This Article is submitted by, Sanjay Rawat. It talks about the Nature of a Company its History, Meaning and Definition under the Indian Companies Act, 2013.
Introduction: Nature of a Company
A company, in its ordinary, non-technical sense, means a body of individuals associated for a common objective, which may be to carry on business for gain or to engage in some human activity for the benefit of the society.
Accordingly, the word ‘company’ is employed to represent associations formed to carry on some business for profit or to promote art, science, education or to fulfill some charitable purpose. This body of individuals may be incorporated or unincorporated.
The concept of ‘Company’ or ‘Corporation’ in business is not new but was dealt with, in 4th century BC itself during ‘Arthashastra’ days. The nature of company got revamped over a period according to the needs of business dynamics. Company form of business has certain distinct advantages over other forms of businesses like Sole Proprietorship/Partnership etc. It includes features such as Limited Liability, Perpetual Succession etc.
Meaning of a Company
The word ‘company’ is derived from the Latin word (Com=with or together; panis =bread), and it originally referred to an association of persons who took their meals together. In the leisurely past, merchants took advantage of festive gatherings, to discuss business matters.
Nowadays, business matters have become more complicated and cannot be discussed at festive gatherings. Therefore, the company form of organization has assumed greater importance. It denotes a joint-stock enterprise in which the capital is contributed by several people. Thus, in popular parlance, a company denotes an association of likeminded persons formed for the purpose of carrying on some business or undertaking.
A company is a corporate body and a legal person having status and personality distinct and separate from the members constituting it.
It is called a body corporate because the persons composing it are made into one body by incorporating it according to the law and clothing it with legal personality. The word ‘corporation’ is derived from the Latin term ‘corpus’ which means ‘body’. Accordingly, ‘corporation’ is a legal person created by a process other than natural birth. It is, for this reason, sometimes called an artificial legal person. As a legal person, a corporation can enjoy many of the rights and incurring many of the liabilities of a natural person.
An incorporated company owes its existence either to a special Act of Parliament or to company law. Public corporations like Life Insurance Corporation of India, SBI etc., have been brought into existence by special Acts of Parliament, whereas companies like Tata Steel Ltd., Reliance Industries Limited have been formed under the Company law i.e. Companies Act, 1956 which is being replaced by the Companies Act, 2013.
Definition of a Company
Lord Justice Lindley has defined a company as,
“An association of many persons who contribute money or money’s worth to a common stock and employ it in some trade or business; and who share the profit and loss (as the case may be) arising therefrom”.
Gower, L.C.B. in his book entitled The Principles of Modern Company Law gives an interesting example. He says, ‘During the war all the members of one private company, while in general meeting, were killed by a hydrogen bomb. But the company survived, not even a hydrogen bomb could have destroyed it’.
In the legal sense in India, a company is an association of both natural and artificial persons (and is incorporated under the existing law of a country). In terms of the Companies Act, 2013 (Act No. 18 of 2013) a “company” means a company incorporated under this Act or under any previous company law [Section 2(20)].
In common law, a company is a “legal person” or “legal entity” separate from, and capable of surviving beyond the lives of its members. However, an association formed not for profit also acquires a corporate character and falls within the meaning of a company by reason of a license issued under Section 8(1) of the Act.
Historical Development of the Nature of Company law in India
In the year 1850, the first Company enactment for the registration of the joint-stock company was introduced in India. This enactment as mentioned before was based upon the English Companies Act, 1844.
In the year 1913 another Indian Companies Act was enacted based upon English Companies Consolidation Act, 1908. Companies Act of 1913 was amended in the year 1914, 1915, 1920, 1926, 1930 and 1932. But the major amendment to the Companies Act of 1913 who was made in the year 1936 this amendment was based upon the English Companies Act. 1929. The act of 1913 regulated the Indian business company until 1956.
On 28th October 1950, the Government of India appointed a Committee of twelve members representing various interests under the chairmanship of Shri H. C. Bhabha, to go into the entire question of the revision of the Companies Act, with particular significance to the development of trade and industry of India. The Bill was referred to a Joint Committee of both Houses of Parliament in May 1954. The Joint Committee submitted its report in May 1955, making some material amendments to the Bill. The Bill, as amended by the Joint Committee, underwent some further amendments In Parliament and was passed in November 1955. The new Companies Act (I of 1956) came into force from 1st April 1956.
