Corporate and capital market laws


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Corporate and capital market laws

  1. 1. 1 CORPORATE AND CAPITAL MARKET LAWS National Stock Exchange of India Limited 4th Floor, Jeevan Vihar Building, Parliament Street, New Delhi – 110 001
  2. 2. 2 Table of Contents Unit 1 Chapter 1 Company Incorporation in India 3 Chapter 2 Prospectus, Issue and Allotments of Shares 35 Chapter 3 Share Capital and Debentures 66 Chapter 4 Management & Control, and Winding up of companies 84 Chapter 5 Genesis and Development of Regulatory framework 115 of Indian Capital Market Chapter 6 The Securities Contracts (Regulation) Act, 1956 126 Unit 2 Chapter 7 The Securities and Exchange Board of India Act, 1992 158 Chapter 8 Depositories 176 Unit 3 Chapter 9 SEBI (Prohibition of Fraudulent and Unfair Trade Practices 219 Relating To Securities Market) Regulations, 2003 & SEBI (Prohibition of Insider Trading) Regulations, 1992 Chapter 10 SEBI (Portfolio Managers) Regulations, 1993 240 Chapter 11 SEBI (Underwriters) Regulations, 1993 261 Unit 4 Chapter 12 SEBI (Ombudsman) Regulations, 2003 274 Chapter 13 Compliances of Listing Agreement 289 Chapter 14 SEBI (Disclosure and Investor Protection) Guidelines, 2000 311
  3. 3. 3 Chapter 1 Company Incorporation in India INTRODUCTION As you are aware, India is one of the fastest growing economies and most attracted investment destination of the world. It is important for you to know different types of business entities that are allowed in India to do business. The following types of business entities are available for Indian resident doing business by Indian legal framework:  Proprietorship  Partnership firm  Limited Liability Partnership  Private Limited Company  Public Limited Company In addition to the above legal entities, the following types of entities are available for foreign investors/foreign companies doing business in India:  Wholly owned Subsidiary Company  Joint Venture Company  Liaison Office/Representative Office  Project Office  Branch Office Other forms of business entities which are beyond the realms of this guide are  Co-operatives  Joint Hindu Family Business Although we have various types of business entities as mentioned above, we will focus the kind of companies that can be promoted and registered under the Companies Act 1956, for the rest of course.There are three basic types of companies‘ viz. Private Limited Companies, Public Limited Companies, and Producer companies. You could classify the companies from the point of incorporation and liability. Let us classify the companies from the point of incorporation:
  4. 4. 4 A. Classification on the basis of Incorporation: There are three ways in which companies may be incorporated. 1. Chartered Companies: A company formed, incorporated and legitimised by the grant of a charter by the Crown is called a Chartered Company. It is regulated by that Charter. The East India Company, British South Africa Company, and the Chartered Bank are examples of Chartered Companies. 2. Statutory Companies: A company formed and incorporated byspecial Act of Parliament or State Legislature. The provisions of the Companies Act, 1956 do not apply to them. Examples of these types of companies are Reserve Bank of India (RBI), Life Insurance Corporation of India (LIC), and so on. 3. Registered Companies: The companies that are incorporated under the Companies Act, 1956 by getting themselves registered with Registrar of Companies (ROC) fall under this category. B. Classification on the basis of Liability: Under this category, there are three types of companies: 1. Unlimited Companies: In this type of company is being related uncommon. The membersare liable for the company's debts in proportion to their respective interests in the company and their liability is unlimited. These types of companies may or may not have share capital. It may be either a public company or private company. 2. Companies limited by guarantee:Usually non-profit organisation such as charities, community projects, clubs, societies and other similar bodies that need legal personality would prefer to incorporate under this category. A company that has the liability of its members limited to such amount as the members may respectively undertake, by the memorandum, to contribute to the assets of the company in the event of winding-up, is known as a company limited by guarantee. The members of a guarantee company are, in effect, placed in the position of guarantors of the company's debts up to the agreed amount. It does not have a share capital or shareholders, but members who act as a guarantor. Further, they do not distribute their profits to their members, but they either retain them within the company or use them for some other purpose. 3. Companies limited by shares: A company that has the liability of its members limited by the memorandum to the amount, if any, unpaid on the shares respectively held by them is termed as a company limited by shares. Companies limited by shares are by far the most common and may be either public or private. C. Other Forms of Companies: in addition to the above, there are six types of companies namely, Associations not for profit having licence under Section 25 of the Act;
  5. 5. 5 Government Companies; Foreign Companies; Holding and Subsidiary Companies; Investment Companies; and Producer Companies. In India, incorporation of a company is governed by the Companies Act 1956. It is the most important part of legislation that empowers the central government to regulate the formation, financing, functioning and winding up of companies. This act is applies to the companies that are registered under this act. However, it does not apply to Universities, co- operative societies, unincorporated trading, and other societies. The incorporation procedures are same all over India. This act lays down the set of rules for the establishment of private or public limited company in India. Let us discuss the definition of private and public limited companies according to the Companies Act 1956. Definition In this section, let us discuss the broad definition of different types of companies. PRIVATE LIMITED COMPANY: U/s 3(1), a private company means a company, which has a minimum paid-up capital of Rs.100,000 (rupees one lakh only) or such higher paid-up capital as may be prescribed, and its articles: a. Restricts the right to transfer its shares, if any; b. Limits the number of its members to 50 not including— i. persons who, are in the employment of the company; and ii. persons who, having been formerly in the employment of the company, were members of the company while in that employment and have continued to be members after the employment ceased; c. Prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company; and d. Prohibits any invitation or acceptance of deposits from persons other than its members, directors or their relatives. PUBLIC COMPANY: U/S 3 (1) (iv), a public company means a company which- a. Is not a private limited b. Has a minimum of paid-up capital of Rs.5 lakh rupees or higher as it is prescribed c. Private company which is a subsidiary of a company which is not a private company. d. Should consist of not less than 7 members which is registered under the Act.
  6. 6. 6 e. Can invite the public to subscribe for any shares in, or debentures of, the company. Moreover, the shares and debentures of a public limited company may be quoted on a stock exchange. LIMITED COMPANY: Section 2(23) defines 'Limited Company'. It means a company limited by shares or by guarantee. In case of limited company, the liability of the members may be limited to the nominal value of the shares held by them in the event of winding up of the company. On the other hand, the liability of the members to the limited by guarantee may be limited to the amount that they have guaranteed to contribute in the event of winding up of the company. Companies Limited by Shares: Under Section 12(2)(a), a company limited by shares is a registered company. The members‘ liability is limited to the amount that is mentioned in the Memorandum of Association. For example, the share price mentioned in the MoA is Rs.100. Accordingly, no member of a company can be called upon to pay more than the face value. However, if a member is paid fully, he/she has nothing more to pay. On the other hand, a member is paid partly, the unpaid portion is payable at any time during the existence of the company of a call being made, whether the company is a going concern or is being wound up. This is the most common form of business entity in existence. Companies Limited by Guarantee: As discussed above, usually no-profit organisations are registered under this category.A special feature of this type of company is that the liability of members to pay their guaranteed amounts arises only when the company has gone into liquidation, not when it is a going concern. UNLIMITED COMPANY:As per Section 12(2) (c) defines an unlimited company refers to a company is not having any limit on the liability of its members. Therefore, the maximum liability of the member of such a company might stretch up to the full extent of their assets to meet the obligations of a company by contributing to their assets. However, the members of an unlimited company are not liable directly to the creditors of the company, as in the case of partners of a firm. Further, the liability of the members is only towards the company and in the event of liquidation only, not during the existence. An unlimited company may or may not have share capital. If it has a share capital, it has to be stated the numbers of members in the articles of association and is to be registered u/s 27(1).Under Section 32, a company registered as an unlimited company may subsequently convert itself as a limited company, subject to the provision that any debts, liabilities, obligations or contracts incurred or entered
