Lecture Notes on Corporate Laws

Introduction

Balkrishna Parab
balkrishnaparab@jbims.edu

1 Introduction
The word company is derived from two Latin words panis meaning bread
basket and 'com' meaning with or together. Originally, it referred to a group
of persons who took their meals together. The word corporate is derived from
the Latin corpus meaning body. It refers to the characteristic of individuals
acting together; "a joint identity"; "the collective mind". In India, corporations
are known as companies.
The company form of organisation is very ancient so ancient that their actual
point of origin is lost in legend of Numa Pompilius and beyond. The oldest
surviving business corporation in the world is probably Sweden's Stora
Kopperberg, which was founded in 1288 and is now known as StoraEnso.
In the context of business, a company is understood as a group of persons who
have voluntarily come together for sharing profits derived from carrying on
some business.
The law defines company as:
A company formed and registered under [the Companies]
Act or an existing company1
Not a very helpful definition! A good starting point is probably United States
Chief Justice John Marshall's definition in the 1819 Dartmouth College case:
A company is an artificial being, invisible, intangible, and
existing only in the contemplation of the law. Among the most
important [of its qualities] is immortality, and if the expression

1
Section 2 (20) of the Companies Act, 2013.
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Introduction
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were allowed, individuality; properties by which a perpetual

succession of many persons may be considered the same, and
may act as a single individual...
Thus, a company is an association, usually, but not necessarily, engaged in a
business for profit with ownership interests, usually, but not necessarily,
represented by shares of stock. A large number of companies are incorporated
in India. As on March 31, 2014, there were 952,433 active companies in
India2.

Features
The principal function of corporate law is to provide business enterprises with
a legal form that possesses five core attributes: legal personality, limited
liability, transferable shares, delegated management under a board structure,
and investor ownership. By making this form widely available and user-
friendly, corporate law enables entrepreneurs to transact easily through the
medium of the corporate entity, and thus lowers the costs of conducting
business.
A company is a legal entity, which, while being composed of natural persons,
exists completely separately from them. This separation gives the corporation
unique powers which other legal entities lack. A company has several distinct
features that together make it a unique organization. Some of these features
include:

Separate Legal Entity

A company is different and distinct from its members in law. A company is a
legal entity, which, while being composed of natural persons, exists
completely separately from them. This separation gives the company unique
powers which other legal entities lack.
A company has its own name and its own seal, its assets and liabilities are
separate and distinct from those of its members. It can own property, incur
debt, lend money, operate a bank account, employ people, enter contracts and
sue and be sued.
Salomon v. Salomon & Co. (1896) is a foundational decision of the House of
Lords in company law. The effect of the House of Lords' unanimous ruling
was to firmly uphold the concept of a corporation as an independent legal
entity, as set out in the Companies Act 1862.

2
58th Annual Report, Ministry of Corporate Affairs, Government of India.
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Lecture Notes on Corporate Laws
Introduction
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Aron Salomon was a

successful leather merchant
who specialized in
manufacturing leather boots.
For many years, he ran his
business as a sole proprietor.
By 1892, his sons had
become interested in taking
part in the business.
Salomon decided to
incorporate his business as a
limited liability company.
Salomon formed a limited
company and sold the
business to it for nearly
40,000 (an overvaluation
of around 8,000). The
subscribers to the Aaron Soloman
memorandum were
Salomon and six members of his family, who subscribed for one share each.
Salomon also took 20,000 1 shares in the company as part of the purchase
price of his business, the remainder of the price being paid partly in cash and
partly by way of a secured debenture for 10,000.
The company did not prosper and was wound up a year later, at which time its
liabilities, including the debenture, exceeded the assets by 7,700. The
liquidator, on behalf of the unsecured creditors, resisted S's claim and argued
that Salomon should in fact be liable for all the debts of the company.
The House of Lords held that Solomon was entitled to be paid under the
debenture, and that he could not be made liable for the company's other debts.
Lord MacNaughton said:
The company is at law a different person altogether from the
subscribers to the memorandum; and though it may be that after
incorporation the business is precisely the same as it was
before, and the same persons are managers, and the same hands
receive the profits, the company is not at law the agent of the
subscribers or trustee for them. Nor are the subscribers liable,
in any shape or form, except to the extent and in the manner
provided by the Act.
In the decades since Salomon's case, various exceptional circumstances have
been delineated, both by legislatures and the judiciary, when courts can

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Introduction
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legitimately disregard a company's separate legal personality, such as where

crime or fraud has been committed.