Recently, the Companies Act, 2013 replaced the Companies Act, 1956. The legislators introduced ideas of the likes of:
- Corporate Social Responsibility (CSR)
- Class action suits
- Fixed term for the Independent Directors
- The provision of raising money from the public was made little stringent
- Prohibition on insider trading by company directors or key managerial personnel by declaring such activities as a criminal offence
- It permits shareholder agreements providing for the ‘Right of First Offer’ or ‘Right of first Refusal’ even in the case of Public Companies
Characteristics and Nature of a Company
Since a corporate body (i.e. a company) is the creation of law, it is not a human being, it is an artificial juridical person (i.e. created by law); it is clothed with many rights, obligations, powers, and duties prescribed by law; it is called a ‘person’.
Being the creation of law, the nature of the company is that it possesses only the powers conferred upon it by its Memorandum of Association which is the charter of the company. Within the limits of powers conferred by the charter, it can do all acts as a natural person may do.
The most striking characteristics and nature of a company are:
- Corporate personality
A company incorporated under the Act is vested with a corporate personality so it redundant bears its own name, acts under a name, has a seal of its own and its assets are separate and distinct from those of its members. It is a different ‘person’ from the members who compose it. Therefore, it is capable of owning property, incurring debts, borrowing money, having a bank account, employing people, entering into contracts and suing or being sued in the same manner as an individual.
Its members are its owners however they can be its creditors simultaneously. A shareholder cannot be held liable for the acts of the company even if he holds virtually the entire share capital.
- Artificial Person
A company is created with the sanction of law and is not itself a human being, it is therefore, called artificial; and since it is clothed with certain rights and obligations, it is called a person. A company is accordingly, an artificial person thereupon the nature of company is artificial too.
A Company is an artificial person created by law. It is not a human being, but it acts through human beings. It is considered as a legal person which can enter contracts, possess properties in its own name, sue and can be sued by others etc. It is called an artificial person since it is invisible, intangible, existing only in the contemplation of law. It can enjoy rights and being subject to duties.
- Limited Liability
The company being a separate person, its members are not as such liable for its debts. Hence, in the case of a company limited by shares, the liability of members is limited to the nominal value of shares held by them. Thus, if the shares are fully paid up, their liability will be nil. So the nature of company is that its members have limited liability.
However, companies may be formed with unlimited liability of members or members may guarantee a particular amount. In such cases, liability of the members shall not be limited to the nominal or face value of the shares held by them. In case of unlimited liability companies, members shall continue to be liable till each paise has been paid off. In case of companies limited by guarantee, the liability of each member shall be determined by the guarantee amount, i.e., he shall be liable to contribute up to the amount guaranteed by him.
In other words, a shareholder is liable to pay the balance, if any, due on the shares held by him, when called upon to pay and nothing more, even if the liabilities of the company far exceed its assets. This means that the liability of a member is limited.
- Perpetual Succession
An incorporated company never dies, except when it is wound up as per law. A company, being a separate legal person is unaffected by death or departure of any member and it remains the same entity, despite the total change in the membership. A company’s life is determined by the terms of its Memorandum of Association.
The nature of a company may be perpetual, or it may continue for a specified time to carry on a task or object as laid down in the Memorandum of Association. Perpetual succession, therefore, means that the membership of a company may keep changing from time to time, but that shall not affect its continuity.
The membership of an incorporated company may change either because one shareholder has sold/transferred his shares to another or his shares devolve on his legal representatives on his death or he ceases to be a member under some other provisions of the Companies Act.
Thus, perpetual succession denotes the ability of a company to maintain its existence by the succession of new individuals who step into the shoes of those who cease to be members of the company.
Professor L.C.B. Gower rightly mentions,
“Members may come and go, but the company can go on forever. During the war, all the members of one private company, while in general meeting, were killed by a bomb, but the company survived— not even a hydrogen bomb could have destroyed it”.
- Separate Property
A company is a legal person and entirely distinct from its members, is capable of owning, enjoying and disposing of property in its own name. The company is the real person in which all its property is vested, and by which it is controlled, managed and disposed of. So one of the nature of company is that it has separate property from its members.