  7. 7. 7 into, by or on behalf of the unlimited company before such conversion are not affected by such changed registration. ASSOCIATION NOT FOR PROFIT: Under Section 13(1)(a), it is essential that the company registered under the limited liability shall have the last words as ‗Limited‘. However, Section 25 permits the registration of associations not for profit with limited liability without being required to use the word ‗Limited‘ or the words ‗Private Limited‘ after their names. This is of great value to companies not engaged in business such as bodies pursuing charitable, educational or other purposes of great utility. Typically, the licence for those companies shall be granted by the Central Government. The Central Government may grant such a licence if: 1. it is intended to form a company for promoting commerce, art, science, religion, charity or any other useful object; and 2. the company prohibits payment of any dividend to its members but intends to apply its profits or other income in promotion of its objects. The company is registered without paying any stamp duty on its Memorandum and Articles. On registration, the Association enjoys all the privileges of a limited company, and is subject to all its obligations, except, those in respect of which exemption by a special or general order is granted by the Central Government. A licence may be granted by the Central Government under Section 25 of the Act on such conditions and subject to such regulations as it thinks fit and those conditions and regulations shall be binding on the body to which the licence is granted. The Central Government may direct that such conditions and regulations shall be inserted in the Memorandum, or in the Articles, or partly in the one and partly in the other. This type of company cannot alter the provisions of its Memorandum with respect to its objects except with the previous approval of the Central Government in writing. GOVERNMENT COMPANIES: Section 617 defines a Government company as any company in which not less than fifty one per cent of the paid-up share capital is held by the Central Government, or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments. A subsidiary of a Government company is also treated as a Government company. The following are the exemptions to Government Companies from applicability of Notified Sections/ Provisions of the Companies Act, 1956: Section 620 of the Companies Act, 1956 empowers the Central Government to direct by notification in the Official Gazette that any of the provisions of the Act shall not apply to Government companies or apply only with such exceptions, modifications and adaptations,
  8. 8. 8 as may be specified in the notification. However, the provisions of Sections 618, 619 and 619A mandatorily apply to such companies.In exercise of its powers under the above mentioned Section 620, the Central Government has issued notifications modifying the operation of different provisions of the Companies Act to Government companies some of which are as under: 1. Sections 17, 18, 19 and 186 shall apply to a Government company with the substitution of the words ‗Central Government‖ for ―Court/CLB‖ wherever it occurs; and Section 166 shall apply with the substitution in the second proviso to Sub-section (1) of the words ‗Central Government‗ for the word ―Registrar, and in Sub-section (2) of Section 166 with the substitution of the words ―such other place as the Central Government may approve in this behalf‖ for the words ―some other place within the city, town or village in which the registered office of the company is situated". 2. Further Government companies are permitted to delete the word ‗Private‖ from their name (Sections 21 and 23). 3. The Central Government has made various exemptions in the application of the provisions of the Act to Government companies. Government companies have been exempted from the following sections: a. Sections 255, 256 and 257 of the Act pertaining to appointment and retirement of directors in companies wholly owned by the Government. b. Sections 198, 259, 268, 269, 309, 310, 311, 387 and 388 of the Act pertaining to appointment of managing/whole-time directors and manager and their remuneration. c. Proviso to Sub-section (1) of Section 297 of the Act requiring the previous approval of the Central Government in respect of contracts entered into by it with any other Government company. d. Section 187C requiring disclosure of beneficial interest in shares of a company. e. Section 205A requiring transfer of unpaid dividend to a special dividend account shall not apply to a Government company in which the entire paid-up share capital is held by the Central Government or by any state Government or Governments or by the Central Government or by any State Government or Governments or by the Central Government and one or more State Governments. This is in supersession of an earlier notification No. G.S.R. 231 dated the 31st January, 1978 [G.S.R. 580(E)]. f. Section 295 of the Act shall not apply to a Government company provided that such company shall obtain the approval of the Ministry or Department of the Central Government which is administratively in-charge of the company or, as the
  9. 9. 9 case may be, the State Government. This is in supersession of an earlier notification No. S.O. 729 dated 24th May, 1978 [G.S.R. 581(E)]. g. Sections 43A*, 149(2A), 205B, 263 to 266, 307, 308, 316, 317 and 386 of the Act shall not apply to a Government company in which the entire paid-up share capital is held by the Central Government or by any State Government or Governments or by the Central Government and one or more State Governments [G.S.R. 577 (E)]. h. Sections 165, 187D*, 294 and Sub-sections (2) and (3) of Section 294AA of the Act shall not apply to a Government company [G.S.R. 578(E)]. i. Section 108 of the Act shall not apply to a Government company [G.S.R. 579(E)]. j. It has further been notified that the following sections of the Companies Act, 1956 shall apply to Government companies with the modification that instead of Court the application will be made to the Central Government. i. Sections 100, 101, 102 and 103 of the Act regarding reduction of capital by a company. ii. Sections 391, 392 and 394 of the Act pertaining to amalgamation of companies. b. Therefore, the legal status of a Government company is not affected because the share capital of the company is contributed by the Central or State Government and all its shares are held by the President of India or Governor of a State or certain nominated offices of the Government. When the Government engages itself in trading ventures, particularly as Government companies under the company law, it does not do so as a State but it does as in essence as a company. A Government company is not a department of the Government. FOREIGN COMPANIES: A foreign company is a company which is incorporated in a country outside India, under the law of that (other) country and has a place of business in India. Sections 591 to 602 of the Act deal with such companies. Foreign companies are of two classes namely: 1. Companies incorporated outside India, which have established a place of business in India after April 1, 1956; and 2. Companies incorporated outside India, which established a place of business in India before that date and continue to have an established place of business in India. It is essential under section 592 of the Act that every foreign company which establishes a place of business in India must file with the Registrar of Companies (ROC) at New Delhi and also with the ROC of the respective state in which such place of business is suited. The company should submit all the relevant documents such as MoA, registered address, nationality and so on.The same requirements as regards accounts and their filing and as
  10. 10. 10 also the registration of the charges created in India are applicable to them, as to Indian companies. No application form for shares or debentures can be issued in India without a copy of the prospectus. Section 584 of the Companies Act, 1956 provides further that when 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 Sections 582 to 590 of the Act, even though the company has been dissolved or ceased to exist under the laws of the country in which it was incorporated. HOLDING AND SUBSIDIARY COMPANIES: „Holding‘ and ‗Subsidiary‘ companies are relative terms. A company is a holding company of another if the other is its subsidiary. According to Section 4 of the Companies Act, a company shall be deemed to be subsidiary of another, if and only if: (a) that other controls the composition of its Board of directors; or (b) that other: (i) where the first-mentioned company is an existing company in respect of which the holders of preference shares issued before commencement of the Companies (Amendment) Act 1960, have the same right in all respects as the holders of equity shares, exercises or controls more than half of the total voting power of such company; (ii) where the first-mentioned company is any other company, holds more than half in the nominal value of its equity share capital, or (c) the first mentioned company is a subsidiary of any company which is the other‗s subsidiary. To illustrate, company A Limited is a subsidiary of company B if, and only if: 1. company B (holding company) controls the composition of the Board of directors of company A (subsidiary); or 2. company B (holding company) controls more than 50% voting power of company A (subsidiary); or 3. Company B (holding company) holds more than half in the nominal value of equity shares of company A (subsidiary); or 4. if company A (the subsidiary) is a subsidiary of company C which is subsidiary of company B, then the company A is also a subsidiary of company B. 5. If Company D is the subsidiary of company A then D will be the subsidiary of company C and also of company B. INVESTMENT COMPANIES: The principal business of these types of companies consists in acquiring, holding and dealing in shares and securities and thereby earning income by way
  11. 11. 11 of interest, dividend etc. In addition, they earn income not only through the acquisition and holding but also by dealing in shares and securities i.e. to buy with a view to sell later on at higher prices and to sell with a view to buy later on at lower prices. If a company is engaged in any other business to an appreciable extent, it will not be treated as an investment company. The following two sets of legal opinions are quoted below as to the meaning of an investment company: According to one set of legal opinion, an "investment company" means company which acquires and holds shares and securities with intent to earn income only from them by holding them. On the other hand, another school of legal opinion holds that ―an Investment Company means a company, which acquires shares and securities for earning income by holding them as well as by dealing in such shares and other securities.According to Section 2(10A) of the Insurance Act, 1938, an investment company means a company whose principal business is the acquisition of shares, stocks, debentures or other securities. PRODUCER COMPANIES: Companies (Amendment) Act, 2002 had added a new Part IXA to the main Companies Act, 1956 consisting of 46 new Sections from 581A to 581ZT. According to the provisions as prescribed under Section 581A(l), a producer company is a body corporate having objects or activities specified in Section 581B and which is registered as such under the provisions of the Act. The membership of producer companies is open to such people who themselves are the primary producers, which is an activity by which some agricultural produce is produced by such primary producers. Objects of Producer Companies:In terms of Section 581B (1) the objects of a producer company registered under this Act may be all or any of the following matters: A. Production, harvesting, procurement, grading, pooling, handling, marketing, selling, export of primary produce of the members or import of goods or services for their benefit. B. Processing including preserving, drying, distilling, brewing, venting, canning and packaging of the produce of its members. C. Manufacturing, sale or supply of machinery, equipment or consumables mainly to its members. D. Providing education on the mutual assistance principles to its members and others. E. Rendering technical services, consultancy services, training, research and development and all other activities for the promotion of the interests of its members.
