of balance due on mortgage in suit
for sale.
Rule 8 of the aforesaid order is as regards a final decree in redemption suit.
Rule 8A makes provision for the recovery of balance due on mortgage in suit for
redemption. It states inter alia that:
“Where the net proceeds of any sale held under Rule 8 are found
insufficient to pay the amount due to the defendant, the court on
application made by him in execution, may, if the balance if legally
recoverable from the plaintiff otherwise than out of the property sold,
pass a decree for such balance.”
Rule 10 of the order 34 is an extremely vital provision and provides how the costs
in a mortgage suit shall be decreed. It reads as hereunder:
“In finally adjusting the amount o be paid to a mortgagee in case of a
foreclosure, sale or redemption, the court shall, unless in the case of
costs of the suit the conduct of the mortgagee has been such as to
disentitle him thereto, add to the mortgage- money such costs of the
suit and other costs, charges and expenses as have been properly
incurred by him since the date of the preliminary decree for
foreclosure, sale or redemption up to the time of actual payment:
Provided that where the mortgagor, before or at the time of the
institution of the suit, tenders or deposits the amount due on the
mortgage, or such amount as is not substantially deficient in the
opinion of the court, he shall not be ordered to pay the costs of the
suit to the mortgagee and the mortgagor shall be entitled to recover
his own costs of the suit from the mortgagee, unless the court, for
reasons to be recorded, otherwise directs.”
As important as the last preceding rule is rule 11 which provides in what manner
interest in a suit for sale, foreclosure or redemption shall be recoverable.
Rule 12 provides that where the sale of property “directed under this order is
subject to a prior mortgage the court may, with the consent of the prior mortgagee,
direct that the property be sold free from the same, giving to such prior mortgagee
the same interest in the proceeds of the sale as he had in the property sold.”
{526}
Rule 14 states that: “where a mortgagee has obtained a decree for the payment of
money in satisfaction of a claim arising under the mortgage, he shall not be entitled
to bring the mortgaged property to sale otherwise than by instituting a suit for sale
in enforcement of the mortgage, and he may institute such suit notwithstanding
anything contained in order II rule”. It however further provides that: “Nothing in
sub- rule (1) shall apply to any territories to which the Transfer Of Property Act,
1882 (4 of 1882), has not been extended”.
In the context of our discussion some of the provisions contained in order XX1 also
have great bearing on the immediate context. As such only the most relevant ones
are being mentioned hereunder.
Rule 30 is in regard to a decree for the payment of money. Rule 31 is with respect
to decree for specific movable property. Rule 35,on the other hand is with regard to
decree for immovable property.
Rule 41 provides that “where a decree is for the payment of money, the decree-
holder may apply to the court for an order that
The judgment debtor, or
Where the judgment debtor is a corporation, any officer
thereof, or
Any other person,
be orally examined as to whether any or what debts are owing to the judgment
debtor and whether the judgment debtor has any and what other property or means
of satisfying the decree; and the court may make an order for the attendance and
examination of such judgment debtor, or officer or other person, and for the
production of any books or documents.”
Also that “where the decree for the payment of money has remained unsatisfied for
a period of thirty days, the court may on the application of the decree holder and
without prejudice to its power under sub- rule (1) b order require the judgment
debtor or where the judgment debtor is a corporation, any officer thereof, to make
an affidavit stating the particulars of the assets of the judgment debtor.”
Furthermore In case of disobedience of any order made under sub- rule (2), the
court making the order or any court to which the proceeding is transferred, may
direct that the person disobeying the order be detained in civil prison for a term not
exceeding three months unless before the expiry of such term the court directs his
release.”
Rule 46 of order XXI is also a vital provision in as much as it provides for the
attachment of debt, share and other property not in possession of judgment debtor.
Rule 46A is in respect of garnishee. It declares that: “(1) the court may in the case
of a debt (other than a debt secured y a mortgage or a charge) which has been
attached under rule 46, upon the application of the attaching creditor, issue notice
to the garnishee liable to pay such debt, calling upon him either to pay into court
the debt due fro him to the judgment debtor or so much thereof as may be sufficient
{527}
to satisfy the decree and costs of execution, or to appear and show cause why he
should not decree so.”
Furthermore, sub- rule (3) thereof states that “Where the garnishee pays in the
court the amount due from him to the judgment debtor or so much thereof as is
sufficient to satisfy the decree and the costs of the execution, the court may direct
that the amount may be paid to the decree holder towards satisfaction of the decree
and costs of the execution.”
{528}
Rule 72A is another provision that tends to secure the interest of the creditors. It
declares that: “(1) notwithstanding anything contained in rule 72, a mortgagee of
immovable property shall not bid for or purchase property sold in execution of a
decree on the mortgage unless the court grants him leave to bid for or purchase the
property.” It further states that: “If leave to bid is granted to such mortgagee, then
the court shall fix a reserve price as regards the mortgagee, and unless the court
otherwise directs, the reserve price shall be
not less than the amount then due for principal, interests and costs in respect
of the mortgage if the property is sold in one lot; and
In the case of any property sold in lots, not less than such sum as shall
appear to the court to be properly attributable to each lot in relation to the
amount then due for principal, interest and costs on the mortgage.”
Of course as has been stated above, the foregoing sections or orders and rules are
only illustrative of the kinds of mechanism envisaged under the provisions of the
Civil Procedure Code, 1908 (V of 1908) to secure the protection of the interest of
the creditors.
Before delving into the aforesaid act itself, it would be most pertinent to recall to
mind section 11 of The Securitisation And Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002 which provides for resolution of
disputes and reads thus:
It would however be pertinent to mention that section 11 has not taken into account
the settlement by arbitration of any dispute between the borrower and the secured
creditor, be it a bank or a financial institution or even a securitisation or
reconstruction company, and this is so because section 17 of the Securitisation And
Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
confers on any borrower aggrieved by any of the measures taken against him by the
secured creditor to prefer an appeal to the DRT and further right of second appeal,
under section 18 against the decision of the DRT to the appellate tribunal.
{529}
Not only there is no provision for arbitration or conciliation for the borrower, there
can indeed be no compulsion for a borrower to go in for arbitration notwithstanding
the fact that there already existed between the borrower and the concerned bank or
financial institution an arbitration agreement, which, in case of acquisition of assets
under section 5 of the Securitisation And Reconstruction of Financial Assets and
Enforcement of Security Interest Act, 2002, automatically devolves on the
concerned securitisation or reconstruction company by force of sub- section (3) of
section 5 of the Act, 2002 last mentioned and the overriding effect of the act over
any other provision of the law, enable the borrowers to ignore the arbitration
clause, if any, treating the same as inconsistent with his right of appeal and second
appeal, provided for respectively under sections 17 and 18 of the act, 2002
abovementioned.
{530}
SECTION 35 relates to the finality of arbitral awards. This section envisages that
the arbitral award is final and binding between the parties and other persons
claiming under them. Where (1) the time for making an application to set aside the
arbitral award under section 34 has expired or (2) such application has been made
but rejected b the court, the award may be enforced under the code of civil
procedure, 1908 in the same manner as if it were a decree of the court (Gulam
Jihani v. Mohd. Hasan, (1901) ILR 29 Cal (PC).
Where the time for making an application to set aside the arbitral
award under section 34 has expired, or such application having been made, it has
been refused, the award shall be enforced under the code of civil procedure, 1908
(5 of 1908) in the same manner as if it were a decree of the court.
Section 36 of the Arbitration and Conciliation Act, 1996 makes a clear departure
from the old Arbitration Act, 1940. Under the old act, after making of the award by
the arbitral tribunal, the parties had to make an application to the court to make the
award a rule of the court and it is only then that the award could be executed as a
decree of the court. The making of the application to the court for recognition of the
award as a decree was termed as filing of the award. But this requirement has been
done away with under the new act of 1996. There is no need for filing the award
and it can be enforced straight away without the necessity for the intervention of
the court. Obviously this would mean saving of time of the parties in filing the
award for execution by a court. In other words, the arbitral award has now been
given a similar status as any other decree of the court and it may be enforced like a
decree in accordance with order XXII of the code of civil procedure, 1908.
The relationship between the debtor and creditor essentially contractual, the
provisions of the Contract Act, 1872 will apply to them. As such it is open to the
creditor to seek his remedies under the Contract Act, 1872. Some of the provisions
relevant to the securing of the interest of the creditor in the said Act are mentioned
hereinbelow. Of course, besides the provisions dealing with breaches of contract
etc., and remedies therefore, there are the sections dealing with indemnity,
guarantee and pledge that are relevant for our purposes too, though reference has
been made to these only in passing as a detailed discussion in that regard would be
beyond the limited scope of the instant work.
{531}
Section 55: EFFECT OF FAILURE TO PERFORM AT FIXED TIME, IN
CONTRACT IN WHICH TIME IS ESSENTIAL
Section 39 provides for anticipatory breach of contract and narrates the effect of
refusal of party to perform promise wholly.
“When a contract has been broken, the party who suffers by such
breach is entitled to receive, from the party who has broken the
contract, compensation for any loss or damage caused to him thereby,
which naturally arose in the usual course of things from such breach,
or which the parties knew, when they made the contract, to be likely
to result from the breach of it.
Such compensation is not to be given for any remote and indirect loss
or damage sustained from the breach…”
Section 74 makes provision for compensation for breach of contract where penalty
stipulated for:
{532}
“Where a contract has been broken, if a sum is named in the contract
as the amount to be paid in case of such breach, or if the contract
contains any other stipulation by way of penalty, the party
complaining of the breach is entitled, whether or not actual damage or
loss is proved to have been caused thereby, to receive from the party
who has broken the contract reasonable compensation not exceeding
the amount so named or, as the case may be, the penalty stipulated
for.
Chapter VIII, more particularly sections 126 to 147 contain provision in regard to
“guarantee”.
Sections 172 to 181 deal with “pledges” and may be perused for better
understanding of the same in relation to the immediate context.
{533}
There are special Acts/ legislations too which provide the mechanisms to secure the
protection of creditors within their framework. Some such legislations are briefly
referred to by way of illustration of the kinds of provisions conceived of therein.
