CHAPTER - 7 FORMATION OF COMPANY

CHAPTER - 7

FORMATION OF COMPANY

Stages of promotion

  Promotion

  Incorporation

  Raising of capital

  Commencement of business

Promotion

Promoters: A company is promoted or formed to run an industrial or trading or service enterprise. The persons who thus bring a company into existence are known as ‘promoters’

            Document like memorandum of association, articles of association etc. are [prepared by them and preliminary expenses are met by them. Promotion is risky business. The promoters may be an individual, a firm, or an association or a body corporate

Types of promoters

Professional promoters: promote a company and hand it over the shareholders

Occasional promoters: do promotional works occasionally

Particular promoters: undertakes promotion of a particular business alone

Functions of promoters

Discovery of business idea: the idea may be about an entirely new line of business or it may be about the expiration of an existing business. the work begins when he gets such an idea

Detailed investigation: he makes an estimate of quality of products to be sold, cost of production, expected profits, capital requirements, market conditions, competition, availability of raw materials, power labor, transport, etc.

Assembling: once satisfied with practicability and profitability of the proposal the promoter assemble the factors of production

Financing: the financial plan should include the type of securities like shared and debenture to be issued for public subscription. To raise capital by public issue he must draft a prospects inviting the public to subscribe

Incorporation: the promoters prepare various documents to be filed with the registrar of companies. Once a certificate is issued by the registrar the company comes into existence.

Legal position of promoters

            A promoter is deemed to act as trustee of the company under promotion. The contracts entered into by the promoter with the various parties are ratified by the company on incorporation. He should to make any secret profits. He is enmities to get remuneration for the service rendered and be reimbursed for the expenses incurred by him. The promoter is personally liable for all the preliminary contracts with the other parties before incorporation. He continues to be personally liable for such contracts even after incorporation of the company.

Incorporation of a company

Form of a company: the promoters should first decide upon the form of the proposed company- private or public

Name of the company: as per the companies act a company cannot be registered by a name which is undesirable in the opinion of central government. Any name which is identical with , or which closely resembles the name of an existing company is undesirable

SEBI’s approval of the draft prospectus: a draft prospectus has to be submitted to SEBI

Industrial license: industrial act.1951 insists that for starting certain industries a license must be obtained from the central government

Procedure for incorporation

            The following documents are to be filed with the registrar of joint stock companies along with necessary filling fees, stamp duty and registration fee.

Memorandum of association: signed by at least seven persons in a public company and two persons in a private company. It should be stamped and witnessed properly

Articles of association: duly stamped and signed by the signatories to the memorandum of association

List of directors: containing names, address and occupation

Written consent of directors: to act in that capacity

Undertaking of the directors: to the effect that they will take up and pay for qualification shares.

Notice of registered office: showing the address of registered office of the company. It need be filed within 28 days of registration

Statutory declaration: by an advocate of the supreme court or a high court or chartered accountant or a director or secretary pr manager of the company that all requirements of the act have been complied with.

After scrutiny, the registrar issues a certificate called ‘certificate of incorporation’

Effect of certificate of incorporation

    This certificate is a conclusive proof of the registration of the company. It may rightly be called the birth certificate of the company. The date show in the certificate denote the date on which the company comes into existence.

It also evidence that the memorandum and articles are within law.

        A private company can start business immediately on receipt of certificate of incorporation. But a public company can start business only after getting another certificate called certificate of commencement of business.

Rising of capital

             The raise capital the directors of a public company have to take the following steps:

1) Agreement with underwriters

2) Application to the stock exchange for listing of shares

3) Appointment of bankers and auditors

4) Invitation to the public for subscription to the share capital

5) Allotment of shares on receiving application for shares6) Filling a statement called “return of allotment “with the registrar.

Commencement of business

                           Certificate of commencement of business is granted by the registrar only when the following formalities are fulfilled. The company filed with the registrar a prospectus or a statement in lieu of prospectus. The number of shares allotted is not less than the minimum subscription stated in the prospectus. The directors have taken up and paid for their qualification shares

            Return of allotment containing names and address of shareholders and the number of shares allotted to each, should be submitted. Declaration to the effect that the company was applied for or obtained permission for dealing its shares in a recognized stock exchange should be filed. Declaration by the secretary or directors of the company is filed with the registrar to the effect that all provisions of the Act in respect of allotment of shares and commencement of business have been complied.

Effect of certificate of commencement of business

            It entitles a company to start business and exercise its borrowing powers. All the contracts entered into by the company in between the date of incorporation and the dates of issue of certificate of commencement of business are provisional. They would now become binding on the company.

