Basics of Company Formation in India and Story of Companies Act Amendment Bill

We all know that the companies in India are regulated by the Companies Act 1956. This act is the most important corporate legislation that empowers the Central Government to regulate the following:

• Formation of the companies
• Financing of the companies
• Functioning of the companies
• Winding up of companies.

It was enacted in 1956. This act enables companies to be formed by registration, and set out the responsibilities of companies, their directors and secretaries.

Government of India administers this act through the Ministry of Corporate Affairs and the Offices of Registrar of Companies, Official Liquidators, Public Trustee, Company Law Board, Director of Inspection, etc. The Registrar of Companies (RoC) handles incorporation of new companies and the administration of running companies. The act applies to whole of India and to all types of companies, whether registered under this Act or an earlier Act. But it does not apply to universities, co-operative societies, unincorporated trading, scientific and other societies.

How a Company is formed in India

Please note that the process of formation of a company in India has three stages viz.

• Promotion stage,
• Incorporation Stage and
• Commencement of Business stage.

Promotion Stage

The formation of a company begins with conceiving an idea. How this idea will work- is termed as promotion of a company. The person or persons who are involved in promotion are called “Promoter(s)”. The promoters are well in advance needed to decide about the product to be produced, the size of the company, the capital involved in the project, the sources of the capital and whether it shall be a Private Company or a Public Company etc before the formation of the company. If they decide that it will be a Private Company, at least 2 persons or If they decide it will be a Public Company, then at least 7 persons shall subscribe their names to a Memorandum of Association (MoA) and they shall also comply with the other formalities in respect of the registration of the company under the Indian Companies Act, 1956.

Then, they approach the RoC with the MoA. Registrar of Companies (ROCs) is appointed under Section 609 of the Companies Act, covering various States and Union Territories. RoC are vested with the primary duty of registering companies floated in the respective States and the Union Territories and ensuring that such companies comply with the statutory requirements under the Act. Their offices function as registry of records relating to the companies registered with them. It is desirable for the promoters to ascertain from the Registrar of the companies that whether the proposed name of the company shall be approved if registration is sought for a new company with such name. If already a company with such name is existing, it shall not be allowed by the Registrar, because two companies with the similar name cannot be registered. If no other company is registered with that name, an application for the registration of the company should be presented to the Registrar of the State.

The application has the following components:

• Memorandum of Association.
• Articles of Association, if any which should be signed by the subscribers to the Memorandum of Association.
• Any agreement with the individual persons who are proposed to e appointed as Managers, Directors or Managing Director of the company.
• A statement of the nominal capital of the Company.
• A notice of address of the registered office of the company.
• List of the Directors who have agreed to become the first Directors of the company along with their consent to act as Directors and to take up the qualification shares of the company in the case of a public company.
• Other declarations and documents

Incorporation & Commencement Stage

If the Registrar of Companies is satisfied that the entire requirement have been complied with, he will register the company and enter the name of the company in the Register of Companies. This is Incorporation Stage. When a company is registered and its name in entered in the register of companies, the Registrar will issue a Certificate of Incorporation.

Types of the Companies

Under the Companies Act, an entrepreneur can form two types of companies, viz. a private company or a public company. Here are the differences for your exam point of view. You need to mug them

• Minimum Paid-up Capital : Private Company→Rs. 1,00,000, Public Company → Rs. 5,00,000
• Minimum number of members : Private Company →2, Public Company → 7
• Maximum number of members : Private Company →50, Public Company →no restriction
• Transerferability of shares : Private Company →Complete Restriction, Public Company →no restriction
• Issue of Prospectus : Private Company →prohibited from inviting the public for subscription of its shares so it cannot issue Prospectus, Public Company →free to invite public for subscription i.e., a Public Company can issue a Prospectus
• Number of Directors : Private Company →at least 2 directors, Public Company→at least 3 directors
• Commencement of Business : Private Company → can commence its business immediately after its incorporation, Public Company → cannot start its business until a Certificate to commencement of business is issued to it.
• Statutory meeting : Private Company →no obligation to call the Statutory Meeting of the members, Public Company →must call its statutory Meeting and file Statutory Report with the Register of Companies.
• Quorum : The quorum in the case of a Private Company is TWO members present personally, whereas in the case of a Public Company FIVE members must be present personally to constitute quorum.
• Managerial remuneration : Total managerial remuneration in the case of a Public Company cannot exceed 11% of the net profits. Whereas these restrictions do not apply on a Private Company.

Why amendment to Companies Act 1956?

The decades old Companies Act, 1956, needs to be amended in keeping with the changes in the corporate world. Mainly the governance and capital structuring requirements of the Companies Act 1956 need an urgent amendment and there is a demand to allow easier incorporation and quick winding up. The existing Act suffers from several infirmities that prevent healthy development of our corporate sector. In particular, the provisions for winding up sick companies have been a sticking point with the industry. There has been a demand for the updations so that the new act would be–

• Short and Crisp
• Harmonizes the company law framework with sectoral regulations
• Should provide greater shareholder democracy and lesser government internevtion
• Protection of rights of minority shareholders
• Makes companies responsible self-regulation with adequate disclosure and accountability.
• Make provisions for formation of One person company
• Simpler regime for smaller companies
• Stringent provisions for companies seeking to raise money from the public.
• Single forum for approval of mergers and acquisitions, whether domestic or with foreign entities.
• Shortening of procedure for merger of holding and wholly-owned subsidiaries.
• Prohibition of insider trading.
• Other relevent updates.