The chapter VIII in the said act is most relevant of our purposes and in the
immediate context of creditor protection. Section 18 of the said act provides that
among the “objects and business” of the Industrial Reconstruction Bank of India
are “as the principal credit agency for industrial revival” and “by coordinating
similar work of other institutions engaged therein, and shall assist and promote
industrial development, reconstruction and revival, and undertake rehabilitation of
industrial concerns, by providing or procuring assistance and operating schemes for
the same, and may, for attaining the said objects, carry on and transact all or any of
the businesses” mentioned in the sub- sections following. These include “granting
loans and advances (including working capital) to any industrial concern” or
“guaranteeing, counter- guaranteeing or providing indemnity as the case may
be…”. Thus it is clear that the Industrial Reconstruction Bank of India acts like a
creditor with extremely vital function entrusted to it. As such it has also been
extended statutory protection under the Industrial Reconstruction Bank of India act,
1984. Some of the sections that do so are as follows:
Section 36(1) in entering into any arrangement under section 18 with an industrial
concern, the reconstruction bank may impose such conditions as it may think
necessary or expedient for protecting the interests of the reconstruction bank, and
securing that the assistance granted by it is put to the best use by the industrial
concern.
Sub- Section(2) of the said Section states that: “where any arrangement entered into
by the reconstruction bank with an industrial concern provides for the appointment
by the reconstruction bank of one or more directors of such industrial concern, such
provision and any appointment of directors made in pursuance thereof shall be
valid and effective notwithstanding anything to the contrary contained in the
companies act, 1956 (1 of 1956), or in any other law for the time being in force or
in the memorandum, articles of association or any other instrument relating to the
industrial concern, and any provision regarding share qualification, age limit,
number of directorships, removal from office of directors and such like conditions
contained in any such law or instrument aforesaid, shall not apply to any director
appointed by the reconstruction bank in pursuance of the arrangement as
aforesaid.”
{534}
Section 39 (1) provide for the rights of an industrial concern in case of default by
the borrower.
{535}
(a) it shall not be lawful for the shareholders of such concern or any
other person to nominate or appoint any person to be a director of
the concern;
(b) no resolution passed at any meeting of the shareholders of such
concern shall be given effect to unless approved by the financial
corporation;
(c) No proceedings for the winding up such concern or for the
appointment of receiver in respect thereof shall lie in any court,
except with the consent of the Reconstruction Bank…”
Section 47 relates to the “restriction on the filing of suits for dissolution etc., of an
industrial concern not being a company when its management is taken over.”
Section 52 of the said Act declares the effect of that Act on other laws and states
that: “The provisions of this act and of any rule or scheme made thereunder shall
have effect notwithstanding anything inconsistent therewith contained in any other
law for the time being in force or in the memorandum or articles of association of
an industrial concern or in any other instrument having effect by virtue of any law
other than this act.”
Section 28 of the said Act declares the rights of the corporation in case of a default
by the borrower, and is thus a crucial Section.
{536}
director, any provision for the holding of any share qualification, age-
limit, restrictions on the number of directorships, retirement by rotation
or removal from office shall apply to any director appointed by the
corporation under this section.
(2)The power to appoint directors under this section includes the power to
appoint any individual, [to be the manager] of the industrial concern on
such terms and conditions as the corporation may think fit.”
Section 30E deals with the application of the Companies Act, 1956 .
(a) .
Section 27 provides for the power of the corporation to impose conditions for
accommodation. It runs as hereunder:
{537}
“(1) where the application is for the relief’s mentioned ion clauses (a) and
(c) of sub- section (1) of section 31, then the district judge shall pass an ad
interim order attaching the security, or so much of the property of the
industrial concern as would on being sold realize in his estimate an amount
equivalent in value to the outstanding liability of the industrial concern to
the financial corporation, together with the costs of the proceedings taken
under section 31, with or without an ad interim injunction restraining the
industrial concern from transferring or removing its machinery, plant or
equipment.
(2)… to … (5)
(6) if cause is shown, the district judge shall proceed to investigate the claim
of the financial corporation in accordance with the provisions contained
in the code of civil procedure, 1908 (5 of 1908), in so far as such
provisions may be applied thereto.
(7) After making an investigation under sub- section (6), the district judge
may-
(a) Confirm the order of attachment and direct the sale of the attached
property;
(b) Vary the order of attachment so as to release a portion of the
property from attachment and direct the sale of the remainder of
the attached property;
(c) Release the property from attachment;
(d) Confirm or dissolve the injunction;
(da) direct the enforcement of the liability of the surety or reject the
claim made in this behalf; or
(e) transfer the management of the industrial concern to the financial
corporation or reject the claim made in this behalf:
provided that when making an order under clause (c) or making an order
rejecting the claim to enforce the liability of the surety under clause (da) or
making an order rejecting the claim to transfer the management of the
industrial concern to the financial corporation under clause (e), the district
judge may make such further orders as he thinks necessary to protect the
interests of the financial corporation and may apportion the costs of the
proceedings in such manner as he thinks fit:
(8A) an order under this section transferring the management of an industrial
concern to the financial corporation shall be practicable, in the manner
provided in the code of civil procedure, 1908 (5 of 1908), for the
possession of immovable property or the delivery of movable property
in execution of a decree as if the financial corporation were a decree
holder.”
{538}
Section 32F provides for restriction on filing of suits for dissolution, etc., of an
industrial concern not being a company when its management is taken over
Section 29 of the aforesaid act is extremely vital to the interests of the Financial
Corporation as a creditor. The said Section states that:
“(1) where any industrial concern, which is under a liability to the financial
corporation under an agreement, makes any default in repayment of any loan or
advance or any installment thereof or in meeting its obligations in relation to
any guarantee given by the corporation or otherwise fails to comply with the
terms of its agreement, the financial corporation shall have the right to take over
the management or possession or both of the industrial concern, as well as the
right to transfer by way of lease or sale and realize the property pledged,
mortgaged, hypothecated or assigned to the financial corporation.
(2)Any transfer of property made by the financial corporation in exercise of its
powers under sub- section (1), shall vest in the transferee all rights in or to
the property transferred as if the transfer had been made by the owner of the
property.
(3)The financial corporation shall have the same rights and powers with respect
to goods manufactured or produced wholly or partly from goods forming
part of the security held by it as if it had with respect to the original goods.
(4)Where any action has been taken against an industrial concern under the
provisions of sub- section (1) , all costs, charges and expenses which in the
opinion of the financial corporation have been properly incurred by it as
incidental thereto shall be recoverable from the industrial concern and the
money which is received by it shall, in the absence of any contract to the
contrary, be held by it in trust to be applied, firstly in payment of such costs,
charges and expenses and, secondly, in discharge of the debt due to financial
corporations and the residue of the money so received shall be paid to the
person entitled thereto.
(5)Where the financial corporation has taken any action against an industrial
concern under the provision of sub- section (1), the financial corporation
shall be deemed to be owner of such concern, for the purposes of suits by or
against the concern, and shall sue and be sued in the name of the concern.”
{539}
Before launching into a discussion of the new legislations that aim particularly to
protect and safeguard the interest of creditors, something must be said of the
economic reforms, more particularly those in the banking and financial sector, and
the causes that led to them.
The decade of the eighties was a period of comparatively high growth in India. But
this is not to detract form the fact of concurrent high fiscal profligacy. Between
1985- 90, on an average, India’s GDP grew at over 5.5. per cent per year, industry
at over 7 per cent, capital goods at 10 per cent, consumer durables at 12 per cent
and so on. However it may be said here that this growth was not the result of any
step- up in savings and investment; in many ways it was the result of over-
borrowing and over- spending. The growth was both debt led (like Latin America
of the 1970’s and then late 1990’s) and the result of an explosion of domestic
budgetary spending. Obviously this kind of growth was not sustainable as the
macroeconomic imbalances were bound to reach a point where crash was
inevitable- as indeed happened in Latin American in the eighties and India almost a
decade later.
The deteriorating fiscal and balance of payment situation had led to a mounting
debt problem, both domestic and foreign, reaching crisis proportions by the end of
the eighties. Total government (centre and state) domestic debt rose from 31.8 per
cent of GDP in 1974- 75 to 45.7 per cent in 1984- 85 to 4.6 per cent in 1989- 90.
The foreign debt situation had also become precarious with debt rising from $23.5
billion in 1980-81 to $37.3 billion in 1985-86 to $83.8 billion in 1990-91. The debt
service ratio (i.e., payment of principal plus interest as a proportion of exports of
goods and services) which was still a manageable 10.2 per cent in 1980-81 rose to a
dangerous 35 per cent in 1990-91. moreover the proportion of confessional debt to
total debt also fell from over 80 per cent to about 40 per cent in this period, i.e.,
increasingly, the debt consisted of short- term commercial borrowing. The
prejudice against foreign direct investment which still remained, led to this
excessive dependence on foreign debt rather than equity capital, and inadequate
returns on the borrowings led to an unsustainable debt service burden.
India’s foreign exchange reserves fell from $5.8 billion in 1980-81 to $4.1 billion
in 1989-90, and in the next year they fell drastically by nearly half to $2.24 billion
in 1990-91, enough only or one month’s import cover. The Iraqi invasion of
Kuwait in august 1990, leading to an increase in oil prices and a fall in Indian
imports to the Middle East and gulf region, partly contributed to this alarming
foreign exchange situation. India’s international credit rating was sharply
downgraded and it was becoming extremely difficult to raise credit abroad. In
addition, NRI deposits in foreign exchange began to be withdrawn rapidly. In such
a situation, where foreign lending had virtually dried up, the government was
{540}
forced to sell 20 tonnes of gold to the union bank of Switzerland in March 1991 to
tide over its immediate transactions. By July 1991 foreign exchange reserves were
down to a mere two week import cover despite loans from the IMF. The country
was at the edge of default.
The long- term constraints that were building up over a few decades and
debilitating the Indian economy combined with certain more recent and immediate
factors led to a massive fiscal and balance of payments crisis that climaxed in 1991.
The crisis pushed India into initiating a process of economic reform, which in the
Indian context were almost revolutionary in nature, were ironically started by a
minority government led by Narasimha Rao and guided by one of the most
distinguished economists of post independence India, Manmohan Singh, as finance
minister.
Reforms of the dirigisme, controls- ridden and inward looking Indian economy was
long overdue. As early as the early sixties, Manmohan Singh had argued that
India’s export pessimism at that time was unjustified. He advised more openness
and a less controlled economy.
The process of reforms started in 1991, involved inter alia, an immediate fiscal
correction; making the exchange rate more realistically linked to the market;
liberalization of trade and industrial controls like freer access to imports; a
considerable dismantling of the industrial licensing system and the abolition of
MRTP; reform of the public sector including gradual privatization; reform of the
capital markets and the financial sector; removing a large number of the restrictions
on the multinational corporations and foreign direct investment and welcoming
them, particularly foreign investment, and so on. In short, it was an attempt to free
the economy for stifling internal controls as well as equip it to participate in the
world wide globalization process to its advantage
Under the WTO regime, economic liberalization has transformed the financial
sector in general and the banking sector in particular towards globalization.