Limited Liability
The liability of the members of the company is limited to the contribution they
promise to make to the assets of the company. The law, though, also permits
incorporation of companies where the liability of the members is unlimited.
The liability of the members, whether limited or unlimited, is to the company,
not to the individual creditors of the company.
The liability of a member of a company is limited to the extent of face value of
shares held by him. The members cannot be called upon to pay more than the
face value of the shares held by them.
Several reasons are proffered for limited liability. The justifications are that
limited liability:
Creates an incentive to invest increasing the level of economic activity;
Encourages socially desirable high risk projects;
Permits the functioning of an efficient capital market;
Enables the promotion of large projects;
Diminishes agency and social costs and spreads risk efficiently;
Encourages diversified portfolios; and
Avoids litigation and bankruptcy costs.
The name of every company in India has a suffix limited to serve a warning
to all concerned that the liability of members is limited, such that in the event
of a companys inability to pay its dues they cannot call upon the members for
the same.

Perpetual Succession
A company continues to exist till it is wound up. Membership of a company
may keep on changing from time to time but that does not affect life of the
company. Death or insolvency of member does not affect the existence of the
company.

Separate Property
A company is a distinct legal entity. The companys property is its own. A
member cannot claim to be owner of the company's property during the
existence of the company.
A company being a legal person and entirely distinct from its members, can
own, enjoying and disposing of property in its own name. The company is the
real person in which all its property is vested, and by which it is controlled,
managed and disposed of.
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Introduction
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In R.F. Perumal v. H. John Deavin3, the Madras High Court held:

No member can claim himself to be the owner of the
companys property during its existence or in its winding-up.
A member does not even have an insurable interest in the property of the
company.
In Macaura v Northern Assurance Co. (1925), Macaura owned an estate in
Ireland and insured some timber on the estate. He transferred the estate and the
timber to a company (which he controlled), but failed to have the insurance re-
issued in the company's name. There was a fire and the timber was mostly
destroyed. Held: Macaura could not claim on the policy. The timber was no
longer his to insure4.
Lord Buckmaster observed:
No shareholder has any right to any item of property owned by
the company, for he has no legal or equitable interest therein.
In other words, the property of the company is not the property of the
individual members. In Gramophone and Typewriter Co. v. Stanley5, Walton,
J. observed:
The property of the company is not the property of the
shareholders, it is the property of the company.
A shareholder has merely an interest in the company measured by a sum of
money for liability, and by a share in the profit. He has merely a right to
participate in the profits of the company subject to the contract contained in
articles of association6.

Transferability of Shares
The capital of the company is divided into shares. A share is an indivisible
unit of capital. Shares in a company are freely transferable, subject to certain
conditions. When a member transfers his shares to another person, the
transferee steps into the shoes of the transferor and acquires all the rights of
the transferor in respect of those shares.
A crucial element in the success of the company as a form of business
association is the idea of the transferable share. Shares in a company are
transferable in the manner provided for in the companys articles. Those
persons who are originally involved in setting up and running the business
may wish to leave the business or to leave their share of it to their
3
A.I.R. 1960 Mad. 43.
4
Macaura v. Northern Assurance Co. Ltd., 1925 A.C. 619.
5
Gramophone and Typewriter Co. v. Stanley, (1906) 2 K.B. 856 at 8691.
6
R.C. Cooper v. Union of India, A.I.R. 1970 S.C. 564.
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beneficiaries on their death but, usually, all parties, particularly those