  12. 12. 12 F. Generation, transmission and distribution of power, revitalisation of land and water resources, their use, conservation and communications relatable to primary produce. G. Insurance of producers or their primary produce. H. Promoting techniques of mutuality and mutual assistance. I. Welfare measures or facilities for the benefit of the members as may be decided by the Board. J. Any other activity, ancillary or incidental to any of the activities referred to in clauses (a) to (i) above or other activities which may promote the principles of mutuality and mutual assistance amongst the members in any other manner. K. financing of procurement, processing, marketing or other activities specified in clauses (a) to (j) above, which include extending of credit facilities or any other financial services to its members. Further, under Section 581B(2) it has also been clarified that every producer company shall deal primarily with the produce of its active members for carrying out any of its objects specified above. FINANCE COMPANIES: According to Rule 2(cc) of the Companies (Acceptance of Deposits) Rules, 1975, a Financial Company‗ means a non-banking company which is a financial institution within the meaning of clause (c) of Section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934). A Financial institution has been defined under Section 45-I of the Reserve Bank of India Act, 1934 as follows: Financial institution means any non-banking institution which carries on as its business or part of its business any of the following activities: (i) the financing, whether by way of making loans or advances or otherwise, or any activity other than its own; (ii) the acquisition of shares, stocks, bonds, debentures or securities issued by a Government or local authority or other marketable securities of the like nature; (iii) the letting or delivery of any goods to a hirer under hire-purchase agreement as defined in clause (c) of Section 2 of the Hire-Purchase Act, 1972; (iv) the carrying on of any class of insurance business;
  13. 13. 13 (v) the managing or conducting or supervising as foreman, agent or in any other capacity, of chits as defined in any law which is for the time being in force in any state, or any business, which is similar thereto; (vi) collecting for any purpose or under any scheme or arrangement by whatever name called, monies in lump-sum or otherwise, by way of subscription or by sale of units, or other instruments or in any other manner and awarding prizes, gifts, whether in cash or in kind or disbursing monies in any other way to persons from whom monies are collected or to any other person, but does not include any institution, which carries on as its principal business: a. agricultural operations; or Industrial activity; or b. the purchase or sale of any goods (other than securities) or the providing of any services; or c. the purchase, construction or sale of immovable property, so, however, that no portion of the income of the institution is derived from the financing of purchases, constructions or sales of immovable property by other persons; Explanation: For the purposes of this clause, ―industrial activity means any activity specified in sub-clauses (i) to (xviii) of clause (c) of Section 2 of the Industrial Development Bank of India Act, 1964 (18 of 1964). d. firm means a firm as defined in the Indian Partnership Act, 1932 (9 of 1932); e. non-banking institution‖ means a company, corporation or co-operative society; f. non-banking financial company means— i. a financial institution which is a company; ii. a non-banking institution which is a company and which has as its principal business the receiving of deposits, under any scheme or arrangement or in any other manner, or lending in any manner; iii. Such other non-banking institution or class of such institutions, as the bank may, with the previous approval of the Central Government and by notification in the Official Gazette, specify. A non-banking institution has been defined in clause (e) of the said section to mean a company, corporation, co-operative society or firm. Thus, a financial company is a company or corporation or co-operative society or firm which is a financial institution within the meaning of clause (c) of Section 45-I of the Reserve Bank of India Act, 1934.
  14. 14. 14 PUBLIC FINANCIAL INSTITUTIONS: Section 4A (1) of the Companies Act, 1956 provides that the following financial institutions shall be regarded, for the purposes of this Act, as a public financial institution:- (i) the Industrial Credit and Investment Corporation of India Limited, a company formed and registered under the Indian Companies Act, 1913; (ii) the Industrial Finance Corporation of India, established under section 3 of the Industrial Finance Corporation Act, 1948; (iii) the Industrial Development Bank of India, established under section 3 of the Industrial Development Bank of India Act, 1964; (iv) the Life Insurance Corporation of India, established under section 3 of the Life Insurance Corporation Act, 1956; (v) the Unit Trust of India, established under section 3 of the Unit Trust of India Act, 1963; (vi) the Infrastructure Development Finance Company Limited, a company formed and registered under this Act. Sub-section (2) of Section 4(A) of the Companies Act, 1956 empowers the Central Government to specify any other institutions, as it may think fit, to be a public financial institution by issuing a notification in the Official Gazette. However, no institution shall be so specified unless: (i) it has been established or constituted by or under any Central Act; or (ii) not less than 51% of the paid-up share capital of such institution is held or controlled by the Central Government. Criteria for declaring an institution as Public Financial Institution: Earlier the Central Government was declaring an institution as Public Financial Institution, if it meets any one of clause (i) & (ii) of Sub-Section (2) of Section 4A of the Act. Now, Central Government has framed the following criteria for declaring any financial institution as Public Financial Institution under Section 4A of the companies Act, 1956 (MCA General Circular No. 34/2011 dated 02.06.2011):- i. A company or corporation should be established under a special Act or the Companies Act being Central Act; ii. Main business of the company should be industrial/infrastructural financing; iii. The Company must be in existence for at least 3 years and their financial statement should show that their income from industrial/infrastructural financing exceeds 50% of their income; iv. The net worth of the company should be Rs.1000 Crore;
  15. 15. 15 v. Company is registered as Infrastructure Finance Company (IFC) with RBI or as an Housing Finance Company (HFC) with National Housing Bank; vi. In the case of CPSUs/SPSUs, No restrication shall apply with respect to financing specific sector(s) and net-worth. So far we have discussed the definition of different types of companies. Now let us focus about Promoters. PROMOTERS Commencement of the business is possible only it receives the Certificate of Incorporation. However, someone lays the ground work for the company before the company gets incorporation. The person(s) who take the responsibility of starting the company are called as Promoter (s).The Companies Act, 1956, does not define the word 'promoters' but the word promoter has been used in Sections 62, 69, 76, 478 and 519 of the Companies Act, 1956. According to SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, ―promoter includes: (i) the person or persons who are in control of the issuer; (ii) the person or persons who are instrumental in the formulation of a plan or programme pursuant to which specified securities are offered to public; (iii) the person or persons named in the offer document as promoters: In addition to the above, it is important you to know that  Provided that a director or officer of the issuer or a person, if acting as such merely in his professional capacity, shall not be deemed as a promoter:  Provided further that a financial institution, scheduled bank, foreign institutional investor and mutual fund shall not be deemed to be a promoter merely by virtue of the fact that ten per cent. or more of the equity share capital of the issuer is held by such person;  Provided further that such financial institution, scheduled bank and foreign institutional investor shall be treated as promoter for the subsidiaries or companies promoted by them or for the mutual fund sponsored by them;
  16. 16. 16 Position of a Promoter:it may be difficulty to describe about promoter, but his legal position is very clear. A promoter is neither an agent of, nor a trustee for, the company, because it is not in existence. However, when he acts with the company in mind, he/she stands in a fiduciary position towards the company. Lord cairns have correctly stated the position of a promoter in Erlanger v. new sombrero phosphate co. (39 LT 269) ―The promoters of a company stand undoubtedly in a fiduciary position. They have in their hands the creation and shaping of the company. They have the power of defining how, and when, and in what shape and under what supervision, it shall start into existence and begin to act as a trading corporation.‖Similarly, it was observed in Lagunas Nitrate Co. v. Lagunas Syndicate, (1899) 2 Ch. 392 that "promoters" stand in a fiduciary relation to the company they promote and to those persons whom they induce to become shareholders in it". There are no provisions regarding the duties of promoters in Companies Act. However, Section 62, 63 and 542 only impose liabilities on promoters for untrue statement in the prospectus and fraudulent trading. There are two fiduciary duties of a promoter, namely: 1. A promoter cannot make either directly or indirectly, any profit at the expense of the company he promotes, without the knowledge and consent of the company and that if he does so, in disregard of this rule, the company can compel him to account for it. In relation to disclosure, it may be noted that part disclosure is worse than none. A promoter is not forbidden to make profit but he is barred from making any secret profit. He/she may make a profit out of promotion with the consent of the company in the same way as an agent may retain a profit obtained through his/her agency with his/her principal's consent. 2. A promoter is not allowed to derive a profit from the sale of his own property to the company unless all material facts are disclosed. If a promoter contracts to sell his own property to the company without making a full disclosure, the company may either repudiate the sale or affirm the contract and recover the profit made out of it by the promoter. Either way the dishonest promoter is deprived of his advantage. In case, therefore, the promoter wishes to sell his own property to the company, he/she should either disclose the fact: (a) To an independent Board of directors; or (b) In the articles of association of the company; or (c) In the prospectus; or (d) To the existing and intended shareholders directly.
  17. 17. 17 It is essential to know that promoter‘s duties cannot depend on a contract. While he/she begins the promotional activities, company is not incorporated and hence cannot contract with its promoters. The promoter's duties must be the same as that of a person acting on his/her behalf of another individual without a contract of employment. If he/she does make any misrepresentation in a prospectus he/she may be held guilty of fraud under Section 17 of the Indian Contract Act and would be held liable for damages under Section 19 of that Act. Liabilities of Promoters A promoter is subject to the following liabilities under the various provisions of the Companies Act, 1956. 1. Section 56 and Schedule II of the Act lays down matters to be stated and reports to be set out in the prospectus. The promoter(s) may be held liable for the non- compliance of the provisions of this Section. 2. Under Section 62, a promoter is liable for any untrue statement in the prospectus to a person who has subscribed for any shares or debentures on the faith of the prospectus. Such a person may sue the promoter for compensation for any loss or damage sustained by him/her. In the event of a false statement in the prospectus the following consequences will follow: a. the allotment of shares may be set aside; b. the promoter may be sued for damages; c. he/she may be sued for compensation for misrepresentation under Section 62(1)(c) of the Act; d. he/she may be sued for damages by shareholders who have suffered by reason of his/her non-compliance with the statutory requirements as to the contents of the prospectus; e. He/she may become liable to criminal proceedings. 3. By virtue of Section 203, of the Companies Act, 1956 the Court may suspend a promoter from taking part in the management of a company for a period of 5 years if:
  18. 18. 18 i. he is convicted of any offence in connection with the promotion, formation or management of a company; or ii. in liquidation it appears that he: A. has been guilty of any offence for which he is punishable (whether he has been convicted or not) under Section 542; or B. 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. 4. Under section 63, besides civil liability, the promoters are criminally liable for the issue of prospectus containing untrue statements. This section imposes severe penalty on promoters who make untrue and deceptive statements in prospectus with a view to obtaining capital. The punishment prescribed, is imprisonment for a term which may extend to two years or with fine which may extend to Rs. 50,000/- or with both. A promoter can, however, escape the punishment if he proves:  that the statement was immaterial; or  that he had reasonable ground to believe, and did, up to the time of the issue of prospectus, believe that statement was true. 5. Under section 478, a promoter may be liable to public examination like any other director or officer of the company if the court so directs on a liquidator's report alleging fraud in the promotion or formation of the company. 6. Under section 543, a company may proceed against a promoter on action for deceit or breach of duty, 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. Remuneration of Promoters Promoters cannot claim remunerations from the company as a matter of right. Further, he/she has no right to claim of promotional expenses for his/her services and preliminary expenses unless there is a valid contract. But, a company before incorporation cannot enter into a contract. After incorporation, he/she may be rewarded for his efforts that are in mercy of the directors(Re English & Colonial Produce Co.). However the Articles of a company generally contain a provision to this effect and authorise the directors to remunerate the promoters.In practice, remunerations to a promoter for his services would be in any of the following ways: i. He/she may sell his/her own property to the company for cash or against fully paid shares in the company at an over valuation after making full disclosure to a disinterested Board of Directors or to the intended shareholders.
