Friday, January 10, 2014


Course Code: ECO - 08
Course Title: Company Law
Assignment Code: ECO – 08/TMA/2015-16
Coverage: All Blocks
Maximum Marks: 100
Attempt all the questions
1. What do you mean by illegal association? What are its exceptions? Explain the consequences of an illegal association?                                                 (4+6+10)
Ans: Illegal Association: Combination of persons for achievement of common objects is called an ‘association’. In order to protect public from the mischief of large trading associations, whose membership may go on constantly changing, section 11 provides for their compulsory registration.
According to section 11 every association consisting of more than 10 persons in banking business and 20 in the case of any other business must either be registered as a company under the Companies Act or be formed according to the provisions of some other Indian Law. An association not so registered is an illegal association having no legal existence. An illegal association is an association of more than 20 persons (10 in case of banking business) which carries a business without being registered under any law.
An association will be termed as an illegal association, when:
(i) The association consists of more than 20 members (10 in case of banking business);
(ii) The association is formed for carrying on a business with the objective of earning of profits; and

(iii) The association is not registered as a company under the Companies Act or not formed according to the provisions of some other Indian law.
Exceptions: The provisions of illegal association are not applicable in the following cases:
(i) Joint Hindu Family: Such a family can carry on family business with more than 20 members without getting itself registered as a company under the Companies Act or any other law.
(ii) Associations not for Profit: Literary, scientific or religious associations, clubs, welfare, charitable and traders associations, or formation of a common fund for investment by trustees in certain securities, etc.
(iii) Foreign Companies.
Rules for counting number of persons:
For counting the number of 10 or 20, as the case may be, the word ‘person’ includes both natural and artificial juristic persons. A company is a separate legal entity and therefore, it will be counted only as one person.
A partnership firm does not have a separate existence and, therefore, if it is a member of an association, each partner of the firm will be counted as a separate person. A Joint Hindu Family carrying on family business or trade shall be counted as only ‘one’ person. In case two Joint Hindu families combine and form a partnership, minors shall be excluded in computing the number of persons.
All the adults of both the joint families shall be counted as members of the association. But if the ‘Karta’ of a family enters into partnership with another family in his representative capacity on behalf of his family, he shall be treated as an individual only.
The consequences are:
1. No legal existence: The consequence of the illegality of the association/partnership is that its members have no remedy against each other for contribution or apportionment in respect of partnership dealings and transactions. An illegal association:
(a) Cannot enter into binding contracts
(b) Cannot sue any member or an outsider if the illegality becomes apparent.
(c) Cannot be sued by a member or an outsider for it cannot contract any debts.
(d) Cannot be wound up under the Act either at the instance of a creditor, a member or the association itself. Members individually or collectively of an illegal association cannot bring about a valid suit against another member or any other persons for any contract made by them.
Subsequent registration will not alter the position with regard to the past acts. Contracts made before registration cannot be validated and sued upon by subsequent registration. No cause of action can arise on the basis of an illegal association.
2. Unlimited personal liability: Every member of an illegal association shall be personally liable for all the liabilities incurred by such business. It will be immaterial if the creditors had knowledge of the illegality of the association, or not.
3. Penalty: Every member of an illegal association shall be punishable with a fine which may extend to? 10,000. The penal provisions will apply only where a company is formed in contravention of this section and not where the illegality supervenes at a subsequent stage.
However, the court may provide relief to a member of illegal association by granting a return of contribution paid provided such money has not been applied for the business by such an illegal association.
In Badri Prasad v. Nagarmal the Supreme Court held that in the case of an illegal association no relief will be granted to its associates or members as the contractual relationship on which it is founded is illegal, but subscribers will be entitled to sue for recovery of their subscriptions and for this purpose have the assets realize. This is because it does not result in enforcement of illegal contract but it will prevent continuance of illegality. The members of an illegal association have a beneficial interest in the property belonging to such association.

2. (a) Discuss the privileges enjoyed by a private company.                        10
Ans: A private company enjoys several exemptions and privileges under the Companies Act. Some of these privileges are given below:
1. Members: A private company can be started by two persons only, whereas seven persons are required to start a public company.
2. Commencement of business: A private company can commence business immediately after its incorporation. It is not required to obtain the certificate of commencement of Business.
3. Prospectus: A private company is not required to issue or file a prospectus or statement in lieu of prospectus with the Registrar of Companies.
4. Statutory meeting: A private company is not required to hold a statutory meeting or to file statutory report with the Registrar.
5. Directors: A private company can have only two directors. It is exempted from restric­tions relating to the appointment, reappointment, retirement, and remuneration etc., of managerial personnel.
6. Shares: A private company can issue deferred shares with disproportionate voting rights. It is not required to observe restrictions concerning allotment of shares, minimum subscription, right shares, investment of funds in the same groups of companies, etc.
7. Transfer of shares: A private company can refuse to register any transfer of shares with­out any appeal.
8. Accounts: A private company is not required to keep its annual accounts open for inspec­tion for non-members.
9. Quorum: Two members personally present is sufficient quorum for the general meeting of a private company.
10. Index of members: A private company is not required to prepare and maintain any index to the Register of members.