remaining involved in the business, will want to affect the company as little as
possible.
In respect of the company, in theory, changes of the shareholders can be
accomplished conveniently and with a minimum of disruption to the
companys business. When a shareholder sells her shares to another person,
that person becomes the new shareholder, and the only involvement of the
company is to change the appropriate entry in the register of members.
Thenceforth, the new person becomes a new member.
Furthermore, because the company is a corporate body and a recognised legal
entity, it survives the death of one, or even all, of the members. The shares of
any deceased member are simply transmitted to their personal representatives.
The company therefore has a potentially perpetual existence.
In practice, in respect of private companies, the position regarding the
transmissibility of shares is likely to be complicated by the presence in the
companys constitution of a clause which states that any member wishing to
sell her shares must first offer them to existing members, who have an option
to purchase them or, possibly, are obliged to purchase them. This is an
important restriction for the small family company to include in its
regulations, since the members will obviously wish to retain control over who
comes into the company. Again, this does not directly affect the company but
it can lead to disputes, especially as to the mechanism for the valuation of the
shares. These clauses are not usually found in the constitution of public
companies, which do not, in the normal case, have any restrictions on transfer.
This reflects the reality that the shares in the public company are an
investment only and that the shareholder has little or no interest in the business
of the company or the identity of the other shareholders.

Delegated Management
The number of members or shareholders may be so large and scattered that
they cannot manage the affairs of the company collectively. Therefore, they
elect some persons to manage and administer the company. These elected
representatives of members are individually called the directors of the
company and collectively called the Board of Directors.
There are two key elements in the ownership of a firm, as we use the term
ownership here: the right to control the firm, and the right to receive the
firms net earnings. Corporate law is principally designed to facilitate the
organization of investor-owned firmsthat is, firms in which both elements of
ownership are tied to investment of capital in the firm. More specifically, in an
investor-owned firm, both the right to participate in controlwhich generally
involves voting in the election of directors and voting to approve major
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transactionsand the right to receive the firms residual earnings, or profits,

are typically proportional to the amount of capital contributed to the firm.

Company Vs Partnership
When two or more people join for a common purpose, usually the purpose of
doing business for profit, such an association is called a partnership. For our
purposes a partnership is an association of more than two people who are
associated with the purpose of doing business for profit.
Partners often do business under a trade name. The partnership has an
existence of its own to the extent that it can sue and be sued in its own name.
However, if the assets of the firms are not sufficient to pay the business
liabilities, each of the partners is fully liable to the entire extent of the debt. A
partner cannot tell her creditor I am only a 20 per cent partner so I will pay
only 20 per cent of the debt. Balance 80 per cent you must get from the other
partner. In law, each partner is the agent for the other. The act of one partner
binds the firm and the other partners
Usually partnerships become unwieldy if there are a large number of partners.
The law therefore requires that if the number of partners exceeds 20 (ten, in
case of banking business), then they must register themselves as a company.
A company differs from a partnership firm in the following respects:
A company can be created only by certain prescribed methods most
commonly by registration under the law. A partnership is created by
the express or implied agreement of the parties, and requires no
formalities, though it is common to have a written agreement, called a
partnership deed.
Shares in a company are normally transferable. But, a partner cannot
transfer his share of the partnership without the consent of all the other
partners.
Members of a company are not entitled to take part in the management
of the company unless they are also directors of it. Every partner is
entitled to take part in the management of the partnership business
unless the partnership agreement provides otherwise.
A member of a company who is not also a director is not regarded as
an agent of the company, and cannot bind the company by his actions.
A partner in a firm is an agent of the firm.
The liability of members of a limited company is limited to the extent
of unpaid amount on their share. Liability of the partners is unlimited.
A partner can be made liable without limit for the debts and obligations
of the firm.

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A company must comply with formalities regarding the keeping of

registers and the audit of accounts, which do not apply to partnership
firms.
The affairs of a company are subject to more publicity and public
scrutiny than those of a partnership.
A partnership can be dissolved by any partner, and is automatically
dissolved by the death or bankruptcy of a partner, unless the agreement
provides otherwise. A company cannot normally be wound up on the
will of a single member, and the death, bankruptcy or insanity of a
member will not result in its being wound up.
Property of a partnership firm belongs to the partners and they are
collectively entitled to it. In case of a company, the property belongs to
the company and not to its members.