  19. 19. 19 ii. He/she may be given an option to buy further shares in the company at par. iii. He/she may take commission on the shares sold. iv. He/she may take a grant of some shares in the company. v. He/she may be paid a lump-sum by the company. vi. The articles may provide for a fixed sum to be paid to him. Such a provision has no contractual effect and he cannot sue to enforce it, but if it is acted upon, the company cannot recover its money. Whatever be the nature of remuneration or benefit, it must be disclosed in the prospectus, if paid, within 2 years preceding the date of the prospectus. INCORPORATION OF COMPANIES In order to incorporate a company, there are procedures that need to be followed systematically. The following are the steps: A. Deciding the types of company:Under the Companies Act, 1956 only three types of companies can be registered, viz.  Public companies;  Private companies; and  Producer companies. In this study, we shall concentrate only on the steps of incorporating Public and Private limited companies. Section 12 of the Act provides that any seven or more persons, or where the company to be formed will be a private company, any two or more persons, associated for any lawful purpose may, by subscribing their names to the Memorandum of Association and otherwise complying with the requirements of this Act in respect of registration, form an incorporated company, with or without limited liability. These companies may further be classified as follows: (i) Companies limited by shares; (ii) Companies limited by guarantee with or without share capital; and (iii) Unlimited companies with or without share capital.
  20. 20. 20 B. Application for Availability of Name of company: 1. A company is identified by the name in order of preference with which it is to be registered upto a maximum of six names. According to Section 13 of the Act, the name of the company should be mentioned in the Memorandum of Association. As discussed earlier, the name of a company must end with the word "Limited" in the case of a public company and the words "private limited" in the case of a private company. The name of a company must end with the ‗Limited‘ or ‗private limited‘ for a company obtaining a licence from the Regional Director under section 25 of the Act. 2. According to Section 20 of the Act a company cannot be registered with the name that resembles the name of any other already registered company. In addition, a company does not violate the provisions of Emblems and Names (Prevention of Improper Use) Act, 1950. Before deciding the name of the company, the promoter can avail the services of checking name availability on the portal. (to decide the availability of names, the Ministry of Corporate Affairs has issued Name Availability Guidelines, 2011 w.e.f. 24th July 2011) 3. The promoter will submit the application to the concerned Registrar of Companies (ROC) in e-Form No. 1A according to the Companies (Central Government's) General Rules and Forms (Amendment) Rules, 2011 vide Rule 4A. A fee of Rs. 1000 (w.e.f. 24.07.11) is to be paid along with e-Form 1A. 4. In case the proposed name is not available, the registrar may reject the same or ask for resubmission of the application with new names or calls for further information, ordinarily within three days of receipt of the application. 5. The applicant shall be given only upto two opportunities for re-submission of their proposal against the fee paid in the first instance for name availability after the original application is filed. After the name approval, the applicant can apply for registration of the new company by filing the required forms (form 1, 18, and 32) within 60 days from the date of name approval. The name allowed shall lapse and no extension will be granted after expiry of sixty days from the date the name is allowed. C. Preparation of Memorandum and Articles of Association: This Memorandum of Association is considered as the constitution of a company. It defines the area within which the company can act. This document consists the objective of the company, nature of business, liability, capital, location of registered office and so on. The other important document is the Articles of Association which contains the rules and regulations relating to the internal management of a company.
  21. 21. 21 D. Vetting of Memorandum and Articles, Printing, Stamping and Signing of the same:The draft of the Memorandum and Articles should be prepared and typed before printing the Memorandum and Articles of Association of a company and submit the same to the Registrar of Companies for vetting the draft Memorandum and Articles. Sometimes you may receive the changes from Registrar of Companies which needs to be incorporated before going for the final printing. It is important to note that there is no definite commitment from the Registrar in this regard vide circular No. 128 (HCC) 64 date 27th July 1964. The Memorandum and Articles have to be stamped and the value of stamp differs from State to State as per respective State Stamp laws. Further, section 15 stipulates that every Memorandum should be signed by each subscriber 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 likewise add his address, description and occupation, if any. Similarly, the Articles of Association should also be signed separately by subscribers. The signatures of the subscribers in the Articles of Association are also to be attested by a witness. E. Power of Attorney: In order to carryout various formalities that are required for incorporation of a company, the promoters may appoint an attorney empowering him to carry out the instructions/requirements stipulated by the Registrar. To do so, it requires execution of a Power of Attorney on a non-judicial stamp paper of a value prescribed in the respective State Stamp Laws. F. Additional documents required:As we discussed earlier, Form 1A application to get approval for the name of the company to be registered. After that depending upon the proposed company type, it required additional documents as given below: i. Form 1 (Statutory Declaration): Section 33(2) requires that a declaration in e-Form No. 1 of the Companies (Central Government's) General Rules and Forms (Amendment) Rules, 2006 duly singed by an advocate of the Supreme Court or a High Court, or an attorney or pleader entitled to appear before the High Court or a Secretary or a Chartered Accountant practising in India who is engaged in the formation of a company or by a person named in the Articles as a director or manager, or secretary of a company, that all the requirements of the Companies Act, 1956 and the rules thereunder have been complied with in respect of registration and matters precedent and incidental thereto to be filed with the Registrar. However, the Registrar may accept such a declaration.It is important that the above declaration should be on a non-judicial stamp paper of appropriate value with reference to the State in which the office of the Registrar of Companies is situated. ii. Form-18 (Registered Address): under section 146 requires that a declaration in e- form about the location of the registered office of a company. This information should
  22. 22. 22 be submitted from the day on which it begins to carry on business or as from the 30th day after the day of its incorporation whichever is earlier. iii. Form 32 (Particulars of Directors): This form requires the details of a person who acts as a director or manager or secretary as mentioned in Articles of Association. This form is also to filled within 30 days of the registration of the company or appointment of first director. iv. Director‟s Identification Number (DIN): This concept has introduced by Ministry of Corporate Affaris (MCA). This number is mandatory, unique, and life time identification for all existing as well as prospective directors. This number is a prerequisite for e-filing.As the number is required at the time of submitting e-form 32, any individual who is a director or intends to be a director of a company shold apply and obtained the same before commencing the procedure for incorporation of a company. v. Registration Fees: In addition to the above documents, the fee prescribed for registration of company is required to be paid to the Registrar. The amount of registration fees depends on the nominal capital of the company to be incorporated in case of companies having share capital. The details have been prescribed in Schedule X to the Act. Certificate of Incorporation If the Registrar of Companies is satisfied that all the aforesaid documents submitted a company, he/she shall certify under his/her hand that the company is incorporated. From the date of incorporation mentioned in the Certificate of Incorporation, members of the company shall be a body corporate by the name contained in the Memorandum, capable forthwith of exercising all the functions of an incorporated company and having perpetual succession and a common seal, but with such liability on the part of the members to contribute to assets of the company in the event of its being wound up as mentioned in the Act (Section 34). From the date of incorporation, the company becomes a separate legal entity notwithstanding the fact that there was only one governing director who also held a majority of the shares of the company. The separate legal entity enabled a director who representing the company, to enter into a contract of employment with himself in his individual capacity. Two companies which are incorporated with the same set of shareholders are nevertheless distinct and separate entities. Let us discuss the contents of Memorandum and Articles of Association, because it helps to understand the importance of the same.