(b) Explain the ways in which a promoter is given remuneration of Promoters.                                 10
Ans: Remuneration of promoters: The nature of the promoters work in the formation of a company calls for considerable skill for which he should be adequately remunerated. A promoter has no right against the company for his remuneration unless there is a contract to that effect. In the absence of such a contract, he cannot even recover from the company payments he has made in connection with the formation of the company. A promoter may be rewarded by the company for efforts undertaken by him in forming the company in several ways. The more common ones are:
1. The company may to pay some remuneration for the services rendered.
2. The promoter may make profits on transactions entered by him with the company after making full disclosure to the company and its members.
3. The promoter may sell his property for fully paid shares in the company after making full disclosures.
4. The promoter may be given an option to buy further shares in the company.
5. The promoter may be given commission on shares sold.
6. The articles of the Company may provide for fixed sum to be paid by the company to him. However, such provision has no legal effect and the promoter cannot sue to enforce it but if the company makes such payment, it cannot recover it back.

3. Explain the doctrine of Indore Management. What are its exceptions? Discuss with examples.                           (10+10)
Ans: Doctrine of Indoor Management: The doctrine of indoor management is an exception to the rule of constructive notice. It imposes an important limitation on the doctrine of constructive notice. According to this doctrine, a person dealing with a company is bound to read only the public documents. He will not be affected by any irregularity in the internal management of the company.
The rule of indoor management had its genesis in Royal British Bank v. Turquand- The directors of the company borrowed a sum of money from the plaintiff. The company’s articles provided that the directors might borrow on bonds such sums as may from time to time be authorized by a resolution passed at a general meeting of a company. The shareholders claimed that there was no such resolution authorizing the loan and, therefore, it was taken without their authority. The company was however held bound for the loan. Once it was found that the directors could borrow subject to a resolution, the plaintiff had the right to assume that the necessary resolution must have been passed. The rule is based on public convenience and justice and the following obvious reasons:
1. The internal procedure is not a matter of public knowledge. An outsider is presumed to know the constitution of a company, but not what may or may not have taken place within the doors that are closed to him.
2. The lot of creditors of a limited company is not a particularly happy one; it would be unhappier still if the company could escape liability by denying the authority of officials to act on its behalf. 
The rule/doctrine is applied to protect persons contracting with companies from all kinds of internal irregularities. It has been applied to cover the acts of de facto directors, who have not been appointed but have only assumed office at the acquiescence of the shareholders or whose appointment is defective, or have exercised authorities which could have been delegated to them under the Act but actually not delegated, or who have acted without quorum.
Exceptions to the rule of “Doctrine of Indoor Management”
Knowledge of irregularity A person who has actual knowledge of the internal irregularity cannot claim the protection of this rule, because he could have taken steps for self-protection. A person who himself is a party to the inside procedure, such as a director is deemed to know the irregularities, if any.  T.R Pratt (Bombay) Ltd. V. E.D. Sassoon & Co. Ltd. - Company A lent money to Company B on a mortgage of its assets. The procedure laid down in the articles for such transactions was not complied with. The directors of the two companies were the same. Held, the lender had notice of the irregularity and hence the mortgage was not binding.
Negligence and suspicion of irregularity: where a person dealing with a company could discover the irregularity if he had made proper inquiries, he cannot claim the benefit of the rule of indoor management. The protection of the rule is also not available where the circumstances surrounding the contract are so suspicious
as to invite inquiry, and the outsider dealing with the company does not make proper inquiry.
Forgery: The rule in Turquand’s case does not apply where a person relies upon a document that turns out to be forged since nothing can validate forgery. In Ruben v. Great Fingall Ltd, a co was not held bound by a certificate issued by tit secretary by forging the signature of two directions. However, in Official Liquidator v. Commr of Police, the Madras High Court held the company liable where the Managing Director had forged the signature of two other directors.
Representation through articles: A person who does not have actual knowledge of the company’s articles cannot claim as against the company that he was entitled to assume that a power which could have been delegated to the directors was in fact so delegated. In Rama Corporation v. Proved Tin and General Investment Co, the plaintiffs contracted with the defendant co and gave a cheque under the contract. The director could have been authorized but in fact, was not. The plaintiffs had not read the articles. The director misappropriated the cheques and plaintiff sued. Held, director not liable as it was outside his authority.

