Module II: Promotion Activities and Formation of a Company-I [08 Lectures]

Promoters – Definition, Importance and Legal Position;

 Rights, Duties and Liabilities of Promoters, Remuneration of Promoters;

 Formation of Companies- important steps;

 Certificate of incorporation of the company;

 Allotment of corporate Identity Number;

 Punishment for furnishing false or incorrect information at the time of

incorporation;

 Incorporation of companies with charitable objects under section 8;

 The doctrine of ultra-vires, Shareholder’s right in respect of ultra vires acts, Effects
of ultra vires Transaction.

Pre-incorporation contracts and contracts made after incorporation of business.

 Conversion of private companies to public companies and vice versa.

Introduction-

Promotion activities generally means the beginning or initial activities of the company to
form or register the company by the promoters.

Person who promote or start the company first time is called as promoter.

Though there is no any definition of promoter in the act.

Certain activities are very essential for initiation of any company. For instance, Registration
act as a birth certificate for any new company. During registration, different documents are
prepared and if the registrar is satisfies with the submitted and documents fulfil all the
required essentials then the company would be registered.

During this period, some moneys are being spent by the promoters from their own pocket and
these moneys are counted as preliminary expenditures.

Duties of the promoter

1) Duty to disclose secret profits- Profit is something that is in excess of the income
over expenditure. Many of the companies are established for the sole purpose for
earning profits. Some of the companies are not established for the purpose of gaining
profits but for the benefit of the society, for promoting research, social welfare,
religion, charity, commerce, art, science, education and many more. These types of
companies are called as Section 8 Company.
 Secret Profit- This profit fulfils the interest of the promoters.
It may happen that there would be conflict of interest or clash between the personal
interest of the promoters and the interest of the company.
e.g. Selling of own land to the company in excess of the market price.
2) Duty of disclosure of interest- Promoters must disclose any interest he has in a
transaction enter into it by. It has wider ambit than the former one. E.g Appointment
of any relative in a company.
3) Promoter’s duties under India Contract Act, 1872- Promoter will be personally
held liable for making any contract before the incorporation or registration of the
company.
Pre- incorporation contract- Contract between the promoter and outsider enter meet
before the registration of the company for the purpose of the company. There are two
situations arises in this- (a) if any contract made before the incorporation; (b) contract
made after incorporation.
4) Termination of Promoter’s duties- A promoter duties do not come to an end on the
incorporation of the company or even when Boards of Directors is appointed that
duties are continue until the company has acquire some property and has raised its
initial share capital. In Lagunas Nitrate Company v. Lagunas Syndicate Limited,
(1899)2 C.H. 392, Hon’ble Court held that promoters will continue their duties until
the Boards of Directors has taken over the management of the company’s affairs from
the promoters.

Liabilities of the Promoters-

I. Section 26- deals with the matters that should be stated and the reports should be set
out in the prospectus. If this provision is not complied with, the promoters may be
held liable under section 35 to compensate the share capital.
II. Section 35- This section provides for civil liabilities for any misstatements made in
the prospectus. As per this section, a promoter can be held liable for any false
statement in the prospectus, by a person who has subscribed for the shares and
debentures of the company acting on the faith of the prospectus.
Debentures- it acts like a loan certificate issued by the company to the common
people. Capital is essential for any company and it can be own capital of the share
holders, loan capital taken from any financial institutions and through issuing
debentures or bonds, Intermediate capital.
III. Section 34- this section contains provisions relating to criminal liabilities for issuing a
prospectus which contains untrue statements. Under this section, promoters can be
held criminally liable if the prospectus issued by them contained misstatements for
imprisonment for a term which shall not be less than 6 months and which may extent
to 10 years. The promoters shall also be liable to pay fine which shall not be less than
the amount involved in the fraud but which may extent to the three times the amount
involved in the fraud.

Q. Is prospectus a legal deed or just a manifesto laying down the aims and objectives
of the company?
 For any Public company, having a prospectus is very compulsory.

• Remuneration of promoters- a promoter is not entitled to recover any

remuneration for his services from the company unless there is a valid contract
enabling him to do so, between him and the company. Without such a contract, he
is not even entitled to recover his preliminary expenses or even the registration
fees.
• Pre-incorporation contract and Promoters- Legal positions of promoters in
respect of pre- incorporation contract may be discussed in two heads-
A. Position of the Pre- incorporation contract before 1963 i.e before quashing
of Special Relief Act, 1963- A pre- incorporation contract never binds a
company as a legal person cannot contract before existence so a company
has no legal existence before its incorporation. The company is also not
entitled to sue on a pre- incorporation contract.
B. Position of Pre- incorporation contract since 1963- Until the passing of
Special Relief Act, 1963, the promoters found it very difficult to carry out
the work of incorporation. As pre- incorporation contract was void.
People hesitated to supply any goods or services before incorporation.
Promoters also hesitated to accept personal responsibility. However,
Special Relief Act, 1963 came as a relief to the promoters.
Section 15(h) of Special Relief Act, 1963 says that where the promoters
of a public company have made a contract before incorporation for the
purposes of the company and if the contract is warranted by the terms of
its incorporation, the company may enforce it.
The meaning of the term “Warranted by the terms of incorporation” is
within the scope of the company’s objects as stated in the memorandum.
Section 19 of Special Relief Act says and allows the other party to enforce
the contract against the company if the company had adopted for same
after incorporation and the contract is warranted by the terms of
incorporation.