Lord Macnaghten in the famous case of Salomon v. Salomon & Co. Ltd. (1897) AC 22 observed that:
“A company is at law a different person altogether from the subscribers…..; and though it may be that after incorporation the business is precisely the same as it was before and the same persons are managers and the same hands receive the profits, the company is at law not the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act”.
The facts of the famous Salomon’s case were as follows:
Salomon carried on business as a leather merchant. He sold his business for a sum of £30,000 to a company formed by him along with his wife, a daughter and four sons. The purchase consideration was satisfied by allotment of 20,000 shares of £1 each and issue of debentures worth £10,000 secured by floating charge on the company’s assets in favour of Mr Salomon. All the other shareholders subscribed for one share of £1 each. Mr Salomon was also the managing director of the company. The company almost immediately ran into difficulties and eventually became insolvent and winding up commenced. At the time of winding up, the total assets of the company amounted to £6,050; its liabilities were £10,000 secured by the debentures issued to Mr Salomon and £8,000 owing to unsecured trade creditors. The unsecured sundry creditors claimed the whole of the company’s assets, viz. £6,050 on the ground that the company was a mere alias or agent for Salomon.
Held: The contention of the trade creditors could not be maintained because the company being in law a person quite distinct from its members, could not be regarded as an ‘alias’ or agent or trustee for Salomon. Also the company’s assets must be applied in payment of the debentures as a secured creditor is entitled to payment out of the assets on which his debt is secured in priority to unsecured creditors.
Their Lordships of the Madras High Court in R.F. Perumal v. H. John Deavin, A.I.R. 1960 Mad. 43 held that “no member can claim himself to be the owner of the company’s property during its existence or in its winding-up”. A member does not even have an insurable interest in the property of the company.
- Transferability of Shares
The capital of a company is divided into parts, called shares. The shares are said to be a movable property and, subject to certain conditions, freely transferable, so that no shareholder is permanently or necessarily wedded to a company. When the joint-stock companies were established, the object was that their shares should be capable of being easily transferred, [In Re. Balia and San Francisco Rly., (1968) L.R. 3 Q.B. 588].
Since business is separate from its members in a company form of organisation, it facilitates the transfer of member’s interests. The shares of a company are transferable in the manner provided in the Articles of the company. However, in a private company, certain restrictions are placed on such transfer of shares but the right to transfer is not taken away absolutely
Section 44 of the Companies Act, 2013 enunciates the principle by providing that the shares held by the members are movable property and can be transferred from one person to another in the manner provided by the articles.
If the articles do not provide anything for the transfer of shares and the Regulations contained in Table “F” in Schedule I to the Companies Act, 2013, are also expressly excluded, the transfer of shares will be governed by the general law relating to the transfer of movable property.
A member may sell his shares in the open market and realize the money invested by him. This provides liquidity to a member (as he can freely sell his shares) and ensures stability to the company (as the member is not withdrawing his money from the company). The Stock Exchanges provide adequate facilities for the sale and purchase of shares.
Further, as of now, in most of the listed companies, the shares are also transferable through Electronic mode i.e. through Depository Participants in dematerialized form instead of physical transfers. However, there are restrictions with respect to transferability of shares of a Private Limited Company which are dealt in chapter 2.
- Common Seal
Upon incorporation, a company becomes a legal entity with perpetual succession and a common seal. Since the company has no physical existence, it must act through its agents and all contracts entered by its agents must be under the seal of the company. The Common Seal acts as the official signature of a company. The name of the company must be engraved on its common seal.
A rubber stamp does not serve the purpose. A document not bearing a common seal of the company, when the resolution passed by the Board, for its execution requires the common seal to be affixed is not authentic and shall have no legal force behind it.
However, a person duly authorized to execute documents pursuant to a power of attorney granted in his favour under the common seal of the company may execute such documents and it is not necessary for the common seal to be affixed to such documents.
The person, authorized to use the seal, should ensure that it is kept under his personal custody and is used very carefully because any deed, instrument or a document to which seal is improperly or fraudulently affixed will involve the company in legal action and litigation.
Seal of company when to be used – The articles of association of the company provide for putting the seal of the company on documents. Apart from those documents, the company seal is to be put on power of attorney, deed of lease, share certificates, debentures, debenture trust deed, deed of mortgage, promissory notes, negotiable instruments (except cheques), agreement of hypothecation, loan agreements with banks and financial institutions, contract of employment, guarantees issued by the company and all formal documents and documents executed on stamp papers.