4. (a) Explain the various ways in which a person may become a member of a Company.                              10
Ans: Modes of acquiring the Membership of a Company:
A person may become a member or shareholder of the company in any one of the following ways:-
1)      By subscribing to the Memorandum of Association: The subscriber to the Memorandum of a company are deemed to have agreed  to become a member of the company and on the registration of the company their names are entered as members on the register of members
2)      By agreeing to take qualification Shares: According to the section 266 directors of the company on delivering to registrar a written undertaking to take their qualification shares and to pay for them become the members of the company and they are in same position as if they were subscribers to the Memorandum.
3)      By transfer of shares: Shares in a company are movable property and are transferable in the same way as provided in the Articles of the company. Thus one person possesses the right to transfer his shares to another person. On the registration of transfer the transferee becomes the member of the company.
4)      By application and allotment of shares: A person may become a member of a company by an application for shares to the formal acceptance by the company. On valid allotment, the name of the shareholder is entered in the register of members
5)      By succession: On the basis of the succession certificate the legal heirs of the deceased member/shareholder get the right to be a member of the company. The company on this basis enters their name in the register of members.

(b) What is a Share Certificate? When must it be issued? What are the effects of a Share Certificate?   10
Ans: Ans. A share certificate is a document of title of share issued by a company under company's common seal which declares that the person whose name written therein is a bon a fide holder of company's share specified in it. A certificate, under the common seal of the company, specifying any shares held by any member, shall be prima facie evidence of the title of the member of such shares.
Two conditions must be fulfilled before the issue of share certificates:
1)      The board of directors should authorise the issue by means of a resolution
2)      The share certificates should be issued only on the surrender of the letter of allotment.
Effect of share certificates: According to section 84, a share certificate shall be prima facie evidence of the title of the member to such shares. When share certificates are issued, a shareholder gets the following rights:
1)      Estoppel as to title: company cannot deny the fact that the person is not holder of the shares.
2)      Estoppel as to payment: company cannot deny the fact that the shares are not paid up if in share certificate the shares are fully paid up.

5. Explain the powers and duties of a Director.                  (20)
Ans: Powers and Duties of directors
Powers of directors: The powers of the Board of directors are co-extensive with those of the company. This proposition is, however, subject to two conditions:
1)      First, the Board shall not do any act which is to be done by the company in general meeting
2)      Second, the Board shall exercise its powers subject to the provisions contained in the Companies Act, or in the Memorandum or the Articles of the company or in any regulations made by the company in general meeting.
Powers to be exercised at Board meetings: The Board of directors of a company shall exercise the following powers on behalf of the company by means of resolutions passed at the meetings of the Board, viz, the power to:
(a)    make calls on shareholders in respect of money unpaid on their shares
(b)   issue debentures
(c)    borrow money otherwise than on debentures
(d)   invest the funds of the company
(e)    make loans
Powers to be exercised with the approval of company in general meeting
(a)    sale or lease of the company’s undertaking
(b)   extension of the time for payment of a debt due by a director
(c)    investment of compensation received on acquisition of the company’s assets in securities other than trust securities
(d)   borrowing of money beyond the paid-up capital of the company
(e)    contributions to any charitable fund beyond Rs.50,000 in one financial year or 5% of the average net profits during the preceding three financial years, whichever is greater.
Duties of the Directors
A. Fiduciary duties-as fiduciaries, the directors must-
(a)    exercise their powers honestly and bona fide for the benefit of the company as a whole; and
(b)   not place themselves in a position in which there is a conflict between their duties to the company and their personal interests. They must not make any secret profit out of their position. If they do, they have to account for it to the company.
B. Duties of care, skill and diligence- directors should carry out their duties with reasonable care and exercise such degree of skill and diligence as is reasonably expected of persons of their knowledge and status. He is not bound to bring any special qualifications to his office.
C. Standard of care-the standard of care, skill and diligence depends upon the nature of the company’s business and circumstances of the case. They are various standards of the care depending upon:
(a)    the type and nature of work
(b)   division of powers between directors and other officers
(c)    general usages and customs in that type of business; and
(d)   whether directors work gratuitously or remuneratively
D. Duty to disclose interest-where a director is personally interested in a transaction of the company, he is required to disclose his interest to the board. An interested director is neither to vote on the matter of his interest nor his presence shall count for the purposes of quorum.
E. Duty to attend board meetings-the Act only says that the office of a director is automatically vacated if he fails to attend three consecutive meetings of the board or all meetings for a period of 3 months, whichever is longer. Moreover, a director’s habitual absence may become evidence of negligence.
F. Duty not to delegate- a director should not delegate his functions to another person. But delegation of functions may be made to the extent to which it is authorized by the Act or the constitution of the company.