Corporate Personality
As soon as a company is incorporated, it acquires a separate legal personality.
This operates as a shield - the courts will not normally look beyond the faade
of the company to the shareholders who comprise it. The screen separating the
company from its individual shareholders and directors is commonly referred
to as "the veil of incorporation".
The classic statement of the principle of corporate personality is found in
Lennard's Carrying Co Ltd v Asiatic Petroleum Co Ltd (1915), where Lord
Haldane said:
My Lords, a company is an abstraction. It has no mind of its
own any more than it has a body of its own; its active and
directing will must consequently be sought in the person of
somebody who is really the directing mind and will of the
corporation, the very ego and centre of the personality of the
corporation.
Sometimes the law is prepared to examine the reality that lies behind the
companys faade - this is described as "lifting" or "piercing" the corporate
veil. The presumption is in favour of separate personality and courts will not
normally infer that legislation is intended to pierce the corporate veil.
Although, a company acquires a corporate personality as soon as it is
incorporated, there are certain situations where the veil is lifted. Some of these
situations are provided by the statutes and some have emerged due to
decisions of the courts.

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Statutory Provisions
The Companies Act itself provides some instances where the Court shall
pierce the corporate veil.
REDUCTION IN NUMBER OF MEMBERS
The law provides that where membership of a company falls below the
statutory minimum (two or seven) and thereafter the business is carried on for
more than six months, then every member who knows he is aware of this
reduction in members will be jointly and severally liable with the company for
company debts contracted after the six-month period has elapsed.
COMPANY NAME IS NOT STATED
If a person acting on behalf of a company signs or authorizes the signing of a
bill of exchange, cheque, order for goods or similar document in which the
companys name is not correctly stated, the person signing will be personally
liable if the company fails to pay. This provision is rigidly enforced.
FRAUDULENT MANAGEMENT
Where a company is being wound up and it appears that business has been
carried on with intent to defraud creditors or where company is in insolvent
liquidation and the director(s) should have known this, but did not take
sufficient steps to minimize losses to creditors. In either case, the court can
order that those involved contribute to the companys assets for the benefit of
creditors.

Common Law Provisions

The courts are willing to pierce the veil of incorporation in some
circumstances, such as:
FRAUD, FAADE OR SHAM. Courts will examine the reality behind the company
where the company was set up purely to evade a legal obligation, or to allow
someone to do something he would not be allowed to do as an individual.
AGENCY. Court may lift the veil on the basis that a company is merely
carrying on business as an agent of another. For example, it may appear that
some transactions entered by the subsidiary companies are in fact transactions
of the holding company:
In Smith, Stone & Knight v Birmingham Corporation (1939),
premises owned by the plaintiffs were compulsorily acquired
by the corporation. Questions arose as to whether the business
for which the premises were used was being carried on by
Smith, Stone & Knight or by its subsidiary - the distinction was
important because an owner-occupier could get compensation,

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but a tenant-occupier could not. It was held that the plaintiffs

were entitled to compensation. The business carried on at the
premises by the subsidiary was being carried on by them purely
as agents for the plaintiffs.
SINGLE ECONOMIC UNIT. In the past, courts have been willing to lift the veil on
the basis that a group of companies was not a group of separate persons, but a
single economic unit.
STATE OF HOSTILITY. In times of war, courts may regard a company as an
enemy alien if the company is controlled by nationals of country with who
India is officially at war.
JUSTICE AND EQUITY. Courts have sometimes pierced the corporate veil where
they felt it is in the interests of justice.

Who Owns a Company?

Shareholders are often referred to as the owners of the company, but the
companys legal personality raises questions about whether it can be
owned in any meaningful and effective way. Ownership is not a simple
concept. The problem with calling shareholders the owners of companies is
that the word "owner" has such a powerful, almost moralistic meaning in our
culture.
Generally, we think of ownership of property as including four elements: right
to enjoy, right to exclude others, right to alienate, and liability for damage.
RIGHT TO ENJOY. The owner has the right to enjoy or use the property as she
wishes. If it is food, she can eat it or sell it. If it is land, she can build on it or
grow crops on it.
RIGHT TO EXCLUDE. The owner has the right to regulate anyone elses use of
property. If it is food, she can share it or not, as she pleases. If it is land, she
can decide who may step over its boundaries.
RIGHT TO ALIENATE. The owner has the right to transfer rights to property on
whatever terms she wishes. If it is a product, she can limit the use of what she
sells or loans. For example, she might stipulate that it may not be resold or
restrict not just the purchaser but also all future purchasers from using the
product for some purpose she does not wish. If it is land, the owner can keep
the land while she gives or sells the right to take a shortcut across it or the
right to extract natural gas or oil from it. If there are apple trees on her
property and she sells to a local farmer all the produce from the trees, she may
no longer pick off an apple whenever she is hungry. She may not be able to
cut a tree down if it blocks her view or she needs the wood.