Banking sector being an integral part of the Indian financial system has undergone
dramatic changes reflecting the ongoing economic and financial sector reforms.
The main objective of these reforms has been to strengthen the banking system
against international best practices and standards which will have lasting effects on
the entire fabric of the Indian financial system. These financial sector reforms have
stimulated greater competition, convergence and consolidation in the Indian
banking industry.
The banking industry which was highly regulated in the pre- reform period is
reorienting itself to face new challenges emerging in the financial sector globally.
The basic factors responsible for the poor performance of public sector banks were
stringent regulation, administered interest rates, directed and concessional lending,
deteriorating portfolio, poor recovery processes and above all the lack of
competition. Against this background, the committee under the chairmanship of
M.Narasimham has laid down the foundation of banking sector reform in 1991
{541}
which entailed several proposals relating to the structure, organization, functions
and procedures of financial system. Broadly these reforms were related with
dismantling of interest rates, prudential regulation and supervision norms,
restructuring of distressed banks, entry of new generation private and foreign banks
and liberalized branch licensing policy.
According to theory, with growing maturity of the financial system, the financing
pattern of firms undergoes change. A shift from internal to external mode of
financing of firms is expected with a deepening of financial sector. Also with firms
able to by pass the banking system or other intermediaries and directly access the
securities market for their fund requirements, the share of intermediaries as
providers of capital to firms is expected to come down.
The two landmark legislations that were born in the post- reform period were:
(1) THE RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL
INSTITUTIONS ACT, 1993
(2) THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL
ASSETS AND ENFORCEMENT OF SECURITY INTEREST ACT,
2002.
But it was not without struggle that they came into being as the discussion
following will amply reveal.
1. NARASIMHAM COMMITTEE I
{542}
The Narasimham committee, constituted in 1991, with a view to study the financial
system prevailing in the country, considered wide- ranging issues relevant to the
economy, banking and financing, etc. the said committee, under chapter V of its
report titled “Capital Adequacy, Accounting Policies and other related matters”,
opined that a proper system of income recognition and provisioning was
fundamental to the preservation of the strength and stability of the banking system.
It also observed that the assets were required to be classified, and also took note of
the fact that the reserve bank of India had classified the advances of the banks, one
category of which was bad debts/ doubtful debts. The report then mentioned that
according to the international practice, an asset is treated as non- performing when
the interest is over due for at least two quarters. Income of interest is considered as
such only when it is received and not on the accrual basis.
Having made the observations above-mentioned, the committee suggested that the
same should be followed by the banks and financial institutions in India and an
advance ought to be shown as non- performing asset where the interest remains due
for more than 180 days. It was further suggested that the reserve bank of India
should prescribe clear and objective definitions in respect of advance which may
have to be treated as doubtful, standard or sub- standard, depending upon different
situations. Apart from recommending the setting up of special tribunals to deal with
the recovery of dues of the advances made by the banks, the committee observed
that the impact of such steps would be felt by the bank only over a period of time,
ion the meanwhile, the committee also suggested for reconstruction of assets
saying:
{543}
The committee also suggested some legislative measures to meet the situation.
The Narasimham Committee observed in their second report that the NPA’s in
1992 were uncomfortably high for most of the public sector banks. The report, in
its Chapter VIII makes certain pertinent observation about the legal and legislative
framework:
“8.1. A legal framework that clearly defines the rights and liabilities of
parties to contracts and provides for speedy resolution of disputes is a
sine qua non for efficient trade and commerce, especially for financial
intermediation. In our system, the evolution of the legal framework has
not kept pace with changing commercial practice and with the financial
sector reforms. As a result, the economy has not been able to reap the full
{544}
benefits of the reform process. As an illustration, we could look at the
scheme of mortgage in the transfer of property act, which is critical to the
work of financial intermediaries…”
3. ANDHYARUJINA COMMITTEE
This was essentially a committee on legal reforms. It was a ten member committee
set up in February, 1999 under the chairmanship of Mr. Anhdyarujina. Former
solicitor general of India to formulate specific proposals for giving effect to the
suggestions as made by the Narasimham Committee. The said committee submitted
its report in May, 2000 and made diverse recommendations relating to legal
reforms in the banking sector, highlighting a crucial need to bring about what we
now know to be the Securitisation and reconstruction of financial assets and
enforcement of security interest act. Key recommendations made in this regard
were as follows:
banks must be vested with the power of taking possession and for the
sale of securities without the intervention of court as regards
mortgaged properties;
the existing recovery of debts due to banks and financial institutions
act, 1993 should be amended to make its provisions more effective;
and
Amendments should be made in the contract act, 1872, by making
provisions of giving more time to banks and financial institutions to
enforce their claims under guarantees.
It may however be recalled that in 1999, the reserve bank of India had proceeded to
set up a working group on development of the market for asset securitisation which
had submitted its report in December 1999, identifying several impediments in the
matter of securitisation and made certain suggestions. This working group was
{545}
followed by its successor which virtually prepared a draft bill on securitisation, and
the same was submitted to the government for consideration.
“ in view of what has been stated above, there is not much substance in the
submission made on behalf of the petitioners that while the recovery of debts
due to banks and financial institutions act, 1993 was in operation, it was
uncalled for to have yet another legislation for the recovery of mounting
dues. Considering the totality of circumstances and the financial climate
world over, if it was thought as a matter of policy to have yet speedier legal
method to recover the dues, such a policy, such a policy decision cannot be
faulted with nor is it a matter to be gone into by the courts to test the
legitimacy of such a measure relating to financial policy.”
For years, Indian banking and institutional lending have had a major complaint:
they are criticized for their inability to control their burgeoning non-performing
assets (bad debt lump), but when it came to recovery and reducing bad debts, they
had little power. When a loan goes into default, it has been operationally difficult
for lenders to take control of the collateral, or to utilize recovery procedures
designed for a company that goes into bankruptcy. The existing environment of
weak creditor rights has been a major cause of NPAs building up in the banking
system.
The report of the committee on banking sector reforms (1998) acknowledged that
non-performing assets of large magnitudes are a major impediment to the healthy
performance of the banking sector. NPAs have an adverse effect on the return on
assets of a bank. They erode current profits, inter alia, through provisioning
requirements, result in reduced interest income and limit recycling of funds. To
address the problem of accumulated NPAs, the first and second Narasimham
Committee, suggested the setting up of an asset reconstruction company.
{546}
4. THE RECOVERY OF DEBTS DUE TO BANKS AND FINANCIAL
INSTITUTIONS ACT, 1993
The Act has now been in force for close to 14 years. How successful has it exactly
been? The answer to the question must lie in the figures reproduced below in the
charts. Little wonder then that the need for giving more teeth to provisions and
means of the creditors to enforce their claims was felt. This was particularly true in
the case of secured creditors, who, inspite of holding securities, were left to
languish in the winding corridors of civil courts for years, without any certain hope
of recovery if the debt were to actually turn bad from doubtful over the years.
The financial sector has been one of the key drivers in India’s efforts to achieve
success in rapidly developing its economy. While the banking industry in India is
progressively complying within the international prudential norms and accounting
practices, there are certain areas in which the banking and financial sectors do not
have a level playing field as compared to other participants in the financial markets
in the world. There is no legal provision for facilitating securitization of financial
assets of banks and financial institutions. Further, unlike international banks, the
banks and financial institutions in India do not have power to take possessions of
{547}
securities and sell them. Our existing legal framework relating to commercial
transactions has not kept pace with changing commercial practices and financial
sector reforms. This has resulted in the slow pace of recovery of defaulting loans
and mounting level of non- performing assets of banks and financial institutions.
Narasimham Committee I and II Andhyarujina Committee constituted by the
central government for the purpose of examining banking sector reforms have
considered the need for changes in the legal system in respect of these areas. These
committees, inter alia, have suggested enactment of a new legislation for
securitisation and empowering banks and financial institutions to take possessions
of the securities and to sell them without the intervention of the court. Acting on
these suggestions, the Securitisation and reconstruction of financial assets and
enforcement of security interest ordinance, 2002 was promulgated on the 21st June
2002 to regulate securitizations and reconstruction of financial assets and
enforcement of security interest and for the matter connected therewith or
incidental thereto. The provisions of the ordinance would enable banks and
financial institutions to realize long- term assets, manage problems of liquidity,
assets liability mismatches and improve recovery by exercising powers to take
possession of securities, sell them and reduce non- performing assets by adopting
measures for recovery or reconstruction.
{548}
borrowers account as non- performing asset in accordance with the
directions given or guidelines issued by the reserve bank of India from
time to time;
(9) The right of secured creditors to be exercised by one or more of its
officers authorized I this behalf in accordance with the rules made by the
central government;
(10) An appeal against the action of any bank or financial institution to the
concerned debts recovery tribunal and a second appeal to the appellate
debts recovery tribunal;
(11) Setting up or causing to be set up a central registry by the central
government for the purpose of registration of transaction relating to
securitisation, assets reconstruction and creation of security interest;
(12) Application of the proposed legislation initially to banks and financial
institutions and empowerment of the central government to extend the
application of the proposed legislation to non- banking financial
intermediaries and other entities;
(13) Non- application of the proposed legislation to security interest in
agricultural lands, loans not exceeding rupees one lakh and cases where
eighty percent of the loans are repaid by the borrower.
Thus these were the primary objects that the said legislation sought to achieve.
{549}
reference can be made to BIFR under SICA (sick industrial companies
(special provisions) act, 1985) when assets have been acquired by
designated entities. If any proceedings are pending before BIFR under
the provisions of SICA in respect of any borrower where secured
creditors holding seventy five per cent or more of secured assets have
taken measures to recover the secured debt, such proceedings pending
before BIFR shall abate.
However in the case of Mardia Chemical Ltd. V. Union Of India AIR 2004 SC 2371
, the hon’ble apex court
(a) Upheld the validity of the provisions of the said act except that of
sub- section (2) of section 17 which was declared ulta vires article
14 of the constitution. The said sub- section provides for deposit
of 75 % of the amount claimed before entertaining an appeal
(petition) by the debts recovery tribunal (DRT) under section 17;
(b) Observed that in case where a secured creditor has taken action
under sub- section (4) of section 14 of the said act, it would be
open to borrowers to file appeal under section 17 of the act within
the limitation as prescribed therefore. It also observed that if the
borrower, after service of notice under sub- section (2) of section
13 of the said act raises any objection or places facts for
consideration of the secured creditor, such reply to the notice must
be considered with due application of mind and the reasons for not
accepting the objections, howsoever brief they may be, must be
communicated to the borrower. The reasons so communicated
shall only be for the purposes of the information/ knowledge of
the borrower without giving rise to any right to approach the debts
recovery tribunal under section 17 of the act at that stage.