Registration or Incorporation of Company- Procedure part

Section 3 of the Act says that A company may be formed or any lawful purpose by 7 or more
persons in case of a public company or 2 or more in case of the private company or 1 in case
of one person company. However, the procedure for registration or incorporation of the
company and the various stages are as follows-

i. The type of company is to be first decided i.e. whether the company is public
company or private company or One person Company.
ii. Application for availability of name- the promoters will obtain the approval of the
proposed name from the ROC (Registrar of the company). Application can now be
made online. The promoters are required to give maximum 6 proposed names in
order of preference in form no. INC. 1.
 As per section 4, no company shall be registered by a name which is identical or
resembles too nearly to the name often existing companies registered under this Act
or any previous company laws.
The name should not be such that its use by the company will constitute any offence
under any law for the time being in force or is undesirable in the opinion of the
central government.
iii. Preparation of Memorandum of Association and Articles of Association-
Promoters shall take necessary steps to prepare Memorandum of Association and
Articles of Association. In this context, the promoters may take help of the corporate
lawyers or chartered accountant or cost accountant or company secretariat. However,
Memorandum of Association of a company has to be in respective forms specified in
table A, table B, table C, table D and table E of Schedule 1.
Table A- Company limited by shares.
Table B- Company limited by guarantee and not having share capitals.
Table C- Company limited by guarantee and having share capitals.
Table D- Company of unlimited liability and not having share capitals.
Table E- Unlimited liability Company and having share capitals.

The Articles of Association are contained in a separate tables and these are table F,
table G, table H, table I and table J of Schedule 1.
Table F is used by the company limited by shares.
Table G- Company limited by guarantee and having share capitals.
Table H- Company limited by guarantee and not having share capitals.
Table I- Unlimited liability company and having share capitals.
Table J- Unlimited liability company and not having share capitals.

Section 7 and Rule XIII of the Company (Incorporation) Rules, 2014 require that
Memorandum of Association and Article of Association of the company shall be signed by
each subscriber to the Memorandum, who shall add their names, addresses, description and
occupation in the presence of at least 1 witness who shall be at least the signature and shall
also sign and add his name, address, description and occupation if any.

• In addition to the previous document, the following documents are also to be prepared
by the promoters-
a) Power of Attorney- Promoters may execute power of Attorney in favour of
any one of them or in favour of an advocate or Chartered Accountant or Cost
Accountant or Company Secretariat. It will be prepared on a Non- judicial
stamp paper. The value of which is prescribed by the Stamp Act of the
respective State Government.
b) Consent of the Directors- A list of persons who have agreed to become the
first directors of the company along with their consent should be filed.
Particulars of the first directors that is their names, surnames, family names,
director’s identification number (DIN), residential addresses, nationality and
proof of identity etc.
 c) Particulars of Managers- where the company names in its Articles, the
person who are to act as Managers, Secretary etc. The particulars of such
manager may be filled with the ROC at the time of registration.
d) Affidavit by Subscribers to the Memorandum and First Directors- Each
Subscribers to the memorandum and the persons named as the First directors
shall file an affidavit that he is not convicted of any offence in connection with
the promotion, permission or management of any company or that he has not
been found guilty of any fraud or of any breach of duty to any company under
the Companies Act or any previous company law during the preceding 5 years
and that all the documents filed with the ROC for registration of the company
are correct and complete and true to the best of his knowledge and belief.
e) Address for communication and notice of registrar address- Address for
communication shall also be supplied until the company acquires its registrar
office. As per Section 12, a company is required to have a registrar office
within 15 days of incorporation.
f) Statutory Declaration- A statutory declaration to the effect that all the
requirements of this Act and the Rules made there under in respect of
registration and matter precedent or incidental thereto, have been complied
with, is also to be filed. The declaration is to be signed by an advocate, a
chartered accountant or cost accountant or a company secretary in practice
who is engaged in formation of the company and another person who is named
in the Article of Association as director, manager or secretary of the company.
g) Filing of documents for registration- after the documents are ready, the next
step is to file this document with the ROC of the company of the concerned
states for the purpose of registration of the company.
• After examining all the documents, the registrar will issue a certificate of registration
with Form No. INC.11. This certificate will act as a Birth certificate and from that
very moment, the company will born and enjoy the status of separate legal entity.