- Capacity to sue or be sued
A company is a body corporate, can sue and be sued in its own name. To sue means to institute legal proceedings against (a person) or to bring a suit in a court of law. All legal proceedings against the company are to be instituted in its name. Similarly, the company may bring an action against anyone in its own name.
A company’s right to sue arises when some loss is caused to the company, i.e. to the property or the personality of the company. Hence, the company is entitled to sue for damages in libel or slander as the case may be [Floating Services Ltd. v. MV San Fransceco Dipaloa (2004) 52 SCL 762 (Guj)].
A company, as a person distinct from its members, may even sue one of its own members. A company has a right to seek damages where a defamatory material published about it, affects its business.
Where video cassettes were prepared by the workmen of a company showing, their struggle against the company’s management, it was held to be not actionable unless shown that the contents of the cassette would be defamatory. The court did not restrain the exhibition of the cassette. [TVS Employees Federation v. TVS and Sons Ltd., (1996) 87 Com Cases 37].
The company is not liable for contempt committed by its officer. [Lalit Surajmal Kanodia v. Office Tiger Database Systems India (P) Ltd., (2006) 129 Com Cases 192 Mad].
In Rajendra Nath Dutta v. Shibendra Nath Mukherjee (1982) (52 Comp. Cas. 293 Cal.), a lease deed was executed by the directors of the company without the seal of the company and later a suit was filed by the directors and not the company to avoid the lease on the ground that a new term had been fraudulently included in the lease deed by the defendants.
Held that a director or managing director could not file a suit, unless it was by the company in order to avoid any deed which admittedly was executed by one of the directors and admittedly also the company accepted the rent. The case as made out in the plaint was not made out by the company but by some of the directors of the company and the company was not even a plaintiff. If the company was aggrieved, it was the company which was to file the suit and not the directors. Therefore, the suit was not maintainable.
- Contractual Rights
A company, being a legal entity different from its members, can enter into contracts for the conduct of the business in its own name. A shareholder cannot enforce a contract made by his company; he is neither a party to the contract nor be entitled to the benefit derived from of it, as a company is not a trustee for its shareholders.
Likewise, a shareholder cannot be sued on contracts made by his company. The distinction between a company and its members is not confined to the rules of privity but permeates the whole law of contract. Thus, if a director fails to disclose a breach of his duties towards his company, and in consequence, a shareholder is induced to enter into a contract with the director on behalf of the company which he would not have entered into had there been disclosure, the shareholder cannot rescind the contract.
Similarly, a member of a company cannot sue in respect of torts committed against the company, nor can he be sued for torts committed by the company. [British Thomson-Houston Company v. Sterling Accessories Ltd., (1924) 2 Ch. 33]. Therefore, the company as a legal person can take action to enforce its legal rights or be sued for breach of its legal duties. Its rights and duties are distinct from those of its constituent members.
- Limitation of Action
A company cannot go beyond the power stated in its Memorandum of Association. The Memorandum of Association of the company regulates the powers and fixes the objects of the company and provides the edifice upon which the entire structure of the company rests.
The actions and objects of the company are limited within the scope of its Memorandum of Association.
In order to enable it to carry out its actions without such restrictions and limitations in most cases, sufficient powers are granted in the Memorandum of Association. But once the powers have been laid down, it cannot go beyond such powers unless the Memorandum of Association, itself altered prior to doing so.
- Separate Management
As already noted, the members may derive profits without being burdened with the management of the company. They do not have effective and intimate control over its working, and they elect their representatives as Directors on the Board of Directors of the company to conduct corporate functions through managerial personnel employed by them.
In other words, the company is administered and managed by its managerial personnel. (xi) Voluntary Association for Profit
A company is a voluntary association for profit. It is formed for the accomplishment of some stated goals and whatsoever profit is gained is divided among its shareholders or saved for the future expansion of the company. Only a Section 8 company can be formed with no profit motive.
- Termination of Existence
A company, being an artificial juridical person, does not die a natural death. It is created by law, carries on its affairs according to law throughout its life and ultimately is effaced by law. Generally, the existence of a company is terminated by means of winding up. However, to avoid winding up, sometimes companies adopt strategies like reorganization, reconstruction, and amalgamation.
