Law and You > Corporate Laws > Companies Act, 2013 >Concept Applications 1.1 Short Notes
These are frequently asked questions (short notes) on basic features of company and case laws associated with it.
a) Distinguish between a company and a partnership firm.
| Company | Partnership Firm |
| A joint stock company is an incorporated voluntary association of individuals for profit, created by law, owned by the shareholders but managed by their few representatives, i.e., Directors. | A partnership firm is a form of business organization owned and managed by two or more persons i.e., partners for earning profit. |
| In Private Company, the minimum number of members is two and maximum 200. In a public company the minimum number of members is seven and there is no upper limit. | In Partnership firm, the minimum number of members is two and the maximum number of members is and maximum 100. |
| Formation of Joint Stock Company is lengthy, tedious process. Numerous legal formalities are involved. | Formation of Partnership firm is easy. |
| Formation of Joint Stock Company is expensive process. | Formation of Partnership firm is not expensive process. |
| Registration of Joint Stock company is compulsory. | Registration of a Partnership firm is not compulsory. |
| Winding up and dissolution of a company is an expensive and long-drawn process. | Dissolution of Partnership firm is easy. |
| Joint Stock company has separate legal existence. It is an artificial person created by law. | Partnership firms has no separate legal existence. Partnership firm and partners are the same. |
| Joint Stock Company is regulated under the Companies Act, 2013. | Partnership firm is regulated under the Partnership Act, 1932. |
| There is possibility of securing huge capital in case of Joint Stock company. It can raise public money by issuing prospectus. | Huge capital for Partnership firm cannot be secured. It cannot raise money from public. |
| In a Joint Stock Company, liability of each shareholder is limited. | In a Partnership firm, liability of each partner is unlimited, joint and several. |
| Property of Joint Stock Company exclusively belongs to company only. | Property of Partnership firm belongs to its partners. |
| In case of Public limited companies, shares can be transferred freely. | In Partnership firm transfer of shares is not possible without the consent of all the partners in a partnership firm. |
| In a Joint Stock Company, management will be in the hands of elected directors. | Partnership Firm is managed by the partners themselves, in general. |
| Audit of accounts of Joint Stock Company is compulsory. | Audit of accounts of Partnership firm is not necessary. |
| A Joint Stock Company has to observe several formalities like annual meetings, registration of changes, etc. | A partnership firm is free from all such formalities. |
| The objects of a Joint Stock Company cannot be changed very easily. | The objects of the Partnership firm can be changed easily. |
| Joint Stock Company can sue and be sued in its own name. | Partnership firm can sue and be sued only in the name of partners. |
| Joint Stock Company has continuous or perpetual existence. | Partnership firm has no continuous existence. |
| Death of a member has no effect on the existence of Joint Stock Company. | Death of a member dissolves Partnership firm |
| Insolvency of a member has no effect on the existence of Joint Stock Company. | Insolvency of a member dissolves Partnership firm unless the partnership deed provides otherwise. |
| A member of Joint Stock Company can contract with the Joint Stock Company. | A partner cannot contract with the Partnership firm. |
| Members can engage in a business in direct competition with the company. | A partner cannot engage in a business in direct competition with the partnership firm. |
| Restrictions in Articles of company affect third parties. A partner cannot contract with the Partnership firm. | Partners generally cannot engage in competing business. |
b) Separate Legal Entity of Company or Theory of Corporate Personality:
A company is a legal person in the eyes of law. It is an artificial person or a juristic person. A company is independent and separate from its members, and the members cannot be held liable for the acts of the company, even when a particular member owns the majority of shares. This was held in the case of Solomon v. Solomon. Salomon’s case established beyond doubt that in law a registered company is an entity distinct from its members, even if the person holds all the shares in the company i.e. a company has separate legal existence. There is no difference in principle between a company consisting of only two shareholders and a company consisting of two hundred members. In each case, the company is a separate legal entity. In case of a partnership firm, it has no separate legal entity. Partners are responsible for every act.
- Due to the creation of a separate legal entity, the members have limited liability. Under Section 34(2) of the Company Act, in the event of a company being shut down, none of its members is legally bound to contribute to anything more than the nominal value of shares held by the member which still remains unpaid.
- The Companies Act states, ‘Members may come and members may go, but the company can go on forever.’ As per Section 34(2) of the Company Act, an incorporated company has the characteristic of perpetual succession. The term perpetual succession of the company means its continuous existence, which means that a company never dies, even if the members cease to exist.