  23. 23. 23 Memorandum of Association This is one of the documents that have submitted with the RoC at the time of incorporation of a company. Section 2(28) defines, ―the memorandum of association of a company as originally framed or as altered from time to time in pursuance of any previous company law or of this act.‖ It is a great challenge to understand about MoA by reading the above definition. Let us discuss in detail, because it is an extremely important document in relation to the affairs of the company. This document sets out the constitution of the company and is therefore the foundation on which the structure of the company is based. It contains the fundamental conditions upon which alone the company is allowed to be incorporated. As discussed above, this is essential document to get incorporation. This is evidenced in This is evidenced in Section 12 of the Act, which provides the mode of forming an incorporated company and states that in the case of a public company, any seven or more persons, and in the case of a private company, any two or more persons, associated for any lawful purpose, may by subscribing their names to a memorandum and complying with the other requirements of this Act in respect of registration, may form an incorporated company, with or without limited liability. It is important that the company pursue the objects and exercise only such powers as are conferred expressly in the documents. The purpose of the memorandum is to enable shareholders, creditors and those who deal with the company to know the permitted range of the company. Further, it defines as well as confines the powers of the company. Lord Cairns in Ashbury Railway Carriage Co. V. Riche pointed out,‖ The memorandum is as it were, the
  24. 24. 24 area beyond which the action of the company cannot go; inside that area the shareholders may make such regulations for their own government as they think fit.‖ Purpose of memorandum: The purpose of the MoA is twofold. 1. The intending shareholders who contemplate the investment of his/her capital shall know within what field it is to be put at risk. 2. Anyone who shall deal with the company shall know without reasonable doubt whether the contractual relation into which he/she contemplates entering with the company is one relating to a matter within its corporate objects. Sections 12 to 23 of the Act prescribe the particulars to be mentioned in a MoA and other requirements. It is considered as the constitution of the company in its relation to the outside world. The company cannot depart from the provisions of the MoA. If it enters into contract or engages in any trade or business which is beyond the powers conferred on it by the MoA, such a contract or the act will be ultra vires the company and hence void. Form of Memorandum of Association Section 14 of the Companies Act provides that the memorandum of association should be in any one of the Forms specified in Tables B, C, D and E of Schedule I to the Companies Act, 1956. The table may be applicable in relation to the type of company proposed to be incorporated. The table and its type of companies are given below: Table Types of Companies B Companies Limited by Shares C companies limited by guarantee D companies limited by guarantee, not having a share capital E companies limited by guarantee and having a share capital A company may either adopt any of the model Forms of the MoA mentioned above, as may be applicable to it, or it may prepare it in any other Form. Nevertheless the same should be as near thereto as the circumstances may admit. Contents of Memorandum: According to section 13, MoA of every company must contain the following clauses:
  25. 25. 25 1. The name of the company with ‗limited‘ as the last word of the name in the case of a public limited company and with ‗private limited‘ as the last word in the case of a private limited company. 2. The state in which the registered office of the company is to be situated. 3. The objects of the company are classified as stated below: a. The main objects of the company to be pursued by the company on its incorporation, objects incidental to the attainments of the main objects, and b. Other objects not included above 4. In the case of companies with object not confined to one state, the states to whose territories the objects extend. 5. The liability of members is limited if the company is limited by shares or by guarantee. 6. In the case of a company having a share capital, the amount of share capital with which the company proposes to be registered and its division into shares of a fixed amount. Note that an unlimited company need not include items 5 and 6 in its memorandum.In the case of a company limited by guarantee, its MoA shall state that each member undertakes to contribute to the assets of the company, in the event of its being winding up while he/she is a member or within or year afterwards for the payment of the debts and liabilities of the company as well. Every member to the MoA shall take at least one share and shall write opposite to his/her name the number of shares taken by him/her.It is to be noted that section 9 of the Companies Act, 1956 shall override the provisions in the memorandum of a company, if the latter contains anything contrary to the provisions in the Act. A brief discussion of the various clauses is as follows: Name clause: In order to maintain its separate entity, it needs to be registered with any name it likes. However, no company shall be registered by a name which, in the opinion of the central government, is undesirable. In particular, a name which is identical or which too nearly resembles the name of an existing company. Note merely that a few words are common may not be considered the name too identical and thus undesirable (section 20). It must that every public company must end with the word ‗limited‘ after its name and every private limited company must end with the word ‗private limited‘ after its name. However, the use of the word ‗company‘ is not compulsory. Companies, whose liabilities are unlimited, are prohibited from using the word ‗limited‘. The words ‗limited‘ may be dispensed with in the name of charitable companies, but companies formed to promote art, science, religion etc, which do not propose to pay dividend, but intend to apply all its profits towards the working
  26. 26. 26 of the company, could be registered without the word ‗limited‘ under licenses granted by the Central Government (Section 25) In addition to the above, a company cannot adopt a name which violates the provisions of the Emblems and Names Act, 1950. This act also prohibits the use of the name and emblems of the united nation, and the world health organization, the official seal and emblem of the central and the state governments, the Indian National Flag, the name and pictorial representation of Mahatma Gandhi and the Prime Minister of India.If a limited company makes a contract without using the word ‗limited‘, the directors who make the contract on behalf of the company would be personally liable. Every company is required to publish its name outside its registered office, and the place where it carries on business, to have its name engraved on its seal and to have its name on all business letters, bill heads, seal, notices and other official publications, as well as in all negotiable instruments (section 147). Ministry of Company Affairs has clarified that expression of its name in English only; in addition to the expression in the local language will be a sufficient compliance with the requirements of the section. Registered office clause:This clause states that name of the state in which the registered office of the company is to be situated must be given in MoA. But the exect address of the registered office is not required to be stated therein. This can be informed with the RoC separately in e-Form 18 within 30 days of incorporation of the company. The clause is important for two reasons.  It ascertains the domicile and nationality of a company. This domicile holds to it throughout its existence.  It is the place where various registers relating to the company must be kept and to which all communications and notices must be sent. A company need not to carry on its business at its registered office. Notice of situation of the registered office and every change therein must be submitted within 30 days from the date of incorporation of the company of after the date of change, as the case may be. Objects clause: The objects clause is the most important clause in MoA of a company. It is not merely a record of what is contemplated by the subscribers, but it serves a two-told purposes: 1. It gives an idea to the prospective shareholders for the purposes in which their money will be utilized.
  27. 27. 27 2. It enables the persons who are dealing with the company to ascertain its powers. In case of companies were existence before the commencement of the Companies Act, 1965, the objects of the company would be stated simply. But in case of companies are registered after the amendment, the objects clause must divide their objects into two sub- clauses, namely:  Main objects. This sub-clause has to state the main objects to be pursued by the company on its incorporation and objects incidental or ancillary to the attainment of the main objects.  Other objects: This sub-clause shall state other objects which are not included in the above clause. In the case of a non-trading company, whose objects are not confined to one state clause, must be stated specifically the states to whose territories the objects extend. The subscribers to MoA may choose and object or objects for their company. There are certain restrictions which are given below: 1. The objects should not be against the policy of the constitution. For example, the object should not be such as to encourage untouched ability which has been abolished under our constitution. 2. The objects should not include anything which is illegal or against public policy. For example, forming a company for dealing in lotteries or for trading with the alien enemies. 3. The object must not be against the provisions of the companies act, as for example, authorizing the company to purchase its own shares. On its being registered, the company has power to do whatever is necessary to do for attaining the objects stated in the memorandum, and to do whatever else is incidental to or consequential upon the attainment of the main object. Therefore, It is clear that any act of the company outside its stated, objects is ultra vires and therefore void and cannot be ratified even by the whole body of shareholders. Liability clause:This clause must state that the liability of the members of the company is limited in the case of company limited by shares or guarantee. The members are liable only to the amount of unpaid on the shares taken by them in the case of limited by shares. For example, a face value of a share is Rs.100. The member has paid only Rs.50. The unpaid amount is Rs.50. The member is liable to pay the unpaid amount of Rs.50 in the event of
  28. 28. 28 liquidation of a company. In case the member paid fully, the member cannot be called upon to pay anything. In a company limited by guarantee, the members are liable to the amount undertaken to be contributed in the event of liquidation of a company. The member cannot be called upon to pay anything before the company goes into liquidation. However, this liability clause is omitted from MoA of unlimited companies.If a company carries on business for more than six months, while the number of members is less than 7 in the case of public company and less than 2 in case of a private company, each member is liable for all the debts contracted by the company after the period of six months has elapsed. Capital clause: The MoA of a company limited by shares must state the amount of the capital with which company is registered. The registered amount of capital is known as authorised capital or nominal capital. It clause also states the different kinds of shares and the nominal value of each share. The authorised capital is determined having regard to the present and future requirements of the capital with reference to its objects. A company cannot issue shares more than the amount lays down in the limit. However, the authorised capital could be altered as provided by Section 94 of the Companies Act, 1956. If a company receives applications for shares beyond the shares mentioned in the MoA, the excess number of shares should be returned. A company may wish to issue the shares to the number of shares mentioned in the capital fully or partially, it is known as issued capital. Out of issued capital, the total amount of actual shares subscribed by the subscribers is known as subscribed capital. The amount of subscribed capital again may be fully paid or partially paid by the subscribers is known as paid-up capital. According to Section 148 of the Act, if the amount of the authorised capital, of the company is stated in any notice, advertisement, official publication, business letter, bill head or letter paper, it shall also contain a statement in an equally prominent position and in conspicuous characters of the amount of the capital which has been subscribed and the amount paid-up. Association Clause and Subscription: TheMoA concludes with the subscription clause in which there is a declaration of association. The subscribers to the memorandum declare: ―We, the several persons whose names and addresses subscribed, are desirous of being formed into a company in pursuance of this memorandum of association, and we respectively agree to take the number of shares in the capital of the company set opposite our respective names. Then follow the names, address, occupations of the subscribers, and the number of shares each subscriber has taken and his signatures attested by a witness. The statutory requirements regarding subscription of memorandum are that:
  29. 29. 29 (a) MoA must be signed by each subscriber in the presence of at least one witness who must attest their signatures; (b) each subscriber must take at least one share; (c) each subscriber must write opposite his name the number of shares which he/she agrees to hold (Section 13). Let us discuss the ways in which we can alter the above discussed clauses. Alteration of Memorandum of Association The memorandum of association of a company may be altered in the following respects: 1. By changing its name clause (Sections 21 to 24). 2. By altering it in regard to the State in which the registered office is to be situated or its objects clause (Section 17). 3. By altering its share capital clause (Section 94). 4. By reorganising its share capital (Sections 391 to 396). 5. By reducing its capital (Section 100). 6. By making the liability of the directors‘ unlimited (Section 322). For the purpose of amendment different clauses of the memorandum are broadly classified into two parts, namely, A. Part relating to conditions, and B. Part relating to other provisions. Under section 16(1) of the Companies Act 1956 lays down the procedures to be followed while changing the conditions of memorandum. The provisions relating to the name clause, registered office clause, the objects clause, limited liability clause, subscriber‗s share clause as provided in Section 13 of the Companies Act, 1956 or any other specific provisions contained in the Act are to be regarded as the conditions contained in the memorandum [Section 16(2)]. For the alteration of those conditions in the memorandum of association, a rigid procedure is to be followed and strict compliance of the procedure is demanded by law. Failure to comply with the express provisions made under the Act for the purpose of
  30. 30. 30 alteration of the conditions contained in the memorandum will be deemed as a nullity.Other provisions which are found included in the memorandum including those relating to appointment of a managing director or manager fall in the category of other provisions in the memorandum [See Section 16(3)]. These may be generally altered in the same manner as the articles of the company unless there are any specific directions as to the procedure to be followed made in the Act. Thus, procedure to be followed as provided in the articles is adhered to for this purpose. Articles of Association (AoA) Section 26 of the Companies Act, 1956 provides that a public company limited by shares may at its option register its articles of association signed by the same subscribers as to the memorandum, or alternatively it may adopt all or any of the regulations contained in Table A of First Schedule of the Act. If articles are not registered, automatically Table A applies, and if registered, Table A applies except in so far as it is excluded by the articles.  To avoid any confusion, normally every public company delivers its articles alongwith the memorandum for registration. Further it will be specifically stated therein that Table‗A‗ will not apply.  The articles of a private company must contain the four restrictions as contained in Section 3(1)(iii).  The articles of association of an unlimited company should state the number of members with which the company is to be registered and if the company has a share capital, the amount of share capital with which it is to be registered [Section 27(1)].  In the case of a company limited by guarantee the articles shall state the number of members with which it is to be registered [Section 27(2)].  A company limited by guarantee or a private company limited by shares or an unlimited company must register their articles. The companies limited by guarantee or unlimited company might adopt any of the appropriate regulations of Table C, D and E respectively in Schedule I (Section 29).
  31. 31. 31 Statutory Requirements: Section 30 requires that the articles must be printed, divided into paragraphs, numbered consecutively, stamped adequately, signed by each subscriber to the memorandum and duly witnessed and filed along with the memorandum. The articles must not contain anything illegal or ultra vires the memorandum, nor should it be contrary to the provisions of the Companies Act, 1956. CONTENTS OF ARTICLES The articles set out the rules and regulations framed by the company for its own working. The articles should contain generally the following matters: 1. Exclusion wholly or in part of Table A. 2. Adoption of preliminary contracts. 3. Number and value of shares. 4. Issue of preference shares. 5. Allotment of shares. 6. Calls on shares. 7. Lien on shares. 8. Transfer and transmission of shares. 9. Nomination. 10. Forfeiture of shares. 11. Alteration of capital. 12. Buy back. 13. Share certificates. 14. Dematerialisation. 15. Conversion of shares into stock. 16. Voting rights and proxies. 17. Meetings and rules regarding committees. 18. Directors, their appointment and delegations of powers. 19. Nominee directors. 20. Issue of Debentures and stocks. 21. Audit committee. 22. Managing director, Whole-time director, Manager, Secretary. 23. Additional directors. 24. Seal. 25. Remuneration of directors. 26. General meetings. 27. Directors meetings. 28. Borrowing powers.
  32. 32. 32 29. Dividends and reserves. 30. Accounts and audit. 31. Winding up. 32. Provision regarding common seal. 33. Capitalisation of reserves. Extra care must be exercised in the preparation of the AoAof a company. At the same time, certain provisions of the Act are applicable to the company "notwithstanding anything to the contrary in the articles". Therefore, the articles must contain provisions in respect of all matters that are required to be contained therein, so as not to hamper the working of the company later. Provision in Articles As Regards Expulsion of a Member: Section 29 provides that nothing in Section 29 shall be deemed to prevent a company from including any additional matters in its Articles, in so far as they are not inconsistent with the provisions contained in the Form in any of the Tables C, D and E, which might have been adopted by the company. In the light of this provision, if there is a provision in the Articles empowering the Directors of the company to expel any member of the company under any of the given conditions, then such a provision shall be totally inconsistent with the provisions of Section 29 of the Act. But the Stock exchanges, registered under the provisions of the Companies Act, can carry such a provision in its Articles, because the Companies Act is a general law whereas the Securities Contracts Regulation (SCR) Act is a special law. The regulation of stock exchanges is done by SCR Act and SEBI Act and not by Companies Act. Hence, the Articles of Stock Exchange may provide for additional matters as per SCR Act, which may not be possible for inclusion in the Articles of a company as per the provisions of the Companies Act. Alteration of Articles of Association A company has a statutory right to alter its AoA, but the power to alter is subject to the provisions of the Act and to the conditions contained in the memorandum. Section 31 provides that subject to the provisions of the Act and the conditions contained in its memorandum, a company may, by special resolution, alter its articles, and adds that any alteration so made shall be as valid as if originally contained in the articles. However, no alteration made in the articles which has the effect of converting a public company into private company shall have effect unless such alteration has been approved by the Central
  33. 33. 33 Government [Section 31(1)]. However, in spite of the power to alter its articles, a company can exercise this power subject only to certain limitations. These are: 1. The alteration must not exceed the powers given by the memorandum. In the event of conflict between the memorandum and the articles, it is the memorandum that will prevail. 2. The alteration must not be inconsistent with any provisions of the Companies Act or any other statute. 3. The Articles must not include anything which is illegal or opposed to public policy. 4. The alteration must be bona fide for the benefit of the company as a whole. 5. The alteration must not constitute a fraud on the minority by a majority. If the alteration is not for the benefit of the company as a whole, but for majority of shareholders, then the alteration would be bad. In other words, an alteration to the articles must not discriminate between the majority shareholders and the minority shareholders so as to give the former an advantage over the latter 6. An alteration of articles to effect a conversion of a public company into a private company cannot be made without the approval of the Central Government [Section 31]. 7. Articles cannot be altered so as to compel an existing member to take or subscribe for more shares or in any way increase his liability to contribute to the share capital, unless he gives his consent in writing (Section 38). 8. By effecting alteration in its articles, a company cannot defeat escape from its contractual obligation with any person. The company will always be liable in such a case. 9. The Articles of Association cannot be altered so as to have retrospective effects. The articles only operate from the date of the amendment 10. The alteration must not be inconsistent with an order of the Court under Sections 397 or 398 and 404. 11. In the case of listed companies, earlier articles cannot be altered except with the approval of Stock Exchange(s) concerned. 12. Amendment of Articles relating to Managing, Whole-time director and non-rotational directors requires Central Government‗s approval. (Section 268) Subject to the foregoing conditions, the Articles in a company can be altered and no clause can be included in the Articles that it is not alterable. Persons who become members of a company have no right to assume that the Articles will always remain in a particular form.
  34. 34. 34 Distinction between Memorandum and Articles of Association The key distinction between the MoA and AoA are given below: 1. Memorandum of association is the charter of the company and defines the fundamental conditions and objects for which the company is granted incorporation. Articles of association are the rules and regulations framed to govern this internal management of the company. 2. Clauses of the memorandum cannot be easily altered. They can only be altered in accordance with the mode prescribed by the Act. In some of the cases, alteration requires the permission of the Company Law Board or the Court. In the case of articles of association, members have a right to alter the articles by a special resolution. Generally there is no need to obtain the permission of the Court or the Company Law Board for alteration of the articles. 3. Memorandum of association cannot include any clause contrary to the provisions of the Companies Act. The articles of association are subsidiary both to the Companies Act and the memorandum of association. 4. The memorandum generally defines the relation between the company and the outsiders, while the articles regulate the relationship between the company and its members and between the members inter se. 5. Acts done by a company beyond the scope of the memorandum are absolutely void and ultra vires and cannot be ratified even by unanimous vote of all the shareholders. But the acts of the directors beyond the articles can be ratified by the shareholders. So far, we have discussed different types of company, its definitions, and procedures to be followed in incorporation of a company, relevant documents to be submitted, and contents of the documents as well. Now let us move on how to raise the funds and its related regulatory framework in the next chapter.