Company Distinguished from Partnership
Section 4 of the Indian Partnership Act, 1932 defines a partnership as ‘the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all’. Persons who enter into a partnership are individually called ‘Partners’ and collectively a ‘Firm’, and the name under which the business is carried on is called the ‘Firm’s Name’.
A partnership firm may be distinguished from a company in the following ways:
- Legal Status: A partnership firm has no existence apart from its members. A company is a separate legal entity distinct from its members.
- Mutual Agency: A partnership is founded on the idea of mutual agency – every partner is an agent of the rest of the partners. A member of a company is not an agent of the other members.
- Liability of Members: The liability of a partner is unlimited, i.e., even his own personal assets are liable for the debts of the firm. The liability of a member of a limited company is limited to the extent of the amount remaining unpaid on shares held by him or the amount of guarantee, as mentioned in the memorandum of association of the company.
- Transfer of Interest: A partner cannot transfer his interest in the partnership without the consent of all other partners. A member, subject to the restrictions contained in the articles, can freely transfer his shares in the company.
- Duration of Existence: Unless there is a contract to the contrary, the death, retirement, or insolvency of a partner results in the dissolution of the firm. In contrast, a company enjoys a perpetual succession. Death or retirement or insolvency of a member of a company does not affect the existence of the company.
- Minimum Membership: The minimum number of persons required to form a partnership is two. The minimum number required to form a private company is two and in the case of a public company the minimum number is seven.
- Maximum Membership: A partnership cannot be formed by more than twenty persons. The number is limited to ten in the case of a banking business. In the case of a public company, there is no limit to the maximum number of members. However, a private company cannot have more than fifty members.
- Audit: The audit of the accounts of a firm is not compulsory, whereas the audit of accounts of a company is mandatory.
- Use of the Words ‘Limited’ and ‘Private Limited’ not Allowed: Section 631 provides that if any person or persons trade or carry on business under any name or title of which the words, “Limited” or “Private Limited” are the last words, that person or each of these persons shall, unless duly incorporated as a public or a private company, as the case may be, be punishable with fine which may extend to 500 for every day upon which that name has been used.
Lifting of the Corporate Veil: The Principle Which Changed the Nature of Company Law
The nature of a company is that it is distinct from its members. It is a separate legal entity. There is thus, a veil between a company and its members keeping them both separate from each other. However, sometimes it becomes necessary to lift this veil, disregard the distinct corporate entity of the company and find out the realities of the company. The court may investigate the real affairs, ownership, etc., of the company. This is called lifting or piercing the corporate veil.
In other words, the Court investigates into the true state of affairs of the company. It has been observed that though a corporation is a distinct entity, yet in reality, it is an association of persons who are in fact the beneficial owners of all the corporate property.
The corporate veil is therefore lifted by the court to understand the real nature of a company, when its working ignores the company and concerns itself directly with the members or managers. It is largely in the discretion of the Courts and will depend upon the underlying social, economic and moral factors as they operate in and through the corporation.
The corporate veil may be lifted in the following instances:
- To investigate the relationships between the holding company and subsidiary company; To investigate the number and names of members of the company;
- To investigate the true nature of company ownership of shares and controlling power over the company; To investigate lawful objects of the company;
- To investigate the nature of company to know if there is any mismanagement and oppression by the majority;
- To investigate the character of the company where it is trading with an alien enemy or persons managing the affairs of the company are under the control of enemies or been residing in enemy country;
- To investigate into the nature of company affairs where there exists a tendency to create monopoly;
- To investigate the company affairs where it is used for tax evasion or to circumvent tax obligation;
- To investigate if the company is acting as an agent for its shareholders;
- To investigate the affairs where it is formed for fraudulent purposes, to defeat the true work and nature of company and circumvent the law or to defraud its creditors or to avoid valid obligations.
Bombay High Court in (2004) 121 Comp. Cas 314 has held that the corporate veil may be lifted to the extent permitted under the statute and no more.
The advantages of incorporation are allowed to be enjoyed only by those who want to make an honest use of the ‘company’. In case of a dishonest and fraudulent use of the facility of incorporation, the law lifts the corporate veil and identifies the persons (members) who are behind the scene and are responsible for the perpetration of fraud.