{550}
In view of the above judgment of the supreme court and also to discourage the
borrowers to postpone the prepayment of their dues and also to enable the secured
creditors to speedily recover their debts, if required, by enforcement of security or
other measures specified in sub- section 4 of section 13 of the said act, it had
become necessary to amend the provisions of the said act.
Since the parliament was not in session and it was necessary to take immediate
action to amend the said act for the above reasons, the enforcement of security
interest and recovery of debts laws (amendment) ordinance, 2004 was promulgated
on the 11th November 2004.
The said ordinance amends the Securitisation and reconstruction of financial assets
and enforcement of security interest act, 2002, the recovery of debts due to banks
and financial institutions act, 1993 and the companies act, 1956. Chapter II of the
ordinance which amends the securitisation and reconstruction of the financial assets
and enforcement of security interest act, 2002-
(a) require the secured creditor to consider, in response to the notice issued
by the secured creditor under sub- section (2) of section 13 of the said
act, any representation made or objection raised by the borrower and cast
an obligation upon the secured creditor to communicate within one week
of receipt of such representation or objection to the borrower and take
possession of the secured asset only after reasons for not accepting the
objections of the borrower have been communicated to him in writing;
(b) enable the borrower to make an application before the debts recovery
tribunal without making any deposit (instead of filing an appeal before
the debts recovery tribunal after depositing seventy five percent of the
amount claimed with the notice by the secured creditor);
(c) provides that the debts recovery tribunal shall dispose of the application
as expeditiously as possible and dispose of such application within sixty
days from the date of such application so that the total period of
pendency of the application with the tribunal shall not exceed four
months;
(d) make provision for the transfer of pending applications to any one of the
debts recovery tribunal in certain cases;
(e) enables any person aggrieved by any order made by the debts recovery
tribunal to file an appeal to the debts recovery appellate tribunal after
depositing fifty percent of the amount of debt due from him, as claimed
by the secured creditor or determined by the debts recovery tribunal,
whichever is less;
(f) enables the borrower residing in the state of Jammu and Kashmir to
make an application to the court of district judge in that state having
jurisdiction over the borrower and make provision for filing an appeal to
the high court from the order of the court of the district judge;
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(g) Makes provision for validation of the fees levied under the said act
before the commencement of this ordinance.
Chapter II of the ordinance amends the recovery of debts due to banks and
financial; institutions act, 1993 so as to enable the bank or financial institution to
withdraw, with the permission of the debts recovery tribunal, the application made
to it and thereafter take action under the Securitisation and reconstruction of
financial assets and enforcement of security interest act, 2002.
Chapter IV of the ordinance amends the companies act, 1956 so as to provide that
any reference under section 424A of that act shall abate if the secured creditors
representing three- fourths in the value of the amount outstanding against financial
assistance disbursed to the borrower have taken measures to recover their secured
debt under sub- section (4) of section 13 of the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002.
The practice of securitization of debts is in vogue all over the world. That is to say
a measure of replenishing funds by recourse to the secondary market. There are
organizations who undertake the exercise of securitization. Such organizations take
over the financial assets and in turn issue securities.
Apparently securitization is a system to convert securities into cash, ye it is
different from the transfer of negotiable instruments or actionable claims as current
in every day practice in the commercial field.
The concept has been thus explained at a place:
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The originator (original lender) transfers or sells loans of a particular
portfolio to SPV (special purpose vehicle). The SPV breaks the loans into
convenient amounts and raises money from investors by selling instruments
which represent loans. These debt instruments issued by the SPV will be
listed on stock exchange, providing liquidity. The debt instruments must
have credit rating.
The original lender utilizes securitization to finance and enhance his
business activities. The lending institution’s assets are removed from its
balance sheet.
The financial assets are transferred to a new entity referred to as SPV;
theoretically, such SPV can be a company or a trust. However, in the present
securities act, the assets will be transferred to an independent securitization
or reconstructing company.”
Furthermore,
The act, for the present has not envisaged public participation and, therefore, the
securities as referred to above will be offered to qualified institutional buyers
(QIBs).
The SPVs thus act as intermediaries in buying the financial assets from the seller or
the transferor and then by issuing securities to the investors. In the result, the
money received from the investors is paid to the seller or the transferor, and finally
the investors are repaid out of the assets realized within a time schedule.
Securitization is, thus, an additional security cover for a secured creditor having
given loans or made some advance to its borrowers. Securitization is, hence, a
process through which another agency, namely the securitization or the
reconstruction company comes in between the secured creditor and the borrower,
and pays the secured creditor the value of his loan at some discounting and
thereafter deals with the borrower directly on the basis of securities recovered from
the secured creditor, relieving the secured creditor from resorting to any recovery
process against its borrowers, since, as a result of securitization, the securitization
or the reconstruction company steps into the shoes of the secured creditor, as if an
insurer gets himself subrogated for the insured by finally settling the claim of the
insured against any third party in respect of the insured interest.
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9. RECONSTRUCTION OF FINANCIAL ASSETS
(i) the proper management of the business of the borrower, by change in, or
take over of, the management of the business of the borrower;
(ii) The sale or lease of a part or whole of the business of the borrower;
(iii) Rescheduling of payment of debts payable by the borrower;
(iv) Enforcement of security interest in accordance with the provisions of
Section 13 of the Act;
(v) Settlement of the dues payable by the borrower;
(vi) Taking possession of the secured assets in accordance with the
provisions of clause (a) of sub- section (4) of section 13 of the Act.
Thus, taking possession of the secured assets and the enforcement of security
interest are included as incidents of the concept of asset reconstruction.
The assets can be acquired only-
(a) for the purpose of realization of the financial assistance; and
(b) when the borrower is in default,
but not otherwise.
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measure directed against the borrower, and for which a default on part of the
borrower is implied.
On the other hand, where the securitization or the reconstruction company proceeds
to acquire the financial assets of a bank or financial institution by-
(a) issuing a debenture or bond or any other security in the nature of
debenture, for consideration agreed upon between such company
and the bank or financial institution; or
(b) Entering into an agreement with such bank or financial institution
for the transfer of such financial assets to such company on such
terms and conditions as may be agreed on between them.
There is no question of default on part of the borrower, and such acquisition can be
made whether or not there has been any default on part of the borrower.
The result of such acquisition is that the securitization or the reconstruction
company becomes, on such acquisition, the lender and all the rights of such bank or
financial institution vest in such securitization or reconstruction company in
relation to the financial assets so acquired ( Section 5(2) of the Act )
The third concept under the preamble is the right of the secured creditor, including
the securititsation or the reconstruction company, to enforce the security interest
without intervention of the court, and though this can be done notwithstanding
anything contained in section 69 or 69A of Transfer of Property Act, 1882, yet such
action can be taken only when a borrower who is under a liability to a secured
creditor under a security agreement-
(i) Makes any default in repayment of the secured debt or any installment
thereof; and
(ii) His debt has been classified as non- performing asset, and
(iii) The borrower has committed a default as aforesaid, after notice to him
to discharge in full his liability to the secured creditor within 60 days from the date
of such notice.
On the above conditions being satisfied, the secured creditor can take, for
enforcement of the security interest, one or more of the following measures to
recover the secured debt, namely-
(1) take possession of the secured assets of the borrower, including the right
to transfer by way of lease, assignment o\r sale for realizing the secured
asset;
(2) take over the management of the secured assets including the right to
transfer by way of lease, assignment or sale and realize the asset;
(3) appoint any person to manage the secured assets the possession of which
has been taken over by the secured creditor;
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(4) Require, at any time, by notice in writing, any person who has acquired
any of the secured assets from the borrower and from whom any money
is due or may become due to the borrower, to pay the secured creditor so
much of the mo0ney as is sufficient to pay the secured debt.
Obviously, the measures of the nature aforesaid can be taken in respect only of the
secured assets whereon their exist a security interest which means a right, title or
interest of any kind whatsoever upon property, created in favour of any secured
creditor and includes any mortgage, charge, hypothecation of assignment, but such
measures cannot be taken in respect of the following, namely-
The act is not merely invalid because it interferes with existing contractual rights of
parties and puts one party at an advantageous position is untenable in view of
public interest involved. The transaction of funding by banks/ institutions may have
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a character of a private contract yet such transactions as a whole having far-
reaching effect on the economy of the country cannot be ignored, purely restricting
it to individual transactions more particularly when financing is through banks and
financial institutions utilizing the money of the people in general, namely, the
depositors in the banks and public money at the disposal of the financial institutions
wherever public interest to such a large extent is involved and it may become
necessary to achieve an object which solves the public purposes, individual rights
may have to give way. Public interest has always been considered to be above the
private interest. Interest of an individual may, to some extent, be effected but it
cannot have the potential of taking over the public interest having an impact in the
socio- economic drive of the country. The unrealized dues of banking companies
and financial institutions utilizing public money for advancing were mounting and
it was considered imperative. Undoubtedly such a legislation would be in the public
interest an\d the individual interest shall be subservient to it. Even if a few
borrowers are affected here and there, that would not impinge upon the validity of
the act which otherwise serves the large interest.
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the law for providing the normal remedy for all classes of creditors is a wider
remedy. There is nothing as such inconsistent in both such remedies, save and
except, when the question arises of restoring to both the remedies simultaneously
qua and secured assets. As such the question of considering the doctrine of election
would arise only when there are two inconsistent remedies provided.( Apex
Electricals Ltd. V. ICICI Bank Ltd (2003) 117 Comp. Cas 412).
{558}
improper. But, distinguishing between willful defaulters and those who
are unable to pay requires an assessment of intent and ability
consideration of which would make the desired strengthening of
creditor’s rights ineffectual.
The act has a non- obstante deeming clause which mandates dispute
resolution by way of arbitration. At the same time, the act states that the
provisions of the act are not in derogation of the other laws, including the
recovery of debts due to banks and financial institutions. Under this act,
all cases where there is a debt due to banks and financial institutions; it
has to be specifically referred to the debt recovery tribunal. This creates
confusion as to whether the dispute should be referred to arbitration or it
should be filed in the debts recovery tribunal.
It is also urged that the Narasimham Committee Report had only
recommended the starting up of the asset reconstruction fund and not
asset Reconstruction Company. Critics also claim that the asset
reconstruction company to be run as a private company would only
function for the purposes of profit.