Corporate Identity Number (CIN)

As per Section 7(3), on and from the date mentioned in the certificate of incorporation,
the Registrar shall allot to the company a Corporate Identity Number (CIN) which shall
be distinct identity for the company. This number shall be incorporated in the certificate
of registration.

Doctrine of Ultra Vires

Ultra vires is made up of two words in which the meaning of Ultra is beyond where as the
meaning of vires is power. Thus, the literal meaning of Ultra Vires is “Doing an act
beyond the powers”.

Historical Background-

The doctrine of Ultra Vires was first time laid down in the case of Ashbury Railway
Carriage and Iron Company Limited vs. Riche, 1878 L.R. 7 H.L. 653, Lord Cairns J.
 Hon’ble Court in this case established two legal principles. The first principle is that “any
act of the company which is ultra vires the memorandum, shall be wholly void and
therefore not binding upon company”. However, the second principle says that “the whole
body of shareholders cannot rectify such acts by passing a resolution in the meeting”.

All the shareholders meet once in a year and this meeting is called as Annual General
meeting.

• Objects and Purpose of the Doctrine

a) To protect investors of the company so that they may know the objects in
which their money is to be employed.
b) To protect the creditors by ensuring that the company funds are not dissipated
(vested) in unauthorized activities as pronounced in the Ashbury’s case.

A. Lakshamanswami Mudaliar vs. Life corporation of India, AIR 1963 SC 1185, High Court
held that power must be exercised to promote the company’s objects. There must be a
proximate connection between the act and the company’s business interest and Hon’ble Court
also upheld the doctrine of Ultra Vires in this case.

However, the doctrine of Ultra Vires was first recognised in India in 1866 in Jahangir R.
Modi vs. Shamji Ladha, Volume 4 Bombay HC HCR 185, Hon’ble Court held that the act of
directors to purchase shares of another company as Ultra Vires.

An Ultra Vires act of the company does not create any legal relationship between the
company and the third parties. So, any activities contrary to or in excess of the scope of the
directors, articles of association, memorandum of association or Company Act will be Ultra
vires.

Difference types of Ultra Vires or Division of Ultra Vires

A. An act Ultra Vires the Directors- If an act or transaction is Ultra Vires the directors
but within the powers of the company, the shareholders can ratify it by resolution in a
general meeting. The act is not altogether void because this act can be ratified by the
general body of shareholders and on such ratification, the act becomes binding on the
company.
B. An act Ultra Vires the Articles- if an act or transaction becomes ultra vires the
Articles, then the company can ratify it by altering the articles by a special resolution.
But, such ratification is possible only if the act is intra vires the memorandum and the
company Act.
C. An act Ultra Vires the Memorandum of Association- A company can’t do anything
which is beyond the purview od the object clause. If the company does any act which
is against the object clause of memorandum, it will be called as Ultra Vires the
Memorandum and it shall be wholly void and inoperative. Such an act can’t be
ratified subsequently even by a unanimous resolution of all shareholders.
 D. An act ultra vires the Company Act- when an act or transaction is ultra vires the
Company Act, it cannot be ratified even by the whole body of shareholders. This act
is, therefore, void ab initio.

Effects of Doctrine of Ultra Vires

a) Void ab initio- The Ultra Vires acts are null and void ab initio. The company is not
bound by these acts. Even the company can’t sue or be sued upon it.
b) Injunction- The members can get an injunction to restrain the company wherein ultra
vires act has been or is about to be undertaken.
c) Personal liability of Directors- It is the duty of the directors to see that the funds of the
company are used only for legitimate business of the company. If directors make an
ultra vires payment then they can be compelled to make good for loss.
d) Ultra Vires Borrowing- It would not create the relationship of creditor and debtor of
the company. The concerned officers and directors will be personally liable for those
borrowings.

Exceptions to the Doctrine of Ultra Vires

i. If an act is ultra vires the directors of a company but is intra vires the company, a
company may ratify it.
ii. If an act is ultra vires the Articles of the company, the articles may be allowed to
include the act within the powers of the company.
iii. If a company has taken an ultra vires loan through some misrepresentation of facts by
directors, then the lender has the right to make the directors personally liable on the
ground of breach of implied warranty of authority.
iv. If a director of a company makes payment ultra vires the company, the company can
compel him to refund the amount. The directors, however has the right to be
indemnified by the person receiving the money provided that he knew of the
transaction to be ultra vires the company.

Doctrine of Constructive Notice

The Memorandum of Association and Articles of Association of every company are required
to be registered with the Registrar of the companies. These documents become public
document at the time of the registration of the company and as per Section 399 as a public
document- these documents are available for public inspection either in the office of the
company or in the office of the Registrar of the company. Every outsider dealing with the
company is deemed to have notice of the contents of the Memorandum and Articles, on
registration these documents assumed the character of public documents. This is known as
Constructive Notice of Memorandum of Association and Article of Association.

