EXERCISES
Short Answer Questions
1. Name the stages in the formation of a company.
Answer: The stages in the formation of a company are: (i) Promotion, (ii) Incorporation, and (iii) Capital Subscription.
2. List the documents required for the incorporation of a company.
Answer: The documents required for the incorporation of a company include:
- Memorandum of Association (MoA)
- Articles of Association (AoA)
- Written consent of proposed directors
- Agreement, if any, with Managing Director, Manager, or whole-time director
- Statutory declaration confirming compliance with legal requirements
3. What is a prospectus? Is it necessary for every company to file a prospectus?
Answer: A prospectus is any document inviting deposits or offers from the public for subscription or purchase of securities. It is not necessary for every company to file a prospectus; specifically, a private company is prohibited from raising funds from the public and does not need to issue a prospectus. Public companies, however, must issue a prospectus to raise funds from the public.
4. Briefly explain the term ‘Return of Allotment’.
Answer: ‘Return of Allotment’ is a statement containing the details of shares allotted by the company (names, addresses, number of shares). It is submitted to the Registrar of Companies within 30 days of allotment. It ensures that the company’s share capital structure is legally recorded.
5. At which stage in the formation of a company does it interact with SEBI.
Answer: A public company interacts with SEBI (Securities and Exchange Board of India) during the Capital Subscription stage. Prior SEBI approval is required before raising funds from the public.
Long Answer Questions
1. What is meant by the term ‘Promotion’. Discuss the legal position of promoters with respect to a company promoted by them.
Answer: ‘Promotion’ is the first stage in company formation, involving conceiving a business idea and taking the initiative to form a company to exploit the business opportunity. It begins with the discovery of a potential business idea and includes analyzing prospects, bringing together resources, and setting the organization in motion. Regarding the legal position of promoters:
- Promoters are neither agents nor trustees of the company.
- They hold a fiduciary position, meaning they must act in good faith and not make secret profits. Any profit made must be disclosed to the company. If secret profits are made and not disclosed, the company can rescind the contract, recover the purchase price, and claim damages.
- Promoters are personally liable for pre-incorporation contracts (preliminary contracts) entered into with third parties on behalf of the company, as the company is not legally bound by these until it chooses to enter into fresh contracts on the same terms after incorporation. The company cannot ratify a preliminary contract.
- Promoters are not legally entitled to claim promotion expenses, but the company may choose to reimburse them or remunerate them through lump sum payments, commissions, or allotment of shares/debentures after incorporation.
2. Explain the steps taken by promoters in the promotion of a company.
Answer: The steps taken by promoters in the promotion of a company are:
- (i) Identification of business opportunity: Identifying an investment potential, such as a new product/service, and analyzing its technical and economic feasibility.
- (ii) Feasibility studies: Conducting detailed studies (technical, financial, and economic) with specialists to determine if the identified opportunities can be profitably exploited. This helps in deciding whether to proceed with the project.
- (iii) Name approval: Selecting a name for the company and submitting an application to the Registrar of Companies for approval, ensuring it is not undesirable (e.g., identical to an existing company or misleading).
- (iv) Fixing up Signatories to the Memorandum of Association: Deciding who will sign the Memorandum of Association, usually the first Directors, and obtaining their written consent to act as Directors and take qualification shares.
- (v) Appointment of professionals: Appointing professionals such as mercantile bankers, auditors, and legal advisors to assist in preparing the necessary documents for the Registrar of Companies.
- (vi) Preparation of necessary documents: Preparing legal documents like the Memorandum of Association, Articles of Association, and Consent of Directors, which are required for company registration.
3. What is a ‘Memorandum of Association’? Briefly explain its clauses.
Answer: The ‘Memorandum of Association’ is the most important document of a company, defining its objectives and scope of activities. No company can legally undertake activities not stated in its Memorandum. Its clauses include:
- (i) The Name Clause: States the approved name of the company, which usually includes ‘Limited’ or ‘Private Limited’ at the end.
- (ii) Registered Office Clause: Specifies the state in which the company’s registered office will be located. The exact address must be notified within 30 days of incorporation.
- (iii) Objects Clause: Defines the main purpose and business activities the company is authorized to carry out. Any act beyond these stated objects is considered ultra vires (beyond powers) and invalid.