The rules define authorized officer (AO) to mean one not less than a
chief manager of a public sector banks or equivalent or, alternatively, any
other person exercising powers of superintendence, direction and control
of the business or affairs of the secured creditor. Benchmarking AO with
the chief manager of a public sector banks could give rise to disputes as
to who is to actually take action under the act. Many private banks and
financial institutions have a plethora of officers who could technically
take the action specified. It would be more useful to have a more wise
definition.
The demand notice, as contemplated by section 13(2) of the act, is to be
served on the registered office of the borrower in case it is a company
and the place at which the borrower actually and voluntarily resides or
carries on business, in other cases. This notice can be served by way of
speed post, courier, and fax or e- mail. Whether a notice served by e-
mail would stand in a court of law is a point that could give rise to
procedural roadblocks.
18.8 Summary
Creditor means person or body to whom one owes any money; one who has a right
to require of another the fulfillment of a contract; one to whom another owes the
performance of an obligation; one in whose favour an obligation exists, by reason
of which he is or may become entitled to the payment of money. In the corporate
world there may be a variety of classes of creditors. Besides the statutorily
recognized Debenture holders, there are also the following important classes. There
are various laws prevailing in India to protect the interest of the creditors like
Companies Act, Contract Act, Transfer of property Act, the Recovery of Debts due
to Banks and Financial Institutions Act, The Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act etc.
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18.9 Check Your Progress
1. Who is a creditor? What is the need for the protection of the interests of the
creditors?
2. Discuss how the law as prevailing in India protects the interests of a creditor.
3. What is the purpose of enacting The Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002?
Structure
19.0 Introduction
19.1 Corporate Governance Measures
19.2 Corporate Governance
19.3 Public Governance System
19.4 Structure of Public and Corporate Governance
19.5 Principles of Corporate Governance
19.6 OECD Principle of Corporate Governance
19.7 Summary
19.8 Check Your Progress
19.0 Introduction
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In the words of Wolfensohn, President of the Word bank- “Corporate governance
is about promoting corporate fairness, transparency and accountability”. It is
concerned with structures and processes for decision making, accountability,
control and behaviour at the top level of organisations. It influences how the
objectives of an organisation are set and achieved, how risk is monitored and
assessed and how performance is optimized.
The term Corporate Governance is not easy to define. The term governance relates
to a process of decision making and implementing the decisions in the interest of all
stakeholders. It basically relates to enhancement of corporate performance and
ensures proper accountability for management in the interest of all stakeholders. It
is a system through which an organisation is guided and directed. On the basis of
this definition, the core objectives of Corporate Governance are focus,
predictability, transparency, participation, accountability, efficiency &
effectiveness and stakeholder satisfaction.
Corporate Governance can also be defined “as the formal system of accountability
and control for ethical and socially responsible organisational decisions and use of
resources.”
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Stakeholders
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Trade Unions
Customers
Shareholders and investors
Suppliers
Local communities
Government
Competitors
Indian Companies are required to comply with Clause 49 of the listing agreement
primarily focusing on following areas:
Board composition and procedure
Audit Committee responsibilities
Subsidiary companies
Risk management
CEO/CFO certification of financial statements and internal controls
Legal compliance
Other disclosures
Developments in India
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The Confederation of Indian Industry (CII) took the lead in framing a desirable
code of corporate governance in April 1998. This was followed by the
recommendations of the Kumar Mangalam Birla Committee on Corporate
Governance. This Committee was appointed by the Securities and Exchange Board
of India (SEBI). The recommendations were accepted by SEBI in December 1999
and enshrined in Clause 49 of the Listing Agreement of all Stock Exchanges in
India.
Sustainable growth and success of any country or society is depending upon its
collective function of its resources. It starts from the vast use of natural resources,
strategic, geographic location, labour (people), and intellectual capital. In a
country private participants may have prominent role in utilization of all these
resources, but public governance or public administration will play a vital role of
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sustainable development of society. It is true that public governance is more
complex as well as important in all kinds of society. It is involved in the most of the
aspects of society, in one and another way. Relevance of public governance
determines culture, quality of life, and sustainable development of society. It helps
to keep the primary aspects, such as discipline, peace; education, planning and
implementation, in the society depend upon the culture and nature of the society. A
complete public governance system with all its strengths will help to build a great
and potential culture and society.
Public governance depicts the utilization of available resources and its use
for public general. In large public governance is for public. According to experts, it
implies the following:
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reference to “the processes, mechanism, principle and structure by which the
business and affairs of the company are directed and managed and governed
effectively. Its goal is to enhance long term shareholder value through improving
corporate performance and accountability while taking into account the interest of
other shareholder”. The Corporate Governance structure specifies the relations, and
the distribution of rights and responsibilities, among primarily three groups of
participants, viz. the Board of directors, managers, and shareholders. This system
spells out the rules and procedures for making decisions on corporate affairs; it also
provides the structure through which the company objectives are set, as well as the
mean of attaining and monitoring the performance of those objectives. The
fundamental concern of Corporate Governance is ensure the conditions whereby an
organization’s directors and managers act in the larges interests of the organization
and its shareholders in particular and stakeholder in general, and to ensure means
by which managers are held accountable to capital providers or the use of assets.
Issues of fiduciary duty and accountability are often discusses within the
framework of Corporate Governance. It allows more constructive and flexible
response to raise standards in running and managing a company as opposed to strict
statutory requirements.
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judiciary. Governance involves interaction between these formal institutions and
those of civil society.
For the purpose of providing better service to the general public these
governing bodies created a legislature structure for the purpose of implanting
specific mandate; this structure involves board, department, minister, cabinet,
house of assembly and public. A successful relationship between governing and the
public will help to accomplish the primary objective of public governance.
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System, the emphasis is given on public. The public is the sole authority to decide
who will govern the entire country. The public governance system has three types :
• Communistic System
• Socialistic System
• Democratic System
Communistic System
The root of the system can be found in the Marxism. According to ideology
of communism, the entire capitalism should be abolished and should be controlled
by the labour, i.e. the working class. The entire property (Land and Industries)
belongs to the government. Everybody should be treated equality (Horse and
Donkey should be treated equally). USSR (Russia), China, Cuba practiced
communism but entire world knows what the result was. The entire system of the
communism collapsed throughout the world.
Socialistic System
Democratic System
The democratic system of governance is the most viable system of all the
Public Governance Systems. People appoint their public representative to rule the
people, to put it in the words of Abraham Lincoin, Democracy means of the people,
for the people, by the people. Earlier people were not ready to accept the fat that a
country of state can be run by people only. They were of the dogmatic view that a
family and a king only can run the dynasty. Democratic system has travelled
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long way from Dynasty to the Democracy and ultimately emerged as the most
viable system of Public Governance. Communism and Socialism failed to establish
its roots in the worlds surviving Democracy as the most feasible system and today;
India is the largest Democratic state in the world.
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Just like public governance, corporate governance is governance of affairs of
a company by the stakeholders. As pubic Governance is people’ democracy,
Corporate Governance is stakeholders’ democracy. Public in public Governance
who choose and elect their representative is analogous to the shareholders in a
company whose should have right to elect their reprehensive in the Board of
Directors and the one who has majority of the shares is appointed as a Chairman of
the company. The Board of Directors, analogous to the Council of Ministers
(Cabinet) is the regulatory body, which is involved in decision-making. It is not
responsible for implementation of any decision taken by it. The Board of Directors
decides the CEO (Chief Executive Officers) of the corporate. The CEO or MD
(managing Director) like Prime Minster is Executive Authority responsible for
executing the decisions taken by the BOD. President along with the Parliament and
Assembly decides President. CEO may or may not be the part of BOD. Where
Chairman and Managing Director is the same, separate CEO is appointed. The
CEO then selects or appoints the Operative body (candidates at the level of General
Manager or GM).
Council of Minster
(Cabinet) Executive Board
President Chairman
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The major difference between the Public Governance and the Corporate
Governance is that the decision made by people’s representatives (cabinet) in
Public Governance affects the entire society (country) but the decisions taken by
shareholder’s representative (BOD) do not affect the entire community through it
affects the entire stakeholders for the company.
Public Governance
Corporate Governance
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Stockholders General Control Board of Directors
nd
Assembly Separation 2 degree decision rights such as
Have the ultimate Separation ratification of major projects
decision rights such as, gains from decide CEO remuneration, hire
voting rights to change specialization and fire management and auditing
the corporate charter, hire in risk-bearing firm secure proper monitor
and fire the board of and decision system, target capital structure
directors and authorized making and corporate risks and secure
major divestitures, Separation corporate focus, for short Decision
acquisition or costs from lack Control
liquidations. For short of incentives.
Decision legitimization.
Management
rd
3 degree decision rights such as, initiate and
implement projects, formulate the corporate strategy
and hire and fire lower level managers. For short
Decision Management.
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They can help shareholders exercise their rights by effectively communicating
information that is under stable and accessible and encouraging shareholders to
participate in general meetings.
Role and Responsibilities of the board: The board needs a range of skills
and understanding to be able to deal with various business issues and have the
ability to revive and challenge management performance. It needs to be sufficient
size and have an appropriate level of commitment to fulfill its responsibilities and
duties. There are issues about the appropriate level of commitment to fulfill its
responsibilities and duties. There are issues abut the appropriate mix of executive
and non-executive directors. The key role of chairperson and CEO should not be
held by the same person.
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international originations and the private sector, a set of corporate governance
standards and guidelines.
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ownership and control. However, this is not simply an issue on the relationship
between shareholders and management, although that is indeed the central element.
In some jurisdiction, governance issues also arise from the power of certain
controlling element. In some jurisdictions, governance issues also arise from the
power of certain controlling shareholders over minority shareholders. In other
countries, employees have important legal rights irrespective of their ownership
rights. The Principles therefore have to be complementary to a broader approach to
the operation of check and balances. Corporate governance is affected by the
relationship among participants in the governance system. Controlling
shareholders, which may be individual, family holdings, or other corporation acting
through a holding company or cross shareholdings, can significantly influence
corporate behaviour. An owner of equity. Institutional investors are increasingly
demanding a voice in corporate governance in some markets. Individual
shareholders usually to do not seek to exercise governance rights but may be highly
concerned about obtaining fair treatment from controlling shareholders and
management. Creditors play an important role in a number of governance systems
and can serve as external monitors over corporate performance. Employees and
other stakeholders play an important role in contributing to the long-term success
and performance of the corporation, while governments establish the overall
institutional and legal framework for corporate governance. The role of each of
these participants and their interactions very widely among OECD countries and
among non-OECD countries as well. These relationships are subject, in part, the
law and regulation and, in part, to voluntary and adaptation and most, importantly,
to market forces.