- An incorporated company has a separate legal existence and an artificial person in the eyes of law. Hence it is capable of owning, holding, enjoying, and disposing of property.
- A person can take legal action on his / her name. Similarly, the company as an independent legal entity could take legal action in its own name against another person. In turn, it can be sued by other companies and people.
All these points elaborate that a company has a separate legal existence.
Case Laws:
- Solomon v. Solomon & Co., 1897 AC 22
- Lee v. Lee’s Air Farming Limited, 1961 AC 12
- Re. Kondoli Tea Co. Ltd., ILR 1886 13 Cal 43
Suggested Reading Click on the Image
c) Solomon v. Solomon & Co.:
Salomon’s case established beyond doubt that in law a registered company is an entity distinct from its members, even if the person holds all the shares in the company i.e. a company has separate legal existence. There is no difference in principle between a company consisting of only two shareholders and a company consisting of two hundred members. In each case, the company is a separate legal entity.
Facts:
Mr. Salomon was the owner of a very prosperous business engaged in the manufacture and sale shoes. He sold his business for the sum of £ 40,000 to Salomon and Co. Ltd. which consisted of Salomon himself, his wife, his daughter, and his four sons (7 shareholders). The purchase consideration was paid by the company by allotment of & 20,007 shares and £ 10,000 debentures and the balance in cash to Mr. Salomon. The debentures carried a floating charge on the assets of the company. 20001 shares of face value £ 1 each were allotted to Salomon. One share of £ 1 each was subscribed by the remaining six members of his family. Salomon and his two sons became the directors of this company. Salomon was the Managing Director. The company went into liquidation within a year due to trade depression. At that time the statement of affairs was like this: Assets: £ 6000, liabilities; Salomon as a secured creditor and debenture holder £ 10,000 and unsecured creditors £ 7,000. Thus, its assets were running short of its liabilities b £11,000.
Issues and Arguments:
The unsecured creditors of the company contended that the company, though incorporated under the Act, had never an independent existence; it was, in fact, Salomon under the name of a company. Actually, the company and Salomon were one and the same person. One argument put forth on the behalf of unsecured creditors was that the company was only the agent of Mr. Salomon, and, in truth, the business belonged to him and not to the company.
Judgment:
House of Lords held that the existence of a company is quite independent and distinct from its members. Shareholders may also be the creditors of the company. The court recognized the separate and independent personality of the company. The Court opined that it is not the case, in fact, Mr. Salomon was the agent of the company and not vice versa. This case is considered as a landmark judgment in the Company Law Worldwide, which gave boost to private investment in the business.
Suggested Reading Click on the Image
d) Advantages of Forming Company / Salient Features of Incorporation of a Company:
The advantages of incorporation of company are as follows:
Separate Legal Existence: A company is a legal person in the eyes of law. It is an artificial person or a juristic person.
Limited Liability: Due to the creation of a separate legal entity, the members have limited liability. Under Section 34(2) of the Company Act, in the event of a company being shut down, none of its members is legally bound to contribute to anything more than the nominal value of shares held by the member which still remains unpaid.
Perpetual Succession: The Companies Act states, ‘Members may come and members may go, but the company can go on forever.’ As per Section 34(2) of the Company Act, an incorporated company has the characteristic of perpetual succession.
Easy Transferability of Shares: Under Section 44 of the company act, the shares or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company.
Separate Property: An incorporated company has separate legal existence and an artificial person in the eyes of law.
Capacity to Sue and Be Sued: A person can take legal action on his / her name. Similarly, the company as an independent legal entity could take legal action in its own name against another person. In turn, it can be sued by other companies and people.
Professional Management: A company with its vast and almost unlimited resources is capable of attracting the best professional talent at the managerial level in a given industry.
Democratic Set-up: The working of a company is governed by the Board of Directors. These directors are elected and appointed by shareholders in their Annual General Meetings.
Capacity to Raise Finance: A company is in a much better position to raise finances than any other form of the business entity since a company can issue shares or debentures to the public.
Suggested Reading Click on the Image
e) Disadvantages of Incorporation of a Company:
The disadvantages of incorporation of company are as follows:
Lifting of Corporate Veil: A company is an artificial person is clothed with a corporate veil. The corporate veil separates the company from its shareholders. There are certain circumstances when the lifting of the corporate veil becomes necessary.
More Formalities: Incorporation requires a host of formalities to be complied with than any other form of the business before the actual incorporation of a company and exist throughout the life of the company.