- (iv) Liability Clause: Specifies the liability of the company’s members, typically stating that it is limited to the unpaid amount on their shares.
- (v) Capital Clause: Specifies the maximum authorized share capital that the company can raise through the issue of shares, along with its division into shares of a fixed face value. The company cannot issue share capital exceeding this amount without further formalities.
4. Distinguish between ‘Memorandum of Association’ and ‘Articles of Association.’
Answer:
| Basis of Difference | Memorandum of Association | Articles of Association |
|---|---|---|
| Objectives | Defines the objectives for which the company is formed and its scope of activities. | Lays down the rules and regulations for the internal management of the company, detailing how the objectives are to be achieved. |
| Position | It is the main document of the company and is subordinate only to the Companies Act. | It is a subsidiary document, subordinate to both the Memorandum of Association and the Companies Act. |
| Relationship | Defines the relationship of the company with outsiders (e.g., creditors, public). | Defines the relationship between the members themselves and between the members and the company. |
| Validity | Acts performed by the company that are beyond the scope of the Memorandum are considered ultra vires and are absolutely invalid. They cannot be ratified even by a unanimous vote of the members. | Acts performed by the company that are beyond the Articles but within the Memorandum can be ratified by the members, provided they do not violate the Memorandum. |
| Necessity | Every company, whether public or private, must file a Memorandum of Association. | It is not compulsory for a public limited company to file its own Articles; it may adopt Table F the Companies Act, 2013. However, private companies must have their own Articles. |
5. What is the meaning of ‘Certificate of Incorporation’?
Answer: The ‘Certificate of Incorporation’ is a legal document issued by the Registrar of Companies upon being satisfied that all the necessary documents and legal requirements for company registration have been fulfilled. It signifies the legal birth of the company. The date printed on this certificate is the date from which the company is legally born as a distinct entity with perpetual succession and the right to enter into valid contracts. It serves as conclusive evidence that the company has been duly incorporated and all the legal formalities for its registration have been complied with.
6. Discuss the stages of formation of a company?
Answer: The formation of a company involves a complex process that can be divided into three distinct stages:
(i) Promotion: This is the initial stage where a business idea is conceived, and initiatives are taken to form a company to exploit the identified business opportunity. It includes activities such as identifying the opportunity, conducting feasibility studies (technical, financial, and economic), selecting and getting the company name approved, deciding on the signatories for the Memorandum of Association, appointing professionals (bankers, brokers, auditors, underwriters), and preparing all necessary legal documents like the Memorandum and Articles of Association. Promoters are the individuals who undertake these activities.
(ii) Incorporation: This stage involves the legal registration of the company. After completing the promotion stage, promoters apply to the Registrar of Companies with all the required documents (Memorandum, Articles, consents, declarations, fee receipt, etc.). Upon satisfactory review and verification that all statutory requirements have been met, the Registrar issues a Certificate of Incorporation. This certificate is crucial as it signifies the company’s birth, making it a legal entity with perpetual succession from the date mentioned on the certificate.
(iii) Capital Subscription: This stage is primarily relevant for public companies that intend to raise funds from the public by issuing securities (shares and debentures). It involves several steps:
- SEBI Approval: Obtaining prior approval from the Securities and Exchange Board of India (SEBI), which regulates disclosures and investor protection.
- Filing of Prospectus: Filing a copy of the prospectus (or a statement in lieu of prospectus) with the Registrar of Companies. The prospectus is a critical document inviting public subscriptions and must contain full disclosure of all material information without misstatements.
- Appointment of Bankers, Brokers, Underwriters: Appointing bankers to receive application money, brokers to distribute forms and encourage applications, and optionally, underwriters to guarantee the subscription of shares.
- Minimum Subscription: Ensuring that a minimum subscription (90% of the issue size as per SEBI guidelines) is received to proceed with allotment. If not met, application money must be refunded.
- Application to Stock Exchange: Applying to at least one stock exchange for permission to deal in its shares. Failure to obtain permission within a specified timeframe (ten weeks) renders the allotment void.
- Allotment of Shares: Allocating shares to successful applicants after all conditions are met, issuing allotment letters, and filing a ‘Return of Allotment’ with the Registrar.
After these stages, particularly the capital subscription for public companies, a company obtains the Certificate of Commencement of Business, allowing it to begin its operations.