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LIABILITY FOR DAMAGE. There is less general agreement on a fourth

component of ownership: the liability for damage. The owner is responsible
for making sure that her use of property does not damage others. If the
property is a dog, the owner is responsible for taking reasonable precautions
for making sure that the dog does not bite anyone. Also, there are often
specific statutory requirements limiting the use of property.

If I own an object I can use it, or not use it, sell it, rent it, give it to others,
throw it away and appeal to the police if a thief misappropriates it. And I must
accept responsibility for its misuse and admit the right of my creditors to take
a lien on it. But shares give their holders no right of possession and no right of
use. If shareholders go to the company premises, they will more likely than
not be turned away.
Shareholders do not have the right to manage the company in which they hold
an interest, and even their right to appoint the people who do is largely
theoretical. They are entitled only to such part of the profit as the directors
declare as dividends, and have no right to the proceeds of the sale of corporate
assets except in the event of the liquidation of the entire company, in which
case they will get what is left; not much, as a rule.
In Mrs. Bacha F Guzdar V. The Commissioner of Income Tax, Bombay7, the
Supreme Court observed:
A shareholder does not, as is erroneously believed by some
people, become the part owner of the company or its property;
he is only given certain rights by law, e.g., to receive or to
attend or vote at the meetings of the shareholders.
The court refused to identify the shareholders with the company and reiterated
the distinct personality of the company. A similar observation was also made
by Evershed, L.J. in these words:
Shareholders are not, in the eyes of the law, part owners of the
undertaking. The undertaking is something different from the
totality of shareholders8.

7
A. l. R. 1955 S.C. 74.
8
Short v. Treasury Commissioners, (1948) A.C. 534
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What responsibilities do shareholders have? Well, none, really. They front up

with a certain amount of money, and expect demand that the company
change its ways to maximise the return to them. In many countries, corporate
law will back that demand to the hilt, too. But in their role as shareholders,
they dont do any of the work of the company; theyre not responsible for any
of the actions that the company takes; by law, they have little or no liability
beyond the risk of perhaps losing their money. Thats it: no responsibilities.
Shareholders also have the benefit of "limited liability," can never be held
personally responsible for the debts of the corporation. Thus, while it is
perfectly consistent with normal usage to say that shareholders "own" their
shares, in large, widely traded companies shareholders have almost none of
the characteristic rights and responsibilities that we would expect them to have
as owners of the corporation itself.

So, who does own a company? The answer is that no one does, any more than
anyone owns the Arabian Sea, the municipality, the streets of Mumbai, or the
air we breathe. There are many kinds of claims, contracts and obligations in
modern economies, and only occasionally are these well described by the term
ownership.
The question reflects a serious misconception about what companies are, a
misconception that, unfortunately, has been hugely influential in finance,
economics, and law in recent years. This is the idea that corporations should
be regarded as bundles of physical assets that belong to the shareholders,

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while managers and directors should be regarded as the hired guns whose job
it is to manage the assets for the shareholders.
Treating the firm as a bundle of assets belonging to shareholders undermines
the expectation of other participants in the firm that their investments will be
protected too. Over time this is likely to discourage working people from
investing themselves in the companies that employ them. Increasingly, they
will come to think of themselves as subcontractors rather than employees
they will do a job only for the immediate return or for the experience it gives
them that they can take elsewhere. If that happens, the economy will lose the
potential benefits of investments by these workers in firm-specific human
capital.

BALKRISHNA PARAB
Jamnalal Bajaj Institute of Management Studies,
University of Mumbai. Contact: E-Mail:
balkrishnaparab@jbims.edu; Cell: 9833528351;
Address: JBIMS, 164, DN House, HT Parekh
Marg, Backbay Reclamation, Mumbai 400 020.

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