More Expenses: The initial cost of incorporation includes the fee required to file the Articles of Incorporation, potential attorney or accountant fees, incorporation service fees. And all the expenses are incurred before the actual incorporation of a company and throughout the life of the company.
More Paperwork: A lot more paperwork involved in maintaining a corporation than a sole proprietorship or partnership firm. Corporations must maintain a minute book containing the corporate bylaws and minutes from all corporate meetings. Most corporations are required to file annual reports on the financial status of the company. The ongoing paperwork also includes tax returns, accounting records, meeting minutes and any required licenses and permits for conducting business.
Publicity and Loss of Privacy: As per the Act, several documents and accounts are to be submitted to the authorities. The files with Registrar of Companies are available for public inspection. Thus, the privacy is lost.
Double Taxation: Double taxation occurs when a company is taxed once on profits, and again on the dividends paid to shareholders.
Denial of Some Fundamental Rights: The Constitution guarantees fundamental articles under Article 14 to all and under Article 19 to the citizens of India. A company has a nationality, domicile, and residence but cannot have fundamental rights.
Control Possible Without Majority Shareholding: It is not always the case that the majority of shareholders have the control of the company. Minor shareholders due to their cohesiveness may be controlling the company.
Possibility of Fraud: The board of directors has full control over every aspect and resource of the company including finance. In such cases, there is a possibility that the resources and finances of the company can be used for personal gains and benefits.
Difficulty in Closing the Business: It requires significant time and money to complete the necessary procedures for dissolution of a company.
f) Lifting of Corporate Veil:
A company is an artificial person is clothed with a corporate veil. It cannot act on its own, it can act only through natural persons i.e. through the Directors. The corporate veil separates the company from its shareholders. This concept of corporate veil is applied in Solomon v. Solomon case, Lee v. Lee’s Air Farming Ltd. But the theory cannot be pushed to unnatural limits. Circumstances must occur which compel the Court to identify a company with its members. There are certain circumstances when the lifting of corporate veil becomes necessary.
The separate personality of the company and its statutory privileges should be used for legitimate purposes only. Where the legal entity of the company is being used for fraudulent and dishonest purpose, the individuals concerned will not be allowed to take the shelter behind the corporate personality. The court in such cases shall break through the corporate shell and apply the principle of what is known as “piercing or lifting of corporate veil”. Thus lifting of corporate veil refers to the possibility of looking behind the company’s framework (or behind the company’s separate personality) to make the members liable, as an exception to the rule that they are normally shielded by the corporate shell.
The Corporate veil can be lifted in the following cases:
- Determination of real character of a company/ trading with the enemy
- For the benefit of revenue
- Under statutory provisions
- Fraud or improper conduct
- International misdescription of name
- Fraudulent conduct of business
- Holding and subsidiary companies
- Provisions of tax laws
- Group enterprises
- Criminal acts
- Government companies
g) Theory of corporate personality:
Corporate personality is the creation of law. And as per the law, a corporation is an artificial person created by the personification of a group of individuals. The theory of corporate personality mainly states that a company has a legal identity different from its members. A company with such personality has an independent legal existence separate from its shareholders, directors, officers and creators. This is separation is known as the corporate veil.
Due to a corporate personality a company bears its own name, acts under the name, has a seal of its own and its assets which are separate and distinct from those of its members. It is a different ‘person’ from the members who compose it. Therefore, it is capable of owning property, incurring debts, borrowing money, having a bank account, employing people, entering into contracts and suing or being sued in the same manner as an individual. Its members are its owners however they can be its creditors simultaneously. A shareholder cannot be held liable for the acts of the company even if he holds virtually the entire share capital.
In Trustees of Darmouth College v woodward (1819) 17 US 518 case, The Court defined company “as a person, artificial, invisible, intangible and existing only in the eyes of the law. Being a mere creation of law, it possesses only those properties which the charter of its creation confers upon it either expressly or as accident to its very existence”
Theories of corporate personality give us a theoretical perspective to understand the concept, but in the real world with practical problems, they are of little use.
A registered company is an entity distinct from its members. A creditor of an incorporated company has remedy only against the company for his debts and not any of the members of whom it is composed. The principle of separate legal entity was explained and emphasized in the famous case of Salomon v Salomon & Co. Ltd 1897 AC 22.
The company, though a legal person, is not a citizen under the Citizenship Act, 1955 or the Constitution of India.
Suggested Reading Click on the Image