Basic company documents

Memorandum of association

            The memorandum of association is the most important document of the company with which a company is registered. It is described ads the charter of Magna Carta of the company. It defines the company’s objects, capital and power. The relation of the company with the outsiders is governed by the provisions of the memorandum.

Contents of memorandum

            The memorandum of association of a company limited by shares contains the following clauses:

1) Name clause

2) Domicile clause or situation clause

3) Objects clause

4) Liability clause

5) Capital clause

6) Association clause or subscription clause

1) Name clause

              The name of the company must be stated in this clause. The name should not be identical with, or similar to, the name of an existing company. The name selected must not suggest any connection with or association or patronage of a national hero. These restrictions are imposed to avoid confusion in the mind of public. The name should end with the word “limited” or “ltd”.

2) Domicile clause

       This clause specifies the name of the state where the registered office of the company is situated. This clause determines the jurisdiction of the registrar of joint stock companies and of the courts. The registrar of the state concerned will be the authority for registration, administration and winding up of the company.

Full address of the company must be filled with the registrar within 30 days of incorporation of the company.

3) Object clause

            It specifies objects of the company. It indicates the extent of company’s powers and the sphere of its activities. The objective of clause serves two purposes: It informs the shareholders and others about the kind of business in which their money is invested .It informs the creditors and outsiders what the company is permitted to do.

4) Liability clause

            It state whether the liability of members is limited by shares or by guarantee. In the latter case the amount to be contributed by each member towards debts and liabilities of the company on winding up is mentioned.

5) Capital clause

            This clause state the total capital of the company with which the company is registered. It is known as registered capital or authorized capital or nominal capital. This is the maximum limit of capital that can be issued. The value and number of shares should also be stated in this clause.

6) Association or subscription clause

              This clause is in the form of a declaration. It states that the subscribers express their willingness and agreement to form a company.

Alteration of memorandum

            Alteration of memorandum alteration must be just and equitable in the best interest of the company. It should not defeat the main objects of the company. Legal formalities for alteration are described below:

1) Alteration of name clause:  

            A company can change its name at any time by passing a special resolution and obtaining the approval of central government. If a private company is converted into a public company the word ‘private, is deleted. Similarly, when a public company is converted into a private company the word “private” is added to the name.

2) Alteration of domicile clause:    

            Change of registered office from one locality to another in the same city or town is effected by a resolution of board of directors. If the changes are from one place to another in the same state a special resolution is required. In both cases the change is notified to the registrar within 30 days. A public notice is also required.

3) Alteration of objects clause;

               The objects clause can be altered only for some specific purpose mentioned in the companies act. The company has passed a special resolution and obtains conformation of the company law board. A copy of the conformation order and a printed copy of altered memorandum must be filed with the registrar.

4) Alteration of liability clause:

            If all the members of a limited or guarantee company give their consent in writing , liability an be altered. Liability of directors, managing directors or manager can be altered by passing a special resolution if the articles of association permit. The registrar should be intimated about the alteration.

5) Alteration of capital clause:

            To increase the share capital an orderly resolution will suffice. A special resolution is a must for reduction of capital. Confirmation of the resolution by the court is also necessary for reduction of capital. Copy of resolution and confirmation by the court should be filed with the registrar.

6) Association clause:  This clause cannot be altered.

      Articles Of Association:

            The articles are to be filed with the registrar to get the company registered. It contains the rules and regulations for internal management and administration of the company.

Contents of articles of association

1) Share capital and its sub-division into different classes’ of shares

2) Rights of different classes of shareholders

3) Allotment of shares by directors

4) The procedure for making calls on shares, transfer, transmission, forfeiture and surrender of shares

5) Minimum subscription

6) Issue of shares certificate and share warrants

7) Company, s lien on shares

8) Alteration of capital

9) Conversion of shares into stocks

10) Borrowing powers of the company

11) Conduct of meeting of shareholders and the board of directors

12) Number, appointment t, remuneration, power and duties of directors.

13) Appointment of manager, managing directors and secretary

14) Dividends and reserve funds

15) Maintenance of books of accounts and their audit

16) Execution or adoption of preliminary contracts

17) Common seal of the company

18) Winding up of the company

19) Arbitration

            The article must be printed, dividend into paragraph and numbered consecutively and signed by every subscriber to the memorandum in the presence of a witness, who shall attest the signatures. It must also be stamped.