  35. 35. 35 CHAPTER 2 PROSPECTUS, ISSUE AND ALLOTMENTS OF SHARES After the receipt of certificate of incorporation, a public limited company is ready for raising funds by issuing shares to the public in order to carry out the business activities, a company will issue a document called prospectus. It is an invitation to the public to subscribe to the share capital of the company i.e. document facilitate the collection of money for a company. The prospectus describes the purpose of the company and the reason why the capital is required. Under section 2(36) of the companies Act, 1956 defines ―any document described or issued as a prospectus and include any notice, circular, advertisement or other documents inviting deposits from the public or inviting offer from the public or inviting offers from the public for the subscription or purchase of any shares in, or debentures of, a body corporate‖. Generally it is known as an offer document. It means ‗prospectus‘ in case of a public limited company (as stated above) or an offer for sale and ‗letter of offer‘ in case of right issue. As this is the basic document of a company, it is circulated among the public in printed pamphlets. This is the only source for the investors to know about the company such as objectives, plans, and soundness. Therefore, legislation has aimed at securing the fullest disclosure of all materials and necessary particulars and laying the same before all the prospective buyers of shares. The following are the important requirements for issuing the prospectus:  Dating of Prospectus: According to Section 55, every prospectus must be dated. This date is considered to the date of publication of prospectus, unless the contrary proved.  Registration of Prospectus: It is absolutely mandatory for a company to submit the copy of the prospectus to the Registrar for registration. This should be done on or before the prospectus is published. However, the prospectus must not be issued more than 90 days after the date on which a copy of it is submitted to the Registrar for registration.  Approval of prospectus by various agencies: The prospectus has to beapproved by various agencies before it is filed with the ROC of the respectiveState. The various authorities who approve the prospectus are as follows: a. All the lead managers to the issue. b. Each of the stock exchanges where the shares of the company are listed and where the shares/debentures are proposed to be listed.
  36. 36. 36 c. The lead financial institution underwriting the issue, if applicable.  The lead financial institution underwriting the issue, if applicable: The prospectus is vetted by SEBI to ensure adequacy of disclosures provided by the company. However, vettingby SEBI does not account to the approval of prospectus. SEBI does not take anyresponsibility for the correctness of the statements made or opinions expressed inthe prospectus by the company. The Ministry of Corporate Affairs, vide its circular 10/8/87-CL V No. 7/91, dated 28-2- 1991 advised the ROCs to ensure that in respect of every prospectus of public issues which comes up for filing with them the merchant bankers to the issue, whether as lead managers, co-managers, advisers or consultants are only those authorised by SEBI. Each merchant bankers has been given a code number. It was also decided that ROC shall not register a prospectus where prior to registration of the prospectus, the ROC before whom the prospectus is filed for registration is informed by SEBI that the contents of prospectus filed are in contravention of any law or statutoryrules and regulations. From the above discussion, it clear that the prospectus is an essential document. The information statutorily needing disclosure is stated fully and precisely so that the public who wish to invest about the present and future prospectus of the company. The purpose of issuing the document is to protect the members of the public again their being misguided by partial truths or falsehoods that the law casts a liability on various person connected with the issue of the prospectus to compensate every person (who subscribes on the faith of theprospectus) for any loss or damage he may have sustained because of the inclusion of any untrue statements in the prospectus [Section 62]. Although the prospectus is an essential document to be issued for raising fund, section 56 of the Companies Act 1956, the issue of a prospectus is not necessary in the following situations: 1. Subsection 5 states when shares or debentures are offered to the existing holders of shares or debentures 2. Subsection 5 tells when the issue relates to shares or debentures uniform in all respects with shares or debentures previously issued and dealt in or quoted in a recognised stock exchange 3. Subsection 3 conveys where a person is bonafide invited to enter into an underwriting agreement and/or where shares are not offered to the public
  37. 37. 37 Before proceeding further about prospectus, it is essential that one should know about the concept of capital, various sources of capital, meaning shares and its types, and provisions for issue the same. Let us now the same. Meaning of Capital Capital has variety of meanings. Capital refers to money that is used to do business. According to company law, the capital is the share capital of a company. It is classified as given below: 1. Nominal, Authorised or Registered Capital:This is the amount mentionedin the MoA of a company limited by shares as the capital of the company. It is the maximum amount that a company is authorized to mobilise the required funds by issuing shares. The company had paid the registration fee at the time of registration on the basis of authorised capital. As and when the registration fee is increased, a company will have to be paid to the Registrar in accordance with table in Schedule X appended to the Companies Act, 1956. The capital is divided into shares of uniform denominations. For example, Rs.10, 000, divided into 1000 equity shares with the face value of Rs.10 each. 2. Issued Capital:a company may issue the capital fully or part of authorised capital. If a company issues fully, authorised capital and issued capital would be same. Otherwise, the part of the authorised or nominal capital is called issued capital. This is computed at the face or nominal value. Considering the above example, a company is issued of 600 equity shares. It means that the authorised capital is Rs.10, 000 and issued capital is Rs.6000. 3. Subscribed Capital:It is that portion of the issued capital at face value which has been subscribed by the subscribers of shares in the company. It is clear that the entire issued capital may or may not be subscribed. 4. Called up Capital:It is that portion of the subscribed capital which has been called up or demanded on the shares by the company. Assume thatRs. 6 has been called up on each of 600 shares of a nominal value of Rs. 10, the called up capital is Rs.3600.
  38. 38. 38 5. Uncalled Capital:It is the total amount not yet called up or demanded by the company on the shares subscribed, which the shareholders are liable to pay as and when called. For example, in the above case, uncalled capital is Rs. 2400. 6. Paid-up-Capital:It is the part of the total called up amount which is actually paid by the shareholder. For example, if only Rs. 2,900 is actually paid by the shareholders the paid-up capital is taken as Rs. 2900 only. 7. Unpaid Capital:It is the total of the called-up capital remaining unpaid i.e., Rs. 700 i.e. the difference between called up and paid-up capital. 8. Reserve Capital: It is that part of the uncalled capital of a company. The limited company has decided by special resolution in terms of Section 99 of the Companies Act, 1956, not to call except in the event and for the purpose of the company being winding- up. For instance, in the above example, out of the Rs. 4 per share uncalled capital, Rs. 2 per share may be resolved to be kept as reserve capital. (Reserve capital should not be confused with capital reserve, which is created out of profits). 9. Preference and Equity Share Capital:Section 86 of the companies Act, 1956 as amended by the Companies (Amendment) Act, 2000 permits a company limited by shares to issueonly two kinds of shares Viz. preference shares and equity shares. Equity share capital may be with similar rights or with different rights as to dividend, voting or otherwise in accordance with the Companies (Issue of Share Capital with Differential Voting Rights) Rules, 2001. Section 85(1) of the companies Act, 1956 provides that a preference share or preference share capital is that part of share capital that fulfils the following requirements: a. With regard to payment of fixed amount of dividend or fixed rate of dividend, which may be either free of or subject to income tax b. With regard to preferential right of the repayment of capital in the event of liquidation of company. With regard to payment of dividend, preference shares may be cumulative or non-cumulative. According to section 85, equity shareholders are entitled to the residue of the divisible profits, if any, after the preference shareholders have received their fixed rate of dividend.
  39. 39. 39 Let us discuss the types of preference shares. Types of Preference Shares:it may be of various types, namely 1. Participating or Non-participating:Participating preference shares are those shares that are entitled to a fixed preferential dividend. In addition, it carries a right to participate in the surplus profits along with equity shareholders, after paying dividend at a certain rate has been paid to equity shareholders. For example, after 30% dividend has been paid to equity shareholders, the preference shareholders may share the surplus profit equally with equity shareholders. Moreover, there are any surplus left after paying to the equity shares in the event of liquidation of a company, preference shares holders get additional share in the surplus assets of the company. Unless expressly sated, preference shareholders get only the fixed preferential dividend and nothing more. The right to participate may be given either in the memorandum or articles or by virtue of their terms of issue. 2. Cumulative and non-cumulative shares:Preference shares may be classified as cumulative or non-cumulative on the basis of dividend payment. A holder of cumulative preference shares has a right to claim fixed dividend of the past and the current year out of profits. The preferential dividend keeps on accumulating until it is fully paid by the company. On the other hand, the non-cumulative preference share gives right to its holder to get the preference dividend on a fixed percentage out of the profits of each year. If a company has not make profits, they get nothing, they cannot claim in subsequent year as well. Preference shares are cumulative unless expressly stated to be non-cumulative. 3. Redeemable and irredeemable Preference Shares: Subject to an authority in the articles of association, a public limited company may issue redeemable preference shares to be redeemed either at a fixed date or after a certain period of time during the life of the company provided the company. However a company complied with the following conditions lay down in section 80 of the Act. a. the articles must have a provision for the issue of such shares; b. they may be redeemed only out of profits available for dividend or out of the proceeds of a fresh issue of shares made for the purpose of redemption; c. if premium is payable on redemption, it must have been provided for out of profits or out of company‗s securities premium account, before the shares are redeemed;
  40. 40. 40 d. no such shares can be redeemed unless they are fully paid; e. Where the shares are redeemed otherwise than out of the proceeds of the fresh issue, a sum equal to the nominal amount of the shares redeemed shall be transferred out of profits which would otherwise have been available for dividend, to the ―Capital Redemption Reserve Account. This fund may also be applied by the company in paying up unissued shares of the company to be issued to the members of the company as fully paid shares. Sweat Equity Shares Sweat equity shares means equity shares that are issued by a company to its employees or directors at a discount or for consideration, other than cash for providing know-how or making available right in the nature of intellectual property rights or value addition, whatever name they called.Section 79A of the Companies (Amendment) Act, 1999 permits to issue of such equity shares to employees or directors in recognition of their contribution for providing know-how etc. as stated above. As the contribution made by employees/directors results in increased profits to the company for a number of years, a company provides sweat equity shares. It is considered as a new form of return. For the purpose of issue of sweat equity shares, ‗company‗ means a company which is incorporated, formed and registered under this Act and includes its subsidiary company incorporated outside India. The intellectual property rights and value additions refers to -  the exclusive property rights that can be prevented from use by others without the authorization of the owners and include patents for invention, industrial designs, copyrights in literacy/scientific and so on matters, registered or pending trademarks etc.  the increase in value of company‗s products etc. in economic termsthat is attributable to the efforts of an employee or a director, in any manner. Notwithstanding anything contained in Section 79, a company can issue sweat equity shares, of a class of shares already issued, if the following conditions are satisfied: (i) The issue has been authorised by a special resolution passed by the company in the general meeting. (ii) the following are clearly specified in the resolution: (a) number of shares (b) current market price (c) consideration, if any (d) Class or classes of directors or employees to whom such equity shares are to be issued.