Every person who deals with the company whether shareholder or an outsider, is presumed
to have read these documents and understood them.

Mohony vs. East Holyfrad Mining Company, 1875 L.R 7 H.L. 869, held that whether any
person have actually read them or not. It will be presumed that the person has read them.
Oak Bank oil Company vs. Crum, (1882)8 A.P.P. Cas. 65, it was held that anyone dealing
with a company is presumed not only to have read the Memorandum of Association and
Articles of Association but to have understood them properly.

Doctrine of Indoor Management

It is an exception to the Doctrine of Constructive Notice.

The Doctrine of Constructive Notice seeks to protect the company from outsiders but the
Doctrine of Indoor Management seeks to protect the outsiders from the company.

The Doctrine of Indoor Management had imposed an important limitation on Doctrine of

Constructive Notice. As per the Doctrine of Constructive Notice, every person dealing with
the company is deemed to have read and understand the contents of Memorandum of
Association and Articles of Association and shall be bound by them. But the persons are not
required to examine whether the internal proceedings have been complied with or not. The
details of Internal Procedures are not open to the public inspection like Memorandum of
Association and Articles of Association. Outsiders can safely assume that provisions of the
articles have been complied with by the company in its internal working. Every person
dealing with the company is entitled to assume that everything has been done regularly so far
as the internal proceedings of the company is concerned.

If the internal formalities have not been complied with, in the contract shall be binding on the
company and it shall be liable to outsiders. This rule is known as the Doctrine of Indoor
Management.

Origin

This Doctrine was first laid down in the case of Royal British Bank v. Turquaind, (1856)119
E.R. 886, and this case popularly known as the Turquainds case.

Facts- Directors of the company issued a bond to the Turquaind. They had the power to issue
such bond but only subject to the resolutions passed at the general meeting of the company.
But no such resolution has been passed. It was held that Turquaind could recover the amount
of the bond from the company on the ground that he was entitled to assume that the
resolution had been passed.

In this case, the Lord Hatherly observed that outsiders are brought to know the external
positions of the company but they are not bound to know the indoor management of the
company.

Exceptions to the Doctrine of Indoor Management

A. Where the outsider has knowledge of irregularity- where a person knowingly well ,
where the directors do not have the authority to make the transaction but still enters
into it, in that case, the person can’t seek protection under the rule of indoor
management. Howard v. Patent Ivory Company, 38 C.H.D. 156, T.R. Pratt(Bombay)
Ltd. v. E.D. Sasson and Company Ltd., AIR 1936 Bombay 62.
 B. No knowledge of Memorandum of Association and Articles of Association- The
doctrine of Indoor Management can’t be invoked in favour of a person who had no
knowledge of Memorandum of Association and Articles of Association. So,
Turquaind’s Rule can’t be applied in favour of a person who did not in fact consult
the Memorandum of Association and Articles of Association of the company and
consequently did not act on relying on these documents. Rama Corporation v. Proved
Tin and General Investment Company, (1952)1 England Report 554.
C. Negligence on the part of the outsider- The doctrine of Indoor Management in no way
reward those who behave negligently. So, where an officer of a company has
something which shall not ordinarily be within his powers, the person dealing with
him must make proper enquiries and satisfy himself as to the officer’s authority. If he
fails to make an enquiry then he is prevented from relying upon the rule of indoor
management. A.L. Underwood v. Bank of Liverpool (1924)1 K.B. 775.
D. Forgery- The protection under this doctrine shall not be available for outsiders who
have relied upon the forged documents. A company is not liable for forgeries
committed by its officers. Rouben v. Great Fingal Consolidated, 1906 A.C. 439, the
secretary of the company issued a share certificate under the company’s seal and the
signature of the director forged by him. It was held that the share certificate was not
binding on the companies. The person who adversaries the moneys on the strength of
this certificate was not entitled to be register as holders of shares.
E. Oppression- The Doctrine of Indoor Management can be invoked only with reference
to acts which relate to provisions of Memorandum of Association and Articles of
Association and not in a case where oppression is alleged.

Q. Pubro Infotech Company was incorporated on 15th January, 2005. The certificate of
incorporation was issued by the Registrar of the Company on 25th January, 2005. In fact, the
promoters of the company put the initiative to form the company in 2003. They performed al
the initiating process for the incorporation of the company. They had also took a loan of Rs. 2
Lakhs in 20th June, 2004 in the name of the company. The amount was spent to meet various
preliminary expenditures. But, the company denies to repay the same loan after 25th June
2005. The promoters did not make any contract in this regard and the matter went to the
court. Decide the liability of the promoter. [ Kilnar v. Baxter (1866) L.R. 2 (174)].