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credible, well understood across broaders and adhere to internationally accepted
principles. Even if corporations do not rely primarily on foreign sources of capital,
adherence to good corporate governance practices will help improve the confidence
of domestic investors, reduce the cost of capital, underpin the good functioning of
financial markets, and ultimately include more stable sources of financing. There is
no single model of good corporate governance. However, work carried out in both
OECD and non-OECD countries and within the Organization has identified some
common elements that underlie good corporate governance. The Principles build on
these common elements and are formulated to embrace the different models that
exist. For example, they do not advocate any particular board structure and the
term, "broad as used in this document is meant to embrace the different national
models of board structures found in used in the Principles refers to the supervisory
board while "key executive refers to the "management applicable to the board are
also, mutatis mutandis, applicable. The terms "corporation and "company are used
interchangeably in the text. The Principles are non-biding and not aim at detailed
prescriptions for national legislation. Rather they seek to identify objectives and
suggest various means for achieving them. Their purpose is to serve as a reference
point. They can be used by policy markers as they examine and develop the legal
and regulatory frameworks for corporate governance the reflect their own
economic, social, legal and cultural circumstances, and by market participants as
they develop their own practices. The Principles are evolutionary in nature and
should be reviewed in light of significant changes in circumstances. To remain
competitive in a changing world, corporate must innovate and adapt their corporate
governance practices so that they can meet new demands and grasp new
opportunities. Similarly, governments have an important responsibility for shaping
and effective regulatory framework that provides for sufficient flexibility to allow
markets to functions effectively and to respond to expectations of shareholders and
other stakeholders. It is up to government and market participants to decide how to
apply these principles in developing their own frameworks for corporate
governance, taking into account the costs and benefits of regulations.
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The OECD Principles are:
Basic shareholder rights should include the rights to: 1) secure methods of
ownership registration 2) convey or transfer shares 3) obtain relevant and material
information on the corporation on a timely and regular basis; 4) participate and
vote the in general shareholder meetings; 5) elect and remove members of the
board; and 6) share in the profits of the corporation.
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company; 2) the authorization of additional shares; and 3) extraordinarily
transactions, including the transfer of tall or substantially all assets, that in effect
result in the sale of the company.
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III. THE EQUITABLE TREATMENT OF SHAREHOLDER
The corporate governance framework should ensure the equitable treatment of all
shareholders, including minority and foreign shareholders. All shareholders should
have the opportunity to obtain effective redress for violation of their rights.
Investors' confidence that the capital they provide will be protected from
misuse or misappropriation by corporate manager, board members or controlling
shareholders is an important factor in the capital markets. Corporate boards,
managers and controlling shareholders may have the opportunity to engage in
activities that may advance their own interests at the expense on non-controlling
shareholders. In providing protection to investors, a distinction can usefully be
made between ex-ante and ex-post shareholders rights. Ex-ante rights are for
example pre-emplitve rights and qualified majorities for certain decisions. Ex-post
rights allows the seeking of redress once rights have been violated. In jurisdictions
where the enforcement of the legal and regulatory framework is weak, some
countries have found it desirable to strengthen the ex-ante rights of shareholders
such as by low share ownership threshold for placing items on the agenda of the
shareholders meeting or by requiring a supermajority of shareholders for certain
important decisions. The Principles support equal treatment for foreign and
domestic shareholders in corporate governance. They do not address government
policies to regulate foreign direct investment. One of the ways in which
shareholders can enforce their rights is to be able to initiate legal and administrative
proceedings against management and board members. Experience has shown that
an important determinant of the degree to which shareholders rights are protected is
whether effective methods exists to obtain redress for grievances at a reasonable
cost and without excessive delay. The confidence of majority investors is enhanced
when the legal system provides mechanisms for minority shareholders to bring
lawsuits when they have reasonable grounds to believe that their rights have been
violated. The provision of such enforcement mechanism is key responsibility of
legislators and regulators. There is some risk that a legal system, which enable any
investor to challenge corporate activity is the courts, can become prone to excessive
litigation. Thus, many legal systems have introduced provisions to protect
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management and board members against litigation abuse in the form of tests for the
sufficiency of shareholders complainants, so-called safe harbours for management
and board members actions (such as the business judgment rule) as well as safe
harbours for the disclosure of information. In the end, a balance must be struck
between allowing investors to seek remedies for infringement of ownership rights
and avoiding excessive litigation. Many countries have found the alternative
adjudication procedures, such as administrative hearings or arbitration procedures
organized by the securities regulators or other regulatory bodies, are an efficient
method for dispute settlement, at least at the first instance level. Also, insider
trading and abusive self-dealing should be prohibited.
In all OECD countries, the rights of stakeholders are established by law (e.g.
labour, business and commercial and insolvency laws) or by contractual
relations. Even in areas where stakeholder interests are not legislated, many
firms make additional commitments to stakeholders, and concern over
corporate reputation and corporate performance often requires the
recognition of broader interests.
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The legal framework and process should be transparent and not impede the
ability of stakeholders to communicate and to obtain redress for the violation
of rights.
Unethical and illegal practices by corporate officers may not only violate the
rights of stakeholders but also be to the detriment of the company and its
shareholders in terms of reputations effects and an increasing risk of future
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financial liabilities. It is the therefore, to the advantage of the company and
its shareholders to establish procedures and safe-harbours for complaints by
employees, either personally or through their representative bodies, and
others outside the company, concerning illegal and unethical behaviour. In
many countries the boards is being encouraged by law and or principles to
protects these individuals and representative bodies and to give them
confidential direct access to someone independent on the board, often an
member of an audit or an ethics committee. Some companies have
established an ombudsman to deal with complaints. Several regulators have
also established confident phone and e-mail facilities to receive allegations.
While in certain countries representative employee bodies undertake the
takes of conveying concerns to the company, individual employees should
not be precluded from or be less protected, when acting along. When there is
an inadequate response to a compliant regarding contravention of the law,
the OECD Guidelines for Multinational Enterprises encourage them to
report their bona fide compliant to the competent public authorities. The
company should refrain from discriminatory or disciplinary actions against
such employees or bodies.
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governance of the company. Other countries have mechanisms which
encourage the debtor to reveal timely information about the company's
difficulties so that a consensual solution can be found between the debtors
and its creditors. Creditor rights vary, ranging from secured bound holders to
unsecured creditors. Insolvency procedures usually require efficient
mechanisms for reconciling the interests of different classes creditors. In
many jurisdictions provisions is made for special rights such as through
"debtor in possession" financing which provides incentives / protection for
new funds made available to the enterprise in bankruptcy.
The Corporate governance framework should ensure that timely and accurate
disclosure is made on all material matters regarding the corporation, including the
financial situation, performance, ownership and governance of the company.
2. Company Objectives.
5. Related Party transactions i.e. whether the company is being run with
due regard to the interests of all its investors. To this end, it is essential for the
company to fully disclose material related party transactions to the market, either
individually, or on grouped basis material related party transactions to the market,
either individually, or on a grouped basis, including whether they have been
executed at arms-length and on normal market terms. Disclosure requirement
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include the nature of relationship control exists and the nature and amount of
transactions.
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Information should be prepared and disclosed in accordance with high quality
standards of accounting and financial and non-financial disclosure
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Board structures and procedures vary both within and among OECD
countries. Some countries have two-tier boards that separate the supervisory
function an d the management function into different bodies. Such systems
typically have a "supervisory board" composed of non-executive board
members and a "management board" composed entirely of executives. Other
countries have "unitary" boards, which bring together executive and non
executive board members. In some countries there is also an additional
statutory body for audit purpose. The Principles are intended to be
sufficiently general to apply to whatever board structure is charged with the
functions of governing the enterprise and monitoring management. Together
with guiding corporate strategy, the board is chiefly responsible for
monitoring managerial performance and achieving an adequate return for
shareholders, while preventing conflicts of interest and balancing competing
demands on the corporation. In order for boards to effectively fulfill their
responsibilities they must be able to exercise objective and independent
judgment. Another important board responsibility is to oversee systems
deigned to ensure that the corporation obeys applicable laws, including tax,
competition, labour, environment, equal opportunity, health and safety laws.
In some countries, companies have found it useful to explicitly articulate the
responsibilities that the board assumes and those for which management is
accountable. The board is not only accountable to the company and its
shareholders but also has a duty to act in their best interests. In addition,
board are expected to take due regard of, the deal fairly with, other
stakeholder interest including those of employee, creditors, customers,
suppliers and local communities. Observance of environmental and social
standards is relevant in this context.
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a. Board members should act on a fully informed basis, is good faith, with due
diligence and care, and in the best interest of the company and the
Shareholders
In some countries, the board is legally required to act in the interest of the
company, taking into account the interests of shareholders, employees and
the public good. Acting in the best interest of the company should not permit
management to become entrenched. This principle states the two key
elements of the fiduciary duty of board members: the duty of care and the
duty of loyalty. The duty of care requires board members to act on a fully
informed basis, in good faith, with due diligence and care. In some
jurisdictions there is a standards of reference which is the behaviour that a
reasonably prudent person would exercise in similar circumstances. In
nearly all jurisdictions, the duty of care does not extend to errors of business
judgment so long as board members are not grossly negligent and a decision
is made with due diligence etc. The principle cal for board members to act
on a fully informed basis. Good practice takes this to mean that they should
be satisfied that key corporate information and compliance systems are
fundamentally sound and underpin the key monitoring role of the board
advocate by the Principle. In many jurisdictions this meaning is already
considered an element of the duty care, while in others it is required by
securities regulation, accounting standards etc. The duty of loyalty is of
central importance, since it underpins effective implementation of other
principles in this document relating to, for example, the equitable treatment
of shareholders, monitoring of related party transactions and the
establishment of remuneration policy for key executives and board
members. It is also a key principle for board members who are working
within the structure of a group of companies even though a company might
be controlled by another enterprise, the duty of loyalty for a board member
relates to the company and all its shareholders and not to the controlling
company of the group.
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b. Where board decisions may affect different shareholder groups differently,
the board should treats all shareholders fairly
It carrying out its duties, the board should be viewed, or act, as an assembly
of individual representatives for various constituencies. While specific board
members may indeed be nominated or elected by certain shareholders (and
sometimes contested by others) it is an important feature of the board's
work that board members when they assume their responsibilities carry out
their duties in an even-handed manner with respect to all shareholders. This
principle is particularly important to establish in the presence of controlling
shareholders the de facto may be able to select all board members.
c. The board should apply high ethical standards. It should take into account
the interests of stakeholders.