  41. 41. 41 (iii) as on the date of issue, atleast one year should have elapsed from the date on which the company was entitled to commence business. (iv) A company whose shares are listed on a recognized stock exchange issuing sweat equity shares should comply with the regulations made in this behalf by SEBI. (v) A company whose shares are not so listed should issue sweat equity shares in compliance with the rules made in this behalf. Employee Stock Option Scheme (ESOP) Section 2 (15A) of the Companies Act, 1956 defines ‗the option given to the whole- time directors, officers or employees of a company, which gives such directors, officers or employees the benefit or right to purchase or subscribe at a future date, the securities offered by the company at a pre-determined price‘. SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999 defines ‗a scheme under which the company grants option to its employees and option means a right but not an obligation granted to an employee in pursuance of ESOS to apply for shares of the company at a pre-determined price‘. The following points are essential and to be followed while issue of ESOP: 1. The issue of ESOPs would besubject to approval by shareholders through a special resolution. In addition, ESOP is more than 1 per cent, it is essentialfor a company to have a specific disclosure and approval from the annual general meeting. 2. A minimum period of one year between grant of options and its vesting has been prescribed. After one year, the period during which the option can be exercised are determined by the company. The operation of the ESOP Scheme would have to be under the superintendence and direction of a Compensation Committee of the Board of Directors. The composition of Compensation Committee would be a majority of independent directors. If a company would cover its subsidiary or a holding company, it needs the specific approval of the shareholders.
  42. 42. 42 Raising Capital Assume that you are a finance manager of a company which was started privately by promoters. Your management has decided to introduce a new product in the market which needs to Rs.500 crores. The responsibility is given to you. You know that there are many ways to raise funds viz. common stock, preferred stock, bonds, and bank borrowings. Bonds and preferred stocks are fixed obligation to the business, whereas shares are the ownership in the business that offer an unknown growth potential to the investors. In the first case, investors get fixed benefits over the investment horizon. On the other hand, investor gets benefits only if company makes profits. As a private limited company, one can raise the funds from the promoters, friends and relatives by private placement. Note that you cannot issue preference shares and bonds. You know that it may not be sufficient for introducing the new product. Therefore, you decide to invite the public to contribute towards the required capital. For raising capital from the public by issuing shares, a company has to comply with the provisions of the Companies Act, 1956, the Securities Contracts (Regulation)Act, 1956, SEBI (ICDR) Regulations 2009 the rules made thereunder and the guidelines and instructions issued by the concerned government authorities, the stock exchanges etc. management of public issue involves coordination of activities and cooperation of a number of agencies such as underwriters, brokers, registrar to the issue, printers, financial institutions, auditors and other government/statutory agencies. The entire process of public issue could be classified into two: viz. (i) Pre-issue activities and (ii) Post issue activities. All activities beginning with the planning of capital issue till the opening of the subscription list are called pre-issue activities. All activities subsequent to the opening of the subscription list are called post-issue activities. Let us discuss the meaning of each term and then discuss the detailed procedures involved in each of these issues.
  43. 43. 43 Public Issue refers to the company‘s shares that are sold to the public through stock exchange. As per the Companies Act 1956, the allotment should be more than 50 persons. The public issue are further classified into two categories namely Initial Public Offer (IPO) and Follow on Public Offer (FPO). Initial Public Offering (IPO) refers to the company‘s shares that are sold to the general public through stock exchange for the first time. By doing this, a private limited company become a public limited company. Note that all public limited companies are not publically traded companies. A company can raise funds through public; however, they may not prefer their company shares are to be traded in the secondary market. Those companies are called unlisted companies. Conversely, there are companies who prefers their shares to be traded in the secondary market opts for listing. Listing is the process whereby shares are offered to the public, become eligible for trading in the stock market. Those companies‘ shares are called listed companies. Those companies‘ shares are available for buying and selling at any point in time. Listing refers to the process whereby shares are offered to the public through an IPO become eligible to be traded in the secondary market (BSE or NSE). Generally there is a gap about 12 -15 days between the closing and listing date of an IPO. (Note that SEBI is planning to reduce from 12 days to 6 days). There are two methods to issue the IPOs: Issues Rights Private Placement Bonus Qualified Institutions for listed companies For un-listed companies Follow on Public Offer (IPO) Initial Public Offer (IPO) Public Preferential issues for listed companies Offer for saleFresh Issue
  44. 44. 44 a. fresh issue, and b. An offer for sale: it refers to the process of offload/dilute the promoters holding in the listed companies to the public for the first time. For a moment assume that your company is a public limited company and listed in the stock exchanges. After careful analysis, you have decided to mobilise funds through equity. You can issue the securities to the public or offer for sale to the public, through an offer document. It is known as Follow on Public offer. Note that a company issues shares through an offer for sale is permitted only if your company satisfy the listing or continuous listing obligations of the stock exchanges. On the other hand, you are interested to issue the shares only to the existing shareholders on a pro-rata basis as on a record date. It is known as Rights Issue. The right issue helps to maintain the ownership stake of its existing shareholders as they have. Suppose you are interested to invite the select set public instead of to the general public. It is known as private placement. The allotment of shares should be less than 50 persons under section 81, of the Companies Act 1956. It is neither rights issue nor a public issue. You are a listed company and want to go for preferential allotment for a select set of people. Buyers/investors may be an individual or institutions. Your company has to comply with the requirements contained in Chapter VII of SEBI (Issue of Capital and Disclosure Requirements) Regulations 2009. If it is qualified institutions‘, the institution should be a qualified buyer on the basis ofSEBI (Issue of Capital and Disclosure Requirements) Regulations 2009. It is known as Qualified Institutional placement. You have mobilised the required fund and launched the new product in the market. It gives more profit to the company. The company has decided to give the dividend to the shareholders. However they do not have adequate cash in their hands. They are permitted to issue of shares equivalent to the dividend at predetermined price on pro-rate basis to the existing shareholders on record date. Generally it is issued out of the general reserve or share premium account. This issue is known as Bonus Issue. Before proceeding further, let us now understand who are eligible to make an offer to the public? 1. The company should have at least Rs.3 crores of net tangible assets for the past preceding three years (each year consists of 12 months) from the year of issue. Of which, the company should held less than 50 per cent of amount held in monetary assets. If the company has more than 50 per cent held in monetary assets, they
  45. 45. 45 have to give the commitment to use those excess monetary assets in its business/project. 2. The company has a track record of distributing dividend to their shareholders at least three out of the immediately five years, excluding ex-ordinary items, as per the section 205 of Companies Act 1956. 3. The company has a net worth of Rs. 1 cores of net worth Issue of shares at a Premium or Discount Issue at a Premium:A company may issue securities at a premium when it is able to sell them at a price more than their nominal value. For example, the nominal value of a share is Rs.100, but it is priced at Rs. 110. The difference of nominal value and issued value is called as a share premium i.e. Rs. 10 per share. This is possible for a company irrespective of the fact whether the securities are listed on Stock Exchange or not (Section 78). In this regard, the Companies Act does not stipulate any conditions or restrictions regulating the issue of securities by a company. However, the Companies Act imposessome conditions for utilisation of the amount of premium amount collected on securities which is given bellow: 1. This amount cannot be treated as profit and should not distribute as dividend to their shareholders. However, this amount can be used for specific purposes mentioned in section 78(2). 2. It should be maintained as a separate account in the name of ‗Securities Premium Account‘. The premium amount may be received in the form of cash or in any kind. 3. The amount of premium is to be maintained with the same sanctity as the share capital. Typically share premium account must be disclosed in the annual balance sheet as a separate item. In case the amount is deposed partially or wholly, it should indicate how it is disposed of or exhausted. [See Schedule VI Part I]. Further, shareholder does not have any preferential rights in the event of liquidation of a company. Section 78(2) of the Act indicates the way in which this fund could be utilised. It is given below: a. Issuing fully paid bonus shares to members; b. Writing off the balance of the preliminary expenses of the company; c. Writing off commission paid or discount allowed, or the expenses incurred on issue of shares or debentures of the company; and d. For providing for the premium payable on redemption of any redeemable preference shares or debentures of the company.