Table A

             The companies act gives table A containing rules and regulations relating to the management of companies. According to section 26 of the companies act, registration of articles is not compulsory for public limited companies

Alteration of articles

            The articles of association can be altered with a special resolution and the fact should be intimated to the registrar. But such alteration must be subject to certain conditions

·     Such alteration shall not be against the companies act the memorandum.

·     It should not lead to conversion of a public company into a previous company unless approved by the central government

·     It should not increase the liability of a member without his written consent

·     It should not violate any existing contract

·     It should not be fraudulent or illegal

·     It should be in the interest of the company.

Distinction between memorandum and articles of association

Memorandum of association	Articles of association
1.         It is the constitution or charter of the company	It forms the bye-laws of the company
2.       It is the fundamental and main document of the company	The articles is only a subsidiary document of the company
3.       It define the relationship between the company and the outsiders	It defines the relationship between the company and its members
4.       It is a compulsory for every company for incorporation	It is not compulsory for all companies
5.       It contains important basic functions such as objects, capital, power, etc	It mentions ways and means by which the objects can be achieved
6.       For alteration it requires a special resolution , permission from the government or from the company law board or from the court	Alteration requires only a special resolution
7.       It is subordinate to the companies act only	It is subordinate both to the companies act and memorandum of association.

Prospectus

            The object of prospects is to arouse interest of the investing public in the proposed company. It therefore contains all material essentials information regarding the company’s affaires and its future prospects. A private company is prohibited from inviting the public to subscribe to its shares

           A copy of the prospectus must be filed with the registrar before it is issued to the public. It must be published within 90 days from the date of filling with the registrar.

Contents of prospectus

·        The main object of a company

·        Name and registered address of the company

·        Name , address and occupations of the signatories to the memorandum and the number of shares taken by them

·        Number and class of shares issued and rights of different classes of shareholders

·        Number of redeemable preference shares to be issued, the date of redemption , notice and the method of redemption

·        The qualification shares, if any , of the directors

·        Names, address and description of directors, managing directors, manager, etc.

·        Name and address of the  promoters of the company and their remuneration

·        Minimum subscription required for allotment of shares

·        Amount payable on application and allotment on each shares

·        Information on listing of shares on a stock exchange

·        Time opening and closing the subscription list

·        Particulars of any option given to any person to subscribe for shares and debentures of the company

·        Details of borrowing power of the company

·        Particulars of all contracts made

·        Particulars of all contracts made

·        Particulars of shares or debentures issued or to be issued for consideration other than cash

·        Particulars of property purchased , name of the vendor and the payment of purchase consideration

·        Name of underwriters and details of underwriting agreement

·        Name of auditors , bankers and brokers

·        Nature and extent of interest of directors or promoters in the promotion and in any property proposed to be purchased

·        Particulars of shares issued at premium

·        Restrictions on members and directors

·        Capitalization of profits

·        Where the prospectus is issued by an existing company, the audited profit and loss accounts and balance sheets for the last 5 years must be attached.

Liability for misstatement of prospectus

                 Prospectus forms the basis of a contract between the company and shareholders. Therefore, if the prospectus contains any mis-statement, misrepresentation or suppression of facts, the contract is violated. The shareholders in such a case can proceed to a court of law to cancel the allotment. To protect the investors, the companies act contains penal provisions to deal with such cases.

a) Civil liability: a person who purchases shares or debenture on the strength of mis-statement or mis-preprecentaion in a prospectus, to claim compensation or refund of money from any directors, promoter or any person authorized to issue such a misleading prospectus.

b) Criminal liability: Every person who has authorized issue of such a prospectus is punishable with imprisonment unto two years or fine unto Rs. 5000 or both.

Statement in lieu of prospectus

            When a public company wants to raise capital privately it must file a statement called “statement in lieu of prospectus” with the registrar at least three days before the first allotment of shares.

Allotment of shares

            Applications for shares duly filled in are sent to the company or its banks along with application money .The shares are allotted by the board of directors, whose decision is final. a letter of allotment is sent to each applicant to whom shares are allotted, while a letter of regret with refund of application to whom shares are not allotted.

Restrictions on allotment

·     Send a copy of the prospectus or statement in lieu of prospectus to the registrar

·     Deposit all application money received in a scheduled bank

·     See that the minimum subscription stated in the prospectus has been achieved and application money received.

Minimum subscription

            The minimum amount of capital which must be subscribed by the public before a public company can allot shares is known as minimum subscription, and is decided by the directors and stated in the prospectus.