VI. FORMATION OF A COMPANY: STAGES & IMPORTANT DOCUMENTS
Case Study 1: The Initial Spark
Manish, an entrepreneur based in Patna, came up with a brilliant idea to manufacture solar-powered electric scooters. Before registering a company, he hired a team of engineers and financial analysts to conduct detailed investigations. The engineers reported that the specific solar panels required are not yet technologically viable for small scooters. Consequently, Manish decided to abandon the idea.
Questions:
(a) Identify the stage of company formation discussed in the above paragraph.
(b) What specific type of feasibility study forced Manish to abandon his project? Name two other feasibility studies usually conducted at this stage.
(a) Identify the stage of company formation discussed in the above paragraph.
(b) What specific type of feasibility study forced Manish to abandon his project? Name two other feasibility studies usually conducted at this stage.
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Answer:
(a) Promotion Stage: This is the first stage where an idea is conceived and investigations are made to form a company.
(b) Technical Feasibility: Manish abandoned the idea because the required technology (solar panels for scooters) was not viable. The other two feasibility studies are Financial Feasibility (availability of funds) and Economic Feasibility (profitability of the project).
(a) Promotion Stage: This is the first stage where an idea is conceived and investigations are made to form a company.
(b) Technical Feasibility: Manish abandoned the idea because the required technology (solar panels for scooters) was not viable. The other two feasibility studies are Financial Feasibility (availability of funds) and Economic Feasibility (profitability of the project).
Case Study 2: Crossing the Boundaries
"Mithila Textiles Ltd." was incorporated with the primary objective of manufacturing and trading cotton garments, which was clearly stated in its principal document. After making huge profits for three years, the Board of Directors decided to use the surplus funds to start a steel manufacturing plant. However, the company's legal advisor immediately warned them that starting a steel business is completely illegal for them and any contract signed for it would be void.
Questions:
(a) Name the "principal document" of the company referred to in the case.
(b) Which specific clause of this document restricts the company from starting the steel business? What is the legal doctrine called when a company acts beyond this clause?
(a) Name the "principal document" of the company referred to in the case.
(b) Which specific clause of this document restricts the company from starting the steel business? What is the legal doctrine called when a company acts beyond this clause?
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Answer:
(a) Memorandum of Association (MoA): It is the principal document or charter of the company.
(b) Object Clause: This clause defines the purpose for which the company is formed. A company cannot legally undertake any activity not stated in this clause. Doing anything beyond the scope of the Object Clause is known as the Doctrine of Ultra Vires (beyond powers), and such acts are completely void.
(a) Memorandum of Association (MoA): It is the principal document or charter of the company.
(b) Object Clause: This clause defines the purpose for which the company is formed. A company cannot legally undertake any activity not stated in this clause. Doing anything beyond the scope of the Object Clause is known as the Doctrine of Ultra Vires (beyond powers), and such acts are completely void.
Case Study 3: The Birth Certificate
The promoters of "Ranchi Auto Parts Pvt. Ltd." submitted all required documents to the Registrar of Companies. The Registrar scrutinized the documents, found them satisfactory, and issued a legal certificate on 15th September. Later, it was discovered that one of the signatures on the Memorandum of Association was forged. A rival company filed a lawsuit claiming that the company's registration is invalid due to the forged signature and it should be shut down.
Questions:
(a) What is the name of the legal certificate issued by the Registrar on 15th September?
(b) Will the rival company succeed in getting the registration cancelled? Give a reason.
(a) What is the name of the legal certificate issued by the Registrar on 15th September?
(b) Will the rival company succeed in getting the registration cancelled? Give a reason.
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Answer:
(a) Certificate of Incorporation: It acts as the birth certificate of the company.
(b) No, the rival company will not succeed. The Certificate of Incorporation is conclusive evidence of the legal existence of the company. Once this certificate is issued, the company becomes a legal entity, even if some irregularities (like a forged signature) are discovered later. The birth of the company cannot be undone.
(a) Certificate of Incorporation: It acts as the birth certificate of the company.
(b) No, the rival company will not succeed. The Certificate of Incorporation is conclusive evidence of the legal existence of the company. Once this certificate is issued, the company becomes a legal entity, even if some irregularities (like a forged signature) are discovered later. The birth of the company cannot be undone.
Case Study 4: The Failed Target
"Jharkhand Infra Public Ltd." wanted to raise funds to build a new factory. The company issued 1,00,000 equity shares to the general public at ₹100 each. However, the stock market was facing a severe crash. By the closing date of the issue, the company received applications for only 75,000 shares. The directors were eager to allot these shares to start the work, but their financial manager stopped them, stating they must legally return all the application money to the investors.
Questions:
(a) Identify the stage of company formation discussed here.
(b) Why did the financial manager advise returning the money? Mention the specific SEBI rule applicable in this situation.
(a) Identify the stage of company formation discussed here.
(b) Why did the financial manager advise returning the money? Mention the specific SEBI rule applicable in this situation.
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Answer:
(a) Capital Subscription Stage: This is the stage where a public company raises funds from the public by issuing shares.
(b) Minimum Subscription Rule: According to SEBI guidelines, a company must receive applications for at least 90% of the issued amount (i.e., 90,000 shares out of 1,00,000) within 120 days of issuing the prospectus. Since they only received applications for 75,000 shares, the minimum subscription was not met. Therefore, the company cannot allot shares and must refund the entire application money within the next 10 days.
(a) Capital Subscription Stage: This is the stage where a public company raises funds from the public by issuing shares.