The board has a key role in setting the ethical tone of a company, not only
by its own actions, but also in appointing and overseeing key executives and
consequently the management in general. High ethical standards are in the
long terms interests of the company as a means to make it credible and trust
worthy, not only in day-to-day operations, but also with respect to longer
term commitments. To make the objectives of the board clear and
operational, many companies have found it useful to develop company
codes of conducts based on, inter alia, professional standards and sometimes
boarder codes of behaviour. The latter might include a voluntary
commitment by the company (including its subsidiaries) to company with
the OECD Guidelines for Multinational Enterprises with reflect all four
principles contained in the ILO Declaration on fundamental Labour Rights.
company wide code serve as a standard for conduct by both the board and
key executive, setting the framework for the exercise of judgment in dealing
with varying and often conflicting constituencies. At a minimum, the ethical
code should set clear limits on the pursuit of private interests, including
dealings in the shares of the company. An overall framework of ethical
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conduct goes beyond compliance with the law, which should always be a
fundamental requirement.
In two tire board systems the supervisory board is also responsible for
appointing the management board which will normally comprise
most of the key executives.
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4. Aligning key executive and board remuneration with the longer term
interests of the company and its shareholders
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with the appropriate knowledge competencies and expertise to
complement the existing skills of the board and thereby improve its
value-adding potential for the company. In several countries there are
calls for an open search process extending to a board range of people.
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responsibility and accountability throughout the organisation. The
board will also need to ensure that there is appropriate oversight by
senior management. One way of doing this is through an internal
audit system directly reporting to the board. In some jurisdictions it is
considered good practice for the internal auditors to report to an
independent audit committee of the board or an equivalent body
which is also responsible for managing the relationship with the
external auditor, thereby allowing a coordinated response by board. It
should also be regarded as good practice fro this committee, or
equivalent body, to review and report to the board the most critical
accounting policies which are the basis for financial reports.
However, the board should retain finial responsibility for ensuring the
integrity of the reporting system. Some countries have provided for
the chair of the board to report on the internal control process.
Companies are also well advised to set up internal programmes and
procedures to promote compliance with applicable law, regulations
and standards, including statutes to criminalize bribery of foreign
official that are required to be enacted by the OECD anti – bribery
Convention and measures designed to control other forms of bribery
and corruption. Moreover, compliance must also relate to other laws
and regulations such as those covering securities, competition and
work and safety conditions. Such compliance programme will also
underpin the company's ethical code. To be effective, the incentive
structure of the business needs to be aligned with its ethical and
professional standards so that adherence to these values is rewarded
and breaches of law are met with dissuasive consequences or
penalties. Compliance programmes should also extend where possible
to subsidiaries.
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The functions and responsibilities of the board and management with
respect to disclosure and communication need to be clearly
established by the board. In some companies there is now an
investment relations officers who reports directly to the board.
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the ownership structure of the company. A dominant shareholder has
considerable powers to appoint the board and the management. However, in
this case, the board still has a fiduciary responsibility to the company and to
all shareholders including minority shareholders. The variety of board
structures, ownership patterns and practices in different countries will thus
require different approaches to the issue of board objectivity. In many
instances objectivity requires that a sufficient numbers of board members
not be employed by the company or its affiliates and not be closely related to
the company or its management through significant economic, family or
other ties. This does not prevent shareholders from being board members. In
others, independence form controlling shareholders or another controlling
body will need to be emphasized, in particular if the rights of minority
shareholders are weak and opportunities to obtain redress are limited. This
has lead to both codes and the law in some jurisdictions to call for some
board members to be independent of dominant shareholders, independence
extending to not being their representatives or having close business ties
with them. In other cases, parties such as particular creditors can also
exercise significant influence. Where there is a party in a special position to
influence the company, there should be stringent tests to ensure the objective
judgment of the board. In defining independent members of the board, some
national principles of corporate governance have specified quite detailed
presumptions for non independence which are frequently reflected in listing
requirements. While establishing necessary conditions, such 'negative'
criteria defining when an individual is not regarded as independent can
usefully be complemented by 'positive' examples of qualities that will
increase the probability of effective independence. Independent board
members can contribute significantly to the decision-making of the board.
They can bring an objective view to the evaluation of the performance of the
board and management. In addition, they can play an important role in areas
where the interests of management, the company and its shareholders may
diverge such as executive remuneration, succession planning, changes of
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corporate control, takeover defences, large acquisitions and the audit
function. In order for them to play this key role, it is desirable that boards
declare who they consider to be independent and the criterion for this
judgment.
19.7 Summary
The term Corporate Governance is not easy to define. The term governance relates
to a process of decision making and implementing the decisions in the interest of all
stakeholders. In the words of Wolfensohn, President of the Word bank- “Corporate
governance is about promoting corporate fairness, transparency and
accountability”. The term governance relates to a process of decision making and
implementing the decisions in the interest of all stakeholders. It basically relates to
enhancement of corporate performance and ensures proper accountability for
management in the interest of all stakeholders. It is a system through which an
organisation is guided and directed. The trend of developing corporate governance
guidelines and codes of best practice began in the early 1990s in UK and Canada in
response to problems in performance in some leading organizations, presumably
due to lack of effective board oversight, leading to pressure from institutional
investors for change; The. Cadbury Report, 1992 in UK became a pioneering
reference code for stock markets. The ‘Blue Ribbon Committee’ set up in the U.S.
in 1998 by New York Stock Exchange and National Association of Securities
Dealers studied the effectiveness of audit committees and provided
recommendations for improvement. In response to these recommendations, New
York Stock Exchange and National Association of Securities Dealers as well as
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other exchanges revised their listing standards relating to audit committees. In 2002
the Sarbanes - Oxley Act, passed in response to major corporate scandals, is
considered to be one of the most significant. The OECD (Organization for
Economic Co-operation and Development) Principles 1999 and 2004 reflect global
consensus regarding the critical importance of corporate governance.
The Confederation of Indian Industry (CII) took the lead in framing a desirable
code of corporate governance in April 1998. This was followed by the
recommendations of the Kumar Mangalam Birla Committee on Corporate
Governance. This Committee was appointed by the Securities and Exchange Board
of India (SEBI). The recommendations were accepted by SEBI in December 1999
and enshrined in Clause 49 of the Listing Agreement of all Stock Exchanges in
India.
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framework for corporate governance in their countries and to provide guidance and
suggestions for stock exchanges, investors, corporations, and other parties that
have a role in process of developing good corporate governance. The Principles
focus on publicly treated companies, both financial and non-financial. However, to
the extent they are deemed applicable, they might also be a useful tool to improve
corporate governance. Corporate governance is one key element in improving
economic efficiency and growth as well as enhancing investor confidence.
Corporate governance involves a set of relationship between a company's
management, its board, its shareholder and other stakeholders. Corporate
governance also provides the structure through which the objectives of the
company are set, and the means of attaining those objectives and monitoring
performance and determined. Good corporate governance should provide proper
incentives for the board and management to pursue objectives that are in the
interest of the company and its shareholders and should facilitate effective
monitoring. The presence of an effective corporate governance system, within an
individual company and across an economy as a whole, helps to provide a degree
of confidence that is necessary for the proper functioning of market economy. As a
result the cost of capital is lower and firms are encouraged to use resources more
efficiently, thereby underpinning growth.
3. How the concept of corporate governance has been assimilated in the Indian
Companies Act?
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UNIT 20: Corporate Social Responsibility
Structure
20.0 Introduction
20.1 Objectives
20.2 Corporate Social Responsibility
20.3 Need for Corporate Social Responsibility
20.4 Corporate Social Responsibility Policies
20.5 Key Developments
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20.6 Corporate Social Responsibility Mechanism
20.7 External Standards and Other Developments
2.8 Benefits of Corporate Social Responsibility
20.9 Summary
20.10 Check Your Progress
20.0 Introduction
The importance of corporate social responsibility surfaced in the 1960s when the
activist movement began questioning the singular economic objective of being
maximization of profits. This has always been a source of contention. For example,
were tobacco companies ignoring health risks associated with nicotine and its
addictive properties? Times have changed and managers must regularly make
decisions about issues that have a dimension of social responsibility. Karl Marx,
commenting on business objectives said “Business is all green, only philosophy is
grey”. What he meant was that business is all about profits and comfort for its rich
owners and discomforts for all other sections of the society who are at the receiving
end of the business. Despite such socialist ideology been relegated to the
background due to fact that capitalism is being gradually accepted; business is still
painted as essentially exploitative in nature. But one has to accept that much of the
progress in the world would not have been possible, without entrepreneurship and
business which involves risk. Corporate Governance is getting a focused attention
particularly after market and public confidence became fragile after a series of high
profile corporate failures in which the absence of effective governance was a major
factor.
Business ethics if properly understood is neither anti business nor anti capitalist. It
is simply articulating a cohesive set of values to guide decision making in running a
business. Globalisation and liberalization of economies has brought corporate
organizations to the center stage of social development. As a result in the process of
corporate decision making, managers contribute, consciously or unconsciously to
the shaping of human society. It is not a choice between profits and ethics, but
profits in an ethical manner. This mantra has lead to the evolution of Corporate
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Governance. Corporate Governance is getting attention for satisfying the divergent
interests of the stakeholders of a business enterprise especially after the corporate
scandals and loss of shareholder value Enron and several other large companies in
the recent past, which focused more attention on the issue of shareholder rights,
calling for greater transparency and accountability and enhancing corporate
reporting and disclosure. The scandals led to numerous corporate governance
reforms, including passage of the Sarbanes - Oxley Act the adoption of new listing
requirements by the New York Stock Exchange in the United States. Other
countries have introduced similar legal requirements. As a result, increasing
number of companies are working proactively to address issues that concern
shareholders and a range of other stakeholders.
20.1 Objectives
After reading this chapter, you will be able to -
Understand Corporate Social responsibility and the need and importance of
being a Corporate Citizen
Explain the implementation and list the benefits of Corporate Social
Responsibility.
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consideration the needs of future generations. It is an integrated combination of
policies, programs, education, and practices extend throughout a corporation’s
operations and into the communities in which they operate, about how companies
voluntarily manage the business processes to produce an overall positive impact on
society. CSR can mean different things to different people:
For a company, however, it can simply be seen, as responding to the needs and
concerns of people who can influence the success of the company and/or whom the
company can impact through its business activities, processes and products.
The term corporate citizenship denotes the extent to which businesses meet the
legal, ethical, economic and voluntary responsibilities placed on them by their
stakeholders.