The efforts to revamp the act began at least 2 decades ago. However, it was in 2008 when Companies Bill, 2008 was introduced on 23 October 2008 in the Lok Sabha to replace existing Companies Act 1956. Due to the dissolution of the 14th Lok Sabha, the Companies Bill, 2008 had lapsed. The companies Bill, 2009 (Bill) was reintroduced on 3 August 2009 in the Lok Sabha with minor modifications to the Companies Bill, 2008. Bill was referred to the Standing Committee on Finance of the Parliament for examination and report on 9 September 2009. Report of the SCF on Companies Bill, 2009 was introduced in the Lok Sabha on 31 August 2010. After that te bill was withdrawn and some more changes were incorporated and the Companies Bill 2011 was introduced in in the Lok Sabha on 14 December 2011. It was refered to the Standing Committee on Finance headed by Mr. Yashwant Sinha. The committee submitted its 57th Report on ‘The Companies Bill, 2011’ on June 26, 2012.Based upon the recommendations, the Companies Bill 2011 has now once again modified and the modified draft has been approved by the cabinet in October 2012.

The Modified Bill

The modified bill gives clearer directions to the role of auditor, corporate social responsibility, inter-corporate loans and makes whole-time directors more accountable and defines private placements. These are some of the areas which have been subjects of debates for long time. Here I am giving summary of the bill and its debated provisions.

Corporate Social Responsibility Clause

The new bill makes provisions for setting aside funds for corporate social responsibility. This has been a big worry in corporate circles. CSR clause says that all companies have to covers that all companies will have to set aside 2% of the average net profit of the preceding three years for CSR activities if they have any of the following:

• Net worth in excess of Rs 500 crore
• Turnover of Rs 1,000 crore or more
• Net profit of Rs 5 crore

The issue is that it’s a huge money. It may not hurt the corporate during good times, but may create problems when economy slows or during recession. The Companies Bill 2011 makes no exception, though an ‘errant’ company can explain the reason for not spending the amount in its annual report. Further, the law would leave a room for the government to lay out rules for determining how the law will be implemented in letter and spirit is another prime concern. The government says that the clause is not mandatory. However, legal experts say that the disclosure requirement would make the CSR spend binding. The corporate are fearful of hefty fines for non-compliance, though there is no mention of penalty in the Bill. They also fear political extortion. Politicians can force companies contribute to their “trusts”. They can even demand that a company develops their constituencies.

Multi-layer subsidiaries Clause

When a company has a web of subsidiaries and subsidiaries of subsidiaries, it is called Multilevel Subsidiaries. A maze of subsidiaries makes it difficult for investors to figure out financial transactions, allowing companies to divert funds. This was highlighted by the Satyam scandal where investigators found it difficult to track the flow of money from the scam-hit firm. The Companies Bill 2011 makes provisions that the companies can have only two layers of subsidiaries for investment. Issue is that the companies have created multiple investment subsidiaries. These offshoots can come up at home or overseas, particularly in tax-friendly nations such as Mauritius for routing investments into another country. Large Indian business houses have several hundred subsidiaries that act as investment arms of the holding company or subsidiaries of the holding company. These are used to start new ventures, acquire businesses and enter into joint ventures. It is true that web of subsidiaries has been mis-used to siphon funds from profitable ventures. By permitting only two levels of subsidiaries, the Bill hopes to check such practices. But companies worry that will restrict their ability to do business. The bill has not provided any timeline for unwinding the existing structure.

Criminal liability Clause

The bill makes provisions that the criminal cases can be slapped on directors for offences of the company. The executives and directors of a company have been held responsible for a wide range of offences, many of them procedural or technical in nature. For instance, failure to file director identification number — a unique ID allotted to every potential director — with the Registrar of Companies can be a serious offence. Likewise, the failure to file certain agreements or delay in registering transfer of shares too could hurt. The corporate say that the Criminal liability should be limited only to serious offences and not the technical and procedural ones. The professional would not like to go to jails for technical problems and that is why it will make finding good directors difficult.

Class-action suit Clause

Class-action suit means that the stakeholder can collectively sue a company’s management and auditors for fraud. This provision is in the interest of shareholders who suffer losses due to fraud by the company’s management, auditors, etc, thus contributing in Shareholder activism. This provision in the Companies Bill was prompted by the multi-crore fraud by the management and auditors of Satyam Computer Services. Shareholders in India suffered a massive fall in the value of their investments and had no recourse to seek damages unlike their counterparts in the US. The Class-action suits clause in Companies 2011 bill makes provisions that the stakeholders will be now allowed to directly sue the management and the advisors. Industry fears government has not fully understood how class-action suits work and has provided the provision under pressure from investor protection groups.
The provision can be of nuisance for companies if a small group of investors sues for flimsy reasons. The legal process in India is time-consuming. Conversely, in genuine cases, not enough shareholders or creditors may come together to sue the company.

Women directors Clause

The Women directors Clause of the companies bill says that some companies would have to induct a woman director. This is a good provision, but given that the directors can be held responsible for company’s offences, it may not work. Intention of the government is that it wants greater participation of women on boards. Industry is still against the idea, and contends that deserving women will reach the top anyhow. Some demand for procedural immunity for women directors.

Flexibility for Rule Making Clause

The Companies Bill is designed to make the law more flexible, easier to amend and alive to the constantly changing business environment.

Auditor Rotation Clause

The cosy relationship between companies and accountants has given birth to many scandals such as Satyam scam. The Companies Bill has proposed rotation of individual auditors every five years and audit firms after two five-year terms.

Buyback of Shares Clause

Companies buy back shares from the market to reward or return money to shareholders. A share buyback can be made using free reserves and money in share premium account. The Bill limits this practice to once a year. So even a company with surplus cash cannot buy back shares.