(b) Minimum Subscription Rule: According to SEBI guidelines, a company must receive applications for at least 90% of the issued amount (i.e., 90,000 shares out of 1,00,000) within 120 days of issuing the prospectus. Since they only received applications for 75,000 shares, the minimum subscription was not met. Therefore, the company cannot allot shares and must refund the entire application money within the next 10 days.
Case Study 5: The Internal Rulebook
The Board of Directors of a company in Ranchi wants to change the procedure regarding the transfer of shares and the rules for conducting the Annual General Meeting. However, the shareholders are confused about which document contains these internal rules and procedures, and whether it can be altered easily.
Questions:
(a) Name the document that contains the rules for the internal management of the company.
(b) How does this document differ from the Memorandum of Association in terms of its purpose?
(a) Name the document that contains the rules for the internal management of the company.
(b) How does this document differ from the Memorandum of Association in terms of its purpose?
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Answer:
(a) Articles of Association (AoA): This document contains the rules and regulations regarding the internal management of a company.
(b) Difference in Purpose: The Memorandum of Association (MoA) defines the company's relationship with the outside world and states its primary objectives. In contrast, the Articles of Association (AoA) defines the internal relationship between the company and its members, and lays down the rules to achieve the objectives mentioned in the MoA.
(a) Articles of Association (AoA): This document contains the rules and regulations regarding the internal management of a company.
(b) Difference in Purpose: The Memorandum of Association (MoA) defines the company's relationship with the outside world and states its primary objectives. In contrast, the Articles of Association (AoA) defines the internal relationship between the company and its members, and lays down the rules to achieve the objectives mentioned in the MoA.
Case Study 6: Inviting the Public
"Ganga Power Public Ltd." has received its Certificate of Incorporation. The directors now want to raise ₹50 Crores by selling shares to the general public of India. To convince people to invest, they publish a detailed document in major newspapers containing the company's future projects, financial health, past profitability, and the number of shares offered.
Question:
Name the specific document published by the company to invite the public to subscribe to its shares. What happens if a company uses private sources for funding and does not want to issue this document?
Name the specific document published by the company to invite the public to subscribe to its shares. What happens if a company uses private sources for funding and does not want to issue this document?
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Answer:
1. Document Name: The document published is called a Prospectus. It is an invitation to the public to subscribe to the share capital of the company.
2. Alternative: If a public company decides to raise funds from friends, relatives, or private financial institutions instead of the general public, it does not need to issue a Prospectus. Instead, it must file a Statement in lieu of Prospectus with the Registrar of Companies before allotting the shares.
1. Document Name: The document published is called a Prospectus. It is an invitation to the public to subscribe to the share capital of the company.
2. Alternative: If a public company decides to raise funds from friends, relatives, or private financial institutions instead of the general public, it does not need to issue a Prospectus. Instead, it must file a Statement in lieu of Prospectus with the Registrar of Companies before allotting the shares.
Case Study 7: The Secret Profit
Sanjay was the main promoter of a new manufacturing company. During the promotion stage, the company needed to buy a piece of land to build its factory. Sanjay owned a plot of land that he had bought years ago for ₹5 Lakhs. Without informing the Board of Directors that he was the actual owner, he sold the land to the newly formed company for ₹25 Lakhs through a dummy agent, making a massive secret profit.
Questions:
(a) Explain the legal relationship a promoter shares with the company he is forming.
(b) What legal action can the company take against Sanjay once they discover this secret profit?
(a) Explain the legal relationship a promoter shares with the company he is forming.
(b) What legal action can the company take against Sanjay once they discover this secret profit?
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Answer:
(a) Fiduciary Relationship: A promoter stands in a fiduciary position (a position of extreme trust and confidence) towards the company they are promoting. They must not make any secret profits while acting on behalf of the company.
(b) Legal Action: Because Sanjay breached this trust by not disclosing his interest and making a secret profit, the company is legally entitled to recover the entire secret profit from him. The company can also choose to cancel the contract of sale.
(a) Fiduciary Relationship: A promoter stands in a fiduciary position (a position of extreme trust and confidence) towards the company they are promoting. They must not make any secret profits while acting on behalf of the company.
(b) Legal Action: Because Sanjay breached this trust by not disclosing his interest and making a secret profit, the company is legally entitled to recover the entire secret profit from him. The company can also choose to cancel the contract of sale.
Case Study 8: The Fast Track
Two brothers formed "Apex Traders Private Limited." On 10th October, they received their Certificate of Incorporation from the Registrar. The younger brother immediately started buying goods and signing business contracts the very next day on 11th October. The elder brother panicked and stopped him, saying they must first issue a prospectus and wait for the "Certificate of Commencement of Business" before they can legally start trading.
Question:
Is the elder brother correct in stopping the business operations? Differentiate between a Private and Public company regarding the stages required to commence business.
Is the elder brother correct in stopping the business operations? Differentiate between a Private and Public company regarding the stages required to commence business.
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Answer:
No, the elder brother is incorrect.
Reasoning: According to the Companies Act, a Private Company can legally commence its business operations immediately after receiving the Certificate of Incorporation. It does not need to go through the Capital Subscription stage or wait to issue a prospectus, because it is strictly prohibited from inviting the public to subscribe to its shares. Therefore, the younger brother was legally allowed to start trading on 11th October. (Note: A public company raising public funds must undergo the capital subscription stage).
No, the elder brother is incorrect.
Reasoning: According to the Companies Act, a Private Company can legally commence its business operations immediately after receiving the Certificate of Incorporation. It does not need to go through the Capital Subscription stage or wait to issue a prospectus, because it is strictly prohibited from inviting the public to subscribe to its shares. Therefore, the younger brother was legally allowed to start trading on 11th October. (Note: A public company raising public funds must undergo the capital subscription stage).
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