Companies can best benefit their stakeholders by fulfilling their economic, legal,
ethical and discretionary responsibilities. The benefits of “good corporate
citizenship” include:
A stable socio-political environment for business as well as enhanced
competitive
advantage through better corporate reputation and brand image.
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improved employee recruitment, retention and motivation, improved
stakeholder relations and a more secure environment in which to operate.
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many see it as a way of integrating the economic, social, and environmental
necessity of business activities. Social issues with which business corporations
have been concerned since the 1960s may be divided into three categories:
(a) Social problems external to the corporation that were not caused by any direct
business action like poverty, drug abuse, decay of the cities and so on.
(b) The external impact of regular economic activities. For example pollution
caused by production; the quality, safety, reliability of goods and services;
deception in marketing practices, the social impact plant closures and plant
location belong to this category.
(c) Issues within the firm and tied up with regular economic activities, like equal
employment opportunity, occupational health and safety, the quality of work
life and industrial democracy.
The second and third categories are of increasing importance and are tied up with
the regular economic operations of business. Improved social performance
demands changes in these operations.
Definition:
Lord Holme and Richard Watts has defined corporate social responsibility as
“Corporate Social Responsibility is the continuing commitment by business to
behave ethically and contribute to economic development while improving the
quality of life of the workforce and their families as well as of the local community
and society at large”.
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Corporate Social Responsibility is achieving commercial success in ways that
honour ethical values and respect people, communities, and the natural
environment.
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Increased Stakeholder Activism: Corporate accounting scandals have focused
attention more than ever on companies' commitment to ethical and socially
responsible behaviour. The public and various stakeholders are increasingly
seeking assistance of the private sector to help with myriad complex and pressing
social and economic issues. There is a growing ability and sophistication of activist
groups to target corporations they perceive as not being socially responsible,
through actions such as public demonstrations, public exposes, boycotts,
shareholders’ resolutions, and even “denial of service” attacks on company
websites. Companies are therefore focusing on meaningfully engaging with their
various stakeholders. Companies and stakeholders have, in many cases, progressed
beyond “dialogue for dialogue’s sake”, and are looking to rationalize the process.
Accountability Throughout the Value Chain: Over the past several years, the
CSR agenda has been characterized by the expansion of boundaries of corporate
accountability.
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credibility of their transparency and reporting efforts. Increasingly, demands for
greater transparency also encompass public policy - stakeholders want to know that
the way companies use their ability to influence public policy is consistent with
stated social and environmental goals. As part of this move toward greater
disclosure, many companies are displaying detailed information about their social
and environmental performance on their publicly accessible websites - even when it
may be negative.
Convergence of CSR and Governance Agenda: In the past several years, there
has been a growing convergence of corporate governance and CSR agenda. In the
1990s, the overlap was seen most clearly on issue such as board diversity, director
independence, and executive compensation. The need for having on the board of
directors, directors who are non-executive and who are independent i.e., directors
who are not involved in the day-to-day administration of the company but who
would bring a non-partisan and unbiased approach to a company’s policies is
emphasized by both CSR and Corporate Governance dictates. Similarly, the need
for putting a reasonable cap on executive compensation, such that, the CEO and the
top level executives do not reward themselves with excessively high pay packages
and unreasonable stock options at the cost of shareholders’ and stakeholders’
interest is stressed by CSR and Corporate Governance regimes. More recently, an
increasing number of corporate governance advocates have begun to view
companies’ management of a broad range of CSR issues as a fiduciary
responsibility alongside traditional risk management. In addition, more and more
CSR activists have begun to stress the importance of board and management
accountability, governance, and decision making structures as imperative to the
effective institutionalisation of CSR.
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strategic business issue. Many socially responsible investors are using the
shareholder resolution process to pressure companies to change policies and
increase disclosure on a wide range of CSR issues, including environmental
responsibility, workplace policies, community involvement, human rights practices,
ethical decision-making and corporate governance. Activist groups are also buying
shares in targeted companies to give them access to annual meetings and the
shareholder resolution process.
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Companies implement CSR by putting in place internal management systems that
generally promote:
Each company differs in how it. implements CSR. The distinction depends on such
factors as the company’s size, sector, culture and the commitment of its leadership.
Some companies focus on a single area - the environment, for example, or
community economic development while others aim to integrate a CSR vision into
all aspects of their operations. Below are some key strategies companies can use
when implementing CSR policies and practices.
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actual performance. Goals and aspirations should be ambitious, but care should be
exercised so that the company says what it means and means what it says.
GSR Reporting: Many companies have come to understand the value of assessing
their social and environmental performance on a regular basis. Annual CSR reports
can build trust among stakeholders and encourage internal efforts to comply with a
company’s CSR goals. The best reports demonstrate CEP and senior leadership
support; provide verified performance data for social, environmental and economic
performance indicators; share “good” and “bad” news; set goals for improvement;
include stakeholder feedback; and many times are verified by outside auditors.
According to Sustainability’s Global Reporters 2002 Survey, the Global Reporting
Initiative has made it easier to produce such reports.
Various performance and reporting standards have been introduced. Some are
explained below.
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accountancy organizations, business associations, universities, and other
stakeholders from around the world. The GRI first released its Sustainability
Reporting Guidelines in 1999 and is now a permanent, independent, international
body with a multi-stakeholder governance structure. The Global Reporting
Initiative’s (GRI) vision is that reporting on economic, environmental and social
performance by all organizations becomes as routine and comparable as financial
reporting. GRI accomplishes this vision by developing, continually improving, and
building capacity around the use of its Sustainability Reporting Framework. An
international network of thousands from business, civil society, labor, and
professional institutions create the content of the Reporting Framework in a
consensus-seeking process.
AA1000: Launched in 1999, AA1000, based on John Elkington’s triple bottom line
(3BL) reporting is an accountability standard designed to complement the Global
Reporting Initiative’s (GRI) Reporting Guidelines with the objective to improve
accountability and performance by learning through stakeholder engagement. The
AA1000 Stakeholder Engagement Standard (AA1000SES) is a generally
applicable, open-source framework for improving the quality of the design,
implementation, assessment, communication and assurance of stakeholder
engagement. The AA1000 Assurance Standard was launched in 2003 as the world’s
first sustainability assurance standard and applies to the principles of Materiality,
Completeness and Responsiveness.
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progressive companies in India like SAIL, BHEL, MMTC, and ONGC, etc., in the
public sector and TISCO, ITC, BATA, etc., in the private sector have ventured into
the field of social responsibility reporting since 1980. Companies like Infosys,
Wipro, Hero Honda and Bharti Enterprises have taken various initiatives to
promote and support the environment, education, health, cultural harmony and
welfare in the society. The Infosys Foundation in the past has provided Rs 38 lakh
of financial assistance to war widows in various parts of India. It has also been
involved with the construction of a super speciality hospital and reconstruction of
schools in Andhra Pradesh and Karnataka. The Azim Premji Foundation run by the
Wipro chairman in his personal capacity is working on the universalizing
elementary education and to improve the quality of learning in schools.
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both the private sector and other social actors to advance responsible corporate
citizenship and universal social and environmental principles to meet the challenges
of globalization. The UN Global Compact was formally launched in September
2000. UN Secretary-General Kofi Annan called on world business leaders to
voluntarily “embrace and enact” a set of nine principles in their individual
corporate practices.
The Caux Round Table (CRT): promotes principled business leadership and the
belief that business has a crucial role in identifying and promoting sustainable and
equitable solutions to key global issues affecting the physical, social and economic
environments. The CRT is comprised of senior business leaders from Europe,
Japan and North America, and is based in Caux, Switzerland. The CRT has
produced "Principles for Business/ a document which seeks to express a worldwide
standard for ethical and responsible corporate behaviour for dialogue and action by
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business and leaders worldwide. The principles include the social impact of
company operations on the local community, a respect for rules and ethics, support
for multilateral trade agreements that promote the “judicious liberation of trade”,
respect for the environment and “avoidance of illicit operation”, including bribery,
money laundering, and other corrupt practices.
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sustainable development agenda, and society at large. Social responsibility
becomes an integral part of the wealth creation process - which if managed
properly should enhance the competitiveness of business and maximize the value of
wealth creation to society. There is a growing body of data, quantitative and
qualitative, that demonstrates many benefits of socially responsible corporate
performance.
Decrease in crime
Easier labour recruitment.
Reduced employee turnover and absenteeism.
Easier access to international capital, better conditions for loans on international
money markets.
Dependable and preferred as supplier, exporter/importer, retailer of responsibly
manufactured components and products.
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A better society would produce a better environment in which the business may
gain long-term profit maximisation.
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domestically and internationally, but also in providing benefits beyond risk
management.
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free” clothing, lower environmental impact, and absence of genetically-modified
materials or ingredients.
20.9 Summary
Karl Marx, commenting on business objectives said “Business is all green, only
philosophy is grey”. What he meant was that business is all about profits and
comfort for its rich owners and discomforts for all other sections of the society who
are at the receiving end of the business. Despite such socialist ideology been
relegated to the background due to fact that capitalism is being gradually accepted;
business is still painted as essentially exploitative in nature. Business ethics if
properly understood is neither anti business nor anti capitalist. It is simply
articulating a cohesive set of values to guide decision making in running a business.
{620}
Globalisation and liberalization of economies has brought corporate organizations
to the center stage of social development. As a result in the process of corporate
decision making, managers contribute, consciously or unconsciously to the shaping
of human society. It is not a choice between profits and ethics, but profits in an
ethical manner.
Corporate Social Responsibility (CSR) is a concept that organizations, have an
obligation to consider the interests of customers, employees, shareholders,
communities, and ecological considerations in all aspects of their operations. This
obligation is seen to extend beyond their statutory obligation to comply with
legislation. CSR is closely linked with the principles of Sustainable Development,
which argues that enterprise should make decisions based not only financial factors
such as profits or dividends, but also based on the immediate and long-term social
and environmental consequences of their activities, especially taking into
consideration the needs of future generations.
CSR is pursued by businesses to balance their economic, environmental and social
objectives while at the same time addressing stakeholder expectations and
enhancing shareholder value. Over the past decade, CSR has risen in global
prominence and importance. More companies than ever before are engaged in
serious efforts to define and integrate CSR into all aspects of their business, with
their experiences being strengthened by a growing body of evidence that CSR has a
positive impact on business economic performance.
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Corporate social responsibility is the commitment of businesses to behave ethically
and to contribute to sustainable economic development by working with all
relevant stakeholders to improve their lives in ways that are good for business, the
sustainable development agenda, and society at large
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